By Dako
Our portfolio is boring on purpose. US-listed ETFs, a handful of individual US stocks, and almost nothing else. No NISA. No Japanese funds. That looks strange for a half-Japanese household, and the reason sounds paranoid until I walk through it.
The reason is a four-letter acronym: PFIC.
Maybe you’re a Japanese person living in the US. Maybe you’re married to one. If anyone has ever suggested you buy Japanese mutual funds, open a NISA, or keep the toshin you bought before moving, this is the one US tax rule to understand first. I learned about it during my own tax research, before we ever bought a Japanese fund. That timing saved us a lot of money and paperwork. Plenty of families find out after, usually from a very unpleasant tax bill.
What a PFIC is, in plain English
PFIC stands for “passive foreign investment company.” The IRS applies the label to any non-US corporation that passes either of two tests. Test one: at least 75% of its gross income is passive (dividends, interest, capital gains). Test two: at least 50% of its assets are there to produce that kind of income.
Read that definition again with a mutual fund in mind. A fund is a company whose entire job is holding income-producing assets. It passes both tests without trying.
“Passive foreign investment company” sounds like it targets shell companies in tax havens. The everyday casualty is far more innocent: a regular investment fund that happens to be domiciled outside the United States. Congress wrote these rules in 1986 to stop US investors from deferring tax through offshore funds. Nearly forty years later, the people actually caught in the net are mostly immigrants who kept their home-country investments.
Why Japanese funds and NISA accounts usually count as PFICs
Essentially all Japan-domiciled investment funds are PFICs. That includes regular toshin (投資信託), Japanese ETFs listed in Tokyo, and the funds inside a NISA or iDeCo account. The r/JapanFinance wiki, one of the better community resources on this topic, states it even more flatly: Japan-domiciled funds are all PFICs.
The NISA part surprises people the most, so let me spell it out. NISA’s tax benefit exists only in Japanese law. The US doesn’t recognize the wrapper at all. To the IRS, a NISA is just a taxable brokerage account, and the funds inside it are just foreign funds. You get zero tax benefit on the US side and a PFIC problem on top. iDeCo has the same issue for most investment options. Parking contributions in cash is generally the exception.
Individual Japanese stocks are a different story. An operating company like Toyota earns its money selling things, not holding passive assets, so it usually fails both PFIC tests. A specific company can still meet the definition, which is why “individual stocks are always fine” is too strong. But the practical risk sits overwhelmingly with funds.
One thing I’m leaving out here: Japanese insurance-based investment products. They have their own separate mess, and they deserve their own post.
How bad is the tax treatment, really?
Bad enough that I decided never to touch it.
By default, a PFIC falls under Section 1291 of the tax code, the “excess distribution” regime. Here’s the short version of how it works when you eventually sell a fund at a gain:
- The entire gain is treated as an “excess distribution.”
- That gain gets spread evenly across every year you held the fund.
- The amounts allocated to past years are taxed at the highest ordinary income rate in effect for each of those years (37% under current 2026 brackets), no matter what your actual bracket was.
- The IRS then adds an interest charge on each of those past-year tax bills, as if you’d owed the money all along and paid late.
There is no long-term capital gains rate. Ever. A US-listed index fund held for a decade gets 15% or 20% treatment on the gain. The same strategy inside a Japanese fund gets 37% plus compounding interest charges. Large distributions get similar treatment: anything above 125% of the fund’s average payout over the prior three years spills into the same regime.
The paperwork is its own punishment. Form 8621 is filed per fund, per year. Miss a required one and the statute of limitations on your entire tax return stays open until you file it, not just the PFIC part. A years-old return can stay auditable indefinitely because of one forgotten fund.
There’s a small mercy: if your total PFIC holdings stay at or under $25,000 ($50,000 married filing jointly) and you receive no excess distributions that year, the annual filing requirement is waived. Helpful for tiny legacy positions. It does nothing about the tax itself when you eventually sell.
Already own Japanese funds? Don’t panic-sell yet
First, take a breath. The worst moves here are the fast ones.
