PFIC Mark-to-Market (MTM) Election Summary Review Guide

PFIC Mark-to-Market (MTM) Election Summary Review Guide by the International Tax Lawyers at Golding & Golding – a Tax Law Firm practicing exclusively in the area of IRS Offshore Voluntary Disclosure.

PFIC Summary Guide to MTM, QEF & Excess Distributions (8621) - International Tax Lawyers

PFIC Mark-to-Market (“MTM”) or Qualified Electing Fund (“QEF”) Election by Golding & Golding

What is a PFIC?

A PFIC is a Passive Foreign Investment Company. It is a legal term that means a person has investments overseas in which a majority of the assets and/or income is generated from passive means.

In the early days, PFICs were limited to holding companies such as BVIs or ‘Anonymous Corporations.’

Fast-forward to 2017, and the definition has expanded significantly to where it is much more encompassing and includes a variety of different investments such as a Mutual Fund or ETF.

Why does the IRS dislike PFICs?

Typical example: You are an astute investor earning a significant amount of money in various investments abroad. Instead of holding each investment individually, you aggregate them under one type of umbrella or structure such as a BVI. It is not registered, such as a pre-2009 BVI, and the IRS has no idea it exists.

The Holding Company does not issue a 1099-INT or 1099-DIV and no financial statements are generated. Moreover, you hold the investment anonymously, or through a number account (common in Switzerland).

Result: You do not report the income, the IRS cannot track it, and you do not pay U.S. Income tax on the earnings.

The IRS Wants Your Complete Financial Picture

As the world started to crack down on Offshore Tax Evasion, Tax Fraud and other International Tax Related Crimes (as much as people would like to place blame on FATCA being the catalyst, it is not, as OVDP and other disclosure programs pre-date FATCA) the IRS expanded the definition of PFIC to include a broad range of different investments.

For the majority of investors, one of the main types of investments abroad in their portfolio are Foreign Mutual Funds. Prior to updated PFIC rules, Foreign Mutual Funds were typically a great investment, wherein your money was not distributed, and it grew tax-free – without the concern of excess distributions.

But now that Foreign Mutual Funds are almost always designated as PFICs, if you are the unfortunate owner of a Foreign Mutual Fund, chances are that unless you made a proper election, at some point you will be hit a tax penalty called an Excess Distribution.

For an in-depth discussion and analysis of the basic access distribution please visit one of our prior blog posts, which can be found by clicking here.

How to Rid Yourself of the PFIC Taint?

The general proposition is that once an investment is once a PFIC, it is always a PFIC. The IRS has gone to great lengths to prove this point, including the fact that even if the investment itself is no longer a PFIC, it will still be considered a PFIC to the investor who invested in the fund.

In other words, once you own an investment abroad that is considered to be a PFIC, your best way to parachute out — short of selling the entire asset and taking excess distribution – along with taxes and penalties that can reach 100% value of the investment is to make a late election – if possible.

By making an election you may be able to limit the fines and penalties that the IRS levy against you at the time of an excess distribution (although a phantom Excess Distribution will be calculated at the time you make any late  MTM election, outside of OVDP).

Mark-To-Market Election (MTM)

The purpose of this summary is to not get bogged down by all the nuances and technicalities of the election; rather, it is to attempt to assist individuals who may be considering making the election (usually through the OVDP process) to get a big picture understanding the pros and cons.

**As a side note, as of May 2017 the IRS will still not allow an individual to make a mark-to-market election if they are in the streamlined program (as opposed to traditional OVDP)

Understanding the MTM Election

Generally, in the United States a person is taxed when an event occurs. For example, if a person purchases a stock for $1 million and in three years the value has increased to $2 million, the person does not pay tax on the increase. Why? Because tax will not be realized unless an event occurs, such as when he sells the stock (presuming that at the time of the sale, the current sale value still exceeds the basis).

But First…A Little Background About Excess Distributions

Likewise, when a person has a PFIC, and they did not make an election, they are not taxed on the increase in value within the PFIC. Rather, the government saves up the tax whammy for when there is a distribution. Unless the distribution is made in the first year of the investment (as opposed to the first distribution, which could be several years after the initial investment was made), the person is going to be hit with an excess distribution.

