This is Part 2 of a focused guide on PFICs, Form 8621, and U.S. tax traps for global investors.
Part 1 . Part 2. Part 3 . Part 4 . Part 5 . Part 6 . Part 7 . Part 8
If this applies to you or someone you know - subscribe to get the rest of the series - before the IRS catches up.
Overview
If you live in the U.S. and hold mutual funds or ETFs that are not based in the U.S., there's a good chance the IRS classifies them as PFICs—Passive Foreign Investment Companies. This classification triggers an entirely separate set of tax rules that are often punitive, poorly understood, and easy to violate without knowing it.
This article focuses on the formal definition of a PFIC, what makes the designation so aggressive, and how to spot less obvious exposure in your portfolio.
What Formally Counts as a PFIC?
Under IRS rules, a foreign corporation is treated as a PFIC if it meets either of the following tests:
Income Test: 75% or more of its gross income is passive (dividends, interest, capital gains, etc.)
Asset Test: 50% or more of its assets produce or are held to produce passive income
Nearly all foreign mutual funds and ETFs meet both. If you own them and are a U.S. tax resident, you likely hold a PFIC—even if:
You bought it before moving to the U.S.
You inherited it from someone outside the U.S.
It’s held inside a non-U.S. retirement account
It hasn’t produced any income yet
Didn’t We Already Cover This?
If you read Week 1, you already know how to spot the obvious PFICs using ISIN codes and fund domicile. This week we go deeper:
What about funds that invest in U.S. stocks but are domiciled abroad?
What if your brokerage calls something a "foreign stock" but it’s actually a fund?
What if your foreign pension holds PFICs you don’t control?
Let’s unpack that.
Gray-Area PFIC Exposure
1. Fund-of-Funds
If you own a foreign-domiciled fund that invests in other funds, each underlying fund may be its own PFIC, requiring its own Form 8621.
You may need to file multiple Form 8621s each year—one for each PFIC entity.
2. Foreign Pensions Holding PFICs
Employer-provided or voluntary pension plans in countries like India or the UK often hold mutual funds inside them (unless exempt under treaty or special treatment rules).
Even if you don’t control investment choices, you may still have a PFIC exposure depending on plan structure.
3. Foreign REITs, Unit Trusts, and Insurance Wrappers
These vehicles may appear tax-efficient in their home countries but are commonly classified as PFICs under U.S. rules.
4. Broker Confusion
Some platforms (especially global brokerages like Saxo, IBKR, or HSBC) may not clearly flag PFICs or provide adequate warnings. The biggest local brokerages in countries such as India and China also don’t usually flag PFICs—because while they may participate in FATCA reporting, they aren’t responsible for helping you comply with U.S. tax rules.
If you rely on them to identify compliance issues, you’re exposed.
Why the IRS Is Aggressive Here
The IRS wants to stop people from using foreign investment funds to delay or hide taxable income. PFIC rules:
Force early and annual disclosure
Apply interest on deferred tax retroactively if you don’t comply
Are designed to be painful enough to discourage PFIC ownership altogether
Even a single dividend or sale can trigger years of back-taxed income plus compounding interest—and it’s not fixable after the fact.
How to Confirm a PFIC (Beyond ISIN)
✅ Read the fund’s prospectus or fact sheet: Is it incorporated outside the U.S.?
✅ Look for “mutual fund,” “investment trust,” “pooled vehicle,” or similar wording
✅ Ask the fund if it issues a QEF statement (a type of annual information report required by the IRS to make a Qualified Electing Fund election—very rare, but if available, it offers the most favorable tax treatment)
This is Part 2 of a focused guide on PFICs, Form 8621, and U.S. tax traps for global investors.
Part 1 . Part 2. Part 3 . Part 4 . Part 5 . Part 6 . Part 7 . Part 8
If this applies to you or someone you know - subscribe to get the rest of the series - before the IRS catches up.