Controlled Foreign Corporation – Learn How to Report a CFC to the IRS

Controlled Foreign Corporation: A Foreign Corporation is controlled (aka Controlled Foreign Corporation or CFC) under IRC 957 when more than 50% is owned by U.S. Persons.

What is a Controlled Foreign Corporation?

A foreign corporation becomes a Controlled Foreign Corporation (aka CFC) and falls under IRS section 957, when more than 50% of the corporation is owned by U.S. Shareholders (who each own at least 10%; attribution rules apply).

Once a foreign corporation is treated as a CFC, it becomes subject to U.S. Subpart F Income (and other tax pitfalls).

Controlled Foreign Corporation - Learn How to Report a CFC to the IRS - (Golding & Golding)

Controlled Foreign Corporation – Learn How to Report a CFC to the IRS – (Golding & Golding)

Common issues involving CFC

If you have a controlled foreign corporation, there are many common questions you may have many questions and concerns.

Here are a few we deal with often:

  • What is a Controlled Foreign Corporation?
  • What if I never reported the income to the IRS?
  • What is Subpart F Income?
  • What is CFC Tax?
  • What if I already paid foreign tax on the money?

The Basics of a Controlled Foreign Corporation

A CFC (aka Controlled Foreign Corporation) is a particular type of foreign corporation — which is evaluated in accordance with Internal Revenue Code, section 957.

Not all foreign corporations are controlled foreign corporations. In order to be considered a controlled foreign corporation, the Foreign Corporation must be owned more than 50% by U.S. Person(s), who each own at least 10% ownership (Attribution Rules Apply). 

Once a U.S. Shareholder is deemed an owner in a Controlled Foreign Corporation, the IRS Tax Rules are different (and more complicated).

What Happens when a Corporation becomes a CFC?

Once a Foreign Corporation becomes a Controlled Foreign Corporation, the rules change. 

Two main issues for most people involve the following:

Controlled Foreign Corporation Examples 

While Controlled Foreign Corporations (CFC) come in many shapes and sizes, there a few common CFCs we work with at Golding & Golding. They include:

– A Sociedad Anonima, in which the U.S. Person usually owns 90% of the Foreign Corporation, with a local resident owning 10%

– A Wholly Owned Foreign Corporation such as Hong Kong Ltd., BVI, or Australia PTY Ltd.

– A Foreign Corporation (Even if established just as a Foreign Trust), but is considered a Per Se Corporation under IRC§ 301.7701-2

Summarizing the Elements of a Controlled Foreign Corporation

These are some of the more important elements and issues to assess if your foreign corporation is treated as a Controlled Foreign Corporation:

More Than 50% U.S. Ownership

In order for a Foreign Corporation to be considered a Controlled Foreign Corporation, it must be owned more than 50% by U.S. Persons. It is important to note that if the Foreign Corporation is owned 50% by U.S. Person (one U.S. Person and One Non-U.S. Person each owning 50% of the corporation), it is not considered a Controlled Foreign Corporation, because it is not being ‘controlled’ in the legal sense of the word.

10% Ownership

Beyond the Foreign Corporation being owned more than 50% by U.S. Persons, it must be also be that each of the shareholders within that +50% each own at least a 10% share. In other words, if 6 unrelated U.S. Persons own at least 9% share each, they would technically own 54% of the corporation, but because none of them each own at least 10%, it is not considered to be a Controlled Foreign Corporation (unless attribution rules applied)

What is Attribution IRC (958)?

Attribution is the idea that one person considered to constructively own stock that another person owns only due to the relationship between the two individuals. The main purpose of attribution is to avoid artificially low tax reductions strategies by making sales or transfers between “related” parties. More information can be found in Internal Revenue Code section 958. As provided by the IRS :

Constructive ownership rules apply for determining whether the U.S. person is a U.S. Shareholder and whether a foreign corporation is a CFC, but are not considered in determining the amount of a U.S. Shareholder’s Subpart F inclusion.

– A corporation, partnership, trust or estate that owns more than 50% of the voting stock of a corporation is considered to own 100% of the voting stock of that corporation.

– Stock owned by a non-resident alien individual is not treated as owned by a U.S. person.

– More than one family member can be attributed the same stock. For example, stock owned by a child can be attributed to both a parent and a grandparent.

What is Subpart F Income (IRC 951)

Subpart F income is income that is earned within a Controlled Foreign Corporation that is going to be taxed to the U.S. person — whether or not any money was distributed to the U.S. persons. One of the main purposes behind this law is that in days past,Controlled Foreign Corporations would stockpile money and neither distribute nor issue it as income, dividends, interest, capital gains, etc.. Thereafter, the Controlled Foreign Corporation would issue loans to shareholders (which is not income) and then when it’s time to repay the loan, the company would simply forgive loan (no major detriment to the corporation).

Therefore, the IRS developed subpart F income, which can be very detailed.

