If you own 10% or more of a foreign company – whether that’s a holding company in Singapore, an operating business in Ireland, or a consulting entity in the Caymans – you’re sitting on a controlled foreign corporation with exposure to two brutal tax regimes most shareholders don’t understand until the IRS bill arrives. I’m talking about Subpart F income and GILTI, and together they can tax you on profits your foreign corporation earned but never distributed to you as dividends.
Here’s the reality that catches business owners off guard every year. Your foreign corporation makes $500,000 in profit. It keeps that money offshore for reinvestment. You personally received zero dividends. The IRS still wants you to report and pay US tax on a portion of that income as if you received it. This isn’t a loophole they’re closing – it’s the law as written under Subpart F provisions dating back to 1962, now amplified by the 2017 Tax Cuts and Jobs Act that added GILTI on top of existing Subpart F rules.
The foreign dividends GILTI tax regime operates on a simple premise that creates complex calculations. The US government doesn’t trust you to defer taxation indefinitely by parking profits in foreign corporations. So they created “deemed distributions” – income you must report and pay tax on regardless of whether you actually received cash. For 2025, with GILTI rates effectively ranging from 10.5% to 21% depending on your structure and domestic deductions, and Subpart F income taxed at your full ordinary rate up to 37%, the cost of ignorance runs six figures for most CFC shareholders I work with.
What makes this particularly urgent in 2025 is the IRS’s enhanced information sharing through FATCA and the increasing scrutiny on foreign corporate structures. Your Form 5471 filing connects your foreign corporation to your personal return. The IRS matches this data against foreign bank account reports and third-party information returns. I’m seeing audit notices specifically targeting CFC shareholders who underreported Subpart F or miscalculated GILTI. The penalties start at 20% of the understatement and climb from there.
What Makes Your Foreign Corporation a CFC Under US Law
Not every foreign corporation triggers these rules. The classification depends on ownership structure, and getting this analysis wrong means either paying tax you don’t owe or missing required reporting that triggers penalties. A controlled foreign corporation exists when US shareholders collectively own more than 50% of the vote or value, and you personally own at least 10% to be considered a US shareholder for these purposes.
The ownership test uses attribution rules that catch people constantly. Shares owned by your spouse, children, grandchildren, and parents get attributed to you. If your brother owns 40% of a foreign corporation and you own 15%, you don’t think you’re over 50% collectively. Wrong. Family attribution means you’re both considered to own 55%, making it a CFC. I worked with siblings who structured their foreign holding company assuming they’d avoid CFC status by splitting ownership. They failed to account for family attribution and faced three years of back reporting.
The 10% threshold isn’t just direct ownership. If you own 8% directly and 3% through a US partnership, you’re over 10% and you’re a US shareholder. Stock held through options, convertible debt, or warrants can count if they’re “substantially certain” to be exercised. The IRS takes an aggressive position on these determinations because more US shareholders means more tax revenue.
Constructive ownership through entities matters enormously. If you own 100% of a US LLC and that LLC owns 15% of a foreign corporation, you’re treated as owning 15% for CFC purposes. The entity gets disregarded. But if you own 40% of a US corporation that owns 30% of a foreign corporation, you’re only attributed 12% (40% of 30%) because C corporations aren’t disregarded for these rules. Structure matters.
Once you’ve established CFC status, every US shareholder owning 10% or more must file Form 5471 annually. This isn’t a simple form – it’s a complete financial statement reporting package including the foreign corporation’s balance sheet, income statement, and detailed analysis of earnings and profits in both functional currency and US dollars. Miss this filing and face penalties of $10,000 per form, per year, with continuation penalties of $10,000 every 30 days up to a maximum penalty that effectively has no cap for ongoing violations.
Subpart F Income – The Original Anti-Deferral Regime
Subpart F hit the tax code in 1962 with a clear purpose that remains today. Congress didn’t want US taxpayers parking passive income in foreign corporations to defer US taxation indefinitely. The rules create immediate US taxation on certain categories of income earned by your CFC, whether or not that income gets distributed to you as actual dividends. You report it, you pay tax on it at ordinary rates, and you increase your basis in the CFC stock for potential future benefit.
Foreign base company income represents the bulk of Subpart F exposure for operating businesses. This breaks into several categories, but foreign base company sales income and foreign base company services income cause the most problems. If your CFC buys property from a related party and sells it to another related party, and the property isn’t manufactured or consumed in the CFC’s country, you’ve got foreign base company sales income. The entire profit from that transaction flows through to US shareholders as Subpart F income in the year earned.
