Do you have foreign investment accounts, such as a pension or mutual fund? Then you might need to file a niche tax form called IRS Form 8621. It’s crucial to pay attention to the details on this form—mistakes can have a big impact on your tax bill and lead to significant penalties.
Form 8621 can be tricky to get right on your own, but our experienced international tax lawyers can help. In this guide, we’ll cover who needs to file this form; the definitions of PFICs, QEFs, and excess distributions; and an overview of how to file.
What is IRS Form 8621?
IRS Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company (PFIC) or Qualified Electing Fund (QEF),” reports income from mutual funds and other passive investment companies located overseas.
Form 8621 is an information return rather than a form used to calculate tax liability. It’s primarily used to report a U.S. shareholder’s interest in certain types of offshore investment accounts. The form provides the IRS with details about the taxpayer’s investments in these foreign entities, but it does not directly calculate or determine tax liability.
Instead, the information provided on Form 8621 helps the IRS ensure proper reporting and tax compliance related to foreign investments. The actual tax liability is calculated on other forms (such as Form 1040 for individuals or Form 1120 for corporations).
What is a Passive Foreign Investment Company (PFIC)?
A Passive Foreign Investment Company (PFIC) is a foreign corporation that primarily generates passive income, such as dividends, interest, or capital gains, from investments rather than engaging in active business operations.
Many U.S. taxpayers might unknowingly invest in a PFIC when they purchase shares of a foreign mutual fund or exchange-traded fund (ETF). These foreign funds often fall under the IRS definition of a PFIC, triggering additional reporting requirements.
There are 2 tests to determine whether a company is a PFIC:
- Income Test: At least 75% of the corporation’s gross income for the taxable year is passive income. Passive income typically includes earnings like interest, dividends, capital gains, royalties, and rent from investments.
- Asset Test: At least 50% of the average value of the corporation’s assets is held for the production of passive income. This could include investments in stocks, bonds, or other assets that generate passive returns rather than active business income.
What is a Qualified Electing Fund (QEF)?
A Qualified Electing Fund (QEF) is a special type of PFIC where the U.S. shareholder elects to be taxed on their share of the company’s income each year, even if no distributions are received.
While this can provide more favorable tax treatment compared to default PFIC rules, it comes with significant reporting complexity. The foreign company must provide detailed annual financial information, which is often difficult to obtain.
Because of the challenges involved and the level of financial disclosure required, the QEF election is rarely used by investors. For those who do make the election, the extra reporting burdens on Form 8621 can be substantial.
Form 8621 Filing Requirements
U.S. taxpayers who are shareholders in a Passive Foreign Investment Company (PFIC) or a Qualified Electing Fund (QEF) are required to file Form 8621. PFICs include foreign corporations where either 75% or more of the corporation’s income is passive (such as interest, dividends, or capital gains) or at least 50% of its assets produce passive income.
Taxpayers who typically need to file this form include:
- Individual Investors: U.S. citizens or residents who directly or indirectly own shares in a PFIC must file Form 8621. This includes investors in foreign mutual funds or foreign corporations that primarily generate passive income (see definitions above).
- Corporate Shareholders: U.S. corporations that hold an ownership stake in a PFIC must also report their interests through Form 8621. This is essential for ensuring that corporate investments in foreign entities are appropriately taxed.
- Partnerships and Trusts: If a partnership, estate, or trust owns shares in a PFIC, the responsibility to file Form 8621 typically falls on the partners or beneficiaries. This ensures that the tax obligations related to foreign passive investments are passed through to the individual taxpayers.
- Indirect Ownership: Even if a U.S. taxpayer holds an indirect interest in a PFIC through another entity (such as a U.S. mutual fund or a foreign trust), they may still be required to file Form 8621. This can involve complex reporting requirements, so professional tax advice is often necessary to navigate these situations.
PFIC Reporting Threshold
Typically, you only need to file IRS Form 8621 if you received income from a PFIC. However, if the total combined value of all your PFICs meets certain reporting thresholds, you must file Form 8621 —even if you didn’t receive any distributions.
