Preparation of PFIC Statements for QEF Elections

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PFIC Rules: An Overview

The PFIC (i.e. Passive Foreign Investment Corporation) rules were enacted to eliminate beneficial tax treatment for certain offshore investments. Under prior law, U.S. taxpayers could accumulate tax-deferred income from offshore investments and, upon the sale of the investment, recognize gain at the long-term capital gains tax rate. Under the PFIC rules, absent a beneficial election, PFIC investments are generally subject to tax on distributions at the highest ordinary income rates in effect for the tax year, rather than the currently more beneficial dividend and capital gains rates.

What is a PFIC?

PFICs are passive investments in offshore mutual funds, hedge funds, stocks, annuities, or income-producing property. A PFIC is defined as a foreign corporation that meets at least one of the following tests:

  • 75% or more of its income is derived from passive sources (the income test), or
  • 50% or more of the average fair market value of the assets it held during the year are passive income-producing assets (the asset test).

If a U.S. taxpayer’s investment is characterized as a PFIC in one year, it is generally also treated as a PFIC in future years—commonly referred to as the PFIC taint.

PFIC Taxation and QEF Elections

The U.S. taxpayer-investor in a PFIC is taxed according to an onerous excess-distribution regime unless the taxpayer cleanses the PFIC taint with either of two elections:

  • Mark-to-market election (available for assets that are regularly traded on qualified exchanges or other markets) or
  • The Election to be treated as a qualified electing fund (QEF)

If either election is made for a tax year other than the year the asset was purchased, the taxpayer must first cleanse the PFIC taint—with a deemed-sale election in the case of the QEF election. Annual IRS Form 8621 reporting is required for each PFIC that is directly or indirectly held by the investor, regardless of which election is made.

Need Help?

UHY Victor has expertise preparing PFIC statements for QEF elections. Contact us for a free consultation regarding your PFIC situation:

UHY Victor LLP Canada U.S. Tax Team
(514) 282-0067

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