This post was originally written in February of 2014. It has been updated September 11, 2020
First, giving credit where credit is due …
A superb “Readers Digest” summary of how the PFIC rules are understood to apply to individuals was prepared by PWC in 2017. You will find the report here and here:
This is a problem that is going to become more and more significant. As a result Dr. Kish and I have authored a separate “PFIC” submission – dated February 6, 2015 – which we have submitted to the U.S. Senate Finance Committee.
This submission is titled: “Request for PFIC Tax Rules Changes for U.S. Citizens Overseas”.
It is intended to be a further elaboration of the “PFIC rules” component of the January 17 2014 submission made to the Senate Finance Committee by Richardson, Yates, and Kish entitled “Request for Tax Rule Changes for U.S. Citizens Overseas.”
Our first submission provided general recommendations and analysis and included only a limited discussion on the PFIC tax rules (pages 21-24). This new submission by two of the co-authors (Mr. Yates is not part of the new submission) provides a detailed and, what we believe to be, important discussion and analysis of the PFIC rules with a specific recommendation to the committee.
The world of PFICs is extremely complicated and confiscatory. The message for U.S. citizens abroad who have purchased mutual funds (and similar investment vehicles) in their country of residence is:
Do NOT buy more and get professional advice for how to deal with the ones you have.
Enjoy (to the extent that it is possible when reading about PFICs).
As an alternative the submission “PFICs And Americans Abroad” may be accessed here.
A comprehensive post on the PFIC issue – Are Canadian mutual funds PFICs?
Appendix – The Actual PFIC Legislation – Added September 11, 2020
The PFIC rules are (by their own admission designed to impose an interest charge on tax deferral) they are aimed at those who interact with non-US entities. My personal guess is that they were created as a mechanism to punish US citizens who were shareholders in non-US corporations that did NOT meet the test of being Controlled Foreign Corporations (See the Subpart F rules found in Section 951 – 958 of the Internal Revenue Code). This is one more example of the United States attacking anything foreign.
There is no evidence of non-US retail mutual funds being treated as PFICs prior to the 2009 OVDP (“Offshore Voluntary Disclosure Programs”). I suspect that the treatment of retail mutual funds was an example of “Interpretation Creep” in tax legislation. There is to date (as far as I am aware) NO statement/ruling/interpretation from the IRS that a non-US retail mutual fund is a PFIC. Interestingly, IRS Publication 54, does NOT contain any statement/warning/suggestion that a non-US mutual fund is a PFIC. That said, I have no doubt that your professional tax preparer (EA/CPA/Tax Preparer) will reflexively take the position that your non-US mutual fund is a PFIC.
Assuming that non-US mutual funds are included in the scope of the PFIC rules, there are reasonable arguments that not all mutual funds are PFICs. I believe that these arguments are worth considering from a defensive perspective (you have a lifetime of non-US mutual fund investments with significant built in gains.)
Here is what the Internal Revenue Code actually says …
Subchapter N—Tax Based on Income From Sources Within or Without the United States (§§ 861 – 1000)
Subchapter O—Gain or Loss on Disposition of Property (§§ 1001 – 1111)
Subchapter P—Capital Gains and Losses (§§ 1201 – 1298)
26 U.S. Code PART VI—TREATMENT OF CERTAIN PASSIVE FOREIGN INVESTMENT COMPANIES
Subpart A—Interest on Tax Deferral (§ 1291) – (The first and default reporting option)
Subpart B—Treatment of Qualified Electing Funds (§§ 1293 – 1295) – (The second reporting option)
Subpart C—Election of Mark to Market for Marketable Stock (§ 1296) – (The third reporting option)
Subpart D—General Provisions (§§ 1297 – 1298)
Let’s focus on the default option in §§ 1291 (the default) and 1297 (the definition):
The Definition: § 1297 – The definition
26 U.S. Code § 1297.Passive foreign investment company
(a)In generalFor purposes of this part, except as otherwise provided in this subpart, the term “passive foreign investment company” means any foreign corporation if—
(1)75 percent or more of the gross income of such corporation for the taxable year is passive income, or
(2)the average percentage of assets (as determined in accordance with subsection (e)) held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.
