Controlled Foreign Corporation (IRS Taxation of U.S. Shareholders) Golding & Golding

Controlled Foreign Corporation (IRS Taxation of U.S. Shareholders) Golding & Golding

Controlled Foreign Corporation (IRS Taxation of U.S. Shareholders)

Controlled Foreign Corporation Tax Laws are difficult – and with IRS enforcement of international tax compliance a key priority, it is important you remain in compliance with the Internal Revenue Service tax rules.

If you are a U.S. Person, and invested in a foreign corporation, you may become subject to IRS Tax Rules involving Controlled Foreign Corporations.

Some common issues involving Controlled Foreign Corporations, include:

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

Controlled Foreign Corporation

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).

Below please find a summary of how controlled foreign corporations work, along with examples and guidance on how to get into tax compliance if you are out of IRS compliance.

A Controlled Foreign Corporation (CFC) is a Legal Term wherein a Foreign Corporation is owned more than 50% by U.S. Person(s), who each own at least 10% ownership (Attribution Rules Apply).

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

What is a Controlled Foreign Corporation?

A Controlled Foreign Corporation (CFC) is a Foreign Corporation that is owned primarily by U.S. Persons. Specifically, the Corporation is owned more than 50% by U.S. Persons and each shareholder owns at least a 10% share of the CFC.  The owners of Controlled Foreign Corporations (or at least one owner) will generally have to file an IRS Form 5471 “Information Return of U.S. Persons With Respect To Certain Foreign Corporations” so that the IRS can keep track of the U.S Persons’ interests in the 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 received No Subpart F Income

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.

Examples of areas of tax we handle

Who Decides to Disclose Unreported Money?

What Types of Clients Do we Represent?

We represent Attorneys, CPAs, Doctors, Investors, Engineers, Business Owners, Entrepreneurs, Professors, Athletes, Actors, Entry-Level staff, Students, Former/Current IRS Agents and more.

You are not alone, and you are not the only one to find himself or herself in this situation.

Sean M. Golding, JD, LL.M., EA – Board Certified Tax Law Specialist

Our Managing Partner, Sean M. Golding, JD, LLM, EA  holds an LL.M. (Master’s in Tax Law) from the University of Denver and is also an Enrolled Agent (the highest credential awarded by the IRS, and authorizes him to represent clients nationwide.)

He is frequently called upon to lecture and write on issues involving IRS Voluntary Disclosure.

*Recent cases we had to fix after taking over from less experienced counsel that flubbed the case can be found by Clicking Here (Case 1) and Clicking Here (Case 2).

*Click here to learn the benefits of retaining a Board Certified Tax Law Specialist with advanced tax credentials.

Less than 1% of Tax Attorneys Nationwide

Out of more than 200,000 practicing attorneys in California, less than 400 attorneys have achieved this Certified Tax Law Specialist designation.

The exam is widely regarded as one of (if not) the hardest tax exam given in the United States for practicing Attorneys. It is a designation earned by less than 1% of attorneys.

IRS Penalty List

The following is a list of potential IRS penalties for unreported and undisclosed foreign accounts and assets:

Failure to File

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty. The failure-to-file penalty is generally more than the failure-to-pay penalty.

The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

Failure to Pay

f you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.

However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Civil Tax Fraud

If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

A Penalty for failing to file FBARs

The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.

A Penalty for failing to file Form 8938

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 3520

The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.

A Penalty for failing to file Form 3520-A

The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.

A Penalty for failing to file Form 5471

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 5472

The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.

A Penalty for failing to file Form 926

The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

A Penalty for failing to file Form 8865

Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Fraud penalties imposed under IRC §§ 6651(f) or 6663

Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.

A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)

Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.

A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)

If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.

An Accuracy-Related Penalty on underpayments imposed under IRC § 6662

Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty

Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)

Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.  Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).

A person convicted of tax evasion

Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.  A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000.  A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.

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.