Inheriting Israeli Funds as a US Person: The PFIC Rules, and the One Fact That Decides How Bad It Is

This is orientation, not legal or tax advice. It maps what exists and the questions to take to a licensed professional. It does not tell you what to do about your own estate or taxes.

An Israeli parent dies holding a kupat gemel le'hashkaa and two kranot ne'emanut at Bank Leumi. The Israeli side is straightforward, because Israel does not tax inheritance. The US side is where this becomes one of the harshest corners of the tax code, and almost everything written about it is written for the wrong person.

Nearly all English-language PFIC material addresses the American who bought a foreign fund and now regrets it. An heir is in a different position, governed by a different provision, and the difference can be the whole tax bill.

Why an ordinary Israeli savings product is a PFIC at all

A foreign corporation is a passive foreign investment company if it meets either of two tests in section 1297: at least 75 percent of its gross income is passive, or at least 50 percent of its assets are held to produce passive income. A pooled investment fund exists to hold income-producing assets, so it clears both tests without effort.

That sweeps in most of what an ordinary Israeli portfolio contains. Kranot ne'emanut (mutual funds), kranot sal (ETFs), kupot gemel le'hashkaa (private investment provident funds), and the kupat gemel track inside the children's savings programme are all commonly treated as PFICs. Nothing about them is exotic in Israel. They are the default retail products a bank or an insurer offers.

Employer-funded pension arrangements and keren hishtalmut sit in a genuinely unsettled area, and practice among US accountants in Israel is not uniform. We deal with those separately in inheriting an Israeli pension, keren hishtalmut, or kupat gemel. This page is about the investment products, where the analysis is far less ambiguous.

What the default regime does to a gain

If no election is in place, a PFIC is what the regulations call a section 1291 fund, and the excess distribution regime applies. It works by throwback.

Gain on a sale, and any distribution above 125 percent of the average of the prior three years, is spread rateably across the holding period. The portion allocated to the current year is ordinary income. The portion allocated to earlier years is taxed at the highest ordinary rate in force for each of those years, with no benefit from capital gains rates and no benefit from your actual bracket. An interest charge then runs on those amounts as though the tax had been underpaid since each of those years.

Two consequences matter more than the arithmetic. Losses in one PFIC cannot be netted against gains in another for US purposes. And Israel, which sees nothing objectionable in these funds, permits offsets that the US will not recognise, so the two systems disagree about what your gain even is.

The length of the holding period drives the entire result. Which is exactly why the identity of the person who died matters so much.

The question that decides your case: was the deceased ever a US person?

Here is the provision almost nobody surfaces.

Section 1291(e) reaches back into the old foreign investment company rules and imports section 1246(e)(1). Under it, the section 1014 basis of PFIC stock acquired by bequest, devise or inheritance is reduced, though not below the decedent's own adjusted basis immediately before death, by the decedent's rateable share of the company's accumulated earnings and profits. In plain terms, the PFIC rules take away the step-up an heir would normally get and push you toward something close to carryover basis.

Then section 1291(e)(2) supplies the exception. That reduction does not apply in the case of a decedent who was a nonresident alien at all times during the holding period of the stock.

Read those two sentences together and the practical shape appears.

If the person who died was never a US person during the time they held the fund, the reduction does not apply. The heir takes the ordinary section 1014 basis, stepped up to fair market value at the date of death. And because the regulation at 1.1291-1 provides that a corporation is not treated as a PFIC with respect to a shareholder for the days in the holding period when the shareholder, or a person whose holding period is included in the shareholder's, was not a United States person, the decades the Israeli parent spent holding that fund are not tainted years. The heir's PFIC holding period effectively begins at death.

If the person who died was a US person, for example an American who made aliyah decades ago and kept US citizenship, neither of those reliefs is available on the same terms. The basis reduction is in play, and the holding period includes years during which a US person held the fund. The same kupat gemel, inherited on the same day, produces a materially worse outcome.

This is the single most consequential fact in the file, and it is a question of the deceased's status, not the heir's. Two siblings inheriting identical funds from two different parents can land in completely different places.

