Your IRS Form 8621 Tax Guide to PFICs, QEFs, MTMs and Filing

What is IRS Form 8621

While there are many complicated aspects to international tax and reporting, the IRS requirements for having to report Passive Foreign Investment Companies (PFIC) are some of the most daunting and complex. Technically, the PFIC is an acronym for Passive Foreign Investment Company, and U.S. taxpayers worldwide (including U.S. Expats) who meet the reporting requirements, may have to report their PFICs on various international information reporting forms each year such as the FBAR and Form 8621. There are only a handful of international tax law firms across the globe that represent taxpayers consistently in PFIC matters. At Golding & Golding, we specialize in international tax, with a focus on international reporting and PFIC compliance for taxpayers who are already out of compliance. Over the past several years, we have written many articles on issues involving PFIC tax and reporting but wanted to take a step back and provide an introductory understanding of the PFIC and whether or not you may be required to report your PFIC to the IRS and FinCEN.

What is a PFIC?

From a baseline perspective, a PFIC is essentially a foreign passive investment that is owned by a US person. For example, a taxpayer may have a holding company overseas that does little more than own foreign investments such as stocks and funds. Alternatively, a taxpayer may not have a foreign holding company but may directly own foreign mutual funds and other pooled Funds such as ETFs. These are examples of a US person owning a foreign passive investment that would most likely qualify as a PFIC.

PFIC/CFC Crossovers, GILTI, Subpart F and Excess Distributions

While identifying whether or not a taxpayer has a PFIC issue can be complicated, there are various rules, exceptions, and nuances that make it very complex to determine what the taxpayer must do next. Without delving too deep into the specifics, taxpayers should be aware that if their PFIC is also a Controlled Foreign Corporation (CFC), then there are certain crossover rules. This will impact whether or not certain transactions result in excess distributions, Subpart F income, and/or GILTI — and what will qualify as an exception. At the outset, it is just important to know that if a Taxpayer owns a controlled foreign corporation that owns passive investments or was created solely to act as a passive investment tool, the Taxpayer will probably have a PFIC situation.

Which Forms to File to Report PFIC?

When it comes to reporting PFICs, the two main international information reporting forms are the FBAR and Form 8621. The FBAR is used to report foreign bank and financial accounts. Pooled funds qualify as foreign accounts, so they are reported to the IRS. Thus, if a taxpayer owns several mutual funds overseas for example, they must report these mutual funds on their FBAR — and the complexity of the reporting involved will be in part determined by whether or not the funds are in an account or held individually. For purposes of Form 8621, each PFIC is parsed out separately to determine basis and income, even if the funds are held in an account.

PFIC Taxation

If a taxpayer does not make any election for their PFICs, then they will be taxed under the excess distribution regime, which means, for example, an otherwise qualified dividend that would be taxed at 0%, 15%, or 20%, will instead be taxed at the highest tax rate available (excluding the allocable amount for the current year unless the Taxpayer is in the highest tax bracket) along with interest on the tax liability. This may result in a tax liability of more than 50% depending on the year of the excess distribution and how long the investment has been held. To try to lessen the blow, the taxpayer may be able to make an election.

Making PFIC Elections

When it comes to PFICs, taxpayers may have the opportunity to elect to treat the income and growth/losses from their PFICs more gently than under the excess distribution regime. The two main elections are the Qualified Electing Fund (QEF) and the Mark-to-Market (MTM). Each type of election has its own pros and cons, noting that the QEF election is typically better from a tax standpoint, but unfortunately requires some cooperation from the Foreign Financial Institution to ensure it is providing the taxpayer with the necessary statements that the IRS requires. Without the information/statements, the election cannot be made. Likewise, to make a mark-to-market election the PFIC must be marketable, which can sometimes pose a problem depending on the nature of the investment.

No PFIC Election – Excess Distributions

As mentioned above, if a taxpayer does not make any election, then they will be taxed under the excess distribution regime. In a nutshell, this means that in most years, if there are no distributions then there is no tax. But, once there are distributions or redemptions, the taxpayer will be taxed at a much higher tax rate than they would have ordinarily been taxed if the investment was domestic, such as a domestic mutual fund.

Late Election/Purging PFIC Election

For taxpayers who make elections after the first year of the investment, they generally also must make a late purging election which means they have to prepare an excess calculation distribution in the year they make the election, along with making the election, and then moving forward they can operate under one of the different election types. Depending on how long the investment has been held, making a late/purging election can be very costly. Likewise, taxpayers may try to qualify for a reasonable cause exception for making a late election, but unlike other types of reasonable cause submissions, there are very strict requirements to qualify for reasonable cause for missed PFIC elections.

Exceptions to Filing the Form 8621

There are not many exceptions to having to file Form 8621. But, for some taxpayers who may qualify as having less than $25,000 in total PFICs ($50,000 Married Filing Jointly) and no excess distributions in the current year of reporting, they may be able to limit their reporting. There is a bit of conflict between what is provided in the instructions and what is provided in the regulations as to whether part one of Form 8621 must be filed or whether the Form is not required at all.

Penalties for Missed PFIC Reporting

Unlike other types of international information reporting forms such as the FBAR or form 8938, there is no monetary penalty for not reporting form 8621. But it is important to note that if the form is not filed then the taxpayer’s tax return remains open for that year and to what extent their return remains open is up for debate depending on whether you are representing the taxpayer or whether the IRS is taking a position contrary to the Taxpayer.

Common Examples of PFIC Reporting

While the reporting and tax complexities of PFIC of IRS Form 8621 can seem daunting, overall, they are usually manageable once the Taxpayer better understands how these types of investments are taxed and reported. Let’s look at some common examples for Taxpayers who have PFIC. *For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA). Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

Foreign Mutual Fund and ETF Reporting

One of the most common types of situations that require PFIC reporting is when a Taxpayer owns foreign mutual funds and/or foreign ETFs. Depending on whether the funds are held within an account or individually may impact the extent of their reporting, but pooled funds are reportable.

