There are 3 options provided under Form
8621 to declare notional appreciation Indian Mutual Funds in US:
Option 1: Election to mark-to-market
(this is the most common option elected)
as income the notional gains in the market value of fund holdings during the
year. In simple words,
In Year of Purchase: Gains will be difference
between Market value at the end of year and cost of purchase.
In subsequent years: Gains are difference
between market value at the end of the year and 'adjusted basis'. Adjusted
basis is usually the market value in the beginning of the year. In case there
is a loss, the loss can be set off against notional gains of only the previous
years. Any loss that is not set off is added back to the adjusted basis of the
next year. So for instance, if in year 1 you incurred a notional gain of $100
on your PFIC, $100 would be taxed as ordinary income in year 1. Suppose your
loss in year 2 was $150. In year 2, you would be allowed to deduct a loss of
$100 from your total income (loss to the extent of gains taxed earlier).
In year of sale: When the units are actually
sold, one will be taxed on long term capital gains only on the portion of gains
that has not been taxed in previous years as ordinary income.
in case where Indian Mutual Funds are before one becomes a US person, in the
first year of tax returns, the value of PFIC income will be the appreciation in
market value of the fund holdings during the tax year.
Eg: "X, a nonresident of the US, buys
marketable stock in a PFIC for $50 in 2005. On Jan. 1, 2023, X becomes a US
resident. The fair market value of the stock on Jan. 1, 2023, is $100. The fair
market value of the stock on Dec. 31, 2023, is $110. X computes the amount of
mark-to- market gain or loss in 2023 using a $100 adjusted basis. Therefore, X
includes $10 in gross income as mark- to-market gain and increases its adjusted
basis in the stock to $110. X sells the stock in 2024 for $120. X must use its
original basis of $50 plus the $10 mark-to-market basis adjustment. Therefore X
recognizes $60 of gain, of which $10 would be ordinary income and $50 long-term
Option 2: Election
to treat as Qualified Electing Fund (QEF)
QEF is taxed like a partnership wherein each investor is considered to have a
share in the total profits of the fund. This option can be exercised only if
the Indian Mutual fund house agrees to share information about one’s share of
Option 3: Excessive
Distribution Method (default option and most taxing option)
As per this option the distribution from
Indian Mutual Funds during current year should be at least 125% of the average
distributions of last 3 years.
If the above condition is not met and
one has not elected any of the above mentioned options, the total distributions
are allocated over the period of holding of such Mutual Funds and taxed in each
year at the highest tax rate of such year alongwith interest for delayed
payment of taxes.
Eg: Mr. X holds Indian Mutual Fund for
10 years and has not received any distributions during such period. In the year
of sale, Mr. X made a gain of $ 100. The said gain of $100 will be distributed
over the past 10 years i.e. $10 per year and it will be treated as no tax has
been paid on said $10 per year. Accordingly, in year 10 Mr. X has to pay tax
for each of these years plus interest on delay.