In many situations, there was no distribution prior to the first distribution the person receives. In other words, there are not steady annual distributions to the investor each year (which could curtail an excess distribution issue), but after a few years there may be a distribution – of either interest, dividends, or capital gains.

Presuming that the distribution exceeds the average of 125% value of the three prior-year distributions, the IRS deems this distribution an excess distribution. In your mind, you should equate excess distribution with penalty.

Why? Because the person is taxed at an obscene tax rate, which can be summarized like this: the total value of the excess distribution is divided by the total number of days that it was held in the PFIC. Thereafter, the person is taxed per day at the highest Ordinary Income tax rate for the corresponding year for each day they held the investment, in addition to interest.

As an example, instead of a person being taxed at a 15% long-term capital gain tax rate, they will be taxed a 39.6% tax rate even if they themselves are not in the highest tax bracket. This is true as to the excess distribution portion, for every year the investment was held – aside from the current year, which is taxed at the taxpayers ordinary tax rate.

As you can imagine, depending on how long the investment was held and the amount of money distributed in the initial distribution, the tax rate can be very high. Moreover, the IRS will also require you make interest payments for each day that the investment was held. Thus, once you calculate the highest tax rate and multiply it by several years, in addition to multiple years of interest payments, the overall payment can reach more than 75% tax.

Therefore, if possible, sometimes it will benefit you to make an election. The MTM election is more common because the other election QEF, requires more complicity from the foreign investment fund – which is usually next to impossible. Why? Because why would a foreign investment company want to succumb to US tax laws, when it doesn’t have to for any other reason?

MTM Election

With the Mark-to-Market election, the investor is making the decision to pay tax on the gains each year, despite the fact that no money is being distributed from the fund. For example, let’s say David owns $100,000 worth of a foreign mutual fund. The fund does great, and David’s fund is now worth $120,000 on the last day of the year.

Even though the investment is not distributing any of the gain to David, he will still pay tax on the $20,000 gain. Moreover, David will pay tax at the ordinary income tax rate, and not any beneficial qualified dividend tax rate. In addition, it should be noted that when the fund loses money, David is highly restricted as to what losses he can take against the gains the already paid tax on.

Can Anybody Make the Election?

No. The election must be made timely and it must be in accordance with Internal Revenue Code section 1296 – which has very strict requirements. As a side note, if a person is submitting to the traditional Offshore Voluntary Disclosure Program (OVDP) they are allowed to make an MTM election at the time of the submission. Otherwise, they have to qualify for Reasonable Cause (see below)

What Are The Requirements?

The most important aspect may be that the stock must be marketable. What does that mean? It means that the stock is traded on a national securities exchange, which is registered with the Securities and Exchange Commission or the national market system in accordance with the securities and exchange act of 1934. Alternatively, the stock must be traded on any exchange or other market which the Sec. determines has rules adequate to carry out the purpose of this part.

(Leave it to the government to keep it nice and ambiguous)

In other words, it needs to be legitimate – and, if it’s not registered with the SEC or national market system, then you have to explain to the IRS why the particular type of stock is still valid and should be considered marketable for the election purpose.

The IRS also provides a catchall for regulated investment companies, which provides “In the case of any regulated investment company which is offering for sale or has outstanding any stock of which it is the issuer and which is redeemable at its net asset value, all stock in a passive foreign investment company which it owns directly or indirectly shall be treated as marketable stock for purposes of this section. Except as provided in regulations, similar treatment as marketable stock shall apply in the case of any other regulated investment company which publishes net asset valuations at least annually.”

Why Would Somebody Want To Make This Election?

There are many reasons why, but the most important reason is to avoid the excess distribution. While most people want to delay paying tax as long as they can, with a PFIC — that delay can come at a very stiff price. With an MTM election, it may seem absurd the pay tax on money that is not distributed to you, but the flip-side is that it will help avoid an even larger excessive distribution tax in the future.

