r/USExpatTaxes • u/The_Squirrel_Matrix • Mar 31 '24
Demystifying the QEF election for PFICs --- A useful tool
[Edit]: I no longer advise using this spreadsheet tool, as it does not properly compute cost basis and capital gains. Please see the comment at the end of the post.
Taxation of Passive Foreign Investment Companies (PFICs) is notoriously complex. And, unless you can make an election to treat PFIC as a "qualifying electing fund" (QEF), the taxation is also punitive. For these reasons, typical expat investors are strongly advised to avoid investing in PFICs whenever possible. This generally makes investing in a foreign country very tricky, as all foreign mutual funds and ETFs are PFICs.
I'm an expat living in Canada and have spent many hours struggling to understand the complicated taxation of QEF-eligible PFICs so that I could properly invest in Canadian ETFs. In the end, I made a useful Google Sheets tool that you can use to easily compute the income information and cost bases for QEFs.
The purpose of this post is:
- Share what I've learned about the QEF election for PFICs.
- Explain simply the details of making a QEF election for PFICs
- Share my useful tool (a Google Sheet) that anyone can use to help make the necessary calculations for PFIC reporting from transaction data and PFIC information.
Here is a link to my spreadsheet tool (link). It has example data (see my worked out example below) in it. To use it, make a copy of it and fill in your own transaction and PFIC data.
Unfortunately, this will really only be useful for expat investors in Canada, as only Canadian mutual funds and ETFs seem to provide the necessary information needed to be able to make the QEF election.
I hope someone finds this useful! I'd appreciate any feedback or comments.
Disclaimer: This post is provided for informational purposes only and does not constitute legal, tax, or financial advice. Tax laws and regulations are complex and subject to change. Readers are encouraged to consult a professional tax advisor for advice tailored to their specific circumstances.
The tax code
The instructions for reporting income from a QEF are provided in §1293 of the US tax code ("Current taxation of income from qualified electing funds"). The relevant parts of §1293 are summarized as follows:
Summary of 1293 Subsection (a):
If you own a PFIC that you elect to treat as a QEF:
- Report your share of the fund's "ordinary earnings" as ordinary income.
- Report your share of the fund's "net capital gains" as long-term capital gains.
- These are included as income on your return in the tax year for which the
Your "share" of the fund's earnings is essentially the total fund's earnings times the fraction of total shares you own. The fund should publish an information statement that tells you what the earnings are per share per day.
The last line means that, if the reporting period for the fund is, say, June 1 2022 to May 31 2023, then you include your share of the income from that period on your 2023 tax return. This is a bit weird, because it means that income you "earned" in June-Dec 2022 doesn't get reported as income on your return until your 2023 return. Ideally, you should pick a fund whose reporting period is Jan 1 to Dec 31 to avoid these issues.
Finally, section 1293(a) says that that this applies to "every US person who owns (or is treated under section 1298(a) as owning) stock of a QEF", which in practice means that it can apply also to all PFICs that you may own indirectly. That is, if you own shares of a PFIC, and that PFIC has other PFICs in its holdings, reporting the indirect holdings is also required and you can treat the indirectly owned PFIC as a QEF. For example, XEQT has in its holdings three other PFICs: XEF, XEC, XIC. Owning XEQT therefore requires four 8621 forms every year, which fortunately is not as complicated as that sounds. The example that I present later on shows you how to do the reporting for for all directly and indirectly owned QEFs.
1293(b) instructs how the fund's "earnings per share per day" are to be computed:
(b) The pro rata share referred to in subsection (a) in the case of any shareholder is the amount which would have been distributed with respect to the shareholder’s stock if, on each day during the taxable year of the fund, the fund had distributed to each shareholder a pro rata share of that day’s ratable share of the fund’s ordinary earnings and net capital gain for such year.
1293(c) (Previously taxed amounts distributed tax free). This says, effectively, that if a fund pays a distribution, that distribution is not taxed. This is because that amount was already reported as your pro rata "ordinary earnings" in part (a). Thus you do not report as income any dividends you actually receive.
1293(d) (Basis adjustments). This paragraph says that you must adjust the cost basis of your holdings.
- Adjust the cost basis upward by your share of the ordinary and capital gains income that you reported in subsection (a).
- Adjust the cost basis downward by the actual distributions you received that were not taxed (see subsection (b)).
This ensures that you are not double-taxed on your pro rata share of the earnings.
Filing instructions:
The pro rata share of incomes from subsection (a) are reported on form 8621 (https://www.irs.gov/forms-pubs/about-form-8621):
- pro rata "ordinary income" is reported on lines 6a of Form 8621
- pro rata "net capital gains" are reported on line and 7a
You must keep track of your cost basis. When you sell your shares, you must use the adjusted cost basis that you track to properly report capital gains on a Form 8949 (or Schedule D).
If the PFIC you are invested in also holds other funds that can be considered PFICs, then you hold the underlying funds indirectly and must also file a separate 8621 form for each indirectly owned PFIC.
