What is a 'Passive Foreign Investment Company - PFIC'

A passive foreign investment company (PFIC) is a foreign-based corporation that exhibits either one of two conditions. The first condition, based on income, is that at least 75% of the corporation's gross income is "passive," income that is derived from investments rather than from the company's regular business operations. The second condition that determines a company as a PFIC, based on assets, is that at least 50% of the company's assets are investments that produce income in the form of earned interest, dividends or capital gains.

BREAKING DOWN 'Passive Foreign Investment Company - PFIC'

PFICs, as defined by the Internal Revenue Service (IRS) tax code, include foreign-based mutual funds, partnerships and other pooled investment vehicles having at least one U.S. shareholder. The majority of investors in PFICs must pay the higher personal income tax rate on all distributions and capital gains resulting from increases in share values, regardless of whether the lower capital gains tax rate would ordinarily apply to such income if it was derived from investments in a U.S.-based corporation.

The History of PFICs

PFICs became recognized through tax reforms in 1986, which were designed to close a tax loophole that some U.S. taxpayers were using to shelter offshore investments from U.S. taxation. The instituted tax reforms not only sought to close the loophole and bring such investments under U.S. taxation, but also to tax such investments at high rates, so as to discourage U.S. taxpayers from making them.

PFICs and the IRS

Investments designated as PFICs are subject to strict and extremely complicated tax guidelines by the Internal Revenue Service, delineated in Sections 1291 through 1297 of the U.S. income tax code. The PFIC itself, as well as shareholders, are required to maintain accurate records of all transactions related to the PFIC, such as share cost basis, any dividends received, and undistributed income that the PFIC may earn.

An example of the strict tax treatment applied to shares in a PFIC is provided by the guidelines concerning cost basis. With virtually any other marketable security or other asset, a person who inherits shares is allowed by the IRS to step up the cost basis for the shares to the fair market value at the time of the inheritance. However, the step up in cost basis is not typically allowed in the case of shares in a PFIC. Additionally, determining the acceptable cost basis for shares in a PFIC is often a challenging and confusing process.

There are some options for an investor in a PFIC that can reduce the tax rate on his shares, such as seeking to have a PFIC investment recognized as a qualified electing fund (QEF). However, doing so may cause other tax problems for shareholders.

Form 8621, the tax form that PFIC investors are required to fill out, is a lengthy, complicated form that the IRS itself estimates may take more than 40 hours to fill out. For this reason alone, PFIC investors are generally advised to have a tax professional complete the form for them.

  1. Passive Income

    A Passive income is earnings derived from a rental property, ...
  2. Tax Shelter

    A tax shelter is a vehicle used by taxpayers to minimize or decrease ...
  3. Federal Income Tax

    A federal income tax is levied by the United States Internal ...
  4. Tax Return

    A tax return is a form(s) filed with a taxing authority which ...
  5. Schedule D

    A U.S. income tax form used by taxpayers to report their realized ...
  6. Income Tax

    A tax that governments impose on financial income generated by ...
Related Articles
  1. Managing Wealth

    What Taxes Do I Owe On Retirement Accounts Abroad?

    If you're a U.S. retiree, but previously worked abroad, here's what you need to know about taxes on foreign pensions and retirement accounts.
  2. Investing

    Why Some Investors Have to Pay Taxes on a Loss

    Here's why some investors need to pay capital gains taxes even if they haven't sold any funds or made any portfolio changes—and how to combat it.
  3. Financial Advisor

    The Basics of Income Tax on Mutual Funds

    Learn about the basics of income tax on mutual funds, including what types of income may be subject to the capital gains tax rate.
  4. Financial Advisor

    Living Abroad in Retirement: Can You Afford It?

    These are the financial implications of retiring abroad, as well as what you need to consider in order to do so.
  5. Insights

    How Fortune 500 Companies Avoid Paying Income Tax

    President Donald Trump is not alone in not paying taxes.
  6. Taxes

    What's IRS Form 1040 For?

    Most U.S. taxpayers will be familiar with the 1040. By the end of filling it out, you'll know how much tax you owe, or what your refund is.
  7. Investing

    How Mutual Funds Are Taxed in the U.S.

    A look at how mutual funds are taxed and how investors can be more tax efficient.
  8. Taxes

    The History Of Taxes In The U.S.

    The number of taxes that we now consider a given did not always exist. Find out how they arose.
  9. Investing

    U.S. Expats and Regular Savings Plans

    Regular savings plans are one of the few investment options for many U.S. expats.
  10. Taxes

    Capital Gains Tax 101

    Find out how taxes are applied to your investment returns and how you can reduce your capital gain tax burden.
Hot Definitions
  1. Federal Funds Rate

    The federal funds rate is the interest rate at which a depository institution lends funds maintained at the Federal Reserve ...
  2. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  3. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  4. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  5. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  6. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
Trading Center