If you're an NRI living in the US and hold Indian investments, you need to know about PFIC. PFIC stands for Passive Foreign Investment Company.
The IRS classifies most Indian mutual funds under this label and taxes them under a regime that costs far more than standard US capital gains rates.
I'll explain what qualifies as a PFIC, how the IRS taxes it, and what you need to file.
What is a PFIC?
A Passive Foreign Investment Company is any foreign corporation that meets at least one of two annual tests under IRC Section 1297.
The two PFIC tests
Income test: 75% or more of the corporation's gross income for the tax year is passive. Passive income includes dividends, interest, rents, royalties, and gains from selling passive assets.
Asset test: 50% or more of the corporation's average assets during the tax year are assets that produce passive income, or are held to produce passive income.
A company only needs to meet one test, not both. Most Indian mutual funds meet both. They hold only passive assets, such as stocks, bonds, and money market instruments, and all their income is passive. There is no active business anywhere in the structure.
The tests run every year. A fund that qualifies as a PFIC this year is almost certainly a PFIC next year too.
| Investment | PFIC? | How it's taxed in the US |
|---|---|---|
| Equity mutual fund | Yes | Section 1291 or Mark-to-Market |
| Debt mutual fund | Yes | Section 1291 or Mark-to-Market |
| Hybrid mutual fund | Yes | Section 1291 or Mark-to-Market |
| ELSS | Yes | Section 1291 or Mark-to-Market |
| ULIP (investment portion) | Yes | Section 1291 |
| Indian ETF (NSE/BSE listed) | Yes | Section 1291 or Mark-to-Market |
| NPS | Uncertain | Seek advice |
| Direct Indian stocks | No | Capital gains |
| PMS | No | Capital gains per stock |
| NRE/NRO fixed deposit | No | Ordinary income (interest) |
| PPF / EPF | No | Varies, not a PFIC |
| Real estate | No | Capital gains |
NPS operates through a statutory trust rather than a corporation, so it may not meet the PFIC definition. The underlying fund pools may qualify separately. Get specific advice before assuming NPS is PFIC-free.
When do PFIC rules apply to you?
PFIC rules apply the moment you become a US tax resident. That timing is determined by the Substantial Presence Test (SPT) for visa holders.
How the Substantial Presence Test works
You are a US tax resident for a calendar year if you were in the US for at least 31 days in the current year and the following formula totals 183 or more:
- All days present in the current year
- Plus one-third of days present in the prior year
- Plus one-sixth of days present in the year before that
Most H1B holders pass this test in their first calendar year of arrival. That means from the beginning of US residency, your Indian mutual funds are subject to PFIC rules.
Green Card holders become US tax residents on the date the card is approved, regardless of when they physically move. L1 visa holders follow the same SPT formula as H1B holders. For a full breakdown of how residency timing works by visa type, including the First-Year Choice election and the green card approval date trap, see when the PFIC clock starts for H-1B and green card holders.
Your Indian mutual funds don't change on the day you become a US tax resident. Your obligation to report and pay US tax on them does. For options available in that first critical year, see our guide on the PFIC first-year cost basis reset.
Why the India-US DTAA doesn't protect you from PFIC
Many NRIs assume the India-US tax treaty will prevent them from being taxed twice on their Indian investments. For most income types, it does. PFIC is a different situation.
The PFIC rules are anti-deferral rules. The US tax code designed them to prevent US taxpayers from postponing tax by holding wealth inside foreign corporate structures. Because they serve this anti-deferral function, they operate outside the scope of normal treaty relief.
In practice, you can claim a Foreign Tax Credit for Indian taxes you paid on your mutual fund gains. That credit will reduce your US tax bill slightly, but it won't eliminate the PFIC tax or the interest charge. The treaty gives you a credit mechanism, not an exemption from PFIC. You still file Form 8621. You still face the excess distribution calculation.
How PFICs are taxed: the three regimes
The IRS gives shareholders of PFICs three ways to be taxed. The default method is almost always the worst outcome.
Section 1291: the default excess distribution method
If you don't make any election, Section 1291 applies automatically. Here's how it works.
When you receive a distribution from a PFIC, the IRS checks whether it is an excess distribution: more than 125% of the average distributions you received in the prior three years (or the entire holding period if shorter). If it is, that excess amount is not taxed like a normal dividend. Instead, it is spread back across every year you held the fund.
Each year's allocated share is taxed at the highest individual rate that applied in that year, currently 37%, regardless of your actual tax bracket. On top of that, the IRS adds an interest charge under IRC Section 6621 to account for the deferred tax from each prior year. When you sell a PFIC, your entire gain is treated as an excess distribution and gets the same treatment.
Example: Amit bought Rs 15 lakh of an Indian hybrid mutual fund in 2022 when he lived in India. He moved to the US on an H1B in mid-2022 and passed the Substantial Presence Test for that year. In 2026, he sells the fund and realises a $12,000 gain. Under Section 1291, that $12,000 is spread across the four tax years he held the fund as a US resident (2022, 2023, 2024, 2025).