Here’s how this catches people. You form a Hong Kong corporation to purchase goods from manufacturers in China and sell them to your US distribution company. The Hong Kong entity adds a 40% markup. None of that income qualifies for deferral – it’s Subpart F income because the goods aren’t manufactured, sold, or used in Hong Kong. Your Hong Kong CFC earned $2 million in profit this year. You personally received zero distributions. You’re still reporting $2 million in Subpart F income on your US return and paying tax at ordinary rates.
Foreign base company services income works similarly. If your CFC performs services for or on behalf of related persons, and those services are performed outside the CFC’s country of incorporation, the income is Subpart F income. A Cayman Islands consulting company providing services to your US clients? That’s Subpart F income. A Singapore management company providing services to your Asian subsidiaries incorporated elsewhere? Also Subpart F income. The only exception requires substantial operations in the country of incorporation – offices, employees, meaningful business activity beyond just invoicing.
Foreign personal holding company income targets passive income – dividends, interest, rents, royalties, and capital gains. If your CFC earns interest on cash deposits, that’s Subpart F income. Rental income from property leased to unrelated parties can be Subpart F income unless the CFC provides substantial services in connection with the rental. Royalties from licensing intellectual property typically flow through as Subpart F income unless they’re received from an active trade or business conducted by the CFC in its country of incorporation.
The de minimis rule provides limited relief. If Subpart F income for the year is less than the smaller of $1 million or 5% of gross income, you can treat it as zero. But this threshold is easy to exceed with any meaningful passive income or related-party transactions. I see CFCs exceed this in Q1 from interest income alone. Once you’re over the threshold, all of that income type becomes Subpart F income – not just the excess.
Investment in US property creates another Subpart F trap that functions differently. If your CFC loans money to a US person, pledges assets as security for a US person’s debt, or makes certain investments that benefit US operations, the IRS treats this as a deemed distribution of Subpart F income. The most common violation: your foreign corporation loans money to your US business or to you personally. The outstanding loan balance gets added to your Subpart F income inclusion each year until repaid.
GILTI – Global Intangible Low-Taxed Income Explained
The Tax Cuts and Jobs Act added GILTI in 2017, and the name itself is misleading. This has nothing to do with whether your income is actually from intangibles, and the “low-taxed” threshold catches income taxed at rates up to 18.9% in the foreign jurisdiction. GILTI targets all active business income earned by CFCs that exceeds a 10% routine return on tangible business assets. Everything above that threshold gets included in your US income with a partial deduction that results in effective rates between 10.5% and 21% depending on your situation.
The calculation starts with tested income – basically your CFC’s active business income after removing Subpart F income, certain high-taxed income, and a few other categories. You then calculate net deemed tangible income return (NDTIR), which is 10% of the CFC’s qualified business asset investment (QBAI). QBAI is your CFC’s average adjusted basis in depreciable tangible property used in a trade or business. The excess of tested income over NDTIR becomes your GILTI inclusion.
Here’s why this matters in practice. Your Irish subsidiary has $5 million in tested income. It owns $8 million in depreciable machinery and equipment (adjusted basis). Your NDTIR is $800,000 (10% of $8 million). Your GILTI inclusion is $4.2 million ($5 million tested income minus $800,000 NDTIR). Absent a 962 election or C-Corp blocker, you personally report $4.2 million in additional income on your US return before any deductions or credits.
Individual shareholders face the worst GILTI treatment. Unlike C corporations that get a 50% deduction under Section 250, individuals receive no GILTI deduction by default. The $4.2 million GILTI inclusion gets taxed at your ordinary rate – potentially 37% federally plus 13.3% in California for a combined rate over 50%. You can elect to be taxed as a C corporation for GILTI purposes only (Section 962 election), which gets you the 50% deduction but creates its own complications on actual distributions.
The foreign tax credit provides partial relief if your CFC paid foreign income taxes. You get 80% of the foreign taxes as a credit against your US tax on GILTI. But this operates on a pooled basis across all your CFCs, with limitations that prevent full credit in many cases. If your CFC operates in a country with rates below 13.125% (the threshold where 80% credit eliminates all US GILTI tax), you’re paying US tax on the difference.
GILTI doesn’t replace Subpart F – it adds to it. You calculate Subpart F inclusions first, then GILTI on the remaining tested income. This creates double taxation risk if you’re not careful. Income that’s Subpart F income doesn’t become GILTI, so you avoid being taxed twice on the same dollar. But both regimes apply in the same year, often creating total inclusions that exceed actual CFC profits when you account for different timing rules and basis calculations.
