@VLJeker Trilogy: Foreign Corporations – Dividends, qualified dividends and subpart F

Prologue:

Controlled Foreign Corporations and Subpart F income were introduced here. Tax professionals about written about the dangers of Americans abroad carrying on business through a corporation. In addition to the tax problems (dividends, Subpart F, etc). there are also extremely invasive, expensive and penalty laden reporting requirements. In fact, Form 5471 is arguably America’s most deadly and dangerous form.

For those who want to understand this difficult topic better …

 

 

Well, she has followed through. Form 5471 is the form required for “Foreign Corporations”. She has written this wonderful trilogy of posts on “Foreign Corporations”. Thank you Virginia La Torre Jeker for the following:

“What you need to know about foreign corporations, but couldn’t even imagine to ask “Triology”.

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Not all dividends are treated the same and the nuances can make a big difference to your ultimate investment return.

 “Regular Dividends” and “Qualified Dividends”

In general, there are two different types of dividends – “regular dividends” and “qualified dividends”. One is taxed far more favorably than the other.  A so-called “qualified” dividend is given beneficial tax treatment because it is taxed at a lower more beneficial long-term capital gains tax rate.  For most individuals this rate is currently at 15% , but the rate can be lower or higher for very low / or very high income earners. …

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Special rules apply to distributions from CFCs. Before detailing these rules, a bit of background about CFCs will be helpful.

Since a foreign corporation is not a US taxpayer, income earned by a foreign corporation from its foreign operations generally is subject to US tax only when that income is distributed to its US shareholder. As such, a US person that is a shareholder in a foreign corporation is generally not taxed on the income earned by the foreign corporation until that income is distributed to the shareholder as a dividend. The US tax law, however, contains a variety of “anti-deferral” tax regimes. If the CFC tax regime applies, it can subject the US shareholder to US tax on income earned by the foreign corporation even if that income is not actually distributed to the shareholder. These rules prevent US taxpayers from otherwise deferring payment of tax by keeping profits within a foreign corporation that is itself, not subject to the reach of the US taxman.

What is a CFC? How do the CFC Rules Work?

Generally speaking, a CFC is any foreign corporation in which so-called “United States shareholders” own more than 50 percent of the total combined voting power of all classes of stock of such corporation entitled to vote or the total value of such corporation. A “United States shareholder” is a US person that owns ten percent or more of the total combined voting power of all classes of stock entitled to vote.

United States shareholders of CFCs are required to include in their gross income, on a current basis, their proportionate share of certain income earned by the CFC. This is a special type of income and is referred to as “Subpart F income”.

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As will be recalled from the previous blog posting that discussed so-called “Controlled Foreign Corporations” (CFC), a United States shareholder of a CFC can possibly be treated as having received “dividend” income at various times. These are when the US shareholder (i) has current income inclusions from the CFC under the anti-deferral regime (Subpart F income); (ii) has amounts actually distributed to him that had not been previously taxed as Subpart F income (these are ‘actual’ dividends); (iii) has amounts actually distributed to him that had been previously taxed as Subpart F income and (iv) recognizes gain on the sale of his CFC stock and the CFC has undistributed earnings and profits.

The question arises whether any of these amounts (i)-(iv), can be treated as “qualified dividend income”?  Full details about the tax beneficial treatment of “qualified dividend income” can be found here.

 

 

 

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