Where this collides with the more common Israeli situation

A great many families in this position are not the clean case. The parent who died may have been a US citizen who moved to Israel in the 1970s and never renounced. They may have been a green card holder for part of the holding period and not for the rest. Section 1291(e)(2) requires nonresident alien status at all times during the holding period, which is an absolute condition, and partial periods do not satisfy it.

Establishing which applies is a documentary exercise about the deceased, sometimes reaching back forty years, and it is the work that has to happen before anyone can calculate anything. It is also the point at which this stops being something a family can reason through from an article.

What has to be filed, and when the clock starts

Form 8621 is the annual reporting vehicle, under the section 1298(f) requirement, and it is generally filed per PFIC per year.

There is a de minimis exception, and it is narrower than it sounds. Under the Form 8621 instructions and the regulation at 1.1298-1, a shareholder need not complete Part I for a section 1291 fund if the aggregate value of all PFIC stock is 25,000 dollars or less on the last day of the tax year, 50,000 dollars on a joint return, and the shareholder received no excess distribution and recognised no gain on a disposition. A 5,000 dollar threshold applies to certain indirectly held PFIC stock. Every condition has to hold. An inherited portfolio of any real size will not qualify, and a sale in the same year defeats the exception on its own.

The reporting clock is separate from the estate. It attaches when the assets become yours, which is the same structural point we set out for accounts in FBAR and Form 8938 for an inherited Israeli account. A PFIC position usually triggers Form 8621 alongside those, not instead of them.

The elections, and why they are often unavailable in practice

Two elections can move a fund out of the default regime, and both have real obstacles here.

A qualified electing fund election under section 1295 produces annual income inclusion instead of throwback, but it depends on the fund providing a PFIC annual information statement. Israeli retail funds were not built to service US tax reporting, and many simply do not supply one. Some Israeli products are now marketed to Americans as QEF-friendly. They remain PFICs, and whether the trade is worth it after Israeli tax is a real question rather than a settled one.

A mark to market election under section 1296 is available only for marketable stock, which excludes a good deal of what sits in a kupat gemel.

Timing is the harder constraint. These elections work cleanly when made for the first year of PFIC ownership. For an heir, that first year is the year of death, which is frequently discovered long afterwards, once probate is finished and someone reads the fund statements properly. Purging elections exist, and Form 8621-A covers late ones under section 1298(b)(1), but they carry their own tax and interest computations.

The Israeli side, and the mismatch

Israel imposes no estate or inheritance tax, so nothing on the Israeli side corresponds to what the US is doing here. Israel will tax a gain on a later disposal under its own rules, and a foreign tax credit may relieve some of the US liability.

The mismatch is structural rather than a matter of rates. Israel measures the gain one way, the US measures it another, and the excess distribution regime allocates income to years in which no Israeli tax was paid at all, which limits what any credit can reach. If you are an oleh, the ten-year window interacts with all of this, and we cover that interaction in the oleh 10-year exemption and inherited US assets.

What to establish before you speak to anyone

Not steps to take. Facts to have in hand, because they determine everything and no one can price the work without them.

The status of the person who died, for the whole period they held each fund. US citizen, green card holder, or never either. This is the section 1291(e)(2) question.

The exact product type for each holding. A keren ne'emanut and an employer pension are not the same problem.

The date of death value of each position, and the date the assets were actually transferred to you.

Whether anything has already been sold. A disposition changes both the tax computation and the reporting exception.

Whether the fund manager can produce a PFIC annual information statement. Ask in writing. The answer is usually no, and having it in writing is what closes off the QEF conversation quickly.

Getting this to the right person

This is not a matter where a general US accountant and a general Israeli accountant working separately will reach a coherent answer. The section 1291(e)(2) determination is US law applied to an Israeli decedent's forty-year history, and the elections have deadlines that reward being early.

We are not tax advisers and this page is orientation, not advice. What we do is match the file to a cross-border professional who has actually run a section 1291 computation on an inherited Israeli fund, which is a much smaller group than the number of firms who will take the engagement. If you have the facts above assembled, that is the point to get in touch.