Legal Mitigation Tactic #1 – High-Tax Exception and Election
The most direct way to eliminate GILTI exposure is proving your foreign income already faces high taxation in the foreign jurisdiction. Income subject to foreign tax at an effective rate exceeding 18.9% (90% of the maximum US corporate rate of 21%) can be excluded from GILTI through the high-tax exception. This requires an election and careful calculation of effective foreign tax rates on a tested unit basis.
The tested unit concept matters here. You can’t just look at your CFC’s overall tax rate. You need to analyze the effective rate for each separate tested unit – which generally means each separate qualified business unit (QBU) or separate group of activities. A CFC operating in multiple countries might have some tested units qualifying for high-tax exception and others not. You make separate elections for each tested unit that qualifies.
I’m working with a client whose Luxembourg CFC operates in three countries – Luxembourg (24% rate), Ireland (12.5% rate), and Switzerland (11.5% rate). The Luxembourg operations qualify for high-tax exception, eliminating roughly 60% of potential GILTI inclusion. The Irish and Swiss operations still trigger GILTI. We had to separate the operations into distinct tested units, track income and expenses properly, and make elections on Form 8992 for each qualifying unit.
The foreign tax credit interaction requires attention. Income excluded from GILTI through high-tax exception doesn’t generate foreign tax credits. You’re choosing between: (1) paying no US tax through the exception but losing foreign tax credits, or (2) including income in GILTI, paying some US tax, but claiming 80% of foreign taxes as credits. The math depends on your specific effective rates and whether you have excess foreign tax credits from other sources.
Making the high-tax election is binding for five years unless circumstances materially change. You can’t game the system by electing in and out based on annual rate fluctuations. Plan this carefully because once elected, you’re committed. I’ve seen taxpayers make premature elections based on one good year, then regret it when rates dropped in subsequent years or when they restructured operations.
Legal Mitigation Tactic #2 – Increasing QBAI Through Asset Investment
GILTI inclusion equals tested income minus 10% of QBAI. Increase QBAI and you reduce GILTI dollar for dollar on that 10% return. This makes tangible asset investment a direct GILTI mitigation strategy, particularly for capital-intensive businesses. Your CFC needs machinery, equipment, and real property anyway – structure the ownership to maximize QBAI.
QBAI uses quarterly average adjusted basis of tangible property. This means timing your acquisitions matters. Purchase $2 million in equipment on December 31? Your QBAI only reflects one quarter of that investment in the current year. Purchase it on January 1 and you get four quarters of basis. The 10% routine return on $2 million is $200,000 – that’s $200,000 of income exempt from GILTI just from timing the purchase correctly.
Depreciation reduces QBAI over time, which gradually increases your GILTI exposure as assets age. This creates a perverse incentive to maintain higher asset bases through ongoing capital investment. I’m seeing clients accelerate replacement cycles specifically to maintain QBAI levels. A CFC with $10 million in depreciable basis generates $1 million in NDTIR. Let that basis depreciate to $6 million and your NDTIR drops to $600,000 – your GILTI inclusion just increased by $400,000 with zero change in actual income.
Leasing versus owning becomes a GILTI calculation. Leased assets don’t contribute to QBAI because you don’t have adjusted basis in them. If your CFC leases its manufacturing equipment, you get zero NDTIR benefit. Purchase that same equipment and you’re building QBAI that reduces GILTI. The lease payments might be deductible, reducing tested income, but the tax calculus often favors ownership for GILTI purposes.
Real estate ownership provides substantial QBAI benefits. A CFC that purchases its operating facility versus leasing can add millions to QBAI. Your Singapore subsidiary buys a $5 million warehouse. That’s $500,000 annual NDTIR, exempting $500,000 of income from GILTI. Over time, as the building depreciates, you lose basis, but real property depreciation happens over 40 years – you’re getting two decades or more of meaningful GILTI relief from a single property purchase.
Some practitioners tried getting creative with related-party asset purchases to inflate QBAI. The IRS shut this down through regulations requiring arm’s length transactions and denying QBAI for assets acquired from related parties in certain circumstances. You can’t just sell appreciated assets from your US company to your CFC at marked-up values to create basis. The transactions need business substance beyond GILTI planning.
Legal Mitigation Tactic #3 – Section 962 Election for Individual Shareholders
Individual CFC shareholders face GILTI taxation at ordinary rates up to 37% with no Section 250 deduction. The Section 962 election allows individuals to be taxed as if they were a C corporation for GILTI and Subpart F purposes only. This gets you the 50% Section 250 deduction on GILTI, reducing effective rates to 10.5% to 21% depending on foreign tax credit availability.
