A Warning for American Olim Only
The PFIC problem is one of the most important and least understood financial issues facing American olim. It does not affect British, Canadian, French, or most other olim — only US citizens and green card holders who remain subject to US tax obligations after making aliyah.
The short version: many Israeli investment products that seem perfectly normal from an Israeli tax perspective are classified as Passive Foreign Investment Companies (PFICs) by the IRS, and the US tax treatment of PFIC investments is punitive enough to make them effectively unusable for American olim.
What Is a PFIC?
A Passive Foreign Investment Company is any non-US corporation (or fund entity) where either 75% or more of gross income is passive (dividends, interest, capital gains), or 50% or more of assets produce passive income. Most foreign mutual funds and many foreign ETFs meet this definition.
Israeli mutual funds (kranot nemanot) are almost always PFICs. Many TASE-listed ETFs structured as exchange-traded notes are also classified as PFICs when analyzed under US tax rules. The classification is not based on the Israeli regulatory structure — it is based purely on US tax law criteria applied to the entity.
The Punitive PFIC Tax Rules
Under the default PFIC regime (called the "excess distribution" method), here is what happens when you hold a PFIC and sell it or receive a distribution:
- Gains are spread back over each year you held the fund — even though you may have earned the gain more recently
- Interest is charged on the deemed tax for each prior year, at the US underpayment rate (currently 8% or more)
- The gains are taxed at the highest ordinary income rate, not the favorable 15-20% long-term capital gains rate
- The combined tax and interest cost often exceeds 40-60% of the total gain — sometimes more than the gain itself if the fund was held for many years
There is no way to elect into the 15-20% long-term capital gains rate for PFICs. The tax law deliberately makes PFIC investing painful to discourage US persons from sheltering income in foreign funds.
What American Olim Can Invest In
The PFIC rules leave American olim with workable but narrower options:
US-Listed ETFs (Not PFICs)
Vanguard, iShares, SPDR, and other US-registered ETFs are NOT PFICs because they are US corporations (registered under the Investment Company Act of 1940). You can hold VOO (Vanguard S&P 500 ETF), VT (Vanguard Total World), or any other US-listed ETF through an Israeli brokerage account without triggering PFIC rules.
From an Israeli tax perspective, US-listed ETFs are treated the same as any other investment — gains are subject to 25% Israeli capital gains tax, with a US tax credit reducing double taxation through the US-Israel tax treaty.
Individual Stocks
Individual shares in Israeli or US-listed companies are not PFICs (unless the company itself qualifies as a PFIC, which operating companies generally do not). Direct stock investments remain available to American olim.
Israeli Pension and Keren Hishtalmut
The US tax treatment of Israeli pension funds and the Keren Hishtalmut is complex and unsettled — these accounts may be subject to PFIC or other foreign trust rules. However, because they are mandatory or employer-funded vehicles, most American olim hold them regardless and rely on the US-Israel tax treaty's provisions for pension income. The important thing is to report them correctly on your US tax return (FBAR, Form 8938, and potentially Form 3520 or 8621 depending on the account type). A US-Israel tax attorney is essential here.
The QEF and Mark-to-Market Elections
There are two alternative PFIC regimes that can reduce the harsh default treatment, but both require specific annual elections on your US tax return:
- QEF election (Qualified Electing Fund): You are taxed annually on your pro-rata share of the fund's income at ordinary rates and capital gains rates. Requires the fund to provide a PFIC Annual Information Statement — which almost no Israeli fund provides, making this practically unusable.
- Mark-to-Market (MTM) election: You recognize gains and losses annually based on year-end value. Gains are taxed as ordinary income (not favorable capital gains rates). This is administratively complex but avoids the most punitive excess distribution rules.
In practice, the simplest approach for most American olim is to avoid Israeli-domiciled funds entirely in their taxable accounts and use US-listed ETFs instead. Keep this constraint in mind when setting up your Israeli investment accounts.
The Practical Takeaway
If you are a US person (citizen or green card holder), before investing in any Israeli investment vehicle beyond your pension and Keren Hishtalmut, ask a qualified US-Israel tax advisor: "Is this a PFIC?" The consequences of getting this wrong are severe, and the question is not always obvious from the product name or structure.