Each prior year's allocated share of $3,000 is taxed at 37%, plus a daily interest charge on each year's deferred amount. His effective tax rate on the gain works out to roughly 42%, compared to the 15% he would have paid on a long-term US stock fund.
For a detailed walkthrough of how Section 1291 applies to Indian equity mutual funds specifically, see our PFIC tax rules guide. Debt funds face the same mechanism on a smaller return base, making Indian debt mutual funds one of the more costly PFIC holdings in a US NRI's portfolio.
QEF election: theoretically better, unavailable for Indian funds
The Qualified Electing Fund (QEF) election is generally more tax-efficient, but unavailable for Indian funds. QEF requires the fund to provide a PFIC Annual Information Statement, no Indian AMC, including HDFC, ICICI, SBI, Axis, or Kotak, issues this document.
Mark-to-Market election: available for Indian mutual funds, but requires a timely election
The Mark-to-Market (MTM) election under Section 1296 treats the PFIC as if you sold it on December 31 each year, paying ordinary income tax on the paper gain. It eliminates the interest charge entirely but must be elected in your first year as a US tax resident, and most Indian open-ended funds qualify under Treasury Regulation Section 1.1296-2(d).
For the full comparison of all three regimes, including the Section 1296(j) mechanism to exit Section 1291 if you missed Year 1, see our PFIC elections guide.
How to report a PFIC: Form 8621
You file Form 8621 for each PFIC you hold, for each year you hold it. The form is attached to your federal income tax return (Form 1040). The current version is the December 2025 revision, available on the IRS Form 8621 page.
Who must file
You must file Form 8621 if you:
- Received a distribution from a PFIC during the year
- Recognised a gain on a direct or indirect disposition of PFIC stock
- Are making or maintaining a QEF or Mark-to-Market election
- Are required to file an annual report under Section 1298(f)
The $25,000 de minimis exception
If the total fair market value of ALL your PFICs combined is $25,000 or less at year-end ($50,000 for married filing jointly), and you received no distributions and made no dispositions that year, you may skip filing Form 8621. This threshold applies to all your PFICs added together, not to each fund individually. If your combined PFIC holdings exceed this amount, you must file separately for each one.
Deadline and the new currency code requirement
Form 8621 is due with your regular tax return: April 15, or October 15 if you file an extension.
Under the December 2025 instructions, Part V includes a new field requiring filers to enter a three-letter currency code (INR for Indian rupees) for amounts reported in a foreign currency.
For a step-by-step walkthrough of how to complete the form, part by part, with Indian mutual fund examples, see our guide to filing Form 8621. For the FBAR and FATCA reporting obligations that often go alongside PFIC compliance, see our guide on FBAR and PFIC compliance for mutual funds.
PFIC-safe ways to invest in India
PFIC rules don't mean you can't invest in India. Direct Indian stocks, Portfolio Management Services, US-domiciled India ETFs like INDA, and certain GIFT City funds all give you India exposure without PFIC treatment. For a full breakdown of how each option works, the setup requirements, and a decision matrix for your situation, see our guide on four PFIC-free Indian investment options for NRIs in the US.
Conclusion
PFIC is one of the most expensive tax surprises for NRIs who held Indian mutual funds before moving to the US. The default Section 1291 method taxes prior-year gains at 37% plus interest, pushing the effective rate well above 40%.
If you're still holding Indian mutual funds, reviewing the Mark-to-Market election or switching to PFIC-compliant alternatives is worth doing now. If you've never filed Form 8621 for years you should have, the IRS Streamlined Filing Procedure offers a path to get compliant before FATCA reporting surfaces the gap.
If you need help with PFIC compliance, our NRI financial advisors at InvestMates are among the best experts in US India cross border taxes.
Frequently asked questions
How does PFIC tax work?
Under the default Section 1291 method, any distribution that exceeds 125% of your average distributions over the prior three years is an excess distribution. Any gain you realise on selling is also an excess distribution. That amount is then spread back across every year you held the PFIC as a US tax resident.
Each prior year's allocated share is taxed at the highest individual rate that applied in that year (37% for recent years), and the IRS adds a daily interest charge under IRC Section 6621 on each portion. The combined effect typically pushes the total tax to 40-45% of the gain.
What form do I need to report a PFIC?
You file Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. A separate Form 8621 is required for each PFIC you hold, for each year you hold it. The form attaches to your Form 1040 and is due by April 15, or October 15 if you file for an extension.
What is the tax rate on PFIC income?
Under Section 1291, each prior-year allocated portion of an excess distribution or sale gain is taxed at the highest individual income tax rate that applied in that year: 37% for tax years 2018 through at least 2025. This rate applies regardless of your actual tax bracket.
On top of the 37%, the IRS adds an interest charge under IRC Section 6621, calculated from the original due date of each prior year's return. The two together regularly produce an effective rate of 40-45% on PFIC gains.