Controlled Foreign Corporation (CFC) Rules

Controlled Foreign Corporation (CFC) Rules

The Controlled Foreign Corporation (CFC) Rules are regulations established by the Internal Revenue Service (IRS) that govern the taxation of U.S. shareholders in foreign corporations. A foreign corporation is classified as a CFC if more than 50% of its stock (by vote or value) is owned by U.S. shareholders who each own at least 10% of the corporation’s stock.

These rules are designed to prevent U.S. taxpayers from deferring U.S. tax on income earned by foreign entities. Under CFC rules, U.S. shareholders must include their pro-rata share of certain types of income earned by the CFC, known as Subpart F income, on their U.S. tax returns, even if that income has not been distributed as dividends. This includes income from sources such as foreign base company income, insurance income, and certain other categories.

For instance, if a U.S. taxpayer owns 25% of a foreign corporation that earns $1 million of Subpart F income, they must report $250,000 of that income on their U.S. tax return, regardless of whether they received any distribution from the CFC. This ensures that the U.S. government can tax foreign income that U.S. residents have access to, thereby closing loopholes related to international tax planning.