PFICs & Foreign Mutual Fund Reporting Requirements for U.S. Expats
4 min read
October 26, 2022
October 26, 2022
At a glance
If you invest in foreign mutual funds, learn more about PFICs, or Passive Foreign Investment Companies, with the Expat tax experts at H&R Block.
Investing made simple can make taxes complicated, especially when you throw foreign mutual funds in the mix. These accounts—like British mutual funds and Unit Trusts, for example—are typically considered Passive Foreign Investment Companies, or PFICs.
Most American expats understand the reporting requirements that come with U.S.-based investments such as mutual funds. However, they don’t typically know that the foreign mutual fund reporting requirements are much more intricate and come with additional costs for U.S. taxpayers.
Learn more about PFICs with H&R Block, or get started on your expat taxes today.
What is a PFIC?
PFIC stands for Passive Foreign Investment Company. Under U.S. tax law, any pooled investment that is registered outside of the U.S. would qualify as a Passive Foreign Investment Company, including multiple types of funds, investment trusts, and certain foreign pension investments. PFICs are taxed through a much more complex system with much stricter rules than U.S. mutual funds or exchange traded funds.
How to identify a PFIC
A common question we hear is, “how do I identify a PFIC?” A key point to understand is that mutual funds from U.S. companies with international investments—like Vanguard, for example—are generally not considered PFICs. If, however, you open a foreign fund with UBS—a Swiss investment company—that fund would be considered a PFIC.
You can generally tell if a foreign corporation or foreign investment fund is considered a passive foreign investment company (PFIC) if it meets one of the following two characteristics:
- 75% or more of its gross income for the taxable year is passive income, or
- At least 50% of its assets are held to produce passive income.
Passive income is income that is generated passively (through investment vehicles) instead of actively (income earned in exchanged for goods and services). Passive income includes:
- Dividends, interest, royalties, rents, or annuities
- Excess gains from certain asset sales or exchanges, certain commodities transactions (including futures), and foreign currency
- Income equivalent to interest
- Income from notional principal contracts
- Payments in lieu of dividends
How are PFICs taxed?
There are three ways a PFIC can be taxed: Excess distribution, Mark-to-Market (MTM), and Qualified Electing Fund (QEF).
- §1291 Fund (excess distribution): The default taxation method is excess distribution as a §1291 Fund. If you choose this route, you’re taxed on excess distributions and would then realize gain on the sale or disposition of stockholdings.
- Mark-to-Market (MTM): With an MTM election, your PFIC’s yearly increases in value are taxed as ordinary gains. At the end of the year, the marketable stock you hold is then treated like you’d sold and repurchased it at its fair market value on that last business day. The value on the last business day of the year will determine the ordinary gains and losses of the fund. Something to note is that if you want to go this route, you need to make that election in the first year. If you don’t, your PFIC will default to being taxed as excess distribution.
- Qualified Electing Fund (QEF): With a QEF election, your PFIC is taxed on your PFIC’s pro-rata share of undistributed earnings for both ordinary income and long-term capital gain. However, this method is tough to employ due to the documentation requirements associated with making the election.
Bottom-line, investing in foreign mutual funds can sometimes be costlier than any economic benefit you might gain. If you can, we recommend you open U.S.-based funds. If you’re dead set on an international fund, it’s important to talk to an H&R Block Expat Tax Advisor to make sure you’re handling foreign investments in the best way possible. U.S. expat taxes aren’t easy to start with and having a pro by your side can make all the difference to your wallet come tax season.
What are my PFIC reporting requirements if I have shares in a foreign mutual fund?
PFIC reporting requirements and PFIC rules are complex and extremely detailed. In general, if you have shares in a foreign mutual fund, you’ll have to report it to the IRS. There are a few reporting requirements you may have:
- Form 8621, Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Electing Fund
- FBAR – Your Foreign Bank Account Report
- Form 8938 – FACTA reporting form
Before you jump in, seek the guidance of an expat tax expert, like our Expat Tax Advisors at H&R Block.
Invested in a foreign mutual fund? Trust your PFIC reporting to H&R Block’s Expat Tax Services
Even the best global mutual funds come with strict reporting requirements and heavy taxes, which is why we don’t recommend clients invest in international mutual funds without knowing the tax consequences up front. However, if you do have PFICs, leave the reporting to us. Our Tax Advisors are trusted by expats all over the globe, and there’s no tax situation we can’t handle with a snap.
Ready to file your PFIC reporting requirements? No matter how complicated your U.S. tax return is, there’s an Expat Tax Expert ready to help. Get started with Virtual Expat Tax Preparation today!
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