PFIC Rules: Why Americans in Israel Get Hit by Their Own Funds

What a PFIC Is, and Why Your Israeli Funds Are One

PFIC stands for passive foreign investment company, and it is the label US tax law puts on almost every ordinary Israeli fund an American might own. The definition is simple: a foreign (non-US) company counts as a PFIC if most of its income, or most of its assets, are passive, meaning dividends, interest, rents, and capital gains rather than the profits of an active business. A pooled investment fund holds stocks and bonds for a living, so it fails that test by its very nature. It is the textbook PFIC.

In practice that sweeps in the everyday Israeli products: a mutual fund (keren neemanut), an exchange-traded fund (keren sal), an investment provident fund (kupat gemel lehashkaa), an education and savings fund (keren hishtalmut), and many of the insurance savings policies that are sold as a place to park money. There is no minimum size. Owning a single share of one of these makes you a PFIC shareholder in US eyes, with all the tax and filing that follows. And this is an income-tax and reporting problem, not an estate-tax one, so it hits you no matter how modest your overall estate is.

Why the Default PFIC Tax Is So Punishing

Here is what makes people wince once they understand it. When you sell a PFIC at a gain, or take an unusually large payout from it, US law does not tax you the normal way. Instead it spreads the gain back across every year you owned the fund, then taxes the slices from earlier years at the highest ordinary income rate that was in effect for each of those years. Not your actual bracket. Not the lower capital-gains rate that a normal investment would get. The top rate, year by year.

Then it adds a compounding interest charge on top, calculated as though that tax had been due and unpaid since each of those past years. The interest is the part that really hurts. On a fund held ten or fifteen years, the combined tax and interest routinely eats more than half of the gain, and in long-held cases it can approach the entire gain. You cannot use the lower capital-gains rate, and you cannot offset it with losses from other years. It is a one-way ratchet, and it was written deliberately to punish leaving money to grow inside an offshore fund. On top of the tax, you owe a separate US form for each PFIC, every single year you hold it.

The Elections That Would Help, and Why They Usually Do Not

US law does offer two ways to escape that brutal default and be taxed more normally. The catch is that, for typical Israeli funds, both usually fall apart on a technicality.

• The QEF election lets you pay tax each year on your share of the fund\'s income, keeping the favorable capital-gains character. But it only works if the fund gives you a specific yearly statement of its earnings computed under US tax rules. Israeli funds essentially never produce one, because their managers have no reason to calculate US-style earnings. No statement, no QEF.
• The mark-to-market election lets you pay tax on the paper gain each year and skip the interest charge. But it is only available for stock that is regularly traded on a recognized exchange. That can fit an exchange-traded Israeli fund (a keren sal on the Tel Aviv exchange may qualify), but it does nothing for the ordinary kupat gemel, keren hishtalmut, or insurance-wrapper policy, which are not traded that way.

So for the products most olim actually hold, neither election is realistically on the table, and you are left in the harsh default regime. That is the whole reason the advice below is so blunt: the reliable fix is not a clever election, it is not owning these funds in the first place.

What About Your Israeli Pension?

This is the one area where the honest answer is "it depends, and we will not guess." A true Israeli pension fund (keren pensia), the pension component of manager\'s insurance (bituach menahalim), and arguably a keren hishtalmut or kupat gemel may be treated differently from a plain investment fund. They might be analyzed as a foreign employer trust, or fall under the pension article of the US-Israel tax treaty, which in some cases even provides an exception from the yearly PFIC form.

But three things keep this genuinely unsettled. The treaty carries a "saving clause" that preserves the US right to tax its own citizens as if the treaty were not there, which weakens any treaty position for an American. The IRS has never issued guidance specific to Israeli products. And the answer can turn on whether contributions were made by an employer or by you as a self-employed person, and on the exact policy. Because a wrong call here is expensive in both directions, we set out the framework for you clearly and then send the definitive classification, and any treaty position, to a US-Israel cross-border tax specialist. We do not opine on it in-house. For how the US taxes and reports Israeli pensions more broadly, see our guide to foreign pensions and US tax.