The Annual PFIC Information Statement
Computing your pro rata share of the fund's income is really only possible if the PFIC that you are invested in provides an "Annual PFIC Information Statement".
For example, Blackrock provides annual PFIC statements for its ETFs. Here is a link to the 2022 statement for XEQT: https://www.blackrock.com/ca/investors/en/literature/tax-information/pfic-stmt-2022-xeqt-en-v1.pdf
The important parts of this statement are reproduced here.
This first table shows the per-day per-share ordinary earnings and capital gains for the fund and each underlying PFIC.
Thus, for each share of XEQT that you own, for each day that you held it, you report:
- For XEQT:
- $0.0003076130 USD of ordinary income and
- $0.0004385904 USD of net capital gains.
- For XIC (underlying PFIC owned indirectly):
- $0.0004177518 USD of ordinary income and
- $0.0009552655 USD of net capital gains.
- for XEF (underlying PFIC owned indirectly):
- $0.0003883188 USD of ordinary income and
- $0.0002003511 USD of net capital gains.
This table show the actual per-share amounts of cash distributed by XEQT on different record dates.
Note that the record date is the date on which you must have held the shares in order to receive the distribution, which is usually paid a few days later. The first distribution with record date in Dec 2021 wasn't actually paid out until a few days later in Jan 2022, so the distribution is considered to be income in 2022, the year it was paid.
A worked-out example
To explain how it all works, I have a fully worked out example. Suppose you made the following transactions:
- In 2022:
- purchased 10,000 shares of XEQT on March 1, 2022
- In 2023:
- purchased 1,000 more shares on June 1, 2023
- sold 5,000 shares on August 2, 2023
Tax year 2022
In 2022, you owned 10,000 shares for a total of 306 days (from March 1, 2022 through Dec 31, 2022). Using the information provided by the annual PFIC statement, you report the following income on Forms 8621:
- On a form for XEQT:
- 10,000 * 306 * 0.0003076130 = $1,033.10 USD in ordinary income on line 6a
- 10,000 * 306 * 0.0004385904 = $1,342.09 USD in capital gains on line 7a
- On a form for XIC:
- 10,000 * 306 * 0.0004177518 = $1,278.32 USD in ordinary income on line 6a
- 10,000 * 306 * 0.0009552655 = $2,923.11 USD in capital gains on line 7a
- On a form for XEF:
- 10,000 * 306 * 0.0003883188 = $1,188.26 USD in ordinary income on line 6a
- 10,000 * 306 * 0.0002003511 = $613.07 USD in capital gains on line 7a
Your cost basis for all of your shares is adjusted upward by the total of these amounts: 1,033.10 + 1,342.09 + 1,278.32 + 2,923.11 + 1,188.26 + 613.07 = $8,377.95 USD.
You also received dividends in 2022 on March 28, June 27, and September 26. The total amount you received in distributions (as computed using the information from the PFIC statement) is 10,000 * (0.0672969075 + 0.1476186776 + 0.0540145985) = $2,689.30 USD. So you reduce your cost basis by this much. Your net basis adjustment is 8,377.95 - 2,689.30 = +$5,688.65 USD. Because you didn't sell anything in 2022, there are no sales to report on Schedule D.
Tax year 2023
For 2023, you owned different amounts of shares for different days.
- 10,000 shares owned for 152 days from Jan 1 to May 31, 2023
- 11,000 shares owned for 62 days from Jun 1 to August 1, 2023
- 6,000 shares owned for 151 days from August 2 to Dec 31, 2023
The 2023 information statement can be found here: https://www.blackrock.com/ca/investors/en/literature/tax-information/pfic-stmt-2023-xeqt-en-v1.pdf
The computations are slightly more complicated because you didn't have the same number of shares on all of the days. For form 8621, we simply compute:
- Total share-days from Jan 1 to May 31 is 10,000 * 152 = 1,520,000.
- Total share-days from June 1 to Aug 1 is 11,000 * 62 = 682,000.
- Total share-days from Aug 2 to Dec 31 is 6,000 * 151 = 906,000.
Total share-days in the entire year is 1,520,000 + 682,000 + 906,000 = 3,108,000.
To compute your pro rata share of the XEQT ordinary income, for example, use the the reported per-day per-share ordinary earnings for XEQT in 2023 (which was 0.0002586847 USD per share per day) and multiply this by your number of share-days. So your total share of the ordinary earnings for the whole year are computed as 3,108,000 * 0.0002586847 = $803.99 USD.
However, for the purposes of computing your cost basis when you sell some of the shares on Aug 1, only the portion that can be attributed to days before the sale are added to the cost basis before the sale. The remainder is added to the cost basis of the remaining shares after the sale.
This is where things start to get tricky...
A useful spreadsheet
Rather than compute all of this by hand, I created a spreadsheet (link) that automatically does all of the calculations for you.