(b)Passive incomeFor purposes of this section—
Except as provided in paragraph (2), the term “passive income” means any income which is of a kind which would be foreign personal holding company income as defined in section 954(c).
(2)ExceptionsExcept as provided in regulations, the term “passive income” does not include any income—
(A)derived in the active conduct of a banking business by an institution licensed to do business as a bank in the United States (or, to the extent provided in regulations, by any other corporation),
(B)derived in the active conduct of an insurance business by a qualifying insurance corporation (as defined in subsection (f)),
(C)which is interest, a dividend, or a rent or royalty, which is received or accrued from a related person (within the meaning of section 954(d)(3)) to the extent such amount is properly allocable (under regulations prescribed by the Secretary) to income of such related person which is not passive income, or
(D)which is export trade income of an export trade corporation (as defined in section 971).
For purposes of subparagraph (C), the term “related person” has the meaning given such term by section 954(d)(3) determined by substituting “foreign corporation” for “controlled foreign corporation” each place it appears in section 954(d)(3).
(c)Look-thru in the case of 25-percent owned corporationsIf a foreign corporation owns (directly or indirectly) at least 25 percent (by value) of the stock of another corporation, for purposes of determining whether such foreign corporation is a passive foreign investment company, such foreign corporation shall be treated as if it—
(1)held its proportionate share of the assets of such other corporation, and
(2)received directly its proportionate share of the income of such other corporation.
(d)Exception for United States shareholders of controlled foreign corporations
For purposes of this part, a corporation shall not be treated with respect to a shareholder as a passive foreign investment company during the qualified portion of such shareholder’s holding period with respect to stock in such corporation.
(2)Qualified portionFor purposes of this subsection, the term “qualified portion” means the portion of the shareholder’s holding period—
(A)which is after December 31, 1997, and
(B)during which the shareholder is a United States shareholder (as defined in section 951(b)) of the corporation and the corporation is a controlled foreign corporation.
(3)New holding period if qualified portion ends
Except as provided in subparagraph (B), if the qualified portion of a shareholder’s holding period with respect to any stock ends after December 31, 1997, solely for purposes of this part, the shareholder’s holding period with respect to such stock shall be treated as beginning as of the first day following such period.
Subparagraph (A) shall not apply if such stock was, with respect to such shareholder, stock in a passive foreign investment company at any time before the qualified portion of the shareholder’s holding period with respect to such stock and no election under section 1298(b)(1) is made.
(4)Treatment of holders of options
Paragraph (1) shall not apply to stock treated as owned by a person by reason of section 1298(a)(4) (relating to the treatment of a person that has an option to acquire stock as owning such stock) unless such person establishes that such stock is owned (within the meaning of section 958(a)) by a United States shareholder (as defined in section 951(b)) who is not exempt from tax under this chapter.
(e)Methods for measuring assets
(1)Determination using valueThe determination under subsection (a)(2) shall be made on the basis of the value of the assets of a foreign corporation if—
(A)such corporation is a publicly traded corporation for the taxable year, or
(B)paragraph (2) does not apply to such corporation for the taxable year.
(2)Determination using adjusted basesThe determination under subsection (a)(2) shall be based on the adjusted bases (as determined for the purposes of computing earnings and profits) of the assets of a foreign corporation if such corporation is not described in paragraph (1)(A) and such corporation—
(A)is a controlled foreign corporation, or
(B)elects the application of this paragraph.
An election under subparagraph (B), once made, may be revoked only with the consent of the Secretary.
(3)Publicly traded corporationFor purposes of this subsection, a foreign corporation shall be treated as a publicly traded corporation if the stock in the corporation is regularly traded on—
(A)a national securities exchange which is registered with the Securities and Exchange Commission or the national market system established pursuant to section 11A of the Securities and Exchange Act of 1934, or
(B)any exchange or other market which the Secretary determines has rules adequate to carry out the purposes of this subsection.
(f)Qualifying insurance corporationFor purposes of subsection (b)(2)(B)—
(1)In generalThe term “qualifying insurance corporation” means, with respect to any taxable year, a foreign corporation—
(A)which would be subject to tax under subchapter L if such corporation were a domestic corporation, and
(B)the applicable insurance liabilities of which constitute more than 25 percent of its total assets, determined on the basis of such liabilities and assets as reported on the corporation’s applicable financial statement for the last year ending with or within the taxable year.
