The PFIC Interest Charge: Daily Allocation, Top Rates, Daily Compounding

By Edward Parsons, CPA · licensed since 2009

Key takeaways

• An excess distribution, or a gain on sale, is allocated to each day of your holding period. For a distribution, the holding period ends on the distribution date.
• Only the current-year and pre-PFIC amounts are ordinary income this year. Every other year gets a deferred tax.
• That tax uses the highest rate in effect for each prior year under section 1, not your own bracket.
• Interest runs from each prior year’s unextended return due date to the current year’s, at the section 6621 underpayment rate.
• That rate can change every quarter, and the interest compounds daily, on a 366-day year in a leap year.
• The PFIC Calculator & Form 8621 Generator works from a stated rate table and refuses to produce a figure when a rate is missing.

You got this far. You know the fund is a PFIC, you’ve run the 125% test, and you’ve found an excess distribution or a gain. You know it gets spread back over your holding period, taxed at the top rate, with interest. Good.

Here is what most calculations miss. The interest charge isn’t one rate times a number of years. It’s a separate tax for every year, a rate that can change every quarter, and a count of days that has to be right at both ends.

My guide to the PFIC excess distribution regime covers how it works. This one covers where the arithmetic slips.

Where does the allocation start and stop?

At the first day of your holding period, and at the date of the distribution or sale.

Section 1291(a)(1)(A) allocates an excess distribution “ratably to each day in the taxpayer’s holding period for the stock,” and section 1291(a)(2) does the same for a gain on sale. The holding period comes from section 1223. Section 1291(a)(3)(A)(i) ends it on the date of the distribution, and the Form 8621 instructions say the same for a sale.

Why it bites: the allocation is by day, not by year. A year you held for two months gets two months’ share, and a leap year has 366 days. Divide by the number of years and you put tax in the wrong years, each with its own rate and its own interest.

The start date moves, too. Wash-sale replacement shares take on the holding period of the shares sold, under section 1223(3), which stretches the allocation back over more years. See wash sales and PFIC shares. And if section 1296 mark-to-market ever applied, section 1291(a)(3)(A)(ii) restarts the holding period after the last year it did.

The excess itself comes from the 125% test, run block by block. See the PFIC 125% test, block by block.

Did you consider that pre-PFIC days are not PFIC days?

Section 1291(a)(1)(B) puts only two slices into this year’s ordinary income: the current year’s slice, and the slice for any period before the first day of the company’s first taxable year as a PFIC. Everything else gets the top rate plus interest under section 1291(c). That split goes wrong in three ways.

• Pre-PFIC days taxed as PFIC days. That charges top-rate tax and interest on days the statute taxes this year as ordinary income.
• The wrong boundary. The line is the start of the company’s first PFIC year, not the start of one of yours. For a fund whose fiscal year isn’t the calendar year, it falls inside one of your tax years. Whether a new fund’s first year counts at all can turn on the start-up exception.
• Later years mistaken for pre-PFIC years. If the fund later stopped passing the tests while you held the shares, those days come after the line. The statute carves out only the current year and the pre-PFIC period. See tainted and clean PFIC lots.

Did you consider that the rate is that year’s top rate?

Section 1291(c)(2) uses “the highest rate of tax in effect for such taxable year under section 1 or 11, whichever applies.” For an individual, that is section 1. Not your bracket, and not this year’s top rate. The Form 8621 instructions print those rates year by year. Use your own rate, or one rate throughout, and the deferred tax is wrong before any interest.

Did you consider when the interest clock starts and stops?

Section 1291(c)(3)(A) runs interest on each year’s increase in tax from the due date for that year to the due date for the year of the distribution or sale. Section 1291(c)(3)(B) defines due date “without regard to extensions,” and the line 16f instructions repeat that for both ends. The common slips:

• The extended due date. Even if you extended every year, the clock starts at the original due date.
• The wrong start: the year end, the purchase date or the distribution date, instead of that year’s return due date.
• The wrong end: the date you file, pay or sell, instead of the current year’s unextended due date.
• Interest on the wrong slices. The current-year and pre-PFIC amounts carry no deferred tax, so they carry no interest.

Did you consider that the rate changes every quarter and compounds daily?

Section 1291(c)(3)(A) uses “the rates and method applicable under section 6621 for underpayments.” Section 6621 sets that rate at the federal short-term rate plus 3 percentage points, with the short-term rate fixed quarter by quarter. Under Treas. Reg. §301.6621-1, each day’s interest uses that day’s rate, and the IRS publishes each rate in a revenue ruling. Section 6622 compounds the interest daily, and Treas. Reg. §301.6622-1 says how: divide the annual rate by 365, or 366 in a leap year.

The traps:

• A static rate table: one rate a year, an average, or a table nobody updated.
• Simple interest instead of daily compounding.
• Leap years ignored: 365 where the year has 366.
• A missing quarter filled with a guess, which gives a figure that looks right and isn’t.