The mechanics work like this: You report your GILTI inclusion on your individual return but elect to apply corporate tax rates with the Section 250 deduction. You pay tax at 21% on 50% of the GILTI inclusion (10.5% effective rate) if you have no foreign taxes. Foreign tax credits at 80% further reduce this. The result often cuts your GILTI tax by more than half compared to ordinary rate taxation.
Here’s the trap that makes this election complicated. When your CFC actually distributes cash to you in future years, those distributions get taxed again as dividends to the extent they exceed your previous Section 962 tax. You’re creating a two-tier taxation structure similar to how C corporations work – tax at the entity level through Section 962, then tax again on distributions. You have to track basis carefully and calculate the previously taxed earnings and profits (PTEP) that would be exempt from second taxation.
I worked with a client who made Section 962 elections for five years, paying 10.5% on $3 million in total GILTI inclusions instead of 37%. Saved about $800,000 in tax over that period. Then he took a $2 million distribution from his CFC. Because of the Section 962 mechanics, $1.7 million of that distribution got taxed again at qualified dividend rates (20% federal plus 3.8% NIIT). He still came out ahead compared to never electing, but the second layer of tax surprised him.
The election is made annually on a timely filed return including extensions. You can elect for GILTI only, Subpart F only, or both. Most taxpayers elect for both to minimize current tax. But you need to model the long-term impact including projected distributions. If your CFC generates significant income but distributes minimally, Section 962 makes enormous sense. If you’re taking regular distributions, the second layer of tax might eliminate much of the benefit.
State tax treatment of Section 962 elections varies wildly. California doesn’t conform to Section 962, meaning you’re taxed at ordinary rates for state purposes regardless of the federal election. New York follows federal treatment. Other states take different positions. In high-tax states, your combined rate might hit 30% even with Section 962 election once you factor in state taxation of GILTI at ordinary rates. You need to model this at both federal and state levels.
Legal Mitigation Tactic #4 – Check-the-Box Elections and Entity Classification
Entity classification elections can eliminate CFC status entirely or collapse multiple CFCs into a single entity for US tax purposes. A foreign entity that’s classified as a corporation under local law can elect to be treated as a disregarded entity or partnership for US tax purposes by filing Form 8832. This “check-the-box” election fundamentally changes your GILTI and Subpart F exposure.
If you own 100% of two foreign subsidiaries – one in Ireland, one in the Netherlands – you have two CFCs with separate GILTI calculations. Make check-the-box elections to treat both as disregarded entities. Now you have one CFC for US purposes with consolidated tested income, QBAI, and foreign taxes. This consolidation can be beneficial when one CFC has high QBAI and low income while the other has the opposite profile.
The strategy works particularly well for holding company structures. Your Luxembourg holding company owns operating subsidiaries in five European countries. Each subsidiary is a CFC triggering separate GILTI calculations. Make check-the-box elections on the subsidiaries to disregard them for US tax purposes. Now you have just the Luxembourg parent as a CFC, with all subsidiary income, assets, and taxes consolidated. This often creates better foreign tax credit utilization and GILTI planning flexibility.
The downside comes from subpart F consequences. Disregarded entity treatment means many related-party transactions disappear for US tax purposes – there’s no related party when the entities are disregarded. But it also means you lose certain exceptions that depend on entity separation. Foreign base company sales income can be worse under disregarded entity treatment if you’re not careful about the structure.
I restructured a client’s Asian operations last year through check-the-box elections. He had six CFCs across Singapore, Hong Kong, Malaysia, Thailand, Vietnam, and Philippines. Each generated $200,000 to $800,000 in income with varying QBAI and foreign tax rates. We made elections to treat five entities as branches of the Singapore CFC, creating a single tested unit for GILTI purposes. This consolidated $3.2 million in tested income with $18 million in combined QBAI, generating $1.8 million in NDTIR. Before restructuring, his GILTI inclusion was $2.4 million. After, it dropped to $1.4 million – $1 million reduction from a purely paper restructuring.
Timing matters. Check-the-box elections are generally effective the first day of the year they’re filed unless you request a specific effective date. Making the election on December 31 versus January 1 can create a full year’s difference in effectiveness. For existing CFCs, you might face a deemed liquidation or other recognition event when making the election. Model these consequences before filing.
