Subpart F Income
Certain types of foreign income earned by Controlled Foreign Corporations that are taxed currently to US shareholders, regardless of distribution.
Detailed Explanation
Subpart F is an anti-deferral regime that prevents US owners (10% or more) of Controlled Foreign Corporations from sheltering passive or easily shifted income offshore. The main categories are foreign personal holding company income (interest, dividends, rents, royalties, and net gains from passive property), foreign base company sales income (income from buying or selling goods through a related party with little local activity), and foreign base company services income. US shareholders include their pro rata share on the current-year return whether or not the CFC distributes anything. Three relief rules narrow the regime: a de minimis rule excludes Subpart F entirely when gross foreign base company and insurance income is less than the lesser of 5% of gross income or $1 million; a full-inclusion rule does the opposite, treating all gross income as Subpart F when those categories exceed 70% of gross income; and a high-tax exception lets a shareholder elect out of income already taxed abroad above 90% of the top US corporate rate (currently 18.9%). Income taxed under Subpart F becomes previously taxed earnings and profits (PTEP) that can later be distributed tax-free, and gain on the sale of CFC stock can be recharacterized as a dividend under Section 1248. Subpart F operates alongside the GILTI regime, which sweeps in most remaining active CFC income. For a 10% US shareholder, a corporation that is both a CFC and a PFIC is taxed under these CFC rules rather than the PFIC rules, under the Section 1297(d) overlap rule.
Key Points
- Anti-deferral regime taxing 10% US shareholders currently on certain CFC income, even if not distributed.
- Main categories: foreign personal holding company income (interest, dividends, rents, royalties) and foreign base company sales and services income.
- De minimis rule (under the lesser of 5% of gross income or $1M) and a full-inclusion rule (over 70%) set the outer bounds.
- A high-tax exception lets shareholders elect out of income already taxed abroad above 18.9%.
- Creates previously taxed E&P (PTEP) that distributes tax-free later; Section 1248 can recharacterize CFC stock-sale gain as a dividend.
- Reported on Form 5471; operates alongside GILTI, and overrides the PFIC rules for 10% CFC owners.
Practical Example
A US person owns a foreign holding company that earns $80,000 of dividends and interest (passive income). That $80,000 is foreign personal holding company income, a Subpart F category, so the owner must include it on the current-year US return through Form 5471 even though the company paid no dividend. When the cash is later distributed, it comes out tax-free as previously taxed E&P.
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Learn about International TaxationRelated Terms
GILTI (Global Intangible Low-Taxed Income)
A US tax on foreign income earned by Controlled Foreign Corporations in excess of a deemed routine return on tangible assets.
Form 5471 (Information Return of US Persons With Respect to Certain Foreign Corporations)
An informational return required of US persons who own or control foreign corporations, with significant penalties for failure to file.
Passive Foreign Investment Company (PFIC)
A foreign corporation that earns mostly passive income or holds mostly passive assets, subjecting US shareholders to a punitive tax regime under IRC Sections 1291 to 1298. Most foreign mutual funds and ETFs are PFICs.
Foreign Tax Credit (FTC)
A dollar-for-dollar credit on the US tax return for income taxes paid to a foreign country, designed to prevent double taxation.
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