A PFIC is a passive foreign investment company. One of the most common types of…
What is a Mark-to-Market (MTM) election for a Passive Foreign Investment Company (PFIC)?
Several clients have recently asked us about the Mark-to-Market (MTM) election for a Passive Foreign Investment Company (PFIC). A MTM election for a Passive Foreign Investment Company (PFIC) is an option that allows a taxpayer to treat their investment in a PFIC as if it were a regular marketable security rather than a PFIC. This election can have significant tax implications.
A PFIC is a foreign corporation that meets certain criteria related to its income and asset composition. PFIC rules were established by the U.S. Internal Revenue Service (IRS) to discourage U.S. taxpayers from deferring taxes on investments held in foreign corporations. Most foreign mutual funds and foreign ETFs are considered PFICs. If an individual holds shares in a PFIC, the taxation of income and gains from the PFIC can be complex and unfavorable.
By making a MTM election, a taxpayer can mark the PFIC investment to its fair market value at the end of each taxable year, recognizing any gain or loss for that year. Under the mark-to-market election, the taxpayer is required to include in their taxable income each year the difference between the fair market value of their PFIC investment at the end of the tax year and the fair market value of the investment at the beginning of the year, regardless of whether the investment was actually sold during the year. This means that the investor is required to pay tax on any unrealized gains each year, even if they have not sold their investment. This eliminates the need to apply the default PFIC rules, which generally impose deferred taxation and a potentially punitive tax regime on PFIC investments.
To make a mark-to-market election for a PFIC, the taxpayer must file Form 8621 with their tax return for the year they wish to make the election. You can only make a current year’s election and not a past year’s election. Once the election is made, it generally applies to all PFIC investments held by the taxpayer in that year and future years.
A MTM election has both advantages and disadvantages and may not be suitable for all taxpayers. Here are a few key points to consider:
- Immediate taxation: Gains on PFIC investment are recognized and taxed annually.
- Capital gains treatment: The gains are generally treated as capital gains, potentially resulting in a lower tax rate.
- Avoidance of excess distributions: Under the default PFIC rules, certain distributions from a PFIC can be subject to an interest charge. The MTM election can help avoid this charge.
- Potential tax liability: Making the MTM election means recognizing gains even if the investment is not sold, which can result in tax liability without cash flow.
- Loss limitations: Under the MTM election, losses from a PFIC investment are generally deductible only to the extent of previously recognized gains.
- Complex calculations: The MTM election requires ongoing tracking and valuation of the PFIC investment.
Taxpayers should consult with a qualified tax professional before making this election for their PFIC investments, as it can have significant tax consequences and may vary depending on individual circumstances.
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