Controlled Foreign Corporations

Frequently Asked Questions

Understanding what are Controlled Foreign Corporations

As a U.S. person, being a business owner of a foreign company may affect your U.S. tax regardless of whether you receive any distribution from the foreign company. Depending on the percentage of your shares or the tax status of other shareholders, such a business entity can be classified as a “controlled foreign corporation” (CFC). Generally, a foreign corporation is a CFC if U.S. shareholders own more than 50 percent of its voting power or value. CFC tax regulations typically apply to U.S. shareholder who owns 10 percent or more of the total voting power of that foreign corporation. Special rules apply if the foreign corporation is an insurance company. Typically, the ownership threshold for a foreign insurance corporation to be considered a CFC is much lower. Besides, circumstantial factors will also be considered when it comes to determining a foreign corporation’s CFC status.

• Subpart F Income

What is Subpart F income, and why is it important? Subpart F income earned by a controlled foreign corporation is taxed to its U.S. shareholders regardless of whether such income has been distributed or not. Subpart F income has different categories. Typically, Subpart F income includes investment income such as dividends, rents, annuities, and interests. Subpart F income also includes gains the CFC receives from purchasing or selling personal property involving a related person and performing services by a related person. A person will qualify as a related person with respect to a CFC if such person (or business entity) controls or is controlled by such CFC (or by the same person who controls the CFC).

Wherever the U.S. shareholder of a CFC resides, he or she should include in their gross income his or her pro rate share of the CFC’s subpart F income as constructive distribution. Although direct, indirect, and constructive ownership is used to determine whether a U.S. person is a U.S. shareholder, only direct and indirect ownership is used for the purpose of assessing the subpart F income inclusion. The good news is that the included constructive distribution can be deducted in the future when the U.S. shareholder receives such income. However, the calculation of such constructive distribution is no simple task. If you want to speak to a professional, contact us today and let us know how we can help.