Your fund fell in value and you still owe tax at the top rate

Figures relate to tax year 2025-26 (UK) · 2025 (US)

Almost every pooled fund sold in Britain is a passive foreign investment company as far as America is concerned. Unit trusts, OEICs, investment trusts, most European ETFs.

What follows from that label is harsh. Gains come out at the highest ordinary rate rather than capital gains rates, spread back across every year you held the thing, with interest charged on the delay.

Form 8621 is where all of it gets reported, one per fund, every year. This article covers which holdings are caught, the three ways they can be taxed, and which escape routes actually exist in Britain.

Key takeaways

• Nearly every pooled British fund is a PFIC in American eyes.
• Form 8621 is filed once per fund, for every year you hold it.
• The default regime taxes gains at the top rate plus interest.
• Two elections exist, and British funds rarely support the better one.
• The ISA wrapper gives no protection from Form 8621 whatsoever.
• A pension generally does protect the funds inside it.
• An unfiled Form 8621 keeps the whole tax year open indefinitely.

Which investments count?

Any foreign company whose income or assets are mostly passive, which captures essentially every pooled fund outside America. Unit trusts, OEICs, investment trusts, exchange traded funds and offshore bonds all tend to qualify. The test looks at the fund's own balance sheet rather than at what you intended.

Individual company shares are not caught, because a trading business is not passive.

That single distinction drives most of the planning we do for clients.

Does the ISA wrapper help?

Not at all, and this is the point British advisers most often miss. America does not recognise the wrapper, so it looks straight through to the funds inside. A stocks and shares ISA holding five funds produces five copies of Form 8621, exactly as a general account would.

Our guide to the lifetime ISA and US tax shows the arithmetic.

The British tax saved is real. The American side simply charges more.

What is the default regime?

The treatment that applies automatically where no election is in place. It exists to strip out any benefit from deferral. The rules spread gains and large distributions evenly across your holding period, apply the top rate for each year, then add interest for the delay.

The longer you held the fund, the worse the outcome becomes.

A holding of fifteen years can see most of the gain disappear once interest piles on top.

How bad is the interest charge?

Heavier than people expect, because it compounds on tax that was never actually due at the time. The rate follows the published underpayment rate, which stood at 7 per cent through 2025. Applied across a decade of slices, it can add a third again to the bill.

No credit reduces it, since Britain levied no matching charge.

In our practice this is the figure that shocks clients most.

A worked example

Take an illustrative example. An American in Bristol buys £40,000 of a British global equity fund in 2019 and sells it for £62,000 in 2025.

The £22,000 gain is spread back across the six years she held it. Each year's slice attracts the highest ordinary rate for that year, not capital gains rates.

An interest charge then runs on each slice from its own year to the date of sale. The oldest slices cost the most.

Britain charges her nothing, because the fund sat inside an ISA. There is therefore no foreign tax credit to set against any of it.

The three regimes compared

What is a QEF election?

An election that taxes you each year on your share of the fund's actual income and gains, much as a partner pays on partnership profits. It removes the interest charge entirely and preserves capital gains treatment on the gain portion. It is comfortably the best of the three outcomes.

The catch is that it needs information only the fund can provide.

That requirement is where it falls apart in Britain.

Can a UK fund actually provide that?

Very few will, because it means preparing an annual information statement to American tax rules for a handful of investors. A British fund manager has no commercial reason to bother. Some larger groups produce them for institutional clients and will not extend that to a retail holder.

Ask the manager in writing before assuming either way.

A refusal is normal rather than unusual.

What is a mark to market election?

An election treating the fund as sold on the last day of each tax year, so you pay on the rise in value even though nothing left your portfolio. It also removes the interest charge. The gain attracts ordinary rates rather than capital gains rates.

It only covers funds that trade regularly on a recognised market.

That covers most exchange traded funds and excludes many unit trusts.

Which election suits most people?

Mark to market, simply because it is usually the only one open to you. It keeps Form 8621 short as well. It demands no cooperation from the fund and the calculation needs nothing more than two year end prices. The price is paying tax annually on paper gains you have not realised.

Our guide to the PFIC purging election covers cleaning up an old holding first.

Making the election in the first year of ownership avoids a great deal of trouble.

What if the fund makes a loss?

Losses are treated far less generously than gains, which is the asymmetry that annoys people most. Under the default regime a loss on sale gives you nothing at all. A mark to market election allows a loss only to the extent of gains you previously reported on that same holding.

So a fund that falls in value can still leave you worse off than an ordinary investment.

That asymmetry is deliberate rather than an oversight in the drafting.

Does a pension protect the funds inside it?

Generally yes, which is the single most useful fact in this whole area. Funds inside a recognised British pension scheme count as owned by the scheme rather than by you. The treaty protection on the pension carries the holdings with it.

Our guide to UK pensions and US retirement reporting sets out the position.

That is why we steer American clients towards pension wrappers over every other option.

Do investment trusts count?

Almost always, despite being companies rather than open ended funds. Their income and assets are passive, which is the only test that matters. The closed ended structure British investors value makes no difference to the analysis.

Venture capital trusts fall in the same category.

British advisers recommend both constantly without knowing this.

What about exchange traded funds?

A European or Irish domiciled ETF is a PFIC like any other pooled vehicle. An American domiciled ETF is not, because it is already an American fund. The domicile on the factsheet decides it, not where you bought it.

Our guide to UK reporting fund status covers the British half of the question.

