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U.S. Taxation of a Controlled Foreign Corporation

Oct 12, 2026 | Business U.S. Expat Taxes

Last reviewed: October 2026

If you are a U.S. citizen or resident and you own a company abroad, the United States can tax that company’s profits on your personal return before you receive a single dividend. Whether that happens depends on one question: is the company a controlled foreign corporation (CFC)?

For tax years beginning in 2026, the rules changed. The One Big Beautiful Bill Act (OBBBA), signed in July 2025, replaced GILTI with “net CFC tested income” (NCTI), cut the Section 250 deduction, raised the foreign tax credit percentage and changed how income is split when shares change hands during the year.

This guide explains exactly how the rules work, what they cost in a worked example, which elections change the result, and where the answer is still genuinely uncertain.

The short version

Key takeaways

CFC test. A foreign corporation is a CFC when U.S. shareholders, each owning at least 10% by vote or value, together own more than 50% by vote or value.

Two income regimes. Subpart F income (mainly passive and certain related-party income) and NCTI (most other operating profit) are taxed to you every year, whether or not the company pays a dividend.

No election = ordinary rates. Without an election, an individual pays up to 37% on these inclusions, cannot use the Foreign Earned Income Exclusion against them and gets no credit for the company’s foreign corporate tax.

Section 962 election. Taxes NCTI at an effective 12.6% (21% after a 40% deduction) and allows a credit for 90% of the foreign corporate tax. If the company’s effective foreign tax rate is at least 14%, current U.S. tax on NCTI is generally zero.

High-tax exclusion. Income taxed abroad at an effective rate above 18.9%, measured under U.S. rules, can be excluded from NCTI and Subpart F altogether.

Form 5471. A 100% owner is normally a Category 4 and Category 5 filer. Missing the form generally triggers a $10,000 penalty per year per company, and the IRS can generally assess tax for that year until three years after the missing information is provided.

What is a controlled foreign corporation (CFC)?

Under IRC §957, a foreign corporation is a CFC if U.S. shareholders own more than 50% of its total voting power or total value.

A U.S. shareholder is a U.S. person (a citizen, a resident, or a domestic entity) who owns at least 10% of the voting power or value of the company. Ownership counts whether it is direct, held through other entities, or attributed from family members and related entities under the constructive ownership rules of §958.

Example 1CFC
Sole owner

You are a U.S. citizen in Germany and own 100% of a German GmbH. The GmbH is a CFC.

Example 2CFC
Several small U.S. owners

Three unrelated U.S. citizens each own 20%; foreign investors own 40%. Each American is a U.S. shareholder (20% ≥ 10%), and together they own 60%.

Example 3Not a CFC
Too many small U.S. owners

Twelve U.S. citizens each own 5%; foreign investors own 40%. U.S. persons own 60% in total, but no one owns 10%, so none is a U.S. shareholder.

Which foreign entities can be CFCs?

The CFC rules apply only to entities classified as corporations for U.S. tax purposes. What the entity is called under local law does not decide this.

Per se corporations

Listed in U.S. regulations as always corporations; they cannot change classification. A German AG and a UK plc are on that list.

Eligible entities

Most others, including a German GmbH and a UK private limited company, can choose their U.S. classification with a check-the-box election (Form 8832). With limited liability for all owners, they default to corporate status.

An eligible entity with one owner can elect to be disregarded, and one with several owners can elect partnership treatment. In either case the CFC rules no longer apply, and the income is reported directly on your return instead (Form 8858 or Form 8865 replaces Form 5471). Option 3 below explains the trade-offs.

How are CFCs taxed? Subpart F and NCTI

A CFC’s earnings fall into three buckets:

Subpart F income
Taxed to you every year
NCTI
Taxed to you every year
Everything else
Mainly high-tax excluded income. Taxed only when distributed

1. Subpart F income (IRC §951 and §954)

Subpart F targets income that is easy to move into a low-tax company. The main categories are:

  • Foreign personal holding company income: interest, dividends, rents, royalties and gains from investment assets.
  • Foreign base company sales income: buying from or selling to a related party, where the goods are both made and sold outside the company’s own country.
  • Foreign base company services income: services performed for or on behalf of a related party outside the company’s country.
  • Certain insurance income.

