Controlled Foreign Corporations (CFCs) and Subpart F Income

Graziano Stefanelli
Jul 31
3 min read

U.S. shareholders face immediate tax on specified earnings of foreign affiliates once control thresholds and attribution tests trigger CFC status, and recent legislation reshapes the scope of inclusions, elections, and reporting.

CFC status turns on 50 percent ownership and refreshed attribution rules.

A foreign corporation becomes a CFC when U.S. shareholders hold—directly, indirectly, or constructively—more than half the vote or value on any day of its tax year.

The 2017 repeal of § 958(b)(4) now pulls “downward‑attributed” stock into the test, sweeping many minority‑owned structures into CFC territory and expanding Form 5471 filings and Subpart F exposure.

Subpart F inclusions accelerate taxation of passive and mobile income.

U.S. shareholders pick up their pro‑rata share of specified foreign earnings—regardless of distributions—once the CFC earns foreign personal holding company income, foreign base company sales or services income, insurance income, or certain boycott or bribe receipts.

Foreign taxes paid by the CFC generate § 960 deemed‑paid credits, but timing mismatches and expense allocation rules often restrict full relief.

High‑tax exception shields income taxed abroad at effective rates above 90 percent of the U.S. rate.

Final regulations published in 2020 let taxpayers annually elect out of Subpart F (and GILTI) if the tested item already bears a sufficiently high foreign levy, provided detailed computations and consistency rules are met.

A parallel GILTI high‑tax election can align the treatment of low‑margin affiliates, but electing groups must monitor currency swings and local incentives that may drop the effective rate below the threshold.

Look‑through rule under § 954(c)(6) becomes permanent after 2025.

The July 2025 legislation makes the related‑party “look‑through” exception permanent, excluding many intra‑group dividends, interest, rents, and royalties from Subpart F if they trace to active earnings.

Taxpayers should refresh cash‑pool and IP‑royalty flows to exploit the new certainty while guarding against hybrid‑mismatch disallowances.

Calculating the inclusion and basis consequences.

U.S. shareholders include their share of current‑year Subpart F income, increase basis in CFC stock under § 961(a), and build previously taxed E&P (PTEP) pools that shelter future distributions.

Illustrative inclusion – $1 million Subpart F income, 21 percent U.S. rate

Journal entry – year‑end

Dr Investment in CFC (PTEP) $1 000 000

Cr Subpart F Income $1 000 000

Dr Income Tax Expense $210 000

Cr Income Tax Payable $210 000

ASC 740 then assesses deferred tax assets for foreign tax credits and uncertain‑tax‑position reserves when elections or allocations remain unresolved.

Compliance filings expand: Form 5471 schedules, Form 8990 for § 163(j), and country‑by‑country data.

Each CFC demands detailed reporting of income, balance‑sheet items, PTEP pools, and high‑tax elections. Late or incomplete filings trigger automatic $10 000 penalties per form, escalating with continued delinquency.

Finance teams should link statutory books, tax sensitised ledgers, and consolidation systems to feed ever‑growing disclosure grids.

Proposed 2025 reforms may stretch Subpart F further.

The Senate Finance draft would let Treasury classify certain “foreign controlled U.S. shareholders” as CFCs for reporting and coordination—even where current Subpart F rules do not apply—while scrapping the one‑month deferral election and narrowing foreign tax credit baskets.

Scenario modelling now needs to layer these proposals on top of Pillar Two top‑up taxes and new § 59(k) CAMT computations.

Pillar Two interplay complicates foreign effective‑rate testing.

OECD global minimum‑tax rules overlay a 15 percent jurisdictional floor; failure to reach it may add domestic top‑up tax but still leave Subpart F untouched, creating parallel timing and credit frictions.

Treasury guidance on foreign‑tax‑credit creditability for Pillar Two taxes remains limited, so ASC 740 disclosures should flag potential double‑inclusion exposures.

Early classification reviews, real‑time effective‑rate monitoring, and robust documentation remain the core defences against unexpected Subpart F hits and steep compliance penalties.

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DATA STUDIOS

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U.S. shareholders face immediate tax on specified earnings of foreign affiliates once control thresholds and attribution tests trigger CFC status, and recent legislation reshapes the scope of inclusions, elections, and reporting.

CFC status turns on 50 percent ownership and refreshed attribution rules.

A foreign corporation becomes a CFC when U.S. shareholders hold—directly, indirectly, or constructively—more than half the vote or value on any day of its tax year.

Subpart F inclusions accelerate taxation of passive and mobile income.

U.S. shareholders pick up their pro‑rata share of specified foreign earnings—regardless of distributions—once the CFC earns foreign personal holding company income, foreign base company sales or services income, insurance income, or certain boycott or bribe receipts.

High‑tax exception shields income taxed abroad at effective rates above 90 percent of the U.S. rate.

Final regulations published in 2020 let taxpayers annually elect out of Subpart F (and GILTI) if the tested item already bears a sufficiently high foreign levy, provided detailed computations and consistency rules are met.

Look‑through rule under § 954(c)(6) becomes permanent after 2025.

The July 2025 legislation makes the related‑party “look‑through” exception permanent, excluding many intra‑group dividends, interest, rents, and royalties from Subpart F if they trace to active earnings.

Calculating the inclusion and basis consequences.

U.S. shareholders include their share of current‑year Subpart F income, increase basis in CFC stock under § 961(a), and build previously taxed E&P (PTEP) pools that shelter future distributions.

Compliance filings expand: Form 5471 schedules, Form 8990 for § 163(j), and country‑by‑country data.

Each CFC demands detailed reporting of income, balance‑sheet items, PTEP pools, and high‑tax elections. Late or incomplete filings trigger automatic $10 000 penalties per form, escalating with continued delinquency.

Proposed 2025 reforms may stretch Subpart F further.

The Senate Finance draft would let Treasury classify certain “foreign controlled U.S. shareholders” as CFCs for reporting and coordination—even where current Subpart F rules do not apply—while scrapping the one‑month deferral election and narrowing foreign tax credit baskets.

Pillar Two interplay complicates foreign effective‑rate testing.

OECD global minimum‑tax rules overlay a 15 percent jurisdictional floor; failure to reach it may add domestic top‑up tax but still leave Subpart F untouched, creating parallel timing and credit frictions.

Early classification reviews, real‑time effective‑rate monitoring, and robust documentation remain the core defences against unexpected Subpart F hits and steep compliance penalties.