Passive Foreign Investment Company (PFIC)

Detailed Explanation

A foreign corporation is a Passive Foreign Investment Company if it meets either of two mechanical tests under IRC Section 1297: the income test (75% or more of gross income is passive, meaning dividends, interest, rents, royalties, annuities, and net gains from passive-producing property) or the asset test (50% or more of assets, measured by value and generally averaged across the year, produce or are held to produce passive income). Cash and cash equivalents count as passive assets, so a foreign holding company sitting on a fundraise can become a PFIC. Because a pooled investment vehicle exists to hold income-producing securities, virtually every non-US mutual fund, ETF, money market fund, OEIC, SICAV, UCITS fund, and unit trust is a PFIC. The "once a PFIC, always a PFIC" taint rule of Section 1298(b)(1) treats the stock as a PFIC for the shareholder's entire holding period once it qualifies, unless a purging election is made. A US person who owns PFIC stock is taxed under one of three regimes, reported on Form 8621: the default Section 1291 excess distribution regime (highest ordinary rates on deferred gains plus a compounded interest charge), a Qualified Electing Fund (QEF) election (annual inclusion of the fund's ordinary earnings and net capital gain), or a mark-to-market election (annual inclusion of unrealized appreciation as ordinary income). A US shareholder who owns 10% or more of a foreign corporation that is both a PFIC and a controlled foreign corporation is taxed under the Subpart F/GILTI rules instead, under the Section 1297(d) overlap rule.