• • • Example: David invested in various foreign mutual funds that are all contained within one single account at a Foreign Financial Institution. The only assets in the investment account are mutual funds and the total value of the funds are $170,000. For FBAR purposes, David will report the single account, but for PFIC/Form 8621 purposes David will report each fund individually.

    • Example: Michelle invests in different ETFs but does not hold the funds in a single account – rather, she owns each fund individually. The total value of the funds is $650,000. Michelle will have to file the FBAR to report each fund individually as well as having to report each fund separately on Form 8621.

    • Example: Peter owns two mutual funds (not in an account) with a combined value of $19,000 and no distributions from the funds. Peter must file the FBAR to report the mutual funds, but is only required to do very limited reporting on Form 8621 because he files as ‘Single’ and is below the $25,000 exception. Noting, there is contradiction between what the regulation requires and what the instructions require for this Form 8621 exception — with many Taxpayers choosing to err on the side of caution by filing the Form 8621 just to complete the very top portion of the form for each fund.

Foreign Mutual Fund and ETF Tax

When it comes to PFIC, one component of filing with the IRS is to report the existence of the account while the other aspect is dealing with the tax implications. Various issues regarding PFIC will help determine what the tax implications may be.

• • • Example: Scott has $700,000 in foreign mutual funds that have grown significantly in value but have not distributed any income — so that there are no distributions. There have also been no sales of the funds. While Scott must report these foreign mutual funds, he may not have any tax implication.

    • Example: Danielle has been holding multiple mutual funds for several years and they never issued dividends in prior years. In the current year, one of Danielle’s mutual funds issued a very large dividend. Since the current year distribution is not in the first year of the fund and it is more than 125% of the average of the three prior years, Danielle will presumably have an excess distribution which she will have to calculate — as well as provide the additional reporting forms to supplement her Form 8621.

    • Example: Brenda has been holding a few mutual funds for several years and has never sold any of the funds or received any dividend distributions. In the current year, Brenda decides to sell one of her funds for a gain. As a result, Brenda will have an excess distribution calculation and will also have to provide the additional reporting forms to supplement her Form 8621.

Foreign Pension/Treaty Exception

If a Taxpayer has a pension-type investment in a foreign country that contains funds that are PFIC, but the country is a treaty country, then the Taxpayer may be able to avoid having to file form 8621 for these investments. PFIC Exception Under Section 1.1298-1 Section 1298(f)(c)(4)

• Exception for PFIC stock held through certain foreign pension funds.

  • “A shareholder who is a member or beneficiary of, or participant in, a plan, trust, scheme, or other arrangement that is treated as a foreign pension fund (or equivalent) under an income tax treaty to which the United States is a party and that owns, directly or indirectly, an interest in a PFIC is not required under section 1298(f) and these regulations to file Form 8621 (or successor form) with respect to the PFIC interest if, pursuant to the applicable income tax treaty, the income earned by the foreign pension fund may be taxed as the income of the shareholder only when and to the extent the income is paid to, or for the benefit of, the shareholder.”

    • Example: Sam has a pension fund in a treaty country that has several types of investments including foreign ETFs and Mutual Funds. Even though Sam will have to report the pension for FBAR and Form 8938 purposes, he may be able to avoid having to file form 8621 for the PFIC investments.

    • Example: Shelly has a pension fund in a non-treaty country that also contains several types of investments including foreign ETFs and mutual funds. Unfortunately, because Shelly’s pension is in a non-treaty country she would have to file IRS Form 8621 to parse out the separate investment funds that are PFIC.

Foreign Corporations Used to Hold Passive Investments

In some countries, it is common for Taxpayers to have a foreign holding company such as a corporation that they use specifically for passive investments. In this type of situation, the company itself may be considered a PFIC, along with individual PFICs for the different types of investments. For example, a Taxpayer may have a foreign holding company that has foreign rental properties but also contains foreign mutual funds. This type of reporting can be very complicated and there may be CFC/Subpart F income crossover.

PFIC Elections

Some Taxpayers may qualify to make an election to reduce the tax implications of the excess distribution PFIC tax regime — such as the QEF election or the MTM election. It is important to note that the Taxpayer should make the election in the first year — or else when they make a late election it will require a purging election and an excess distribution calculation at that time. The Taxpayer may qualify to make a reasonable cause late submission, but unlike other types of reasonable cause submissions a late PFIC reasonable cause submission requires very specific requirements that most Taxpayers cannot satisfy.

*Crossover with Subpart F Income

Taxpayers who have foreign-holding corporations that would qualify as PFIC but also qualify as Controlled Foreign Corporations (CFC) generally will fall under the Subpart F tax regime for CFC and not the PFIC reporting for Form 8621. A key issue will be whether the foreign corporation is a CFC or not and Taxpayers should review the requirements in detail if they believe they may fall into this category. One common example would be a corporation in a foreign country that is owned primarily by family members who are considered U.S. persons and the corporation is used for passive investments.

The Tip of the Iceberg

The goal of this article is to help clarify some of the basics of Form 8621/PFIC. Reporting foreign assets to the U.S. tax authorities can be very complicated, especially when it involves additional items such as foreign life insurance policies, foreign corporations, foreign partnerships, and transactions between U.S. persons and foreign companies. Taxpayers should try to stay in compliance if they are already in compliance or should consider getting into compliance if they have not properly filed the necessary reporting forms if for no other reason than the fact that the IRS has made offshore compliance a key enforcement priority and has been issuing fines and penalties for non-compliance. 

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.  *This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.