Legal Mitigation Tactic #5 – Restructuring Ownership Below CFC Thresholds
The simplest way to eliminate GILTI and Subpart F exposure is not being a CFC shareholder. This requires careful ownership restructuring to get below the 10% threshold or to break the more-than-50% US ownership requirement. Both paths work but require giving up control or diluting ownership in ways that create real business consequences beyond tax.
Bringing in non-US shareholders is the most common approach. If US persons collectively own 50% or less of vote and value, there’s no CFC regardless of individual ownership levels. You own 40% of a Singapore company, your business partner (US citizen) owns 40%, and you bring in a Singaporean investor for 20%. You’re now at 80% US ownership – still a CFC. Flip that to 45%-45%-10% and you’re at 90% US. Structure it as 35%-35%-30% and you’ve broken CFC status. The company still operates identically, but US tax treatment changes completely.
The non-US shareholder must be genuinely non-US. Using nominees or related foreign persons doesn’t work. The IRS has anti-abuse rules attributing ownership of related foreign persons back to US shareholders in certain circumstances. Your Cayman Islands trust isn’t a non-US shareholder if you’re the beneficiary. Your spouse’s foreign company isn’t non-US if attribution rules apply. You need legitimate third-party ownership with real equity and economic rights.
Reducing your personal ownership below 10% eliminates your individual reporting obligation and GILTI inclusion. You still need to be careful – going from 10% to 9% doesn’t help if your spouse owns 5% because family attribution puts you at 14%. But genuine third-party dilution works. I’ve seen shareholders bring in strategic investors specifically to get below 10%, accepting dilution as the price of eliminating annual GILTI inclusions.
The business consequences matter more than the tax benefits in many cases. Bringing in a 30% foreign shareholder means sharing 30% of future growth, giving up some control, and adding complexity to governance. You need to weigh this against the GILTI tax you’re avoiding. If your annual GILTI inclusion runs $500,000 with $180,000 in tax, is it worth giving up 30% of a business valued at $10 million? Sometimes yes, often no.
Preferred equity structures offer a middle ground. Issue non-voting preferred stock to non-US investors with fixed returns. This can break CFC status by reducing US ownership of value below 50% while maintaining US control through voting common stock. The IRS scrutinizes these arrangements, so the preferred needs real equity characteristics – meaningful liquidation preferences, market rates of return, and genuine transfer rights. Preferred stock that’s really debt gets recharacterized.
Legal Mitigation Tactic #6 – Timing Income Recognition and Distributions
While you can’t avoid Subpart F and GILTI inclusions if your CFC has the income, you can manage timing to optimize foreign tax credits, utilize domestic losses, or coordinate with other tax planning. This requires multi-year projections and careful attention to estimated tax obligations, but the savings can be substantial.
Accelerating tested income into high foreign tax years improves your foreign tax credit position. If your CFC will face a 25% foreign rate in 2025 but expects rates to drop to 15% in 2026 due to expiring tax incentives, you want income in 2025. That higher foreign tax generates better credits against your GILTI inclusion. The same income earned in 2026 creates larger net US tax liability because foreign credits only cover 80% of foreign taxes and the credits are worth less at lower rates.
Deferring income to loss years on your US return helps if you have domestic losses that otherwise expire. You have $800,000 in expiring NOLs from your US business. Your CFC could accelerate or defer $1 million in income through timing of sales, services, or collections. Pulling that income into the year with NOLs lets you offset the GILTI inclusion, effectively using losses that would otherwise be wasted. You can’t offset more than 80% of GILTI with NOLs under Section 250 limitations, but 80% of $1 million is still significant tax savings.
Making actual distributions from your CFC to yourself doesn’t trigger additional US tax if you’ve already paid tax on the earnings through Subpart F or GILTI inclusions. The income gets tracked as previously taxed earnings and profits (PTEP) on Form 5471. Distributions of PTEP are tax-free to US shareholders. This creates opportunity for cash management – you can take distributions when you need cash without US tax consequences because you’ve already paid tax on the income.
The PTEP tracking requires careful attention. Subpart F PTEP sits in different accounts than GILTI PTEP, with different ordering rules on distributions. Section 962 elections create additional PTEP accounts with special rules on distribution taxation. If you don’t track this correctly, you end up paying tax twice on the same income or failing to claim tax-free distributions you’re entitled to. I spend significant time reconstructing PTEP accounts for clients whose prior preparers didn’t maintain proper records.
