How to Handle PFIC Compliance: Form 8621 Tips for Foreign ETFs

As a Certified Public Accountant (CPA), I frequently assist clients with the complexities of U.S. tax rules, including those related to Passive Foreign Investment Companies (PFICs) and Form 8621. Recently, I’ve received questions from individuals navigating these rules for the first time—whether due to moving to the U.S., managing overseas investments, or handling dual citizenship. Below, I’ll address three specific scenarios to provide clarity on how PFIC rules apply, what options exist, and key considerations for compliance.

Scenario 1: First-Year U.S. Resident with Foreign ETFs

Question Recap: You moved to the U.S. in 2023 on a work visa and are filing your first tax return as a U.S. resident. You’ve discovered the PFIC rules and Form 8621 while preparing your return, particularly regarding ETFs held in your home country’s retirement accounts. You’re concerned about high tax rates, taxes on unrealized gains, and the cost of compliance. You’re also wondering if Form 8621 applies to you and why these rules target someone in your situation rather than others with larger offshore holdings.

Explanation: A PFIC is defined as a foreign corporation where at least 75% of its income is passive (e.g., dividends, interest) or 50% of its assets generate passive income. Many foreign ETFs and mutual funds, including those in retirement accounts, meet this definition. As a U.S. resident for tax purposes, you’re subject to U.S. tax rules on worldwide income, which includes reporting PFICs on Form 8621.

Form 8621 is required for each PFIC you own, directly or indirectly, unless an exception applies (e.g., total PFIC value under $25,000 for individuals, though this exemption has conditions). The default tax treatment taxes “excess distributions” (e.g., gains upon sale) at the highest ordinary income rate, plus interest on deferred tax. Alternatives like the Qualified Electing Fund (QEF) or mark-to-market elections may reduce the tax burden but require specific information from the fund and additional calculations.

The rules apply regardless of your intent or the size of your holdings because they’re designed to ensure U.S. taxpayers report foreign investments consistently. Foreign retirement accounts aren’t automatically exempt, as the IRS doesn’t recognize their tax-deferred status unless covered by a specific tax treaty.

Options to Consider:

• Confirm whether your ETFs are PFICs (check fund documentation or consult a tax professional).

• File Form 8621 for 2023 if applicable, choosing a tax method based on available data.

• Explore selling the ETFs and reinvesting in U.S.-based funds, noting any home country taxes or penalties.

• Work with a tax advisor to assess costs and compliance requirements specific to your situation.

Scenario 2: Starting PFIC Compliance Without Amending Past Returns

Question Recap: You hold overseas mutual funds and are addressing PFIC compliance. A CPA advised starting compliance with the current year’s return rather than amending past ones, suggesting the IRS may not actively enforce prior non-filing due to limited automated oversight. You’re seeking experiences from others who’ve taken this approach, insight into IRS enforcement, and tips for managing compliance.

Explanation: Form 8621 must be filed annually for each PFIC, even if no distributions occur, unless an exception applies. The IRS doesn’t currently issue automated notices for missing Form 8621s, unlike some other forms. Enforcement typically occurs during audits, often triggered by unrelated issues like unreported foreign accounts or significant income discrepancies. If Form 8621 was never filed, the statute of limitations may remain open for those tax years, allowing the IRS to assess penalties later.

Some taxpayers choose to begin filing Form 8621 in the current year without amending prior returns, particularly if past PFIC activity was minimal. Others opt to amend past returns or use programs like the Streamlined Filing Compliance Procedures to report prior omissions, depending on their risk level and exposure.

Options to Consider:

• Begin filing Form 8621 with your 2023 return, selecting a tax method (default, QEF, or mark-to-market) based on available fund data.

• Evaluate amending past returns if your PFIC holdings or distributions were significant, weighing the cost against potential audit risk.

• Shift future investments to U.S.-based funds to simplify reporting.

• Consult your tax advisor to determine the best approach for your specific circumstances and document your compliance efforts.

Scenario 3: Dual U.S./Canada Citizen with Canadian ETFs

Question Recap: As a dual U.S./Canada citizen living in Canada, you’ve invested in VFV (Vanguard Canada’s S&P 500 ETF), worth $200,000 with $50,000 in gains. You’ve learned VFV is a PFIC and provides a PFIC Annual Information Statement. You’re considering selling it, paying taxes on the gains, and buying U.S. ETFs instead. You’re asking if Canadian ETFs are problematic for U.S. citizens and whether selling resolves past non-compliance.

Explanation: VFV, as a Canadian-registered ETF, is classified as a PFIC under U.S. tax rules, even though it tracks a U.S. index like VOO. U.S. citizens, regardless of residence, must report PFICs on Form 8621 annually. The availability of a PFIC Annual Information Statement from VFV allows you to use the QEF election, reporting your share of the fund’s income each year rather than facing the default tax treatment.

Holding Canadian ETFs isn’t prohibited, but it triggers PFIC reporting requirements, which many U.S. taxpayers find burdensome. Selling VFV and buying a U.S.-listed ETF (e.g., VOO) eliminates future PFIC issues. However, past years without Form 8621 filings remain non-compliant unless addressed.

Options to Consider:

• Sell VFV, report the $50,000 gain on your Canadian and U.S. returns, and reinvest in a U.S. ETF to avoid future PFIC reporting.

• For past years, file late Form 8621s with QEF elections using VFV’s statements, or begin compliance with the current year if the risk seems low.

• Use a brokerage that allows purchases of U.S.-listed ETFs from Canada for future investments.

• Review your situation with a tax professional familiar with U.S./Canada tax rules to confirm requirements and address prior years.

Key Takeaways

The PFIC rules and Form 8621 apply to U.S. taxpayers with foreign mutual funds or ETFs, often requiring detailed reporting and tax calculations. Whether you’re new to U.S. tax residency, managing overseas investments, or a dual citizen, the steps forward include:

• Identifying which of your holdings are PFICs.

• Deciding how to report them (or reposition assets to avoid PFICs).

• Assessing past compliance and future strategies with a tax professional.

Each situation is unique, so professional guidance tailored to your circumstances is essential. If you have additional questions about PFICs or other tax matters, feel free to reach out—I’m happy to assist with resources or referrals.

Disclaimer: This blog provides general information and is not a substitute for personalized tax advice.