A Passive Foreign Investment Company (PFIC) defined under IRC § 1297 is generally any non-U.S. corporation, mutual fund, or ETF where:

  • 75% or more of its gross income comes from passive sources (like interest, dividends, or capital gains), or
  • 50% or more of its assets produce passive income.

If you are a U.S. taxpayer and hold shares in foreign mutual funds, foreign ETFs, or certain foreign corporations (often found in foreign investment accounts), the IRS classifies those investments as PFICs. Check the issuer and fund structure to clarify the reporting requirement.

U.S. shareholders generally file taxes under one of three regimes for each fund:

  • Qualified Electing Fund (QEF). Electing under IRC § 1295 to treat the PFIC as a QEF allows current taxation of ordinary earnings and net capital gains, building basis and preserving capital gain character upon sale. The fund provided Annual Information Statement (AIS) is required for this election. The QEF election made after the first year of ownership generally needs a purging election to clear the §1291 history.
  • Mark-to-Market (MTM). Available for marketable stock under IRC § 1296; recognizes annual unrealized gains and losses (up to unreversed inclusions) as ordinary income or loss.
  • Default Section 1291 Rules. Applies under IRC § 1291 when no QEF or MTM election is made; taxes excess distributions and disposition gains at the highest marginal rate over the holding period, plus interest charges.

Form 8621 is the principal reporting form, one form required for each PFIC. The following is the summary of reporting rules in each regime.

QEF

The fund’s Annual Information Statement (AIS) provides ordinary earnings and net capital gains per share as shown below:

Fund Fund Ticker Ordinary Earnings (US$) Net Capital Gains (US$)
BMO Canadian Bank Income Index ETF ZBI 0.0031484545 0.0008078236

This is the most tax efficient option, and we report as follows:

  • We compute the pro-rata share of ordinary earnings and net capital gains based on the weighted average shares held during the fund’s fiscal year. Ordinary earnings are reported on Schedule 1 (Form 1040), Line 8z, and net capital gains are reported on Schedule D as capital gain distributions.
  • Dispositions of QEF stock are reported on Schedule D, with gain or loss calculated using the adjusted basis (which is increased by QEF inclusions and adjusted as sales and cash distributions of previously taxed income occur).
  • Cash distributions within the previously taxed income (PTI) are not reported separately.
  • Both ordinary income and capital gain increase the basis for the final sale of the fund, while distributions of previously taxed income (PTI) decrease the basis.

Fiscal Year and Calendar Year Timing Rules (IRC § 1293)

Suppose a fund’s fiscal year runs from July 1, 20X1 to June 30, 20X2. The fund’s income, sales, and cash distributions are reported under IRC § 1293 as follows:

  • QEF ordinary earnings and net capital gains generated between 07/01/20X1 and 06/30/20X2 are reported in 20X2, the shareholder’s tax year in which the fund’s fiscal year ends (IRC § 1293(a)).
  • Sales of shares follow normal calendar year rules; for instance, gains or losses from sales occurring between 01/01/20X2 and 12/31/20X2 are reported on the 20X2 tax return.
  • Cash distributions received follow the normal calendar rules as well.

MTM

  1. Unrealized gains (comparing the year-end Fair Market Value to the adjusted basis) are reported on Schedule 1 (Form 1040), Line 8z as ordinary income, increasing both adjusted basis and unreversed inclusions.
  2. Unrealized losses are allowed as ordinary losses on Schedule 1, Line 8z only up to the extent of prior unreversed inclusions (previous MTM gains included in income), decreasing adjusted basis and unreversed inclusions.
  3. Any market decline exceeding that amount cannot be taken as a current deduction and is tracked on Form 8621.
  4. Realized gain on the sale of MTM shares is treated entirely as ordinary income.
  5. Realized loss is treated as ordinary loss to the extent of remaining unreversed inclusions, and any excess loss is reported on Schedule D as a capital loss, either short term or long term depending on the hold period.
  6. Dividends are reported normally outside of Form 8621 as ordinary dividends, which are ineligible for qualified dividend rates under IRC § 1(h)(11)(C)(iii).
  7. Taxpayers must separately track stock basis and unreversed inclusions accounts, adjusting for annual MTM gains/losses reported and prorating accordingly for partial share sales.

