5 Simple Tips to Understanding CFC Taxation & Reporting Rules
In general, the IRS does not have the right or authority to tax a foreign business that conducts business outside of the U.S.
But, once a foreign corporation is owned by more than 50% by U.S. persons (with each Shareholder owning at least 10%), and is deemed a controlled foreign corporation, the rules change.
What is a CFC?
The Controlled Foreign Corporation concept is not unique to the U.S.; many foreign countries have their own set of CFC rules that are similar to U.S. CFC rules.
And, once the corporation becomes a Controlled Foreign Corporation, the tax and reporting rules change.
Here are 5 common errors we find:
More than 50% Ownership
In order for a foreign corporation to be a Controlled Foreign Corporation, the corporation must be owned more than 50% by U.S. Person(s). Therefore, if Joe a foreign person, and Jane a U.S. person each own 50% — it is not a controlled foreign corporation.
Family Constructive Ownership (aka Attribution)
With attribution, the shares of one person may be attributed to another person. So, if foreign person Joe owned 40%, Jane owned 40% and Jane’s U.S. spouse owned 20%, the 20% owned by Jane’s spouse could be “attributed” to Jane. With attribution, Jane owns 60%.
- There are exceptions, exclusions, and limitations.
- The attribution rules can differ when the spouse (or other attributes person) is foreign.
IRS Form 5471
Certain categories of filers who own (or have an interest in) foreign corporations may have to file form 5471. The forms is a complex form, and requires an understanding of general accounting principles. The IRS estimates 30 hours to complete the form.
Some categories require the foreign corporation to be a CFC, in order for the certain category of filer to have to file the form. Therefore, it is important to evaluate each category of 5471, to determine if a particular category requires the foreign corporation to be a CFC.
When income is Subpart F, it generally means that the U.S. owner of the corporation is imputed his or her “Ratable Share” of certain income (usually passive) based on ownership percentage. It does not matter if the income was actually distributed or not — taxes are still due. But, in order for Subpart F rules to apply, there are certain requirements, and one key requirement is current year E&P (earnings and profit).
Reporting for the CFC
If the controlled foreign corporation maintain bank accounts, assets, and other investments, the U.S person shareholder may have additional reporting requirements for FBAR, FATCA, etc beyond possible form 5471.
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