Controlled Foreign Corporations: Why the IRS cares so much



In Part 1 of our Controlled Foreign Corporations/Form 5471 video series, we talked about what a Controlled Foreign Corporation (CFC) is, and why they are such a big deal to the IRS and US persons investing overseas.


What is a Controlled Foreign Corporation?

A CFC is a corporate entity that is registered and conducts business in a different jurisdiction or country than the residency of the controlling owners. In the US, control of the foreign company is defined according to the percentage of shares owned by U.S. citizens.


Prior to 1962, it was easy for an offshore corporation to avoid taxes. It worked as simply as this: A US person could fund an offshore corporation and be its sole shareholder, and that corporation could invest and earn passive income. All that passive income was non-taxable unless it was repatriated back to the US. This is what is known as deferral. Deferral is a legal way to avoid taxes until a later point. Because of the present value of money and the fact that having money grow tax-free is always better than it not growing tax-free, deferral was frowned upon by a federal government that wants more money.


With new reporting laws in place, it is now difficult to do so. Deferral is fairly well-known to most people, albeit under a different structure. A common form of deferral is a 401(k) plan.


Subpart F

Indefinite deferral means the US Treasury gets no money. And that makes the government so sad. So very sad.

In 1962 Subpart F was passed to increase revenues. Now what happens is it gets attributed to you as income in that year. Subpart F is even more terrible than that — the income is taxed at ordinary rates, even though the investment would have otherwise been taxed at lower passive rates. The way to combat Subpart F is with the use of Form 8858, and make sure you "check the box" to disregard the entity. Then all income is passed through to the taxpayer and is taxed at whatever rate the investment would be taxed at; that is dividend, passive real estate rates of 15/20%.


If you need assistance with a tax issue, contact us. We can help. Call us at 888-727-8796 or email info@irsmedic.com. 


For more about Subpart F and why it is difficult to use offshore tax shelters for the individuals, click here.