If You Already Own Them: Damage Control

If you are reading this with a portfolio full of kranot, do not do the two things people instinctively do: panic-sell everything, or keep contributing while you figure it out. A blind full liquidation can set off the entire tax-and-interest charge in one year, and every new contribution starts a fresh holding period that makes the math worse. So the first step is simply to stop adding money today.

From there the sequence is: inventory every fund with its purchase dates and values, get current on the yearly forms going forward, and if past years were missed, fold the catch-up into a streamlined filing so the back-tax and the forms move together rather than raising a flag on their own. If a fund is exchange-traded, the mark-to-market election may be worth making, sometimes paired with a one-time election that resets the clock. Then plan an orderly exit into US-compliant holdings, spread across tax years to soften the hit. There is one piece of built-in relief worth knowing: if all your PFICs together are worth $25,000 or less ($50,000 for a couple filing jointly) at year-end and you took no distribution or sale, you can skip the detailed per-fund filing, though that relief vanishes the moment you sell or take a payout, and it never waives your foreign-account reports. We coordinate the whole wind-down with a cross-border tax preparer. Our related guides on fixing late FBARs and the streamlined filing procedures cover the disclosure side.

What to Buy Instead

The fix is refreshingly simple: own US-domiciled funds and securities. A fund that is registered in the United States is a domestic company, not a PFIC, and it reports on a clean 1099 like any American\'s brokerage account. So a US person living in Israel can hold US-domiciled mutual funds and ETFs, or individual stocks and bonds, through a US brokerage that opens accounts for Israeli-address clients, and end up with a globally diversified portfolio and no PFIC problem at all.

Two cautions. First, the label that fools people: many "international" or "global" funds marketed in Israel are actually Irish or Luxembourg funds, and to the IRS those are still PFICs. Being traded on a US exchange is not enough either. It has to be a genuinely US-domiciled, US-registered fund. Second, US-domiciled holdings raise a separate US estate-tax question, because US stock is US-situated property, and that is worth planning for on its own if your balances are large. We coordinate both sides, and our guide to US estate tax for non-resident aliens covers the situs piece.

Inheriting Israeli Funds, and the Mixed-Family Split

Two points here matter for families, and both are easy to get backwards. First, inheriting a PFIC is not like inheriting a normal asset. Normally an heir gets a "stepped-up basis," meaning the built-in gain is wiped clean at death. With a PFIC inherited from a US person, US law largely takes that step-up away, so the old built-in gain rides straight through to you, the heir. The important exception: if the person who died was a non-US citizen for the whole time they owned the fund, the step-up survives in full. So an Israeli parent who is not a US person can pass their kranot to a US-citizen child in Israel with a clean step-up, while the same funds coming from a US-citizen parent arrive tainted. That is worth planning around.

Second, the same investment advice flips depending on who in the family is a US person. A US citizen or green-card holder should own US-domiciled funds (to avoid the PFIC rules, accepting the separate US estate-tax point). A non-US-citizen family member, like an Israeli parent or spouse, is better off in Irish-domiciled funds, which are outside the US estate-tax net and carry lower dividend withholding, and the PFIC rules simply do not apply to them. In one household, the American and the non-American should often hold opposite portfolios. And when a US person inherits cash from a US estate, the money should go into the US-compliant menu, not get swept by an Israeli bank back into kranot, which would rebuild the very problem the plan just solved.

How We Work, and When We Refer

PFIC work has a clear division of labor, and we are upfront about it. What we do is the part that prevents the damage and ties it to your estate: we screen every olim household\'s Israeli holdings at intake, we give the one-sentence warning that saves the most money (do not buy Israeli pooled funds while you are a US person), we build the inventory, and we coordinate the exit alongside your US will, powers of attorney, probate-avoidance plan, and any inheritance.