Is the interest deductible? For an individual, no. Temporary Treas. Reg. §1.163-9T(b)(2)(i)(B) lists section 1291(c) interest as personal interest, and section 163(h)(1) allows no deduction for personal interest except to a corporation.

Did you consider losses and currency?

A loss produces nothing on line 16. The Form 8621 instructions say a loss isn’t taken into account under section 1291 and doesn’t reduce the gain subject to it, and the form says to show it in brackets and skip line 16. No deferred tax, no interest, no offset against another block’s gain. See PFIC losses on Form 8621.

The allocation runs in dollars. The instructions divide the dollar excess by the days in your holding period. A foreign-currency excess is translated at the spot rate on the date of its distribution, not year by year at each year’s rate. See PFIC currency translation.

How the PFIC Calculator handles it

The PFIC Calculator & Form 8621 Generator allocates each excess distribution and gain by day across the full holding period, separating the current-year and pre-PFIC amounts from each prior PFIC year. It applies each prior year’s highest rate from a stated, versioned table. It computes interest at the quarterly underpayment rate, compounded daily with leap years counted, from each year’s unextended due date. Wash-sale replacement shares keep the sold shares’ holding period. A loss stays on its own Part V, in brackets with no line 16 amounts, so it never nets against a gain. You can see every figure behind the form and export it.

What it won’t do: guess. When a rate it needs is missing, it refuses to produce a figure. And it computes the default method under section 1291 only, not QEF or mark-to-market.

When to have a CPA look

Long holding periods, many blocks or an unusual fiscal year are where a second look pays. The optional CPA review covers the calculator’s own workpapers: you send them for review, your figures are frozen while they’re checked, and a CPA reviews them before you file. It isn’t a review of a return or forms prepared somewhere else. Details are in the calculator’s pricing section.

The rest of the edge-case series

• PFIC Edge Cases: What Most Form 8621 Calculations Miss
• The PFIC Start-Up Exception: When a New Fund’s First Year Doesn’t Count
• Tainted and Clean PFIC Lots: One Fund, Two Tax Treatments
• PFIC Lot Tracking: Why Every Purchase Is Its Own Calculation
• Wash Sales and PFIC Shares: The Loss and Holding Period That Move
• Fund Mergers, Splits and Spin-Offs: PFIC Events That Don’t Look Like Sales
• ISIN, Listing or Charter: What Makes a Fund Foreign for PFIC Purposes
• The PFIC 125% Test, Block by Block
• PFIC Losses: Why a Loss on One Block Doesn’t Offset a Gain on Another
• PFIC Currency Translation: Spot Rates, Fund-Currency Math and Pence
• Form 8621 Filing Exceptions: Every One, and Where Each Stops

Glossary

• Holding period: the days you held the shares, determined under section 1223. For an excess distribution it ends on the distribution date.
• Pre-PFIC period: the part of your holding period before the first day of the company’s first taxable year as a PFIC. Amounts allocated to it are ordinary income this year.
• Deferred tax: the tax on amounts allocated to prior years outside the pre-PFIC period, at the highest rate in effect for each of those years.
• Underpayment rate: the section 6621 rate, the federal short-term rate plus 3 percentage points, fixed quarter by quarter.
• Daily compounding: interest added each day at the annual rate divided by 365, or 366 in a leap year.
• Unextended due date: the date the law sets for filing the return, ignoring any extension.

Frequently asked questions

How is the PFIC interest charge calculated?

The excess distribution or gain is allocated to each day of your holding period. Each prior year’s share, other than the pre-PFIC period, is taxed at the highest rate in effect for that year. Interest on each year’s tax runs from that year’s unextended return due date to the current year’s, at the section 6621 underpayment rate, compounded daily.

What interest rate applies to the PFIC interest charge?

The section 6621 underpayment rate: the federal short-term rate plus 3 percentage points, fixed quarter by quarter and compounded daily under section 6622. A long holding period can cross many different rates.

What tax rate applies to prior PFIC years?

The highest rate in effect for that year under section 1 for an individual, whatever your own bracket was. Section 1291(c)(2) sets it, and the Form 8621 instructions list the rates by year.

Does the interest start from the extended due date?

No. Section 1291(c)(3)(B) defines the due date without regard to extensions, and that applies at both ends of the period.

Is the PFIC interest charge deductible?

Not for an individual. Temporary Treas. Reg. §1.163-9T(b)(2)(i)(B) treats section 1291(c) interest as personal interest, and section 163(h)(1) allows no deduction for personal interest to anyone other than a corporation.

What holding period does the allocation use?

Your holding period under section 1223, ending on the date of the distribution or sale. Wash-sale replacement shares include the period of the shares sold, and a past mark-to-market election under section 1296 restarts the holding period after the last year it applied.

Get every day, rate and quarter right. Load your history into the PFIC Calculator and see the allocation, the top rate and the interest behind each year.