The Top 10 Form 8621 Problems

What is Form 8621?

Form 8621 is an election that may be filed by the shareholders of a foreign corporation that is a “passive foreign investment company” or PFIC. A foreign corporation is a PFIC if 75% or more of the corporation’s gross income for it’s tax year is passive income as defined in tax code section 1297(b), or if at least 50% of the average value of the corporations’ assets for its tax year is attributable to assets used in the production of passive income or held for the production of passive income.

The form must be prepared for each PFIC in which the taxpayer is an investor and wants to elect a current method of taxation on the shareholder’s portion of the income of the PFIC. The extent of the percentage of ownership in the PFIC by the U.S. person is not a factor in filing this form.

What is a PFIC?

A PFIC is a foreign corporation that has one of the following attributes: (i) At least 75% of its income is considered “passive” (e.g., interest, dividends, royalties), or (ii) At least 50% of its assets are passive-income producing assets.  

Most foreign mutual funds fall within the definition of a PFIC.  This can be the case even if such funds are held through a tax-deferred savings account (e.g., U.K. individual savings accounts (“ISAs”), New Zealand Kiwi Saver accounts, and Canadian tax-free savings accounts (“TFSAs” or “RRSPs”)) or a non-qualified pension and retirement account.

PFIC investment income is generally subject to punitive U.S. ordinary income tax rates.  A non-deductible penalty interest charge can also compound daily while holding an interest in a PFIC.  Several elections are available to mitigate the more onerous aspects of PFIC taxation (e.g., a “QEF election” or “mark-to-market” election).

Why are foreign mutual funds considered a PFIC?

US mutual funds created and held in the United States have a mandatory distribution which results in IRS taxation. However, non-U.S.-based mutual funds can defer distributions and therefore defer tax liability.

PFIC’s imposition of additional reporting requirements and a burdensome tax structure discourage United States persons to invest in foreign mutual funds and protect the interests of the US mutual funds. The PFIC status of foreign mutual funds render foreign mutual funds unattractive and financially and administratively burdensome.

Who must file Form 8621?

Form 8621 must be filed to compute the tax due on any “excess distributions” from or dispositions of a PFIC. Generally, an “excess distribution” is a distribution (after the first year) that exceeds 125% of the average distribution in the previous three years. All dispositions appear to be treated as excess distributions and are treated the same as distributions in excess of 125% of the average distributions.

A separate Form 8621 must generally be filed for each PFIC in which stock is held directly or indirectly.

Generally, a U.S. person that is a direct or indirect shareholder of a PFIC must file Form 8621 for each tax year under the below five circumstances.  If the U.S. person:

  1. Receives certain direct or indirect distributions from a PFIC;
  2. Recognizes gain on a direct or indirect disposition (e.g., a sale) of PFIC stock;
  3. Is reporting information with respect to a QEF or section 1296 mark-to-market election;
  4. Is making an election reportable in Part II of the form; or
  5. Is otherwise required to file an annual report pursuant to section 1298(f).

Are there exceptions to the Form 8621 filing requirement?

There are certain exceptions to the PFIC reporting requirement. A U.S. shareholder of a PFIC is not required to file the Form 8621 under the following circumstances

  1. The U.S. shareholder of the PFIC is not subject to tax on so-called “excess distributions” and gains on the disposition of PFIC stock during the year; and
  2. Either: (a) the aggregate value of PFIC stock owned by the U.S. shareholder at the end of the tax year is not greater than $25,000 ($50,000 for taxpayers who are married filing jointly); or (b) the U.S. shareholder owns the PFIC stock through another PFIC and the value of the shareholder’s share of the upper-tier PFIC’s interest in the lower-tier PFIC is not greater than $5,000.

Hence, it is not mandatory to file this form unless there is a distribution of income from a passive foreign investment company (PFICs) in which a U.S. person is a shareholder or a disposition of the shares of a PFIC by gift, death and most types of otherwise tax free exchanges or redemptions.

Is tax due with Form 8621?

