Subpart F Income

Subpart F income is the category of controlled foreign corporation income that a US shareholder includes currently, in the year the CFC earns it, rather than when it is distributed. The regime dates to 1962 and rests on a simple policy judgment: income that is mobile enough to be parked in a low-tax jurisdiction with no real business reason should not get the benefit of deferral. Income from genuine local operations generally still does.

The bulk of it is foreign base company income under Section 954. That has three principal components. Foreign personal holding company income is the passive bucket: dividends, interest, rents, royalties, annuities, net gains from property producing that income, and certain commodities and currency gains. Foreign base company sales income arises where a CFC buys from or sells to a related party, and the goods are both manufactured outside and sold for use outside the CFC's country of incorporation, which is the classic invoicing-subsidiary pattern. Foreign base company services income arises where the CFC performs services for or on behalf of a related person outside its country of incorporation. Insurance income under Section 953 is separate, and Section 952 adds a short list of policy-driven items including international boycott income, illegal bribes and kickbacks, and income from Section 901(j) countries.

Four limitations do most of the real work at preparation. The de minimis rule drops the whole computation if gross foreign base company income and gross insurance income together are less than the lesser of 5% of gross income or $1 million. The full inclusion rule runs the other way: if they exceed 70% of gross income, the CFC's entire gross income is treated as foreign base company income. The high-tax exception under Section 954(b)(4) lets a taxpayer elect out of items subject to an effective foreign rate above a threshold tied to the maximum US corporate rate. And Section 952(c) caps the current inclusion at the CFC's current earnings and profits, with a recapture mechanism in later years. Same-country and look-through exceptions further narrow the passive bucket for related-party payments inside a chain.

Subpart F and GILTI are not alternatives, they are sequenced. Subpart F is computed first, and income already picked up as Subpart F is excluded from tested income for the Section 951A computation. Both inclusions create previously taxed earnings and profits under Section 959, which is what prevents the same dollar being taxed again on distribution.

On the return, inclusions land on Schedule I of Form 5471, which is prepared per US shareholder rather than per corporation. The PTEP those inclusions create must be tracked by separate category on Schedules J and P. Schedule J is the single most common source of multi-year error on the form: once the PTEP and non-PTEP columns are wrong, every subsequent distribution ordered under Section 959 is wrong too.

Related terms: GILTI, Form 5471, Foreign Tax Credit, Transfer Pricing

Go deeper: Form 5471: Who Must File, Every Schedule, and the Errors That Trigger Penalties

Testing a CFC's income against the Subpart F categories means going back to the underlying transactions, by counterparty and by jurisdiction, not to a summarized trial balance. Adopt's agents pull that detail from the source systems and carry PTEP forward year over year without the workbook drift. Sign up free.