Several specific rules keep ordinary business income out of Subpart F:

De minimis rule §954(b)(3)

If foreign base company income and insurance income together are less than the lesser of 5% of gross income or $1 million, none of it is Subpart F income. If they exceed 70% of gross income, all of the company’s gross income is treated as Subpart F income.

Active rents and royalties

Rents and royalties earned in the active conduct of a business with unrelated parties are excluded.

Related-CFC look-through §954(c)(6)

Dividends, interest, rents and royalties paid between related CFCs out of active income are excluded. OBBBA made this rule permanent.

High-tax exception §954(b)(4)

Covered in Option 2 below.

For consultants and developers

If your company earns service fees from unrelated clients, Subpart F is usually limited to interest on the company’s bank balances and investment income. The operating profit falls under NCTI instead.

2. Net CFC tested income (NCTI), formerly GILTI (IRC §951A)

NCTI captures most of what Subpart F does not: ordinary operating profit. Despite the old GILTI name (global intangible low-taxed income), it has never been limited to intangible income.

Your NCTI is your share of the “tested income” of all your CFCs, minus your share of their “tested losses.” Tested income is the CFC’s gross income, excluding Subpart F income, high-tax excluded income and a few other items, minus the deductions allocable to it (including the foreign income tax it paid).

New for 2026

Until 2025, GILTI was reduced by a deemed 10% return on the company’s depreciable tangible assets (QBAI). OBBBA removed that reduction. A manufacturing or rental business with significant equipment or buildings will see a larger inclusion. A consulting or software company with few tangible assets will see almost no difference.

What changed for 2026

Provision Through 2025 (GILTI) From 2026 (NCTI)
Name Global intangible low-taxed income Net CFC tested income
Reduction for tangible assets (10% of QBAI) Yes Removed
Section 250 deduction (corporations and §962 electors) 50% 40%
Effective U.S. rate before credits (at 21%) 10.5% 12.6%
Deemed-paid foreign tax credit 80% of foreign taxes 90% of foreign taxes
Foreign effective rate at which U.S. tax is fully offset 13.125% 14%
Expenses allocated against this income for credit purposes Interest, stewardship, R&E and other expenses Only the §250 deduction and “directly allocable” expenses
Who includes income when shares change hands Owner on the last day the company is a CFC Every owner, for the part of the year they owned shares
Downward attribution from foreign persons (§958(b)(4)) Repealed (2018–2025) Restored
Effective date

These changes apply to CFC tax years beginning after December 31, 2025. For a calendar-year company, that means 2026. For a fiscal-year company, the new rules start with the first fiscal year that begins in 2026: an April–March company applies GILTI to the year from April 1, 2025, and NCTI from April 1, 2026.

Ownership during the year

Until 2025, the U.S. shareholder who owned the shares on the last day the company was a CFC generally included the whole year’s Subpart F income and GILTI. A seller who exited mid-year could escape the inclusion entirely.

From 2026, every U.S. shareholder includes income for the portion of the year in which they owned the shares. Proposed regulations published in August 2026 split the income day by day. They also close the company’s year automatically on the day it becomes or stops being a CFC. These rules are still proposed, but taxpayers may rely on them if they apply them in full and consistently.

What this means in practice

If you sell or give away shares in the middle of the year, you still owe tax on your share of income up to the date of the transfer.

Downward attribution

From 2018 to 2025, stock owned by a foreign person could be attributed “down” to a U.S. company it owned. This made many foreign sister companies of U.S. subsidiaries into CFCs on paper and triggered Form 5471 filings. OBBBA restored the old limitation in §958(b)(4), and a new §951B handles the narrower cases Congress still wanted to reach.

Who this affects

Mainly U.S. persons in groups with a foreign parent company. If you are an individual who owns your own foreign company, this change will rarely affect you.

What happens without an election?

By default, an individual U.S. shareholder:

Up to 37%

Ordinary income rates on Subpart F income and NCTI.

No Section 250 deduction

Available only to corporations and to individuals who make a §962 election.