Year-end planning should include GILTI projections before December 31. If you’re close to the high-tax exception threshold, accelerating foreign tax payments might push you over. If you’re building QBAI for NDTIR calculations, moving equipment purchases from Q1 next year to Q4 current year improves this year’s average basis. These timing moves require coordination with your foreign operations, but they work if you plan ahead.
Real-World Example: E-commerce Business With Foreign Fulfillment Entity
Let me walk through a complete example showing how Subpart F and GILTI work together, and where planning creates savings. This mirrors dozens of structures I see with e-commerce businesses using foreign entities for logistics.
Please note: The examples in this section are simplified for educational purposes to illustrate how Subpart F and GILTI calculations work. Real-world CFC tax situations involve additional complexities including functional currency translations, detailed E&P calculations, multiple tested units, state tax considerations, and numerous other factors not reflected in these examples. These illustrations should not be used as a template for actual tax calculations without comprehensive professional analysis.
You own 100% of an Irish corporation that handles European fulfillment for your US-based online business. The Irish company purchases inventory from your US company at cost plus 20%, stores it in Irish warehouses, and fulfills orders to European customers. In 2025, the structure generates these results:
- Gross sales to European customers: $8 million
- Cost of goods (purchased from your US entity): $5 million
- Operating expenses (wages, rent, logistics): $1.5 million
- Net income: $1.5 million
- Irish corporate tax at 12.5%: $187,500
- After-tax profit: $1,312,500
- Qualified business asset investment (warehouse equipment): $4 million average adjusted basis
First, analyze Subpart F exposure. The inventory purchases from your related US entity and sales to unrelated European customers might trigger foreign base company sales income rules. However, the manufacturing exception applies if the Irish entity adds substantial value beyond just reselling. With $1.5 million in operating expenses including wages for fulfillment operations, you have a reasonable position that this is substantial activity. No Subpart F income from sales operations.
Investment income complicates this. The Irish entity keeps $2 million in operating cash, earning $80,000 in bank interest. That’s foreign personal holding company income – automatic Subpart F income. You report $80,000 in Subpart F income on your Form 1040, taxed at ordinary rates. At 37% federal plus 13.3% California, you’re paying about $40,000 in US tax on this interest income.
Now calculate GILTI. Tested income starts with $1.5 million in earnings, minus the $80,000 already taxed as Subpart F, equals $1,420,000. NDTIR is 10% of $4 million QBAI, or $400,000. GILTI inclusion is $1,020,000 ($1,420,000 tested income minus $400,000 NDTIR).
Without Section 962 election, you’re taxed at 37% on $1,020,000, owing $377,400 in federal tax. Add 13.3% California tax on the same amount (California doesn’t conform to GILTI rules), and you’re at $513,060 in total US tax. You also paid $187,500 to Ireland. Total tax bill: $700,560 on $1.5 million income, an effective rate of 46.7%. Your Irish company distributed zero to you – all this tax comes from phantom income.
Make Section 962 election and the math changes. GILTI inclusion remains $1,020,000, but you get the 50% Section 250 deduction, leaving $510,000 taxable at 21%. That’s $107,100 federal tax before credits. You claim 80% of Irish taxes as foreign tax credits – 80% of $187,500 is $150,000 in credits. Your credit exceeds your US tax, so you owe zero federal GILTI tax. California still wants its 13.3% on $1,020,000, costing $135,660. Total US tax: $135,660 on GILTI plus $40,000 on Subpart F, total $175,660.
Combined with Irish tax of $187,500, your total tax is $363,160 on $1.5 million income, an effective rate of 24.2%. Section 962 election saved $337,900 in current-year tax. The downside surfaces when you take actual distributions. When the Irish company eventually distributes this $1,312,500 to you, you’ll owe dividend tax on the portion exceeding your Section 962 basis step-up. But even accounting for future dividend tax at 23.8%, you’re better off with the election.
How do we optimize this further? Three immediate moves:
First, eliminate the interest income Subpart F problem. Rather than keeping $2 million in Irish bank accounts earning interest, make an interest-free loan to your US company or invest in operating assets that produce active income. The $80,000 in interest income created $40,000 in unnecessary current tax.
Second, increase QBAI. The Irish entity leases its warehouse space. If you purchased the warehouse for $3 million, you’d add $3 million to QBAI (average basis around $2.9 million after first year’s depreciation). That increases NDTIR by $290,000, reducing GILTI inclusion from $1,020,000 to $730,000. With Section 962 election, this saves roughly $60,000 in annual tax. The warehouse purchase pays for itself through GILTI savings within ten years, ignoring any appreciation or operational benefits.
