What Is a PFIC? Passive Foreign Investment Company Rules

A passive foreign investment company, or PFIC, is taxed under one of three regimes, and the PFIC tax default is deliberately punitive. If you own shares in a PFIC and do nothing, the IRS applies the excess distribution regime: gains are spread across every year of your holding period, taxed at the highest individual rate in effect for each of those years, and hit with compounding interest on top. The two elections that let you avoid this outcome, the Qualified Electing Fund (QEF) election and the Mark-to-Market (MTM) election, shift you to annual taxation at ordinary rates instead of waiting until you receive a distribution or sell.

What Counts as a PFIC

A foreign corporation is a PFIC for any tax year it meets either of two tests. Under the income test, 75 percent or more of its gross income is passive, meaning dividends, interest, rents, royalties, and similar investment income. Under the asset test, at least 50 percent of its assets (measured by average value over the year) produce or are held to produce passive income. One test is enough.¹

The usual suspects are foreign-based mutual funds, foreign ETFs, offshore pooled investment vehicles, and some foreign holding companies or startups sitting on large cash reserves. If you live abroad and invest in a locally domiciled mutual fund, that fund almost certainly qualifies. A US-based mutual fund that happens to hold foreign stocks is not a PFIC, because the fund itself is a domestic entity.

Once a foreign corporation qualifies as a PFIC during any year you hold the stock, it stays a PFIC for you going forward, even if the corporation later fails both tests. This “once a PFIC, always a PFIC” rule sticks unless you make a purging election to clear the taint.²

The Default Excess Distribution Regime

If you don’t make a timely QEF or MTM election, the excess distribution regime applies automatically. This is where most taxpayers who stumble into PFIC ownership get burned.

An excess distribution is the portion of any distribution you receive during the year that exceeds 125 percent of your average distributions over the three preceding years (or your entire holding period, if shorter). If you sell PFIC stock at a gain, the whole gain is also treated as an excess distribution.³

The IRS then takes that excess distribution and allocates it evenly across every day of your holding period. The portion allocated to the current year and to any pre-PFIC years is taxed as ordinary income on your current return. The portions allocated to all other prior years get harsher treatment: each year’s slice is taxed at the highest individual income tax rate that was in effect for that year (currently 37 percent), regardless of your actual bracket. On top of that tax, you owe a compounding interest charge running from the original due date of each prior year’s return through the current year.³

The interest uses the federal underpayment rate under Section 6621, which for the first quarter of 2026 is 7 percent and adjusts quarterly.⁴ Compounded over a long holding period, the interest alone can exceed the original tax. The regime also eliminates any preferential long-term capital gains rate. Every dollar of gain is ordinary income or taxed at the highest rate. The design is intentional: Congress wanted to strip any advantage from parking money in a foreign fund and deferring tax.

The QEF Election

The Qualified Electing Fund election is the most favorable treatment available. It lets you pay tax each year on your share of the PFIC’s earnings at your normal rates, preserving the distinction between ordinary income and long-term capital gain. You avoid the punitive interest charge entirely.

Each year you include your pro-rata share of the PFIC’s ordinary earnings as ordinary income and your share of its net capital gain as long-term capital gain, whether or not the fund actually distributes cash. Your basis in the stock increases by what you include in income and decreases by any distributions that aren’t taxable (because you already paid tax on them), which prevents double taxation when you eventually sell.

The catch is practical. To make a QEF election you need a PFIC Annual Information Statement from the foreign corporation, breaking out its ordinary earnings and net capital gain. Many foreign funds have no reason to produce this statement for their handful of US shareholders, and some refuse outright. Without the statement, you can’t make the election.⁵

You make the QEF election by completing Form 8621 and attaching it to your federal return. The election must be filed by the due date (including extensions) of your return for the first year you want QEF treatment to apply. Once made, it stays in effect for all future years and is generally irrevocable without IRS consent.⁵

The Mark-to-Market Election

MTM is the fallback when a QEF election isn’t possible, usually because the PFIC won’t provide the required annual information statement. It avoids the excess distribution regime’s interest charge, though all income is treated as ordinary rather than preserving capital gain character.

Under MTM, you compare the fair market value of your PFIC stock on the last day of your tax year to your adjusted basis. If the value went up, you include the unrealized gain as ordinary income and increase your basis by that amount. If the value went down, you can deduct the loss, but only up to the total net gains you’ve previously included under MTM, a cap the regulations call “unreversed inclusions.”⁶ Any loss beyond that ceiling is suspended. Gains are always taxable; losses may not be deductible.

MTM is available only for “marketable stock,” meaning stock regularly traded on a national securities exchange registered with the SEC, or on a foreign exchange the Treasury has approved as having adequate trading rules.⁷ If your PFIC shares aren’t publicly traded, MTM isn’t an option. The election is made on Form 8621 and, like QEF, is generally irrevocable once made.