(2)Alternative facts and circumstances test for certain corporationsIf a corporation fails to qualify as a qualified insurance corporation under paragraph (1) solely because the percentage determined under paragraph (1)(B) is 25 percent or less, a United States person that owns stock in such corporation may elect to treat such stock as stock of a qualifying insurance corporation if—
(A)the percentage so determined for the corporation is at least 10 percent, and
(B)under regulations provided by the Secretary, based on the applicable facts and circumstances—
(i)the corporation is predominantly engaged in an insurance business, and
(ii)such failure is due solely to runoff-related or rating-related circumstances involving such insurance business.
(3)Applicable insurance liabilitiesFor purposes of this subsection—
(A)In generalThe term “applicable insurance liabilities” means, with respect to any life or property and casualty insurance business—
(i)loss and loss adjustment expenses, and
(ii)reserves (other than deficiency, contingency, or unearned premium reserves) for life and health insurance risks and life and health insurance claims with respect to contracts providing coverage for mortality or morbidity risks.
(B)Limitations on amount of liabilitiesAny amount determined under clause (i) or (ii) of subparagraph (A) shall not exceed the lesser of such amount—
(i)as reported to the applicable insurance regulatory body in the applicable financial statement described in paragraph (4)(A) (or, if less, the amount required by applicable law or regulation), or
(ii)as determined under regulations prescribed by the Secretary.
(4)Other definitions and rulesFor purposes of this subsection—
(A)Applicable financial statementThe term “applicable financial statement” means a statement for financial reporting purposes which—
(i)is made on the basis of generally accepted accounting principles,
(ii)is made on the basis of international financial reporting standards, but only if there is no statement that meets the requirement of clause (i), or
(iii)except as otherwise provided by the Secretary in regulations, is the annual statement which is required to be filed with the applicable insurance regulatory body, but only if there is no statement which meets the requirements of clause (i) or (ii).
(B)Applicable insurance regulatory body
The term “applicable insurance regulatory body” means, with respect to any insurance business, the entity established by law to license, authorize, or regulate such business and to which the statement described in subparagraph (A) is provided.
The Default Option: § 1291 – The default treatment – which is expressed in Form 8621
26 U.S. Code § 1291.Interest on tax deferral
(a)Treatment of distributions and stock dispositions
(1)DistributionsIf a United States person receives an excess distribution in respect of stock in a passive foreign investment company, then—
(A)the amount of the excess distribution shall be allocated ratably to each day in the taxpayer’s holding period for the stock,
(B)with respect to such excess distribution, the taxpayer’s gross income for the current year shall include (as ordinary income) only the amounts allocated under subparagraph (A) to—
(i)the current year, or
(ii)any period in the taxpayer’s holding period before the 1st day of the 1st taxable year of the company which begins after December 31, 1986, and for which it was a passive foreign investment company, and
(C)the tax imposed by this chapter for the current year shall be increased by the deferred tax amount (determined under subsection (c)).
If the taxpayer disposes of stock in a passive foreign investment company, then the rules of paragraph (1) shall apply to any gain recognized on such disposition in the same manner as if such gain were an excess distribution.
(3)DefinitionsFor purposes of this section—
(A)Holding periodThe taxpayer’s holding period shall be determined under section 1223; except that—
(i)for purposes of applying this section to an excess distribution, such holding period shall be treated as ending on the date of such distribution, and
(ii)if section 1296 applied to such stock with respect to the taxpayer for any prior taxable year, such holding period shall be treated as beginning on the first day of the first taxable year beginning after the last taxable year for which section 1296 so applied.
The term “current year” means the taxable year in which the excess distribution or disposition occurs.
For purposes of this section, the term “excess distribution” means any distribution in respect of stock received during any taxable year to the extent such distribution does not exceed its ratable portion of the total excess distribution (if any) for such taxable year.