Generally, yes. The form is basically an election to pay taxes currently on the taxpayer’s income of the PFIC. There are two methods of electing to pay current taxes on the income of a PFIC and a default method of taxation if no election is made.

The default method involves a complicated allocation of an “excess distribution” to the prior tax years in which the taxpayer was a shareholder. For each of those years, the income tax (as ordinary income (not capital gain)) is computed on the basis of the highest tax bracket for that year even though the taxpayer may have been in a much lower marginal tax bracket. After computing the tax, there is an interest charge (compounded daily) on the tax for each of those years. 

This punitive form of taxation can be avoided by electing to pay the tax on the current income of the PFIC in one of two general ways:

One method, which is usually better than the default method, is with a “mark-to-market” (MTM) system, which creates a fictitious taxable (as ordinary income (not capital gain)) year-end sale based on market price of publicly listed foreign mutual funds. There is no interest charge on the tax. A MTM election cannot be made on a late filed return. A MTM election must be made with timely filed return. A late MTM election is only allowed in certain situations via an IRS private letter ruling, which is rare and expensive for most expensive taxpayers. As a result, most people will choose to make a timely MTM election or none at all. 

The other method, which is the best method, is called the “Qualified Electing Fund” (QEF) and requires extensive information from the PFIC. A QEF election may permit a taxpayer to retain the benefits of the lower tax rate on long term capital gains realized by the PFIC. In order to use the QEF election, the U.S. shareholders must own enough of the stock to force the fund managers to provide the required information for the shareholders to compute their share of the income of the PFIC each year. Most foreign mutual funds are not QEFs. Hence, this method rarely applies.

What type of information is requested on the Form 8621?

The types of information requested include the following:

  • Description of the PFIC shares (amount, value, etc.)
  • Elections made with respect to the PFIC shares
  • Income from a QEF, if applicable
  • Gain (or loss) from a mark-to-market election, if applicable
  • Distributions from or dispositions of a non-electing PFIC, if applicable

What is the due date for Form 8621?

The form should be filed with the tax return of the U.S. taxpayer for each separate PFIC in which the taxpayer is a shareholder.  Form 8621 must be attached to the shareholder’s tax return and filed by the due date, including extensions, of the return.

Where Should Form 8621 Be Filed?

It should be filed with the IRS center to which the taxpayer sends his or her return or the Philadelphia address above. If the taxpayer is not required to file an income tax return, then copies of the form 8621 should be sent to the Internal Revenue Service Center, POB 21086, Philadelphia, PA 19114.

What are the penalties for not filing Form 8621?

Unlike other information returns, Form 8621 does not carry a penalty for not filing the form.  Where there are no distributions to the shareholders, there are no penalties for a failure to file the form. Generally, it is to the advantage of a U.S. taxpayer to file this form and to make an election to pay taxes on the current income of the PFIC. If an election is not made to pay taxes on the current income of the PFIC, then any future distributions may be subject to the punitive tax on excess distributions. In addition, the QEF election may permit the taxpayer to retain the benefits of the lower tax rate on long term capital gains realized by the PFIC. Failing to file the form does leave open the statute of limitations on all tax matters for that tax year indefinitely until the Form 8621 is filed.

While there is no Form 8621 penalty, most filers fail to simultaneously file Form 8938 to report the investment. The failure to report the PFIC interest on Form 8938 gives rise to a $10,000 penalty for failure to file, per incidence penalty. This penalty applies with respect to the Form 8938, but is tied to the failure to file the Form 8621. The maximum penalty is up to $50,000 penalty for failing to comply with the Form 8938 reporting requirements after IRS notification. If Form 8621 is filed, then in Form 8938, you must simply complete only Part IV and indicate that Form 8621 was filed. 

Also, while there is no Form 8621 penalty, most filers fail to an FBAR to report the investment. The failure to report an FBAR gives rise to a $10,000 penalty for failure to file, per incidence penalty. 

In addition, a 40% accuracy related penalty applies to any unreported tax attributable to undisclosed foreign financial assets.

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