Perhaps you moved to the US with toshin already in your account. Or a well-meaning parent opened something in your name. Either way, you have a compliance question and a strategy question, and they need answering in that order. The compliance question: have the required Forms 8621 been filed for the years you’ve been a US taxpayer? If not, stop there. Fixing past years is a job for a cross-border tax professional, not a weekend project. Catching up on unfiled international forms has established procedures, and doing it wrong can cost more than the investments are worth.
The strategy question is what to do with the funds going forward. There are three standard paths:
- Sell and take the Section 1291 hit once. Painful, but it caps the damage and stops the interest clock. For small positions with modest gains, this is often the cleanest exit.
- Make a mark-to-market election. Available only for funds that trade on a qualifying exchange. You pay ordinary income tax on the gain every year, which is not great, but you escape the interest-charge regime.
- Make a QEF election. The theoretical best option, and usually a dead end for Japanese funds: it requires the fund company to issue a special “PFIC Annual Information Statement,” and Japanese fund companies generally don’t produce them.
There’s also a “purging” election that lets you pay the Section 1291 tax on paper gains now to move into better treatment afterward. Whether any of this is worth doing depends on position size, unrealized gain, and how long you’ve held. This is exactly the situation where one consultation with a US-Japan tax specialist pays for itself.
How we keep PFICs out of our own portfolio
Our setup is simple, and it’s simple because of everything above.
Everything we actively invest in is US-domiciled: US-listed ETFs plus some individual US stocks, held at US brokerages. When I want Japanese market exposure, a US-listed fund that holds Japanese stocks does the job without any PFIC issues, because the fund itself is a US corporation.
I’ll admit our hands aren’t perfectly clean. I still have a Japanese brokerage account holding a small position in individual Japanese stocks — less than half a percent of our portfolio. The account can’t place trades anymore, so it just sits there. Because they’re individual operating-company stocks rather than funds, they don’t create a PFIC problem, and at that size the reporting burden is manageable. Is leaving it untouched the optimal move? Honestly, I go back and forth. It’s on the someday-cleanup list, somewhere behind things that actually move the needle.
One more reason this matters to us specifically: we haven’t decided whether we’re moving to Japan, splitting time between both countries, or staying in the US. PFIC rules apply to US persons, which includes green card holders. Until the day we actually give up US tax residency (we’ve written about what that exit involves), every Japanese fund we buy would be a PFIC. Keeping the portfolio US-domiciled keeps all three doors open.
FAQ
My family in Japan keeps telling me to open a NISA. Should I?
If you’re a US citizen or green card holder, almost certainly not. The Japanese tax benefit doesn’t exist on your US return, the funds inside are PFICs, and many Japanese brokerages restrict US-person accounts anyway. A taxable US brokerage account with low-cost index ETFs will usually beat a NISA once US tax is counted.
Are individual Japanese stocks safe to hold?
Usually, yes. An operating company rarely meets the PFIC tests. Rare exceptions exist, so check before building a large position. Holding them also comes with other reporting duties (like FBAR) once foreign account balances cross the thresholds.
I only have a small amount in old Japanese funds. Do I need to do anything?
If the total stays at or under $25,000 ($50,000 filing jointly) and nothing was sold or distributed beyond the limits, you may be exempt from the annual Form 8621 filing. The tax treatment on an eventual sale doesn’t go away, though. Small position, small problem — but not zero problem.
What about iDeCo?
Same core issue: the investment options are Japan-domiciled funds, so for a US person they’re PFICs, and the US doesn’t recognize iDeCo’s tax deferral. The cash-deposit option is generally the exception. If you’re a US person already contributing, that’s another one for the cross-border professional.
If you take one action after reading this, make it a ten-minute inventory. List every account you hold in Japan and write down what’s inside each one. Individual stocks and cash are one conversation. Funds, in any wrapper, are the one this whole article was about.
This article is general information about US tax rules, not tax or legal advice. PFIC rules are among the most complex parts of the tax code, and the right move depends on your specific holdings and history. Please talk to a qualified cross-border tax professional before acting, and see our Disclaimer for details.