The PFIC regime has been in existence since 1986.  Introduced in the Tax Reform Act, the regime closed a loophole. Prior to the change, assets could be transferred to entities organized outside the U.S., in order to escape U.S. taxation.

As with other foreign entities, such as foreign corporations, PFICs are brought to account in the U.S. tax system by their U.S. owners/investors. These rules can require attribution of unrepatriated income [1] to a U.S. person, as well as income deemed to be in excess of prior year’s income from an investment being subject to additional U.S. tax.

Whichever way foreign investments are held, for U.S. federal income tax purposes the objective of these rules is to tax income which would otherwise escape U.S. taxation. In the case of PFICs, the objective is also to disincentivize U.S. persons from holding investments in vehicles which generate primarily passive income. As mentioned above this is achieved by taxing what are perceived as ‘excess distributions’ under the PFIC regime. The results are two types of taxation for an income year. The first type of tax is the current year’s income tax calculated using the marginal income tax rate of the taxpayer’s taxable income on one portion of a distribution known as the non-excess distribution.

The second type of tax is ‘PFIC tax’, or S1291 tax on another portion of a current year’s distribution. S1291 tax is calculated at the top federal income tax rate (which currently sits at 37%). S1291 tax is commonly referred to as ‘throwback tax’. This term refers to the method by way of which the tax is imposed, which is on the excess distribution portion of a distribution which is allocated in retrospect over the holding period of the PFIC. The tax is then charged on the prior-year PFIC income. This is explained in greater detail later.

This article dives into the mechanics of PFICs. It looks at the three methods for calculating income under the Internal Revenue Code (Code)and includes the Excess Distribution method. The three methods of accounting for PFICs are presented with examples to demonstrate how PFICs are taxed under the tax laws of the U.S.

The availability of tax treaty relief, de minimis exemption, and the interrelationship with U.S. Controlled Foreign Corporation rules are also discussed.

All amounts are expressed in U.S. dollars unless stated otherwise.


A U.S. person has a PFIC where one of two tests is met as follows.

  1. If a U.S. person has a share of an entity that holds assets of which more than 50% of the assets produce, or are held for, the production of passive income (the asset test).
  2. If a U.S. person has a share of an entity whose income is more than 75% passive in nature (the income test).

Passive income includes interest, dividends, royalties, rents and gains.

Example. B, a U.S. citizen purchases stock in NZCo. NZCo is in the business of farming and holds assets of NZ $20m. NZCo also holds an investment portfolio with a fair market value of NZ $2m.

NZCo generates farm income of NZ $5m and passive income of NZ $0.2m representing total assets of NZ $5.2m.

  • The income test is failed, as NZ $.2m (passive income) / NZ $5.2m (total income) is less than the 75% threshold.
  • The asset test is failed, as NZ $2m (passive investments) / NZ $22m (total assets) is less than the 50% threshold.

In the above example, NZCo is not a PFIC for U.S. tax purposes.

Example. B, a U.S. citizen, opens a KiwiSaver with a local financial institution. The KiwiSaver is a PIE (NZ PIE). B transfers NZ $100 cash into NZ PIE and receives 100 units in exchange.

NZ PIE is managed by fund managers and is in the business of investing.  Fund managers sell units in NZ PIE to investors.

NZ PIE’S assets consist of shares and bonds in health care companies. Those shares and bonds generate dividends and interest and are passive in nature. NZ PIE has:

  • 100% of its income classed as passive income, and
  • 100% of its assets generate passive income.

NZ PIE is a PFIC for U.S. tax purposes.

The Mechanics – Taxation of PFICs under the Code

As mentioned earlier, three methods exist. Of those methods, the Excess Distribution method is the default method. Unless an election is made to mark-to-market or to treat the PFIC as a QEF, the Excess Distribution method must be used. This all is covered by Sections 1291-1298 of the Code.


Under the mark-to-market method the gain or loss is measured as the difference between the fair market value at the end of the income year and the taxpayer’s adjusted basis in the PFIC.

Depending on the outcome for the income year, a taxpayer will have a gain or a loss. If a loss under the mark-to-market calculation, the loss will be subjected to loss limitation rules. Those rules assess a loss calculated under the mark-to-market calculation for deductibility. The loss limitation relates to the total PFIC gains returned under the mark-to-market rules for the years over which the fund has been subject to U.S. tax as a PFIC. The outcome being that a loss for the current year may be deducted from other non-PFIC gross income to the extent that prior year gains have been included in past years’ total gross income on a U.S. income tax return. Disallowed losses are forfeited. Disallowed losses are unavailable to be carried forwards or back to prior years. This is different treatment to other types of losses calculated under the Code, such as capital losses and net operating loss carryforward and carryback provisions.