(2)Total excess distributionFor purposes of this subsection—
(A)In generalThe term “total excess distribution” means the excess (if any) of—
(i)the amount of the distributions in respect of the stock received by the taxpayer during the taxable year, over
(ii)125 percent of the average amount received in respect of such stock by the taxpayer during the 3 preceding taxable years (or, if shorter, the portion of the taxpayer’s holding period before the taxable year).
For purposes of clause (ii), any excess distribution received during such 3-year period shall be taken into account only to the extent it was included in gross income under subsection (a)(1)(B).
(B)No excess for 1st year
The total excess distributions with respect to any stock shall be zero for the taxable year in which the taxpayer’s holding period in such stock begins.
(3)AdjustmentsUnder regulations prescribed by the Secretary—
(A)determinations under this subsection shall be made on a share-by-share basis, except that shares with the same holding period may be aggregated,
(B)proper adjustments shall be made for stock splits and stock dividends,
(C)if the taxpayer does not hold the stock during the entire taxable year, distributions received during such year shall be annualized,
(D)if the taxpayer’s holding period includes periods during which the stock was held by another person, distributions received by such other person shall be taken into account as if received by the taxpayer,
(E)if the distributions are received in a foreign currency, determinations under this subsection shall be made in such currency and the amount of any excess distribution determined in such currency shall be translated into dollars,
(F)proper adjustment shall be made for amounts not includible in gross income by reason of section 959(a) or 1293(c), and
(G)if a charitable deduction was allowable under section 642(c) to a trust for any distribution of its income, proper adjustments shall be made for the deduction so allowable to the extent allocable to distributions or gain in respect of stock in a passive foreign investment company.
(c)Deferred tax amountFor purposes of this section—
(1)In generalThe term “deferred tax amount” means, with respect to any distribution or disposition to which subsection (a) applies, an amount equal to the sum of—
(A)the aggregate increases in taxes described in paragraph (2), plus
(B)the aggregate amount of interest (determined in the manner provided under paragraph (3)) on such increases in tax.
Any increase in the tax imposed by this chapter for the current year under subsection (a) to the extent attributable to the amount referred to in subparagraph (B) shall be treated as interest paid under section 6601 on the due date for the current year.
(2)Aggregate increases in taxes
For purposes of paragraph (1)(A), the aggregate increases in taxes shall be determined by multiplying each amount allocated under subsection (a)(1)(A) to any taxable year (other than any taxable year referred to in subsection (a)(1)(B)) by the highest rate of tax in effect for such taxable year under section 1 or 11, whichever applies.
(3)Computation of interest
(A)In generalThe amount of interest referred to in paragraph (1)(B) on any increase determined under paragraph (2) for any taxable year shall be determined for the period—
(i)beginning on the due date for such taxable year, and
(ii)ending on the due date for the taxable year with or within which the distribution or disposition occurs,
by using the rates and method applicable under section 6621 for underpayments of tax for such period.
For purposes of this subsection, the term “due date” means the date prescribed by law (determined without regard to extensions) for filing the return of the tax imposed by this chapter for the taxable year.
(d)Coordination with subparts B and C
(1)In generalThis section shall not apply with respect to any distribution paid by a passive foreign investment company, or any disposition of stock in a passive foreign investment company, if such company is a qualified electing fund with respect to the taxpayer for each of its taxable years—
(A)which begins after December 31, 1986, and for which such company is a passive foreign investment company, and
(B)which includes any portion of the taxpayer’s holding period.
Except as provided in section 1296(j), this section also shall not apply if an election under section 1296(k) is in effect for the taxpayer’s taxable year. In the case of stock which is marked to market under section 475 or any other provision of this chapter, this section shall not apply, except that rules similar to the rules of section 1296(j) shall apply.
(2)Election to recognize gain where company becomes qualified electing fund
(i)a passive foreign investment company becomes a qualified electing fund with respect to the taxpayer for a taxable year which begins after December 31, 1986,
(ii)the taxpayer holds stock in such company on the first day of such taxable year, and
(iii)the taxpayer establishes to the satisfaction of the Secretary the fair market value of such stock on such first day,
the taxpayer may elect to recognize gain as if he sold such stock on such first day for such fair market value.