Purging Elections When You’re Late

If you owned a PFIC for years before making a QEF or MTM election, the excess distribution regime already tainted those earlier years. A going-forward election doesn’t erase that taint. To get a clean start, you need a purging election that settles the tax on the pre-election period.

Two options exist. A deemed sale election treats the PFIC stock as if you sold it at fair market value on the relevant date, triggering a gain that runs through the excess distribution rules. You pay the deferred tax and interest charge on that gain, your basis then steps up, and your holding period resets. The QEF or MTM election applies to a clean slate going forward.

A deemed dividend election, available only when the PFIC is also a controlled foreign corporation (CFC), treats a portion of the corporation’s post-1986 earnings and profits as distributed to you. That deemed dividend is taxed as an excess distribution and clears the pre-election taint.⁸

Either way, you take an upfront hit to escape the ongoing punitive regime. The deemed sale election is more commonly available because it doesn’t require CFC status. Both purging elections are made on Form 8621-A.⁹

If you missed the QEF election deadline entirely, the IRS may grant retroactive relief through a private letter ruling. Revenue Procedure 2026-10 outlines the framework, but a favorable ruling requires reasonable cause, detailed financial records for every missed year, and clearing a high procedural bar. This is not a do-it-yourself process.

When the PFIC Rules Don’t Apply

Two situations take you out of the PFIC regime even though the corporation would otherwise qualify.

The first is the CFC overlap. Some foreign corporations are simultaneously a PFIC and a controlled foreign corporation under Subpart F because US shareholders own more than 50 percent of the voting power or value. Section 1297(d) provides that if you’re a US shareholder of a CFC that also qualifies as a PFIC, the PFIC rules generally don’t apply to you; you’re taxed under Subpart F instead.¹ This only helps if you qualify as a “US shareholder” under the CFC rules, meaning you own at least 10 percent of the corporation’s voting power or value. Below 10 percent, the PFIC rules still apply to you even though the corporation is a CFC for its larger shareholders.

The second is retirement accounts. If you hold PFIC shares inside a tax-favored US retirement account, you aren’t treated as a PFIC shareholder for that investment. The IRS instructions for Form 8621 list the covered accounts:

IRAs and Roth IRAs (individual retirement plans under Section 7701(a)(37))
401(k) and similar plans (accounts exempt under Section 501(a))
403(b) and 457(b) plans
529 education savings plans and ABLE accounts

If the PFIC sits in one of these accounts, you don’t need to file Form 8621 for it.¹⁰ Outside these specific account types, the full PFIC regime applies.

Form 8621 and Why Filing Matters

Every US person who is a direct or indirect shareholder of a PFIC must file Form 8621 for each PFIC they own. You file a separate form for each fund, attached to your annual return. Filing is required whenever you have an excess distribution, a QEF income inclusion, an MTM gain or loss, or a sale.¹¹

Indirect ownership counts. If you hold PFIC shares through a foreign partnership, foreign trust, or chain of foreign entities, the filing obligation flows through to you. The only breaks are when another US person in the ownership chain is already filing for that PFIC, or when the shares sit in one of the exempt retirement accounts.¹¹

A limited small-holdings exception exists. If the total value of all your PFIC stock across every PFIC you own, directly or indirectly, is $25,000 or less on the last day of the tax year, you don’t need to file Form 8621 for a Section 1291 fund, provided you didn’t receive an excess distribution or sell any of the stock that year. For joint filers, the combined threshold is $50,000. The exception does not cover shares under a QEF election.¹¹

The consequence for not filing is unusually harsh. Under Section 6501(c)(8), the statute of limitations on your entire tax return stays open until the form is filed. The IRS can audit that return with no time limit. This isn’t a dollar penalty; it’s the removal of the normal three-year window that would otherwise close the year. For taxpayers who didn’t realize they owned a PFIC and never filed, every return from those years remains exposed.¹¹

1
Office of the Law Revision Counsel. 26 USC 1297 – Passive Foreign Investment Company
2
Office of the Law Revision Counsel. 26 USC 1298 – Special Rules
3
Office of the Law Revision Counsel. 26 USC 1291 – Interest on Tax Deferral
4
U.S. Department of Labor. IRC 6621 Table of Underpayment Rates
5
eCFR. 26 CFR 1.1295-1 – Qualified Electing Funds
6
eCFR. 26 CFR 1.1296-1 – Mark to Market Election for Marketable Stock
7
Office of the Law Revision Counsel. 26 USC 1296 – Election of Mark to Market for Marketable Stock
8
eCFR. 26 CFR 1.1291-9 – Deemed Dividend Election
9
Internal Revenue Service. Instructions for Form 8621-A
10
Internal Revenue Service. Instructions for Form 8621 (12/2025)
11
eCFR. 26 CFR 1.1298-1 – Section 1298(f) Annual Reporting Requirements