Let’s say you own PFIC stock. (Hint: foreign mutual funds almost certainly are PFICs. So even normal people can own PFICs, to their absolute horror.)
You sell your PFIC stock. Better yet, you sell at a profit. “Buy low, sell high!” How hard can that be? 🙂 To make this example extremely simple, I am going to assume that you bought and sold the PFIC stock in a single calendar year, and that the PFIC never paid you a dividend (a “distribution” in PFIC jargon).
How will you report your gain on disposition of the PFIC stock on your tax return? Is this capital gain or ordinary income?
Answer: it depends. I’m going to show you the default method here.
There are three ways that PFIC stock sales are taxed. You will be shackled to using the default method unless you made a “mark-to-market” election or a “QEF” election. If you don’t know what those words mean, then you probably didn’t make those elections and you are forced to use the default method described here.
If you use the default method, the Internal Revenue Code uses the phrase “section 1291 fund” to describe your PFIC. So if you see this phrase on Form 8621 or in the Instructions to Form 8621, now you know what that means.
If you have a PFIC and you have a disposition, you first have to figure out “Do I have a gain or loss?” according to the normal rules of the Internal Revenue Code. The normal “sales price minus basis” stuff applies. So let’s assume you have gain. (Tax buffs call this “realized” gain. You have income that is theoretically subject to tax, unless you can find a way out of being taxed.)
Now that you know you have realized gain, you have to figure out whether the gain is recognized. (This is tax insider jargon for “the income you received is going to go onto your tax return and tax will be imposed.”) The default assumption of the Internal Revenue Code is that all realized gain will be recognized, unless you can find an explicit exception that applies to you.
These explicit exceptions are called “nonrecognition” provisions in the Internal Revenue Code. Let’s just assume (to make my example easy) that all of your profit from “buy low, sell high” will be recognized.
At this point we know the gain on sale of your PFIC stock will be taxable. We just don’t know whether it will be capital gain (you owned some stock as an investment, and you sold it) or as ordinary income.
The default PFIC taxation rule is in Section 1291. It is called the “excess distribution” rule. It flatly states that gain from disposition of PFIC stock will be taxed as if it is an “excess distribution.” See Section 1291(a)(2). So now we have to know how an “excess distribution” is taxed.
Again, Section 1291 helpfully (!) hardwired the answer to that question for us. An “excess distribution” is taxed as ordinary income. See Section 1291(a)(1)(B).
Dispositions of PFIC stock are reported on Form 8621. You will be filing Form 8621 along with your tax return. Here is how you do it:
Ta-DAH! You’re done.