Foreign Mutual Funds and the PFIC Rules

If you invested in mutual funds before you moved, or still run a monthly investment plan into funds at home, this chapter covers the rule most likely to cost you money. To the US tax code, almost every mutual fund or exchange-traded fund set up outside the United States is a passive foreign investment company, or PFIC. Once you are a US resident, a PFIC is taxed under rules written to make holding one unattractive: gains are taxed at the top rate, an interest charge is added, and a separate form is due for each fund. Indian mutual funds are the most common case among readers of this shelf, but the rules are the same for funds from any country.

What makes a fund a PFIC

A foreign corporation is a PFIC if either of two tests is met in a year, as the instructions for Form 8621 set them out: 75% or more of its gross income is passive income, or at least 50% of its assets, on average, produce passive income. Interest, dividends and capital gains are passive. A mutual fund exists to hold shares and bonds, so a foreign fund meets the test almost by definition, and most funds organised abroad are treated as corporations for US tax.

Two contrasts help. A share of an ordinary operating company abroad, a bank or a manufacturer, is usually not a PFIC; it is simply foreign stock. And a fund organised in the United States is not a PFIC even if every share it holds is a foreign company, so a US-listed fund that invests in your home country's market is taxed like any other US fund.

The default rules: why holding one is costly

Unless you make an election (below), a PFIC is a "section 1291 fund" and the gain when you sell is an excess distribution. The Form 8621 instructions describe what happens next. The gain is spread evenly over every day you held the shares. The share that falls in the year of sale is taxed as ordinary income at your own rate. The share that falls in each earlier year is taxed at the highest rate in effect for that year, 37% in 2026, whatever your actual bracket was, and interest is charged as if that tax had been paid late, at the IRS underpayment rate compounded daily. That rate is 7% for the last quarter of 2026. No long-term capital gains rate applies. Large distributions, those above 125% of the average of the three previous years, are treated the same way.

Here is a growth path to make it concrete.

Suppose $20,000 grows at 10.0% a year to $51,875 over 10 years, a gain of $31,875. Held in a US fund for more than a year, that gain would be a long-term capital gain, taxed at 15% for a single filer whose taxable income sits between $49,450 and $545,500. Held in a foreign fund under the default rules by someone who was a US resident for all ten years, the gain is cut into ten equal yearly shares. One share is taxed at the holder's bracket, 24.0% for a single filer with $130,000 of income. The other nine are taxed at 37%, and each carries interest for the years it is treated as overdue, the oldest share the most. The longer the holding, the larger the interest. The PFIC calculator runs this allocation year by year and compares it with a US fund and with the mark-to-market election.

A monthly plan makes this worse administratively. Every monthly purchase is a separate lot with its own holding period, so a sale spanning years of instalments needs the allocation for each lot.

Investing $300 a month for 10 years puts in $36,000 across a hundred and twenty separate purchases, which grow to $59,959. Each purchase has its own date, cost, exchange rate and share of the $23,959 gain.

The two elections, and their limits

Mark-to-market. If the fund's shares are "marketable stock", you can elect to treat the fund as sold at the end of each year. The rise in value is ordinary income every year, at your own rate, with no interest charge, and a later decline can be deducted to the extent of earlier inclusions. The instructions define marketable stock as stock regularly traded on a national securities exchange, the US national market system, or a foreign exchange regulated by a government authority; regulations extend it to certain foreign funds that redeem at net asset value under conditions. Whether a particular mutual fund qualifies is a technical question. When it does, the election made in the first year you hold the fund as a US person avoids the default regime; made later, the earlier years still fall under it.

Qualified electing fund (QEF). This election taxes your share of the fund's earnings each year, keeping long-term capital gains treatment for the fund's gains. It needs a PFIC Annual Information Statement from the fund giving your pro rata share of ordinary earnings and net capital gain. Most foreign retail funds do not produce one, so for most readers this election is not available.

Form 8621, every fund, most years

Each PFIC you hold is reported on its own Form 8621, attached to your tax return, in any year you receive a distribution, sell shares, make or report an election, or are otherwise required to file. There is a narrow exception: you need not complete Part I for a section 1291 fund if, on the last day of the year, all your PFIC stock together is worth $25,000 or less ($50,000 on a joint return) and you neither sold shares of that fund nor received an excess distribution from it. A sale always requires the form. If a required Form 8621 is not filed, the IRS's time to assess tax can stay open, for all or part of the return, until three years after the information is provided, under section 6501(c)(8). Foreign funds also count toward the FBAR and Form 8938 thresholds in chapter 2.

Choosing what to do

There is no single right move; there are trade-offs.

• Stop adding. New purchases add new lots under the same regime. Many residents pause monthly plans into foreign funds and invest new money through US accounts instead.
• Sell, accepting the tax. Selling ends the problem going forward at the cost of the excess-distribution tax now. Years you held the fund before becoming a US person are treated more gently: under Treasury Regulation 1.1291-9(j)(1), a fund is not treated as a PFIC for the days you held it while you were not a US person. In the Form 8621 calculation those days fall with the "pre-PFIC" years, whose share of the gain is taxed as ordinary income in the year of sale, without the top rate and interest charge. How much of the gain that covers depends on your dates. Run both a sale now and a sale later through the calculator, and confirm the treatment with a preparer before you sell.
• Hold under an election. Where mark-to-market is available, it turns an unpredictable bill at sale into a yearly one at your own rate.
• Hold and accept the default. Sometimes reasonable for a small position you plan to sell after leaving the US, but the forms still apply while you are resident, and the interest charge grows with time.
• Think about the other country too. Selling may be taxed at home as well, and the foreign tax credit (chapter 3) may not line up neatly with an excess distribution.