Check the domicile before every purchase rather than afterwards.

What is Form 8621?

The annual return an American files for each holding in a passive foreign investment company. It reports what you own, what it paid you and what you sold, then applies whichever of three regimes governs that holding. According to IRS guidance on the form, every such holding needs its own.

Form 8621 runs long for something covering a single fund. Six holdings produce six of them.

That volume, rather than any single calculation, is what makes it expensive to prepare.

Is there a small holdings exemption?

A limited one. Where your total PFIC holdings stay under $25,000, or $50,000 for a married couple filing jointly, and no excess distribution reached you, you can skip the annual Form 8621. The underlying tax rules still apply when you eventually sell.

The exemption covers the paperwork rather than the charge.

Crossing the threshold mid-year brings the filing back.

Do you file while simply holding?

Usually yes, even in a year with no sale and no distribution. Form 8621 reports the holding itself, not merely transactions. Under the default regime a quiet year still needs the form, which surprises people who expect nothing to report.

Elections make the annual filing meaningful rather than merely formal.

Either way, the obligation runs every year you own the fund.

What is an excess distribution?

A distribution larger than 125 per cent of the average you received over the previous three years. Anything above that line gets the full default treatment, including the interest charge. A fund that suddenly pays out after a quiet period can trigger it.

Your first ever distribution from a holding automatically falls into this category.

So a brand new fund can produce a charge in its first year.

How are ordinary dividends treated?

Distributions within the normal range attract ordinary income rates rather than the preferential dividend rate. A PFIC can never pay a qualified dividend. That alone costs a higher rate taxpayer several percentage points every year.

Our guide to UK dividends on a US return covers the rates.

Reinvested distributions count exactly as cash ones do.

What if you inherited the funds?

Your holding period generally starts at the date of death, which limits the damage considerably. A recently inherited holding has few years to spread a gain across. Selling promptly keeps it that way.

Executors frequently hold investments for a year or more while an estate settles.

Our guide to US executors of UK estates covers that period.

Does a joint holding split?

Each owner reports their own share, so a jointly held fund produces a form for the American spouse covering their portion. A non-American spouse reports nothing at all. Where the money genuinely belongs to them, no form arises.

That is the planning route most mixed couples take.

The holding has to be genuinely theirs rather than nominally so.

What if you have never filed one?

You are in a large group, and the position is fixable. Most people discover the rules years into holding the funds, long after a British adviser recommended them. The route back depends on whether income went unreported as well.

Our guide to delinquent information returns covers one of the two options.

Acting before the IRS writes to you keeps the cheapest routes open.

Does an unfiled form keep the year open?

Yes, and this is the strongest argument for dealing with it. The assessment period for the entire return does not begin until the missing form arrives. A year from 2016 with an unfiled form is still open today, exposing every item on that return.

Filing late starts a three year clock that otherwise never runs.

The exposure covers the whole return, not just the fund.

What does it cost to prepare?

More than the rest of the return in many cases, because each Form 8621 needs its own calculation and its own history. A portfolio of eight funds can double a preparation fee on its own. That running cost often exceeds the British tax the funds were saving.

Selling the funds removes the cost permanently.

Our guide to ISA alternatives for Americans sets out what to hold instead.

Should you simply sell everything?

Often yes, though timing matters because the charge crystallises on sale. Selling in a low income year reduces the rate applied to each slice. Holding on merely defers a bill that grows with every further year of interest.

Very few clients regret selling once they see the annual cost.

Model the exit before acting, since a large portfolio can span several tax years.

Does the form affect your state return?

Most states simply follow the federal figure, so the charge flows through without a separate calculation. A few decouple from federal treatment and reach a different number. Anybody still tied to a state should check before assuming the federal result settles it.

Our guide to state tax for expats covers breaking residence.

Most expatriates have no state filing at all, which removes the question entirely.

What records should you keep?

Keep the purchase contract for every fund, the dollar cost on that date, every distribution notice and the year end value for each year held. Those four items are what the calculation runs on, and no platform statement contains all of them.

Record the exchange rate used alongside each figure.

Keep them for as long as you hold the fund, plus six years.

How to handle Form 8621

1. List every pooled fund you hold, inside and outside an ISA.
2. Check each one's domicile and whether it is exchange traded.
3. Ask each manager in writing for an annual information statement.
4. Make a mark to market election where the fund qualifies.
5. Record the purchase date and dollar cost for every holding.
6. File one Form 8621 per fund for each year you hold it.
7. Check whether the small holdings exemption lets you skip Form 8621.
8. Review annually whether the fund is worth keeping at all.

Mistakes and penalties we see with Form 8621

The first is assuming an ISA protects the funds. It protects them from HMRC and from nobody else.

The second is filing one form for a whole portfolio. Each fund needs its own.

The third is missing the election window in the first year of ownership, which forces the default regime afterwards.

The fourth is holding on to defer the charge, which simply adds another year of interest to it.

How US UK Tax Accountants helps

We go through a portfolio line by line and tell you which holdings the rules catch and which stay clean. Then we work out whether any of them support the better election.

Where funds should go, we model the exit across tax years rather than selling everything at once. Our PFIC reporting service covers the forms while the position unwinds.

If a British adviser has just built you a fund portfolio, get in touch before the first year end.

Last reviewed 18 October 2026. This article is general information and not personal tax advice, and nothing here is a recommendation to buy or sell any investment.