PFIC gains are recognized as ordinary income, Gains are subject to U.S. tax at ordinary income tax rates.

An election to use this method must be done on a timely basis. An election isn’t available on overdue U.S. income tax returns. In this situation, either of the other two methods (discussed later) are available.

Example. Mark-to-market calculation

A, U.S. citizen acquires stock in PFIC B in year 1. The cost price is $100. At the end of year 1, the fair market value of A’s share of PFIC B is $110.

In year 2, A. files a U.S. income tax return for year 1 and files it by the due date of the tax return. On the return, A makes an election for PFIC B to use the mark-to-market method. A has timely filed the return for the year in which PFIC B was acquired and thus the mark-to-market calculation results in A having income from PFIC B for the income year of $10. $10 is included in A’s U.S. income tax return for year 1 as ordinary income subject to tax at ordinary income tax rates applicable to A’s filing category and income bracket.

Example. Mark-to-market calculation

A, U.S. citizen, purchases PFIC stock on 1/1/2018 for $100.

On 12/31/2018 the fair market value of the stock is $110. A calculates a gain of $10 under the mark-to-market method, files a U.S. income tax return for 2018 and declares $10 of income from the PFIC as ordinary income subject to tax at ordinary income tax rates applicable to A’s filing category and income bracket.

On 1/1/2019 B has an adjusted basis in the PFIC stock of $110.

On 12/31/2019 the fair market value of the stock is 90. B’s basis in the stock is $110. B has a loss of $20 for the 2019 income year.

Of the $20 loss, $10 can be claimed against other, non-PFIC ordinary income on B’s income tax return for 2019.

Designated an ‘unreversed inclusion’, the loss can be claimed to the extent of any previously recognized gain. In the above example the unreversed inclusion amount of $10, being the recognized gain from 2018.

The remaining loss, $10, is disallowed for the 2019 income year, and is forfeited.

On 1/1/2020 B has an adjusted basis in the stock of $100. That is, $100 + $10 – $100.

On 12/31/2020, the FMV of the stock is $150. B has a taxable gain from the PFIC for 2020 of $50.

On 1/1/2021 B’s adjusted basis in the stock is $150.

During 2021 the market value of the PFIC plummets, and on 11/11/2021 B disposes of the stock for $10.

Overall, B has a loss of $140. To the extent to which B has had previously recognized gain under the MTM method, which has not, as at the date of the sale, been allocated against prior losses, B may claim an ordinary loss.

For 2021, B has an ordinary loss, that is an unreversed inclusion, of $50.

The remaining $90 is recognized as a capital loss on B’s 2021 U.S. tax return according to the rules applicable for losses provided elsewhere in the Code and regulations.

Excess distribution method

A, U.S. citizen acquires stock in PFIC B in year 1. The cost price is $100. A. doesn’t file a U.S. income tax return for the year in which the stock was acquired, year 1.

In year 3, A files a U.S. income tax return for year 2.

A cannot elect the mark-to-market method for the $100 stock in PFIC A. This is because the election was not made in the return covering the year of acquisition of the stock. A must either use the QEF method or the excess distribution method.

The method takes the average distribution from the three preceding years and adds a 25% uplift.  Comparing the result to the current year’s distribution the difference is treated as excess distribution. The excess distribution is spread evenly across the holding period. The holding period usually represents the period of time from the date the PFIC was acquired, to the end of the income year. For most, but not all PFICS, the holding period start date is the date that the fund was acquired. These amounts, being spread across the prior years that the PFIC was held by the U.S. person, are taxed at the top federal income tax rate (currently 37%). Interest is also charged from the start of the holding period, the date that the fund commenced being a PFIC.

 Example: Excess distribution method for 2021 income year.

C, U.S. citizen, purchases 100 units in NZ PIE for $100 on 1/1/2018.

NZ PIE pays a dividend of $10 on 12/31/2018, also on 12/31/2019 and 12/31/2020.

On 12/31/2021 NZ PIE pays C a dividend of $1000.

The excess distribution is calculated as follows:

Total amount of distributions received: for 2018, 2019, 2020 and 2021:

Total    Excess   Year

$10        0         2018

$10        0         2019

$10        0         2020

$1,000              2021

The calculation is as follows.

  1. Calculate total current year distributions:  $1,000.
  2. Calculate the three preceding years’ distributions net of any excess distribution already returned under this method as PFIC income in a prior year:  $30.
  3. Calculate the average distribution for the three preceding years: $10.
  4. Multiple the result by 125%: $12.5.
  5. Deduct the result from the total current year distributions: $ 987.50.

The result, $987.50, is allocated across all four years as follows:

2018 $246.87

2019 $246.87

2020 $246.88

2021 $246.88

Total excess distribution allocated:  $987.50

Then, the excess distributions allocated to the prior year are taxed at the top marginal income tax rate of 37% as follows.