(B)Additional election for shareholder of controlled foreign corporations
(I)a passive foreign investment company becomes a qualified electing fund with respect to the taxpayer for a taxable year which begins after December 31, 1986,
(II)the taxpayer holds stock in such company on the first day of such taxable year, and
(III)such company is a controlled foreign corporation (as defined in section 957(a)),
the taxpayer may elect to include in gross income as a dividend received on such first day an amount equal to the portion of the post-1986 earnings and profits of such company attributable (under regulations prescribed by the Secretary) to the stock in such company held by the taxpayer on such first day. The amount treated as a dividend under the preceding sentence shall be treated as an excess distribution and shall be allocated under subsection (a)(1)(A) only to days during periods taken into account in determining the post-1986 earnings and profits so attributable.
(ii)Post-1986 earnings and profits
For purposes of clause (i), the term “post-1986 earnings and profits” means earnings and profits which were accumulated in taxable years of such company beginning after December 31, 1986, and during the period or periods the stock was held by the taxpayer while the company was a passive foreign investment company.
(iii)Coordination with section 959(e)
For purposes of section 959(e), any amount included in gross income under this subparagraph shall be treated as included in gross income under section 1248(a).
(C)AdjustmentsIn the case of any stock to which subparagraph (A) or (B) applies—
(i)the adjusted basis of such stock shall be increased by the gain recognized under subparagraph (A) or the amount treated as a dividend under subparagraph (B), as the case may be, and
(ii)the taxpayer’s holding period in such stock shall be treated as beginning on the first day referred to in such subparagraph.
(e)Certain basis, etc., rules made applicableExcept to the extent inconsistent with the regulations prescribed under subsection (f), rules similar to the rules of subsections (c), (d), and (e) of section 1246 (as in effect on the day before the date of the enactment of the American Jobs Creation Act of 2004) shall apply for purposes of this section; except that—
(1)the reduction under subsection (e) of such section shall be the excess of the basis determined under section 1014 over the adjusted basis of the stock immediately before the decedent’s death, and
(2)such a reduction shall not apply in the case of a decedent who was a nonresident alien at all times during his holding period in the stock.
(f)Recognition of gainTo the extent provided in regulations, in the case of any transfer of stock in a passive foreign investment company where (but for this subsection) there is not full recognition of gain, the excess (if any) of—
(1)the fair market value of such stock, over
(2)its adjusted basis,
shall be treated as gain from the sale or exchange of such stock and shall be recognized notwithstanding any provision of law. Proper adjustment shall be made to the basis of any such stock for gain recognized under the preceding sentence.
(g)Coordination with foreign tax credit rules
(1)In generalIf there are creditable foreign taxes with respect to any distribution in respect of stock in a passive foreign investment company—
(A)the amount of such distribution shall be determined for purposes of this section with regard to section 78,
(B)the excess distribution taxes shall be allocated ratably to each day in the taxpayer’s holding period for the stock, and
(C)to the extent—
(i)that such excess distribution taxes are allocated to a taxable year referred to in subsection (a)(1)(B), such taxes shall be taken into account under section 901 for the current year, and
(ii)that such excess distribution taxes are allocated to any other taxable year, such taxes shall reduce (subject to the principles of section 904(d) and not below zero) the increase in tax determined under subsection (c)(2) for such taxable year by reason of such distribution (but such taxes shall not be taken into account under section 901).
(2)DefinitionsFor purposes of this subsection—
(A)Creditable foreign taxes
The term “creditable foreign taxes” means, with respect to any distribution, any withholding tax imposed with respect to such distribution, but only if the taxpayer chooses the benefits of section 901 and such taxes are creditable under section 901 (determined without regard to paragraph (1)(C)(ii)).
(B)Excess distribution taxes
The term “excess distribution taxes” means, with respect to any distribution, the portion of the creditable foreign taxes with respect to such distribution which is attributable (on a pro rata basis) to the portion of such distribution which is an excess distribution.
(C)Section 1248 gain
The rules of this subsection also shall apply in the case of any gain which but for this section would be includible in gross income as a dividend under section 1248.
Reporting Form 8621 …
Further warning …
The results of a Google search for “Treasury Regulations PFIC” reveal more confusion and upcoming headwinds.