In many foreign investments (just as in US investments), the investment does not pay-out during the initial phase of the investment. Rather, many years down the line once the company or investment is successful, then the investor (you) are rewarded with a nice distribution.

With the excess distribution tax/penalty scheme, the longer that the investment remains profitable — but is not being distributed to you — is another year and wish you be paying significant taxes and interest.

Making The Election Late (Excess Distributions)

Outside of the specifics surrounding MTM and OVDP – as with most late elections or other mistakes you want to remedy with the IRS – you can generally make a late Mark-to-Market election under the proper circumstances. Without going into specifics, this generally means that you can show reasonable cause as to why the election was not made earlier.

Please keep in mind, that you will still have to take one excess distribution at the time you make the late election for the prior year gains that were not previously taxed.

For example, let’s say you purchase the fund in 2005 for $100,000. It is now 2017, and after hanging out with your dorky tax lawyer friend, you realize that he is correct and that your foreign mutual fund is considered a PFIC. You also realize that the fund is expected to continue to grow indefinitely. Thus, in 2017 when your fund is worth about $400,000, you decide to take a late mark-to-market election.

While going forward you can use the MTM rules, for the prior years — starting from the cost basis (which is the value when you purchased it) and through the current value of the investment — you will have to perform a phantom excess distribution analysis (Phantom, because based on these facts you are not actually receiving any distribution from your foreign mutual fund).


At our international tax law firm of Golding & Golding, we limit our entire law practice to offshore disclosure.   Many of our clients still want to enter traditional OVDP, and sometimes, one of the main reasons is in order to take advantage of the mark to market election – which is not available under the new streamlined program.

The reason why the IRS permits the mark to market election for OVDP is mainly due to time. In other words, it can be very difficult to obtain the information necessary to perform the excess distribution calculation – especially the investment is an old investment then there commenced many many years ago.

As a result, when a person enters the offshore voluntary disclosure program the IRS permits them to make a mark to my election, which is similar but not identical to the election described herein.

As provided by the IRS for Mark to Market Elections under Traditional OVDP:

  • If elected, the alternative resolution will apply to all PFIC investments in cases that have been accepted into this program. The initial MTM computation of gain or loss under this methodology will be for the first year of the OVDP application, but could be made after that year depending on when the first PFIC investment was made. For example, for the earliest disclosures under this program, the first year of the OVDP application will be the calendar year ending December 31, 2005. This will require a determination of the basis for every PFIC investment, which should be agreed between the taxpayer and the Service based on the best available evidence.
  • A tax rate of 20 percent will be applied to the MTM gain(s), MTM net gain(s) and gains from all PFIC dispositions during the voluntary disclosure period under the OVDP, in lieu of the rate contained in IRC § 1291(a)(1)(B) for the amount allocable to the current year and IRC §1291(c)(2) for the deferred tax amount(s) allocable to any other taxable year.
  • A rate of 7 percent of the tax computed for PFIC investments marked to market in the first year of the OVDP application will be added to the tax for that year, in lieu of the interest charge mechanism described in IRC §§ 1291(c) and 1296(j).
  • MTM losses will be limited to unreversed inclusions (generally, previously reported MTM gains less allowed MTM losses) on an investment-by-investment basis in the same manner as IRC § 1296. During the voluntary disclosure period under the OVDP, these MTM losses will be treated as ordinary losses (IRC § 1296(c)(1)(B)) and the tax benefit is limited to the tax rate applicable to the MTM gains derived during the voluntary disclosure period (20%). MTM and/or disposition losses in any subsequent year on PFIC assets with basis that was adjusted upward as a result of the alternate resolution in voluntary disclosure years, will be treated as capital losses. Any unreversed inclusions at the end of the voluntary disclosure period will be reduced to zero and the MTM method will be applied to all subsequent years in accordance with IRC § 1296 as if the taxpayer had acquired the PFIC stock on the last day of the last year of the voluntary disclosure period at its MTM value and made an IRC § 1296 election for the first year beginning after the voluntary disclosure period. Thus, any subsequent year losses on disposition of PFIC stock assets in excess of unreversed inclusions arising after the end of the voluntary disclosure period will be treated as capital losses.
  • Regular and Alternative Minimum Tax are both to be computed without the PFIC dispositions or MTM gains and losses. The tax from the PFIC transactions (20% plus the 7% for the first year, if applicable) is added to (or subtracted from) the applicable total tax (either regular or AMT, whichever is higher). The tax and interest (i.e., the 7% for the first year of the voluntary disclosure) computed under the OVDP alternative MTM can be added to the applicable total tax (either regular or AMT, whichever is higher) and placed on the amended return in the margin, with a supporting schedule.
  • Underpayment interest and penalties on the deficiency are computed in accordance with the Internal Revenue Code and the terms of the OVDP.
  • For any PFIC investment retained beyond the voluntary disclosure period, the taxpayer must continue using the MTM method, but will apply the normal statutory rules of IRC § 1296 as well as the provisions of IRC §§ 1291-1298, as applicable.