The parts we send out are the parts that call for a different tool: the actual yearly PFIC form computations, the purging elections, the streamlined catch-up mechanics, and any pension classification or treaty position go to a US-Israel cross-border tax preparer or specialist, and Israeli tax is handled by Israeli counsel. Most of our side runs remotely, by phone and video, which suits olim and Americans abroad. The highest-value step is the earliest one: the screen, because catching a PFIC before you buy, or before you add to it, is worth far more than fixing it later. See our estate-planning guide for olim →

Frequently Asked Questions

Common Situations

The new oleh with cash to invest. A family just arrived in Israel with a few hundred thousand shekels to put to work, and the bank advisor pitches a menu of kranot. A quick screen stops it in time: they open a US-compliant brokerage instead and buy US-domiciled ETFs, ending up diversified with zero PFIC exposure and ordinary 1099 reporting. The most valuable advice took one sentence and cost them nothing.

The oleh eight years in, never filed. An American who made aliyah years ago holds a couple hundred thousand dollars across three kranot and a kupat gemel and has never filed the PFIC form. The plan is to stop contributions immediately, inventory the funds, fold the catch-up into a streamlined filing with a cross-border preparer, and sequence the wind-down across tax years so the charge does not land all at once.

The mixed family and the inheritance. A US-citizen oleh is due to inherit funds from an Israeli parent who is not a US person. Because the parent was never a US person, the funds can pass with a full step-up in basis, a real advantage, so the plan is to receive them cleanly and then move the money into US-domiciled holdings rather than letting it be reinvested into new kranot.

Sources of Law

• The PFIC regime and definition: 26 U.S.C. §§1291 to 1298; §1297 (the 75% passive-income and 50% passive-asset tests; passive income per §954(c)); §1291 (the excess-distribution regime, the highest-rate allocation, and the §6621 interest charge). Form 8621 (per-PFIC annual filing; the $25,000 / $50,000 de minimis exception per the Form 8621 Instructions). law.cornell.edu
• The relief elections: 26 U.S.C. §1295 and Treas. Reg. §1.1295-1 (the QEF election and the required PFIC Annual Information Statement); 26 U.S.C. §1296 and Treas. Reg. §1.1296-1 (mark-to-market, limited to marketable stock).
• Attribution, taint, and inherited stock: 26 U.S.C. §1298(a) (indirect ownership through partnerships, estates, and trusts); §1298(b)(1) ("once a PFIC, always a PFIC" and the purging elections, Treas. Reg. §§1.1291-9, 1.1291-10); §1291(e) (the reduced basis step-up on inherited PFIC stock, with the nonresident-alien-decedent carve-out that restores a full §1014 step-up).
• Pensions and treaty relief: Treas. Reg. §1.1298-1(c)(4) (the Form 8621 filing exception for PFIC stock held through a treaty-recognized foreign pension fund); the US-Israel Income Tax Treaty pension article and saving clause; a treaty position is disclosed on Form 8833; foreign-pension trust reporting may implicate Forms 3520 and 3520-A, with Rev. Proc. 2020-17 relief for tax-favored retirement trusts. irs.gov (retrieved 2026-07-16)

Updated on July 16, 2026. Reviewed by Kevin D. Klagge, Esq., Fla. Bar No. 99502. Attorney Kevin Klagge represents families, businesses, and international clients in estate planning and international law, with a focus on Florida legal tools. He litigates estate and business issues in court. This article is general information about US law, not legal or tax advice, and does not create an attorney-client relationship. PFIC compliance is specialized: the firm screens holdings and coordinates the exit and estate side, while the Form 8621 computations, purging elections, and any pension classification are handled with a US-Israel cross-border tax specialist, and Israeli tax is handled by Israeli counsel. Figures are per current federal rules and may change. Your result depends on your specific facts.