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Passive foreign investment company (PFIC) tax rules apply to US persons who own shares in a foreign corporation that earns mostly passive income or holds mostly passive assets, and the default treatment is designed to hurt. If you do nothing, gains and certain distributions are spread across your entire holding period, taxed at the highest individual rate in each prior year, and hit with compounding interest. Two elections, the Qualified Electing Fund (QEF) election and the Mark-to-Market (MTM) election, let you swap that regime for annual taxation at ordinary rates.

What Counts as a PFIC

A foreign corporation is a PFIC in any year it meets either of two tests. The income test looks at gross income: if 75 percent or more is passive (dividends, interest, rents, royalties, and similar investment income), the corporation qualifies. The asset test looks at what the company owns: if at least 50 percent of its assets by average annual value produce or are held to produce passive income, it qualifies. Meeting one test is enough.¹

The most common PFICs are foreign mutual funds, foreign ETFs, offshore pooled investment vehicles, and some foreign holding companies or startups sitting on large cash reserves. Americans living abroad who invest in a locally domiciled mutual fund almost always end up owning a PFIC. US-based mutual funds that hold foreign stocks are not PFICs, because the fund itself is domestic.

Once a foreign corporation is a PFIC during any year you hold the stock, it stays a PFIC for you going forward, even if it later fails both tests. The only way to shake that status is a purging election.²

The Default Excess Distribution Regime

With no election in place, the Section 1291 excess distribution regime kicks in automatically. This is where most accidental PFIC owners get hurt.

An excess distribution is the part of any distribution during the year that exceeds 125 percent of your average distributions over the three preceding years (or your full holding period, if shorter). Sell the stock at a gain and the entire gain is also treated as an excess distribution.³

The IRS then spreads that amount evenly across every day of your holding period. The slice allocated to the current year and any pre-PFIC years is taxed as ordinary income on your current return. Slices allocated to other prior years get worse treatment: each year’s slice is taxed at the highest individual income tax rate in effect for that year (currently 37 percent), regardless of the bracket you were actually in. On top of that tax, you owe a compounding interest charge running from the original due date of each prior year’s return through today.³

The interest charge uses the federal underpayment rate under Section 6621, which is 7 percent for the first quarter of 2026 and adjusts quarterly.⁴ Compounded over a long holding period, the interest alone can exceed the underlying tax. Preferential long-term capital gains rates disappear entirely. Every dollar of gain is either ordinary income or taxed at the top rate. That was the point: Congress wanted to eliminate any deferral advantage from parking money in a foreign fund.

The QEF Election

The Qualified Electing Fund election is the best treatment available. You pay tax each year on your share of the fund’s earnings at your own rates, and you keep the distinction between ordinary income and long-term capital gain. No interest charge.

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 shares adjusts so you aren’t taxed twice when you eventually sell.

The practical hurdle is documentation. 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 for a handful of US shareholders, and some refuse. Without the statement, the election is off the table.⁵

You make the election on Form 8621, attached to your federal return by the due date (including extensions) 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

When a QEF election isn’t possible, usually because the fund won’t produce the annual statement, the Mark-to-Market election is the fallback. It avoids the interest charge, though all income comes through as ordinary rather than preserving capital gain character.

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

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

Cleaning Up a Late Election with a Purging Election

If you owned a PFIC for years before making a QEF or MTM election, the earlier years are already tainted by the excess distribution regime. Going forward with an election doesn’t wipe that away. A purging election settles the tax on the pre-election period so the QEF or MTM election starts from a clean slate.

Two options exist. The deemed sale election treats the stock as if you sold it at fair market value on the relevant date, triggering a gain run through the excess distribution rules. You pay the deferred tax and interest, but your basis then steps up and your holding period resets. The deemed dividend election is available only when the PFIC is also a controlled foreign corporation, and treats a portion of the corporation’s post-1986 earnings and profits as distributed to you, taxed as an excess distribution.⁸

Either route means taking a hit upfront to escape the ongoing regime. The deemed sale election is more commonly available because it doesn’t require CFC status. Both are made on Form 8621-A.⁹

When PFIC Rules Don’t Apply

Retirement Accounts

PFIC shares held inside a tax-favored retirement account are generally outside the PFIC rules. The Form 8621 instructions list the accounts that shield you from shareholder treatment: IRAs and Roth IRAs, 401(k) and similar plans exempt under Section 501(a), 403(b) and 457(b) plans, and 529 education savings plans and ABLE accounts. Hold the PFIC in one of these and you are not treated as a PFIC shareholder for that investment and don’t file Form 8621 for it.¹⁰ Outside these account types, the full regime applies.

Overlap with Controlled Foreign Corporations

Some foreign corporations qualify as both a PFIC and a controlled foreign corporation. Section 1297(d) provides an overlap rule: if you are a US shareholder of a CFC that also qualifies as a PFIC, the PFIC rules generally don’t apply and you are taxed under Subpart F instead.¹ The relief only reaches shareholders who own at least 10 percent of the corporation’s voting power or value. Smaller holders still fall under the PFIC rules even when the corporation is a CFC for its larger shareholders.

Filing Form 8621

Every US person who is a direct or indirect shareholder of a PFIC files Form 8621 for each fund, attached to the annual income tax return. Filing is required whenever you have an excess distribution, a QEF income inclusion, an MTM gain or loss, or a sale of the stock.¹¹

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

A narrow exception exists for small holdings. If the combined value of all your PFIC stock is $25,000 or less on the last day of the tax year ($50,000 for joint filers), you don’t file Form 8621 for a Section 1291 fund, so long as you had no excess distribution and no sale during the year. This exception doesn’t cover shares subject to a QEF election.¹¹

The consequence of not filing is unusual. Under Section 6501(c)(8), the statute of limitations on your entire tax return stays open until Form 8621 is filed. There is no dollar penalty; instead, the normal three-year window that would otherwise close the year to audit never starts. Every return from a year with an unfiled Form 8621 remains exposed to examination indefinitely.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