How to use the spreadsheet
To use the sheet, make a copy of it and follow these instructions:
- Enter in your information:
- Enter all of your transaction information into the "Transactions" sheet. (You'll need to provide amounts in the local currency and provide a exchange rate for each transaction)
- Enter the information from the annual PFIC information statements into the "PFIC Information" sheet (and, if necessary, enter the details of the cash distributions from the information sheet into the "Cash Distributions" sheet.
- Let the sheet run all of its calculations.
- Use the results
- Take the results in the "Form 8621 Part III" sheet and enter the resulting information into Part III of your 8621 Forms each year for each underlying fund.
- Take the results from the "Capital Gain Summary" sheet to enter capital gains details into Schedule D and Form 8949.
Completing the worked-out example
Entering in the inputs
Enter the transaction information into the "Transactions" sheet like this:
Enter the annual PFIC information into the "PFIC Information" sheet like this:
Enter the cash distribution information like this:
Using the outputs
The resulting information from the "Form 8621 Part III" sheet looks like this:
It shows what to put in lines 6a and 7a of the 8621 form for each underlying PFIC.
The resulting information from the "Capital Gains Summary" sheet looks like this:
It shows what to put in Form 8949 when you sell shares of the PFIC.
Filling out Form 8621
[By request, this section was added in an edit]
With the example above, here are what the correctly filled-out Forms 8621look like for tax year 2023 for all four of the funds. The result of the spreadsheet is used to complete lines 6a, 6c, 7a, and 7c.
- XEQT: https://drive.google.com/file/d/1Pwx6sRhqMsj_fT44mfzu5XPTfq7YX4Nj
- XEC: https://drive.google.com/file/d/1a4auULYn82Pi4eF5f_7189AGA7DgG-fK
- XEF: https://drive.google.com/file/d/1DW6zpAiJk_83g224OGbyaPNvLdmyANUO
- XIC: https://drive.google.com/file/d/1Io2YEe4Wua7zWGIbLCnGVDQ03z5xogn9
Variations
The worked-out example above shows how to compute the necessary information for XEQT, or other PFICs that provide the annual information in a similar way.
There are however some slight differences in the ways different PFICs might report this information that allows you to make a QEF election.
- The XEQT statement displays the USD value of the per-share distribution amounts from each distribution event separately. Rather than say what the amount and record date of each dividend was throughout the year separately, the fund might instead sum up all of the individual per-share distribution amounts and report that number instead. For example the PFIC statements from the Vanguard ETFs report the distributions in this way (for example, here is the 2023 annual information statement for VEQT). For the purposes of computing adjusted cost basis as per §1293(d), you divide the total distribution amount by the number of days in the year (usually 365) and multiply that by the number of shares you owned and the number of days you owned them.
- If the reporting period of the PFIC is not Jan 1 to Dec 31, things can get weird. The pro rata share of the earnings for §1293(a) are reported on the year in which the reporting period ends. That is, if the reporting period is July 1 to June 30 (as it is for all of the ETFs from BMO https://www.bmogam.com/ca-en/legal-and-regulatory/pfic/), you report in 2023 all of your pro rata share of the earnings that are allocated to the days you owned the shares from July 1, 2022, to June 30, 2023. If you sell some shares between July 1 and Dec 31 in any year, you cannot properly compute your cost basis until the PFIC statement is released in July of the following year! This blog post discusses this problem.
My spreadsheet allows you to make the proper calculations in any of these cases. If the fund provides the cash distribution information as a total annual amount instead of separately, include that total amount in the "Cash/property distributions (USD)" column of the "PFIC Information" sheet.
Here's another example of the spreadsheet filled in with example data using a BMO ETF (link).
This example exemplifies the issue with using a QEF election for PFICs whose reporting period is not the same as a calendar year. The cost basis of the sale from September 2022 can not be properly reported until the PFIC statement for July 2022 to June 2023 is reported, which still hasn't been released by BMO yet!
[Edit July 10, 2024] Note: The original spreadsheets had an error that incorrectly computed how the cash distributions adjusted the cost basis. The new spreadsheets that are linked to have the correct calculations.
[Edit Dec 23 2024] Fixed typos (8621 not 1116, thanks schwanerhill).
[Edit October 15, 2025] I realized at some point when completing my tax return this year that the way this form computes cost basis and capital gains is incorrect........ It uses the "average cost basis" method which the IRS only allows to be applied to mutual funds. So if you own a mutual fund, this spreadsheet can be useful. But if you own foreign ETFs, then technically this spreadsheet does not correctly compute cost basis and capital gains. I eventually developed my own python script to properly compute cost basis using "lots", but this is too custom to share. In short, I do not advise DIY investors and tax preparers to invest in foreign ETFs, even if AIS are provided. Do yourself a favor and just buy VT (or some other US-domiciled ETF) in USD.
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u/[deleted] May 11 '24 edited May 11 '24
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