Third, consider whether the Irish entity needs to exist at all. If you restructured to use a US entity for fulfillment or contracted with third-party logistics providers, you’d eliminate CFC reporting and GILTI entirely. You’d lose Ireland’s 12.5% rate, but given that GILTI is capturing most of the deferral benefit anyway, the compliance savings alone might justify bringing operations back to the US. This needs full modeling including VAT, customs, and operational impacts, but it’s worth analyzing.
Compliance Requirements – Forms You Cannot Skip
CFC ownership triggers reporting obligations that go far beyond a typical Schedule C or partnership K-1. Miss these forms and you’re facing minimum penalties of $10,000 per form, with continuing penalties that effectively have no cap. I’ve seen penalty assessments exceed the underlying tax by multiples because clients ignored filing requirements.
Form 5471 is your primary CFC reporting vehicle, due with your individual or corporate return including extensions. This form has five categories of filers, but most CFC shareholders file as Category 4 or 5 filers, requiring complete financial statements, E&P calculations, and detailed schedules. You’re translating foreign GAAP to US tax principles, converting functional currency to dollars, and tracking basis and E&P accounts across multiple years. Plan on 20-40 hours of professional time per CFC annually just for Form 5471 compliance.
The form includes these critical schedules:
- Schedule E – Income statement showing income by category (tested income, Subpart F, excluded income)
- Schedule H – Current E&P calculation in both functional currency and US dollars
- Schedule I-1 – Summary of shareholder’s share of Subpart F income and tested income
- Schedule J – Accumulated E&P not previously taxed
- Schedule M – Transactions between CFC and shareholders or related persons
- Schedule Q – QBAI calculation for GILTI purposes
Form 8992 reports GILTI inclusion amounts, including detailed calculations of tested income, tested loss, QBAI, and specified interest expense. Individual shareholders making Section 962 elections complete additional calculations showing corporate-equivalent tax and credits. This form connects to Form 5471 and pulls data from multiple schedules, requiring careful coordination.
Form 8993 reports Section 250 deductions for GILTI and foreign-derived intangible income (FDII). Individual shareholders making Section 962 elections use this to calculate their deduction. C corporation shareholders file it regardless. The form requires detailed sourcing of income and allocation of deductions between domestic and foreign income.
Form 1118 claims foreign tax credits for GILTI and Subpart F income. This 20-page form separates credits into different baskets (general, passive, Section 951A/GILTI), applies limitations, and calculates carryforwards. The 80% credit limitation for GILTI appears here, along with adjustments for Section 78 gross-up of foreign taxes. Most CFC shareholders need professional help with this form because the calculations are intricate and mistakes are expensive.
FinCEN Form 114 (FBAR) reports foreign financial accounts exceeding $10,000 aggregate. If you have signature authority over CFC bank accounts, you’re reporting those accounts even though they’re not personally yours. This form has separate filing requirements (due April 15 with automatic extension to October 15) and penalties for willful violations reach 50% of account balances. It’s not a tax form – it files separately through FinCEN’s system.
Form 8938 (Statement of Specified Foreign Financial Assets) reports your CFC stock if total foreign assets exceed thresholds ($50,000 to $600,000 depending on filing status and residence). This overlaps with FBAR but uses different thresholds and definitions. The form attaches to your 1040 and has penalties of $10,000 for failure to file, plus continuing penalties of $10,000 every 30 days starting 90 days after IRS notice.
State reporting adds another layer. Many states require separate CFC reporting or have different conformity positions on GILTI and Subpart F. California requires detailed worldwide reporting on Schedule R, adding California-specific calculations. New York has its own CFC inclusion rules. You can’t just check a box and be done – you’re preparing parallel calculations for federal and each applicable state.
The Cost of Getting This Wrong
I inherit clients from other preparers constantly, and the pattern is always the same. They knew they had a foreign corporation, they filed something, but nobody calculated GILTI correctly or they missed Subpart F income entirely. The IRS catches this through automated matching of Form 5471 against individual returns. When income reported on Form 5471 doesn’t flow through to your Form 1040, the system flags it.
A client came to me with a $340,000 tax assessment from IRS. His Singapore CFC had generated $1.8 million in tested income over three years. His prior CPA filed Form 5471 showing the income but never calculated GILTI inclusions on his personal return. The IRS added $1.2 million to income (after NDTIR calculations), assessed tax at 37% plus accuracy penalties at 20% of the understatement, plus interest compounding for three years. The total bill hit $450,000 by the time we negotiated it down.