The main information is found in code section IRC 951:

Amounts included

In general: If a foreign corporation is a controlled foreign corporation for an uninterrupted period of 30 days or more during any taxable year, every person who is a United States shareholder (as defined in subsection (b)) of such corporation and who owns (within the meaning of section 958(a)) stock in such corporation on the last day, in such year, on which such corporation is a controlled foreign corporation shall include in his gross income, for his taxable year in which or with which such taxable year of the corporation ends—

(A)the sum of—

(i) his pro rata share (determined under paragraph (2)) of the corporation’s subpart F income for such year,

(ii) his pro rata share (determined under section 955(a)(3) as in effect before the enactment of the Tax Reduction Act of 1975) of the corporation’s previously excluded subpart F income withdrawn from investment in less developed countries for such year, and

(iii) his pro rata share (determined under section 955(a)(3)) of the corporation’s previously excluded subpart F income withdrawn from foreign base company shipping operations for such year; and

(B) the amount determined under section 956 with respect to such shareholder for such year (but only to the extent not excluded from gross income under section 959(a)(2)).

But I Did Not Receive any Subpart F Income Distribution

It is immaterial whether the US shareholder of controlled foreign corporation actually received any of the money. That is why the phraseology used by the Internal Revenue Service code is “pro rata share” and “amount determined” vs. “received.” There are certain other factors that are important regarding subpart F income such as whether there is any current earnings and profits (E&P), whether taxes have been paid, and whether dividends have also been issued (these will all impact the complex ordering rules of Subpart F Income)

I have Signature Authority over Corporate Accounts

When a person has signature authority over a controlled foreign corporation account, even if the person cannot really take the money, they will have to file an annual FBAR, if the annual aggregate total of foreign accounts exceeds $10,000. When completing the FBAR, the individual will complete the portion involve signature authority, so it will not appear as if the person necessarily owns that money (A common concern amongst clients.)

Impact of Disregarding the Entity

It depends, and this is a very complex question which goes beyond basic summary. The ideas that unless certain restrictions apply the corporation is considered a per se corporation, a corporation can sometimes disregarded entity for tax purposes. An example would be a single member LLC in the United States in which the single-member (married members in community property states) can simply disregard the entity and instead of reporting on corporate forms, the individual reports the income, expenses, deductions, etc. on a schedule C with the 1040.

When it involves a controlled foreign corporation, it is important to determine whether it is Corporation which can even be disregarded, and if so, whether the corporation meets the requirements for doing so.

*The IRS has certain rules regarding foreign corporations as to how they should be taxed/treated depending on whether the IRS considers them a corporation or partnership (such as if it is a limited company). You should speak with an experienced tax lawyer before filing any forms with the IRS on this issue – because oftentimes they cannot be reversed.

What is Form 5471?

Form 5471 is used as an information return of U.S. persons with respect to certain foreign corporations. In other words, it is a form that is used to describe ownership and business operations of a foreign corporation. More specifically, the form is used to report the operations of the foreign business (Balance Statement, Income, Equity, Liabilities), but that does not mean the form will result in the individual having to pay any additional tax on the income.

Taxation will depend largely on whether the corporation is a Controlled Foreign Corporation or not, if the income is subpart F income or not, and whether any distributions, salary, or incomer were made to the U.S. person owner.

What is Form 8938

Under current U.S. Tax law, the IRS and U.S. Government have made Foreign Financial Reporting a key enforcement priority.

Form 8938 (Statement of Specified Foreign Financial Assets) is an IRS Form associated with FATCA (Foreign Account Tax Compliance Act). It is similar to the FBAR, but more detailed in scope as to what has to be filed (Stock Ownership and Actual Income Earned for example). The failure to file this FATCA Form can lead to extensive Fines and Penalties.

CFC Penalties Will Flow Through 8938

There are many penalties a person may be subject to if they have a controlled foreign corporation but did not file properly. These include penalties for not filing of an FBAR or 8938. They also include started properly report Subpart F Income, or filing a form 5471 form 8621 (depending on the nature of a controlled foreign entity/partnership).

What if I Never Reported Income or Asset?

Presuming the money was from legal sources, your best options are either the Traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs.

We Specialize in Safely Disclosing Foreign Money

We have successfully handled a diverse range of IRS Voluntary Disclosure and International Tax Investigation/Examination cases involving FBAR, FATCA, and high-stakes matters for clients around the globe (In over 65 countries!)

Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

What Should You Do?

Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.

Be Careful of the IRS

With the introduction and enforcement of FATCA for both Civil and Criminal Penalties, renewed interest in the IRS issuing FBAR Penalties, crackdown on Cryptocurrency (and IRS joining J5), the termination of OVDP, and recent foreign bank settlements with the IRS…there are not many places left to hide.

4 Types of IRS Voluntary Disclosure Programs

There are typically four types of IRS Voluntary Disclosure programs, and they include:

Contact Us Today; Let us Help You.

International Tax Lawyers - Golding & Golding, A PLC

International Tax Lawyers - Golding & Golding, A PLC

Golding & Golding: Our International Tax Lawyers practice exclusively in the area of IRS Offshore & Voluntary Disclosure. We represent clients in 70 different countries. Managing Partner, Sean M. Golding, JD, LL.M., EA and his team have represented thousands of clients in all aspects of IRS offshore disclosure and compliance during his 20-year career as an Attorney. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo and various Law Journals nationwide.

Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)
International Tax Lawyers - Golding & Golding, A PLC