US Tax Guide for Expats (2019): Form 8621
Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
What Is A PFIC?
A foreign corporation is a passive foreign investment company (PFIC) if it meets either of the following two tests:
- 75% or more of its gross income for the taxable year is passive income (generally investment income such as interest, dividends, royalties, rents and annuities), or
- At least 50% of its assets are held to produce passive income.
This definition describes most foreign mutual funds, since mutual funds outside the United States tend to be organized as corporations (or organizations deemed corporations under US tax law). PFICs can also be ETFs, bond funds, currency tracking funds, precious metal funds, investment trusts, hedge funds, private equity funds, startups and more. Many expats own PFICs, either directly or indirectly, without understanding their toxic treatment under US tax law. Here is a look at Form 8621 and here are the Instructions. But really, forget about the instructions. You are not going to want to try this on your own.
Why Is It The Worst Investment You Can Possibly Own?
Rather than trying to explain the technical tax rules, which would be even more sleep inducing than the rest of this stuff, we will explain the rationale for the punitive tax treatment of PFICs and the general results. US mutual funds essentially pass through current taxation of the investment income to mutual fund shareholders. However, foreign corporations, which hold foreign mutual funds, can accumulate investment income for the benefit of the shareholders without current taxation to the shareholders. Therefore, in order to create a rough parity in tax treatment between shareholders of US and foreign mutual funds, Congress enacted the PFIC rules. (IRC Sections 1291 - 1298). In doing so, the intent was clearly to discourage investing in foreign mutual funds.
As an example, there is a default calculation for what is called a section 1291 fund. Two alternative calculations are available by election, 1) the "qualified electing fund" (QEF) election, and 2) the mark-to-market election. Treatment under these elections is generally less harsh than the section 1291 fund calculation, but the QEF election is restrictive, and either election must be timely. See Instructions for Form 8621.
Under the "default" section 1291 fund calculation, "excess distributions" are determined on a per share basis and allocated to each day in the shareholder's holding period. The portion of the excess distribution allocated to the current year is taxed as ordinary income. A separate tax and interest charge is computed for the portion of the excess distribution allocated to prior years of the PFIC. The tax is computed hypothetically for each prior year of the PFIC, at the top rate for individuals. Interest is then charged (again, hypothetically) as if the tax was due on the due date of each prior year. See IRC Section 1291. The net result is a very large amount of tax and interest.
Because each reinvested dividend or new purchase is considered a separate block of stock, and because the section 1291 fund calculation must be performed separately for each block of stock, the computations required for one PFIC can fill several worksheets. For that reason, even top-of-the-line practitioner tax software is incapable of performing the detailed calculations required. We employ special PFIC software to handle this task, to ensure the calculations are performed correctly.
Form 8621 Filing Requirements
IRC Section 1298(f) says, "Except as otherwise provided by the Secretary [in regulations], each United States person who is a shareholder of a passive foreign investment company shall file an annual report containing such information as the Secretary may require." [Form 8621.] Therefore, if you are the owner of a PFIC, either directly or indirectly, you must file Form 8621 annually. If you 1) recognize gain on a direct or indirect disposition of PFIC stock, 2) receive certain direct or indirect distributions from the PFIC, or 3) are making an election reportable on the form, you might have a tax obligation.
Generally, indirect ownership includes ownership as the beneficiary of a foreign estate, trust or retirement plan, but not a retirement plan that is exempt from US taxation. Unfortunately, most foreign retirement plans are not exempt from US taxation. If you are the "owner" of a foreign trust, including a foreign pension fund, you are considered an indirect owner of any PFIC owned by the trust. You are not considered the owner of an "employees' trust." Neither the Code nor the regulations define this term. However, if a foreign pension (i) was created by a foreign employer, (ii) is administered by the foreign employer, and (iii) is more than half funded by the foreign employer, it appears that the foreign pension (trust) would be considered an "employees' trust." If your pension plan meets these conditions, Form 8621 is not required. However, if you contributed more to the foreign pension than your foreign employer, you will be treated as the owner of the portion of the plan attributable to your contributions. Treas. Reg. Sec. 1.402(b)-1(b)(6). That means if the trust owns PFICs, reporting is required, unless the trust is a foreign pension fund, income from which is exempt by treaty until distributed. Temp. Treas. Reg. Sec. 1.1298-1(b)(3)(ii).
Exemption From Filing
PFIC shareholders subject to the interest-charge rules (the section 1291 fund calculation) are not required to file Form 8621 under §1298(f) if the following conditions are met:
- The shareholder is not subject to tax under §1291 on an excess distribution received (or treated as received) from the PFIC during the shareholder's tax year; and
- The shareholder has not made a QEF election with respect to the PFIC, and either: 1) the aggregate value of all PFIC stock owned by the shareholder at the end of its tax year does not exceed $25,000 ($50,000 for married taxpayers filing a joint return); or 2) the PFIC stock is owned by the shareholder through another PFIC, and the value of the shareholder's proportionate share of the upper-tier PFIC's interest in the lower-tier PFIC does not exceed $5,000. (Reg. Sec. 1.1298-1(c)(2)).
Additionally, Foreign insurance policies are usually not considered to be PFICs. (IRC Sec. 1297(b)(2)(B) & (f)). Form 8621 Is not required if the holder of a life insurance contract does not have control over the available investment accounts. (IRC Sec. 1297(b)(2)(B)).
What Happens If You Don't File?
There is actually no penalty for not filing this form when you are supposed to. However, the statute of limitations for assessing penalties is suspended until you do file the form, if required. That means your entire return remains subject to audit until three years after you file the required Form 8621. See IRC Section 6501(c)(8).