The math on that negotiation matters. We demonstrated reasonable cause for the error – the prior preparer had no international tax experience and the client relied on professional advice. We also showed the client would have qualified for Section 962 elections, reducing the deficiency significantly. After eight months of appeals work, we settled at $180,000 total tax and penalties. Still painful, but better than the alternative.
Form 5471 penalties alone can exceed tax on the income. The penalty is $10,000 per form per year for failure to file. If you own three CFCs and missed three years of Form 5471 filings, that’s $90,000 in penalties before considering the tax on unreported income. These penalties can be abated for reasonable cause, but you need documented justification – not just “I didn’t know I had to file.”
Willful FBAR violations destroy wealth. A client failed to report his CFC’s bank accounts on FBAR for four years while the accounts grew to $2.3 million. The IRS assessed willful penalties at 50% per year, demanding $4.6 million on unreported accounts with maximum aggregate balance of $2.3 million. The penalty exceeded the account balance because each year triggered separate 50% penalties. We eventually settled through the Offshore Voluntary Disclosure Program, but the cost was still over $800,000 when including back taxes, interest, and reduced penalties.
What You Must Do Now
If you own 10% or more of a foreign corporation, here’s your immediate action list. Don’t wait until tax season to address this because the planning strategies require time to implement and some require advance elections or restructuring before year-end.
First, confirm your CFC status using the ownership and attribution rules I outlined. Include family attribution, look-through rules for entities, and constructive ownership. If you’re over 10% or if US persons collectively exceed 50%, you have CFC obligations. Determine this accurately because everything else flows from getting this classification right.
Second, gather complete financial information for each CFC. You need balance sheets, income statements, and detailed transaction records in both functional currency and US dollars. You need depreciation schedules showing adjusted basis in tangible property for QBAI calculations. You need documentation of foreign tax payments with proof of payment and effective rate calculations. Collect this quarterly, not annually, because reconstructing it later costs significantly more.
Third, run preliminary Subpart F and GILTI calculations before December 31. This tells you whether year-end planning makes sense. If you’re close to high-tax exception thresholds, can you accelerate foreign tax payments? If QBAI is borderline, does accelerating equipment purchases reduce GILTI? If you’re considering Section 962 elections, model the immediate and long-term impacts including distribution taxation. You can’t make these decisions on April 14.
Fourth, ensure all historical Form 5471 filings are complete and accurate. If you missed prior years or filed incomplete forms, address this before IRS discovers it. The Streamlined Filing Compliance Procedures or Delinquent International Information Return Submission Procedures offer penalty relief for non-willful violations. These programs work, but you need to use them before IRS contacts you about the missing forms.
Fifth, evaluate restructuring opportunities that reduce or eliminate CFC exposure. Can you bring in non-US shareholders to break CFC status? Would check-the-box elections consolidate multiple CFCs beneficially? Does the business justify foreign incorporation at all, or would US operations with foreign branches work better? These aren’t tax-only decisions, but tax should inform the business structure.
The cost of planning versus fixing mistakes later differs by orders of magnitude. Spending $15,000 to $30,000 annually on proper CFC compliance and planning prevents the $200,000+ costs I see clients pay when the IRS catches unreported GILTI or missing Form 5471 filings. The foreign dividends GILTI tax regime isn’t going away. The reporting requirements aren’t getting simpler. Information exchange between governments isn’t decreasing.
Your foreign corporation is visible to the IRS whether you report it properly or not. Bank information flows through FATCA. Foreign tax authorities share data through information exchange agreements. The IRS matches this information against Forms 5471 filed with returns. When they find discrepancies – and they will – you’re defending yourself instead of planning proactively.
Get this handled by someone who works with CFCs regularly. Not your local accountant who does 500 individual returns and sees one or two CFCs per year. Someone who understands the difference between tested units and QBUs, who knows when Section 962 elections create more problems than they solve, who can calculate PTEP accounts and track them across multiple years and entity restructurings.
I work with CFC shareholders navigating Subpart F, GILTI, and international compliance daily. The rules are complex but they’re manageable with proper planning and execution. You don’t have to pay maximum tax on phantom income you never received. You just need to understand the rules and use the legal mitigation tactics that fit your specific structure.
Schedule a consultation with Dimov Tax Specialists to analyze your CFC situation. We’ll review your structure, calculate your exposure, identify planning opportunities, and ensure your compliance covers all required forms. You get tax minimization through legal strategies and protection from penalties that destroy wealth. The foreign dividends GILTI tax regime creates real obligations – handle them correctly before they become real problems.