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US Shareholders Taxed on Distributive Share of CFC Income

Those persons who qualify as “U.S. shareholders” of a CFC are taxed on their distributive share of the income of the CFC that is deemed “Subpart F income”—that income that is effectively connected income (see above).

However, those individuals who do not so qualify (i.e. those individuals who own 10% or less of the stock) are not immediately taxed on their distributive share. But there is an exception to this rule. In particular, IRC § 951(a)(1) requires certain shareholders of a controlled foreign corporation to include certain amounts in income, even if the corporation has not distributed these amounts. The rule is that if a foreign corporation is a CFC for at least 30 consecutive days during the year as a result of the constructive ownership rules, then all of the U.S. shareholders who are also shareholders on the last day of the CFC’s tax year will be taxed, even if it were not actually distributed to the shareholder. IRC §951(a)(1).

One of the main purposes of the Subpart F rules is to discourage people from attempting to defer paying U.S. taxes by placing businesses overseas in places where certain taxes are levied at a low rate or not at all (i.e. tax havens). These rules were designed to limit an artificial deferral of tax by using offshore entities subject to a low tax. The CFC rules are required only for the income of an entity that is not currently taxed to the owners of the entity.