Your broker in Lisbon, Dublin or Amsterdam sells you the country’s own index fund, and the United States does not see an index fund, because it taxes the wrapper rather than the fund. It sees a company abroad that earns dividends and interest, and that is enough to make it a passive foreign investment company — the code’s label for a fund whose income is passive. What it bills you is not the capital-gains rate you would pay at home. Each slice of the gain is taxed at the top rate in force for the year it falls in, 37% in the tax agency’s latest table. Then interest is added for the years the tax went unpaid. The rule is decades old, and it lands on the purchase rather than the sale; the label is decided by what the fund holds, not by what you do with it.
Why the wrapper stays invisible
Nothing at the counter tells you the local fund is different from your neighbour’s. A European index fund holds shares and collects dividends, and that is enough to meet the definition on either of two counts. The asset test is the one that catches a plain share fund. Shares count as assets held to produce income even when the fund never sells them.
Once the label sticks, the capital-gains treatment disappears. Each year’s payouts are measured against a moving line. The part above it is an excess distribution: the fund’s payouts in the year, less 125% of the average of the three years before [2]. A sale gets no separate rule. The whole gain counts as an excess distribution, so the entire profit joins the sum at once [4].
Then comes the part few readers have seen described. The excess distribution is spread evenly across every day the fund was held. Each slice is taxed at the top rate in force for the year it falls in [3]. A ten-year hold becomes ten annual bills at ten top rates, none of them the long-term capital-gains rate. Interest is added on each slice, at the rates the agency uses for tax paid late [3].
I would start with the wrapper, which is the cheapest thing to change and the last thing anyone checks. The paperwork at purchase looks the same either way.
By the numbers
- 75% — Income test: a fund abroad is caught when 75% or more of its gross income is passive, or when at least 50% of its assets produce passive income [1].
- 125% — Payout line: a payout above 125% of the three-year average is an excess distribution, and only the excess is taxed this way [2].
- 8621 — One form per fund: the return is filed for each fund held, directly or not, once a year — so five local funds is five returns, sold or unsold [4].
One route keeps the gains rate
Advisers describe three routes: accept the default, elect to mark the fund to market, or elect the qualified-elect treatment.
| Route | How the tax lands | What it needs |
|---|---|---|
| Accept the default | Each year’s slice at the top rate, plus interest | Nothing |
| Mark to market | Yearly rise as ordinary income, no interest | Shares that trade on an exchange the agency accepts for the election, which can be chosen in any year [6] |
| Qualified-elect | Preferential rates on the fund’s gains | The fund’s own yearly earnings statement, and an election in the first year of ownership [6] |
The difference between the last two rows is where the planning sits. Marking to market is not a one-time choice. A reader who has held a fund for years can still make it if the shares trade on the right exchange. The qualified-elect route keeps the lower rate on gains, and it closes after the first year unless the agency approves a late election [6].
What I keep circling is the count of forms. A reader who buys four local funds in one year and holds them for a decade files forty returns, sold or unsold. Each one needs the fund’s year-end value and the year’s payouts. That is a bill paid in hours, and it arrives years before the tax bill does.
The exemption is smaller
No reporting is needed when the funds are worth $25,000 or less at year end, or $50,000 on a joint return. That holds only if the investor also took no excess distribution and booked no gain on a sale [4]. The relief therefore ends in the year it would have mattered, because a sale is what creates the gain. A reader who has sat under the line meets the full rule in the year they sell.
Two limits on the argument, and the first is what I had to check twice. A fund that fails both tests sits outside the label entirely, so the tests are worth running on the fund’s own reports rather than assumed. And the rate moves. The table’s 37% is the top rate for 2018 through 2025, while the 20% capital-gains rate it displaces is a separate rate on a separate base [4][5]. Interest is still to add. The gap is a direction, not a total, and anyone quoting the difference as the whole cost has left out the interest.
The question I would run before the sale year is whether the wrapper or the election timing changes the default bill. That is what the expat financial and international tax evaluator is built to model.
At a glance
The shift: The wrapper, not the fund, decides whether the US taxes a gain at capital-gains rates. The number: 37% is the top rate each slice is taxed at, before interest. The risk: The $25,000 reporting exemption ends in the year of the sale.
Related reading
Sources
[1] 26 U.S.C. § 1297(a), passive foreign investment company defined (U.S. Code, 2024 edition) — https://www.govinfo.gov/content/pkg/USCODE-2024-title26/html/USCODE-2024-title26-subtitleA-chap1-subchapP-partVI-subpartD-sec1297.htm [2] 26 U.S.C. § 1291(b)(2)(A), total excess distribution (U.S. Code, 2024 edition) — https://www.govinfo.gov/content/pkg/USCODE-2024-title26/html/USCODE-2024-title26-subtitleA-chap1-subchapP-partVI-subpartA-sec1291.htm [3] 26 U.S.C. § 1291(a)(1)(A), § 1291(c)(2) and § 1291(c)(3)(A), allocation, rate and interest charge (U.S. Code, 2024 edition) — https://www.govinfo.gov/content/pkg/USCODE-2024-title26/html/USCODE-2024-title26-subtitleA-chap1-subchapP-partVI-subpartA-sec1291.htm [4] Internal Revenue Service, Instructions for Form 8621 (rev. December 2025) — https://www.irs.gov/instructions/i8621 [5] Internal Revenue Service, Topic no. 409, Capital gains and losses — https://www.irs.gov/taxtopics/tc409 [6] Greenback Expat Tax Services, “PFIC” knowledge-centre page, accessed 5 November 2026 — https://www.greenbacktaxservices.com/knowledge-center/pfic/