QEF – An Alternative to the MTM Election

A QEF is a Qualified Electing Fund election. The QEF is different than the Mark-to-Market election, the QEF does not have many downsides to it, aside from the fact that you may be hard-pressed to get the information you need from the foreign investment company. Unlike the Mark-to-Market election, QEF election requires some cooperation from the foreign investment fund, which pretty much never happens.

But, if you are able to obtain the necessary information from the foreign investment fund in order to make the election, then it is something to consider because it will essentially put you into the same tax position that you would be in if it was a US fund (but not exactly).

Character of the Income

Unlike the mark-to-market election in which all gains are considered to be ordinary income, under the QEF election the income retains its character. Therefore, it was capital gain inside the fund, then it will be considered capital gain when you pay tax on it in the United States. It should be noted, that even under a QEF election, dividends issued by the foreign investment will not qualify as qualified dividends under US tax law.

The biggest problem with the QEF election is that unless it was the first year of your investment, what happens to all of the accumulated money in the prior years… Unfortunately, even with the QEF, you will still have to do at least one excess distribution.

Why an Excess Distribution if making a QEF election?

The reason you still have one excess distribution (unless the QEF election is made during the first year of the investment) is because during the time you held investment, and up until the time you make election, the fund may be growing.

And, once you make the QEF — election you will be entitled to nearly the same tax treatment the foreign investment just as if it was a US investment — so what about all the gains during the time between the initial investment and the QEF?

In other words, to rid yourself of the horrible excess distribution in the future (Read: PFIC Taint), you have to suck it up at the time you make the QEF election, and pay the 1291 tax rate for all the gains up until the time you make the election and pay them as an excess distribution.

Is a QEF Worth it?

For the majority of people — if the offshore investment is legitimate — and they are able to obtain the necessary information from the foreign fund to determine the annual growth, the QEF election is a good option. In reality, many people invest in offshore funds for the simple reason that they don’t want to know the annual growth, or how the investment increased in value – they just want the payout.

For example, you invest in a foreign fund in year one and you can get back double your initial investment in year 5. Many people do not want to know what happened between year 1 and year 5…

Golding & Golding, A PLC

We have successfully represented clients in more than 1000 streamlined and voluntary disclosure submissions nationwide, and in over 70-different countries.

We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe.

Golding and Golding, Board-Certified Tax Law Specialist

Golding and Golding, Board-Certified Tax Law Specialist

Golding & Golding: Our international tax lawyers practice exclusively in the area of IRS Offshore & Voluntary Disclosure. We represent clients in 70+ different countries. Managing Partner Sean M. Golding is a Board-Certified Tax Law Specialist Attorney (a designation earned by < 1% of attorneys nationwide.). He leads a full-service offshore disclosure & tax law firm. Sean and his team have represented thousands of clients nationwide & worldwide in all aspects of IRS offshore & voluntary disclosure and compliance during his 20-year career as an Attorney.

Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.
Golding and Golding, Board-Certified Tax Law Specialist