PFIC Rules for US Expats: What You Can (and Can't) Hold Abroad

One of the most consequential — and most commonly violated — rules in US expat taxation. If you hold foreign mutual funds or ETFs, read this carefully.

What Is a PFIC?

Under IRC §§ 1291–1298, a foreign corporation qualifies as a PFIC if it meets either of two tests for any taxable year:

• Income test: 75% or more of gross income is passive income (dividends, interest, rents, royalties, capital gains).
• Asset test: 50% or more of average asset value consists of assets that produce (or are held for production of) passive income.

This captures virtually all foreign mutual funds, ETFs (including most UCITS funds), and many foreign insurance wrappers. The fund doesn't need to be exotic — a plain vanilla foreign index fund from a local broker is almost certainly a PFIC.

The Three Tax Regimes

1. Default Regime — § 1291 "Excess Distribution"

If you hold a PFIC and make no election, the § 1291 default rules apply. These are designed to be punitive:

• Excess distributions (distributions exceeding 125% of the average distribution over the prior 3 years) are taxed as if earned ratably over your holding period — at the highest ordinary income rate in each prior year (37% for 2026), not at the current year's rate.
• On sale or disposition, all gain is treated as an excess distribution: allocated back over your holding period, taxed at the highest ordinary rate for each year, with an interest charge added on top (the IRS underpayment rate, compounding, on tax that was "deferred").
• No long-term capital gains rate. Ever. Not 15%, not 20% — ordinary rates only, plus interest.
• No step-up in basis at death for PFIC gain. The interest charge survives to your heirs.

2. QEF Election — § 1295 (Qualified Electing Fund)

A Qualified Electing Fund election converts the PFIC into something that behaves like a pass-through — you pay US tax currently on your pro-rata share of the PFIC's ordinary income and net capital gain each year, whether distributed or not.

• Requires a PFIC Annual Information Statement (AIS) from the fund — documenting ordinary earnings and net capital gains per share. Most non-US funds do not provide this, making QEF elections practically unavailable for the vast majority of foreign funds.
• If the fund does provide an AIS and you make the election, gain on sale is taxed at long-term capital gains rates (if held >1 year), eliminating the § 1291 interest charge.
• QEF is the "clean" election — but rarely accessible for retail foreign funds.

3. Mark-to-Market Election — § 1296

For PFICs that are publicly traded on a qualified exchange, you can elect mark-to-market (MTM). Each year, you recognize any appreciation as ordinary income (or a loss limited to prior MTM gains) — similar to a §1256 contract.

• Eliminates the § 1291 interest charge and the carryback-over-holding-period calculation.
• Gain is ordinary income each year (not capital gain rates), so this is not a panacea — but it's far better than the default § 1291 regime on a large, long-held position.
• Available for publicly-traded PFICs. MTM election is generally made on Form 8621.
• Once elected, MTM applies to all subsequent years (can't switch back to default).

Form 8621 — The Annual Compliance Obligation

Every US person who holds a PFIC must file Form 8621 for each PFIC for each tax year — even if no distribution was received and no gain was recognized. The form reports:

• Whether you've made a QEF or MTM election
• Distributions received during the year and excess distribution calculation
• Gain on disposition (if any), allocated over holding period

Failure to file Form 8621 does not carry a standalone penalty (unlike FBAR), but it leaves your return incorrect and keeps the statute of limitations open on your entire return. Your CPA should be filing a separate 8621 for each PFIC you hold.

Irish-Domiciled UCITS: The "US Expat Exception"

There is one narrow carve-out that advisors working with UK/EU-based expats discuss: Irish-domiciled UCITS ETFs (iShares, Vanguard, etc. domiciled in Dublin). These are still PFICs — no exception from the definition — but they are publicly traded, making a mark-to-market election available.

• With a properly filed MTM election, Irish UCITS can be held without the § 1291 death spiral.
• However: MTM income is ordinary (not capital gains), and current-year losses are limited to prior MTM income — not a clean solution for buy-and-hold investors.
• Many advisors still recommend against them for US expats. The compliance burden (annual 8621 per fund, MTM income calculations) plus the ordinary-rate treatment on unrealized gains makes simple US-domiciled ETFs in a US-custodied account cleaner for most people.
• Never hold Irish UCITS without making the MTM election in the year of purchase. Late elections are possible but procedurally complex.

What US Expats Should Hold Instead

The practical answer for most US expats:

• US-domiciled ETFs and mutual funds in US-custodied accounts (Schwab International, Fidelity, Vanguard with proper non-resident account — though US brokers are increasingly restrictive about non-US clients). These are not PFICs.
• Individual stocks — a foreign company is not a PFIC merely because you're a US person. A non-US stock held directly is taxed normally (dividends as ordinary income, gains at capital rates). The PFIC rules apply to the fund vehicle, not to direct stock ownership.
• US Treasuries and US-domiciled bond funds — same: US-custodied, no PFIC issue.
• Avoid: foreign bank investment products, "assurance vie" in France, offshore unit trusts, foreign-denominated structured notes — these are almost all PFICs or create other filing nightmares (Form 3520 for foreign trusts, etc.).

Common Mistakes

• Moving abroad and keeping existing foreign investments. Investments that were not PFICs (or had no US compliance issue) for a non-US person become your PFIC problem the moment you remain a US citizen.
• Opening a local brokerage and buying index funds. A natural thing to do; creates a PFIC compliance problem immediately.
• Assuming your local advisor handled it. Foreign advisors have no obligation to understand US PFIC rules and often don't.
• Thinking the ISA / SIPP wrapper protects you. A UK ISA holding a UCITS fund: (a) the UCITS is still a PFIC from a US perspective, and (b) the ISA wrapper itself provides no US tax deferral — it's a taxable account in the eyes of the IRS.
• Not filing Form 8621 because "nothing happened." The filing obligation exists even in years without distributions or dispositions.

If You Already Hold PFICs

If you're reading this and already hold foreign funds, your options depend on the situation:

1. Recent purchase, publicly traded: Make a mark-to-market election on this year's return. Your tax advisor can file Form 8621 with the election. Future years will be MTM; the pre-election gain stays in the § 1291 regime on disposition (the MTM gain resets your starting point going forward).
2. Long-held position, large unrealized gain: Selling now triggers § 1291 on the gain. Sometimes it's worth paying the tax and "cleaning up" the position; sometimes the tax cost makes holding and electing MTM the lesser evil. Run the numbers with a specialist.
3. Inherited PFIC: No step-up in basis applies to the PFIC gain (the estate may owe something on exit, but the income-in-respect-of-decedent rules interact with § 1291 in ways that require specialist analysis).

There is no clean, cost-free way out of a legacy PFIC position with unrealized gain. The earlier you address it — ideally before accruing large gains — the better.

Sources

1. IRC §§ 1291–1298 — Passive Foreign Investment Companies
2. IRS Form 8621 — Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
3. IRC § 1295 — Qualified Electing Fund (QEF Election)
4. IRC § 1296 — Mark-to-Market Election for Marketable Stock

PFIC rules require specialist tax preparation. This page reflects IRC provisions current through 2026. Your specific situation — elections available, holding-period allocation, interaction with foreign tax credits — requires a US CPA or advisor with expat expertise.