Important CFC Tax Planning Considerations for U.S. Owners

Overview of CFC Shareholder, GILTI, Subpart F Tax Planning

Overview of CFC Shareholder, GILTI and Subpart F Tax Planning

When a U.S. Person forms a foreign corporation, one of the key tax considerations is whether the foreign entity falls under the CFC tax regime (Controlled Foreign Corporation). When a foreign corporation is determined to be a Controlled Foreign Corporation, it typically means that more than 50% of the corporation is owned by U.S. persons who each own at least a 10% share of the company. In the common situation in which a U.S. person may invest overseas or move overseas and wants to form an entity in that country, chances are high that it will be a one-or-two-person operation (attribution and constructive ownership rules apply), and thus it will be considered a CFC for tax purposes — which has can cause tax complications involving GILTI and Subpart F. Not only are the tax rules more complicated for CFC income but so are the reporting requirements. Oftentimes the CFC will require filing a Form 5471 in all years, along with various complex Form 5471 schedules. Let’s look at some of the basics involving CFC and Subpart F income.

What is a Controlled Foreign Corporation?

In dealing with individuals, a controlled foreign corporation is usually when the corporation is owned more than 50% by U.S. shareholders, with each U.S. shareholder owning at least 10% of the entity.  For example, if a U.S. Taxpayer forms a Canadian corporation, it will generally be considered a CFC.

What is GILTI and Subpart F Income?

GILTI and Subpart F are two sides of the same coin. Subpart F income has been around for many years and the idea behind it is that back in the day, the U.S. government was concerned that Taxpayers were moving money overseas and not paying income taxes on their earnings. That is because back when subpart F income was introduced, the U.S. tax rate was much higher than it is now and so this was a very real concern. More recently was the introduction of GILTI (Global Intangible Low Taxed Income), which is designed to ensure that Taxpayers who are earning money overseas and keeping it in a foreign corporation are paying tax (although elections and foreign tax credits may effectively eliminate any tax liability). The most important component of GILTI and Subpart F Income is that a Taxpayer does not have to receive the income from the foreign entity to be taxed on it. In other words, under these two types of tax regimes, a person may be subject to U.S. income tax on earnings that were accrued but not distributed to them.

CFC Tax Considerations                                                                   

When possible, Taxpayers should consider whether there are alternatives to forming a controlled foreign corporation, but sometimes it is just not possible to avoid CFC status because to protect the assets in the foreign country the Taxpayer has to form an entity and most Taxpayers do not want to offer ownership of their corporation to non-U.S. persons today they do not know very well just to avoid CFC status.

First, Can the Taxpayer Avoid CFC Status?

The first thing to consider is possibly avoiding controlled foreign corporation status. Ideally, the Taxpayer would either form a corporation that is not owned more than 50% by U.S. persons or not at least 10% by each shareholder. It is important to note though, that the attribution and constructive ownership rules apply so even if 11 people each owned ~9.09%, related parties may be considered one owner for purposes of the U.S. shareholder definition.

Should the Taxpayer Disregard the Entity?

Alternatively, the Taxpayer may consider disregarding the entity for tax purposes. For example, if the entity is a controlled foreign corporation but the Taxpayer elects to be treated as a disregarded entity, then the Taxpayer may avoid CFC status. But there are some other issues as well, such as possibly having to file Form 8858 each year and having to include all of the income on the U.S. tax return, even if it is not distributed — because as a nonentity, all of the income would be taxable.

* In addition, some foreign entities cannot be disregarded and this list can be found under the per se corporation rules.

Can the Taxpayer Make an Election(s)?

Even if a Taxpayer operates as a controlled foreign corporation, they may be able to make certain elections that can ultimately reduce their overall tax liability — but then the tax return may become very complicated. Imagine the situation in which a Taxpayer has a relatively straightforward U.S. tax return but then opens a controlled foreign corporation overseas, the Taxpayer may now have to file Form 5471 along with several schedules in addition to making various elections to avoid income or to apply certain foreign tax credits. Especially in situations in which no income was distributed, this can be overwhelming to the Taxpayer.

Some Exceptions May Apply

If a Taxpayer is in a position where they cannot otherwise avoid forming a CFC or disregard the entity, there are various exceptions, such as the high-tax jurisdiction exception (which means that the Taxpayer paid a certain percentage amount of tax in the foreign country) then he may escape GILTI or Subpart F income taxes in the United States. There are other exceptions as well, but they are very technical and should be evaluated on a case-by-case basis.

Late Filing Penalties May Be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.