PFIC (Passive Foreign Investment Company)

A foreign corporation is a PFIC if 75% or more of its gross income is passive or 50% or more of its assets produce passive income. Mutual funds and ETFs organized outside the U.S. meet that test by design, so Indian mutual funds, UK unit trusts, Canadian mutual funds, and many unit-linked insurance plans are PFICs in the hands of a U.S. taxpayer. The rule exists to stop U.S. investors deferring tax inside foreign funds; it does not care that the fund is ordinary and tax-efficient at home.

Under the default (section 1291) regime, any gain on sale and any distribution larger than 125% of the average of the prior three years is an excess distribution. It is spread evenly over your holding period, taxed at the highest ordinary rate in effect for each year, and an interest charge is added as if the tax had been due each year. Long-term capital gains rates never apply. Two elections can change this: a qualified electing fund (QEF) election, which Indian and most foreign funds cannot support because they do not issue the required statements, and a mark-to-market election for funds that are regularly traded, which taxes annual gains as ordinary income without the interest charge.

Each PFIC is reported on its own Form 8621 every year it is held, whether or not anything was sold, unless the aggregate value of all PFICs was $25,000 or less ($50,000 joint) and there was no distribution or disposition. An unfiled Form 8621 suspends the statute of limitations on the whole return. Rubric Financial computes the treatment, documents the elections actually available, and prepares the forms; whether to keep or sell any fund is the client's decision.