- Single or Married Filing Separately: Total PFIC value exceeds $25,000
- Married Filing Jointly: Total PFIC value exceeds $50,000
- Living Abroad: For shareholders living abroad, the threshold increases to $200,000 ($400,000 for joint filers)
Form 8621 Instructions
Once you’ve determined that you need to file Form 8621, the following information is required:
- Identification of the PFIC or QEF: Provide details of the foreign corporation, including the name, address, and tax identification number. If you hold shares in more than one PFIC, identify each company separately.
- Shareholder’s Interest: Report the number and class of shares you hold, along with any changes in ownership during the tax year. Accurate reporting is essential for calculating income and tax liabilities.
- Income and Distributions: You must report all income received from the PFIC or QEF, even if no cash distributions were made. This includes:
- Dividends
- Capital gains
- Interest
- Rental income
- Excess distributions
- And other forms of passive income
- Elections: In Part II, there are several optional elections you can make. Be sure to consult a professional to understand how each option might affect your situation.
- QEF Election: If you’ve made a QEF election, provide additional details about your pro rata share of the earnings, including any undistributed income. This requires extremely complex and technical reporting, so most taxpayers don’t make this election.
Excess Distributions and PFICs
One of the key tax issues for PFIC shareholders is excess distributions. An excess distribution occurs when a PFIC pays out a large distribution to its shareholders relative to previous years.
The IRS applies a special tax treatment to these excess distributions, which can result in a higher tax burden for U.S. taxpayers.
Here’s how excess distributions are handled:
- What is an Excess Distribution?: An excess distribution is any distribution received from a PFIC that exceeds 125% of the average distributions received over the previous 3 years (or the shareholder’s holding period if less than 3 years).
- This means that if you’ve held PFIC shares and suddenly receive a larger-than-usual dividend, it might be classified as an excess distribution.
- Tax Consequences: Excess distributions are not taxed like regular dividends. Instead, they are treated as if they were received over the entire period you’ve held the PFIC shares. The IRS applies the highest tax rate applicable to the shareholder over those years and may also impose interest charges.
- This can result in a significantly higher tax bill compared to other types of investment income.
How to File Form 8621
Form 8621 is generally filed along with your annual tax return (e.g., Form 1040 for individuals or Form 1120 for corporations).
You can file it electronically or by mail, following the same process as your federal income tax return. It’s essential to ensure that all supporting documentation is attached and that the information is accurate, as errors can result in penalties.
Given the complexity of reporting PFIC or QEF investments, many taxpayers seek assistance from an international tax attorney to ensure the form is completed correctly and all compliance requirements are met.
Additional Offshore Tax Forms
If you invest in foreign mutual funds, there are some offshore tax forms you should be aware of. You may need to file these in addition to IRS Form 8621:
- FBAR (FinCEN Form 114): If you have foreign accounts and assets (including some mutual funds), and their total combined value exceeds $10,000 at any point in the tax year, you may need to file the FBAR.
- Form 3520: If your PFIC investment is held through a foreign trust, Form 3520 may be required.
- Form 8938 (FATCA): U.S. taxpayers with foreign financial assets exceeding certain thresholds must file Form 8938 under the Foreign Account Tax Compliance Act (FATCA). This form is broader than the FBAR and covers a wide range of foreign assets, including PFICs.
Each of these forms serves a specific reporting purpose, and failure to file them can result in significant penalties. It’s important to review your foreign investments and consult an experienced offshore tax professional to ensure you meet all your filing requirements.
Need Help Reporting Foreign Investments on Your Taxes?
Gordon Law has focused on offshore disclosures and international tax concerns since 2012. We’ve helped hundreds of investors like you minimize their taxes while avoiding IRS penalties.
Our team is experienced and friendly, helping you gain a crystal-clear understanding of your tax situation. We’ll ensure every detail is taken care of and answer all your questions along the way. Reach out today at (847) 580-1279 for professional filing assistance!