2018 $246.87 x 37% = $91.34375

2019 $246.87 x 37% = $91.34375

2020 $246.87 x 37% = $91.34375

Interest is calculated at the rate prescribed in the Code on the tax amounts as follows.

Qualified Electing Fund (QEF) method 

The third method is the QEF method. To use this method, an election can be made for a PFIC to be treated as a QEF and is done in the same way that the mark-to-market election is made.

This method requires the unitholder’s pro-rata share of the PFIC’s income and gains to be declared on the U.S. income tax return. In addition, a statement from the U.S. person agreeing to open the books and records of the PFIC entity to the IRS.

In the author’s experience QEF elections on PFICs are rare. This is likely to be due to the appetite of the owners of a PFIC fund to open the books of account to the Internal Revenue Service, unsurprisingly, to be zero.

A U.S. person may hold more than 10% of a PFIC. This in turn crosses over into CFCs for U.S. tax purposes. In this case, the CFC rules apply, and not PFIC rules.

NZ environment for PFICS

The ubiquitous KiwiSaver, a retirement account and a PFIC is very common for U.S. expats in NZ.

It is important to be aware that by the nature of the portfolio investment entity there will in most cases be no credit for NZ income tax by way of the PIE paying the tax on the investment.

It would only happen that a foreign tax credit will be available if the taxpayer has top up tax to pay in their NZ income tax return.

This situation arises when a pie unit holder has had incorrect PIE tax paid by the fund.


A, U.S. citizen, holds 100 units in P, a NZ PIE and a PFIC for U.S. tax purposes.

A’s PIR is 17%.  However, under N.Z. income tax rules for Portfolio Investment Entities A’s PIR should be 28%.

On A’s NZ income tax return for the year ended March 31, 2023, A has $100 gross income with $17.50 PIE tax credits.

A has incremental tax due of $28 minus $17.50 = $10.50 to pay.

A may claim NZ 10.50 as a foreign tax credit. This credit is subsumed within the PFIC calculation and is a separate calculation to the regular and alternative minimum tax foreign tax credit calculation for other items of foreign sourced income that may be recognized on a U.S. income tax return for a U.S. citizen.

Aside from KiwiSaver there are numerous other investments which may constitute PFICS for Us tax purposes. These include other types of financial investments in which an individual may subscribe and receive a share of the entire investment.

In addition, any entity which meets the definition of a PFIC and thus including entities of which a U.S. person may be a controlling investor such as a NZ limited liability company.

Irrespective of the percentage of shares held in a company it will be a PFIC and it may also be a CFC for U.S. tax purposes.

A U.S. citizen is subject to CFC rules in such a situation and disregards the PFIC rules.

De minimis exemption

If a PFIC is subject to Excess Distribution method, there is a limited exemption available. Should there be no distributions and either

a) the total combined value of all PFIC funds held by a U.S. person do not exceed $25,000, or

b) a fund is held indirectly, and the U.S. person’s indirect interest doesn’t exceed $5,000 for the year,

there is no requirement to report under the PFIC rules. 

The exemption does not apply to funds for which a mark-to-market election, or a QEF election have been made in the year prior.

Tax Treaty relief

In situations where the PFIC is held inside a foreign retirement trust, tax treaty relief may be available. This will depend firstly on the tax residency of the PFIC holder for tax treaty purposes.

An example is contained in Article 18(5)(a)(ii) of the U.K.-U.S. tax treaty.

(ii) any benefits accrued under the pension scheme, or contributions made to the pension scheme by or on behalf of the individual’s employer, during that period, and that are attributable to the employment, shall not be treated as part of the employee’s taxable income in computing his taxable income in the United States.

The N.Z.-U.S. tax treaty’s corresponding provisions don’t contain any equivalent exemption for N.Z. retirement accounts such as and including KiwiSaver accounts. Therefore, absent any exemption the account is subject to the PFIC rules for U.S. account holders.


This article has discussed the mechanics of U.S. PFIC taxation as applicable to any U.S. person holding a foreign investment classed as PFIC.  PFICs provide a layer of complexity to U.S. taxation designed to discourage U.S. persons from holding these. U.S. tax code and regulations impose tax on an unrealized basis under the mark-to-market basis as discussed above. If a U.S person reports under the Excess Distribution method there is a surcharge tax, the 1291 tax. These rules are described as being some of the most complex rules present in U.S. taxation.  Notwithstanding, PFIC taxation mirrors, to some extent, N.Z’s Foreign Investment Fund (FIF) regime. Insofar as the international tax landscape goes, policy objectives mirror other countries’ – including N.Z.’s, being the disincentive to hold passive investments in foreign entities.

[1], such as Subpart F income in the case of controlled foreign corporation

[2] Section 1297