Transition rule for individuals becoming subject to United States income taxation:

Treas. Reg. § 1.1296-1(d)(5) provides that if an individual becomes a U.S. person and timely makes a valid §1296 MTM election for eligible PFIC stock, the opening basis for §1296 purposes is the greater of first-day fair market value or adjusted basis. This rule limits first-year §1296 income or loss to post-entry changes in value. For general sale purposes under I.R.C. § 1001, the regulation’s example uses the original basis, adjusted only by actual MTM basis adjustments. Example:

  • Buys PFIC stock for $50 as a nonresident alien.
  • Becomes a U.S. person on January 1; stock is worth $100; makes a valid §1296 election.
  • Stock is worth $110 at year-end, so first-year MTM income is $10, using the $100 special §1296 basis.
  • §1296 basis becomes $110; the other tax basis becomes $60.
  • A later sale for $120 produces $60 total gain under §1001 and $10 ordinary income under §1296; the remaining $50 is long-term capital gain in the example.

Default Section 1291 Rules

Here is a step-by-step summary of how the Default Section 1291 Rules (IRC § 1291) work for PFICs:

  1. Trigger Events (Distributions or Sales): Tax is deferred during ownership; tax events occur upon receiving actual distributions or recognizing gain on sale or disposition.
  2. Calculate the 125% Threshold: Compare total distributions in the current year to 125% of the average distributions received over the prior 3 tax years (or the taxpayer’s holding period, if shorter).
  3. Separate Excess vs. Non-Excess Distributions: Distributions up to 125% are non-excess distributions taxed as ordinary dividends in the current year; amounts exceeding 125% (and all gain on sale) are excess distributions.
  4. Allocate and Tax Excess Distributions: Allocate the excess distribution or gain ratably on a daily basis over the taxpayer’s entire holding period. The portion allocated to the current year and pre-PFIC years is taxed as ordinary income in the current year. The portion allocated to prior PFIC years is taxed at the highest marginal tax rate for each year (for example, 37% for the year 2025), plus an underpayment interest charge from that year’s tax return due date.
  5. Fulfill Reporting via Form 8621: File Form 8621 for each PFIC to compute ordinary income, deferred tax, and interest penalties, transferring the deferred tax and interest to Form 1040 as additional taxes.

Canada exceptions: PFICs in RRSPs, RRIFs, and RESPs

PFIC holdings inside an eligible Canadian Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF) generally are not separately reportable on Form 8621 merely because of the annual PFIC information-reporting rule. Treas. Reg. § 1.1298-1(c)(4) provides that a shareholder participating in a treaty-recognized foreign pension fund is “not required under section 1298(f) and these regulations to file Form 8621” for that PFIC interest if the fund income is taxed to the participant only when paid out. The current Form 8621 instructions restate this in form mechanics: such a shareholder “is not required to complete Part I” with respect to the PFIC. Revenue Procedure 2014-55 supplies the treaty-deferral framework for eligible Canadian RRSPs and RRIFs.

An RESP, by contrast, is a Registered Education Savings Plan, not a pension arrangement. There is no comparable pension-fund exception for RESPs in Treas. Reg. § 1.1298-1(c)(4). The general Form 8621 rule therefore applies per the instructions that state that “A separate Form 8621 must be filed for each PFIC in which stock is held directly or indirectly.” Revenue Procedure 2020-17 may relieve certain RESP foreign-trust reporting, but that relief concerns Forms 3520 and 3520-A, not PFIC reporting under § 1298(f).

Conclusion

PFIC taxation rules are highly complex and can result in significant tax liabilities, punitive interest charges, and detailed reporting requirements under Form 8621. Selecting the appropriate regime (QEF, MTM, or Section 1291) depends heavily on individual circumstances, investment structure, and available documentation.

My PFIC input template will help you to organize your information for filing.

Disclaimer: The information provided in this document is for general informational and educational purposes only and does not constitute formal tax, legal, or financial advice. Taxpayers should consult with a qualified CPA or tax professional specializing in U.S. international taxation to determine the specific reporting obligations and tax strategies applicable to their foreign investments.