Moving from India to the US? The Indian Mutual Fund “Trap” Explained
For many Indian professionals moving to the U.S. on H1B, L1, or O1 visas, the biggest tax shock doesn’t come from their U.S. salary—it comes from the mutual funds they left back home.
In 2025, the KKCA team saw a record number of inquiries from clients who realized too late that their Indian portfolio triggered the IRS’s most punitive tax regime: PFIC (Passive Foreign Investment Company).
Why Your Indian Portfolio is a PFIC
Under IRS rules, a foreign investment is classified as a PFIC if it meets either the Income Test (75% of income is passive) or the Asset Test (50% of assets produce passive income).
Almost every Indian financial product fits this bill:
- Mutual Funds: Equity, Debt, and Hybrid funds.
- ETFs: Nifty 50 or Sensex trackers.
- REITs: Embassy, Mindspace, and Brookfield.
- ULIPs: Unit Linked Insurance Plans (often viewed as PFICs rather than insurance by the IRS).
The Three Ways the IRS Taxes Your Indian Funds
If you hold these assets as a U.S. person, you must file Form 8621 for each individual fund. How much you pay depends on the “election” you make.
1. Section 1291 (The Default “Penalty” Method)
If you do nothing, the IRS applies this method. It assumes you are hiding income.
- Tax Rate: Your gains are taxed at the highest marginal rate (currently 37%), regardless of your actual income bracket.
- Interest: The IRS charges compounded daily interest back to the day you bought the fund.
- The Result: It is common for the tax and interest to swallow 50-70% of your total gain.
2. Mark-to-Market (MTM) Election
This is the most common choice for Indian funds. You treat the fund as if you sold it on Dec 31 and pay tax on the “paper gain.”
- Pros: No interest charges; taxed at ordinary income rates.
- Cons: You pay tax on gains even if you didn’t sell the fund.
3. Qualified Electing Fund (QEF)
The “Gold Standard” of reporting, where you are taxed similarly to U.S. capital gains.
- The Problem: This requires an “Annual Information Statement” from the Indian fund house (like HDFC or ICICI). Currently, almost no Indian fund houses provide this, making QEF nearly impossible for Indian assets.
Already Missed Your Filings?
If you’ve lived in the U.S. for a few years and haven’t been reporting your Indian mutual funds, don’t panic, but do act. Because Form 8621 has no statute of limitations, an unfiled form leaves your entire 1040 tax return “open” for audit forever. The IRS can come back 10 years later to contest your entire return because of one missing $5,000 mutual fund.
The Solution: Streamlined Procedures The IRS offers a “Streamlined Filing Compliance Procedure” for non-willful taxpayers. This allows you to:
- File the last 3 years of tax returns.
- File the last 6 years of FBARs.
- Pay a small 5% penalty (or 0% if living abroad) and catch up on PFIC reporting without the threat of massive fines.
The KKCA Expert Take
The most common mistake we saw in 2025 was clients reporting Indian mutual fund dividends on Schedule B but ignoring the fund itself. Reporting the income does not satisfy the PFIC reporting requirement. ### Your 2025 Action Plan:
- Inventory: List every Indian folio, REIT, and ULIP you own.
- Evaluate: Determine the “High Water Mark” value for each.
- Elect: If it’s your first year in the U.S., make the MTM election on your first return to lock in the best possible treatment.
Looking for personalized tax services about your specific tax situation, please contact us. We are here to help you with your specific tax matters.
Disclaimer
This blog is intended for informational purposes only and does not constitute legal or tax advice. Please consult a qualified U.S. CPA or tax attorney for guidance specific to your situation.