No credit for corporate tax

Deemed-paid credits under §960 are available only to corporations and §962 electors.

No FEIE

CFC inclusions are not earned income, so the Foreign Earned Income Exclusion does not apply.

The individual can still credit foreign taxes they pay personally, but the company’s corporate tax is not one of them. This is where the double taxation comes from: the profit is taxed abroad at the corporate level and again in the U.S. at full individual rates, with nothing to offset one against the other.

Three ways to reduce U.S. tax on CFC income

Two numbers to remember
14%
Foreign effective rate at which a §962 election brings U.S. tax on NCTI to zero
18.9%
Foreign effective rate above which income can be excluded entirely
Option 1

Section 962 election

A §962 election lets an individual be taxed on Subpart F income and NCTI as if they were a U.S. corporation. What you get:

  • The 21% corporate rate instead of up to 37%.
  • The 40% Section 250 deduction on NCTI. Treasury regulations (§1.962-1) confirm that §962 electors may claim it.
  • Credits for the CFC’s foreign taxes: 90% of those attributable to NCTI, and 100% of those attributable to Subpart F income.

When the U.S. tax on NCTI reaches zero: the U.S. tax before credits is 12.6% of the pre-tax profit (21% × 60%). The credit is 90% of the foreign tax. These meet when the foreign effective tax rate is 14% (90% × 14% = 12.6%).

Company’s effective foreign tax rate U.S. tax on NCTI under §962 (approx.)
0% 12.6% of profit
9% 4.5% of profit
12.5% 1.35% of profit
14% or more $0
Try it
Estimate current U.S. tax on your company’s NCTI

Drag the two sliders: set your company’s annual profit before foreign tax, then its effective foreign tax rate. The three boxes below update instantly.

No election
$259,000
up to, at 37% on after-tax profit
§962 election
$0
$144,000 of unused credit is lost
High-tax exclusion
$0
Rate is above 18.9%
Illustration only. Assumes all income is NCTI, U.S. and foreign taxable income are equal, and the profit is retained. Ignores tax on later distributions.

For Subpart F income there is no §250 deduction, so the U.S. rate is 21%. With a 100% credit, the U.S. tax reaches zero at a 21% foreign rate.

Excess credits in the NCTI category cannot be carried forward or back. If your foreign rate is 30%, the credit beyond what is needed to reach zero is simply lost.

The cost: tax on later distributions

Under §962(d), when the company later pays out profits taxed under the election, the dividend is taxable to the extent it exceeds the U.S. tax you already paid on them. If the election produced $0 U.S. tax, essentially the whole dividend is taxable when paid.

  • Dividend rate. If the company is resident in a country with a comprehensive U.S. income tax treaty (Germany, the UK, France, Canada and most of Europe), the dividend generally qualifies for the 0%, 15% or 20% qualified rates. If not (Hong Kong or the UAE, for example), the Tax Court held in Smith v. Commissioner (2018) that it is taxed at ordinary rates.
  • NIIT. The 3.8% net investment income tax can also apply. Foreign tax credits generally cannot offset it.
  • Foreign tax on the dividend. Foreign tax your country imposes on the dividend is generally creditable against the regular U.S. tax on it.

How the election works:

  • It is made each year, by attaching a statement to your timely filed return.
  • It applies to all of your CFCs for that year.
  • It requires careful tracking of the company’s earnings and profits, and of the U.S. tax paid on them, so that later dividends are taxed correctly.

For details, see our Section 962 Election Guide and our guide to the Section 250 deduction.

Option 2

High-tax exclusion and high-tax exception

If the company already pays enough foreign tax, the income can be removed from NCTI and Subpart F altogether.

The threshold is 18.9%. Income qualifies if its effective foreign tax rate is above 90% of the U.S. corporate rate. With the corporate rate still at 21%, that is 18.9%.

The rate is measured under U.S. rules, not the headline local rate. The test is run separately for each “tested unit” (each company and each foreign branch). It divides the foreign income taxes attributable to that unit’s income by that income, computed under U.S. tax principles. This creates mismatches:

  • Different depreciation or reserves. If German tax depreciation is faster than U.S. depreciation in a given year, the income measured under U.S. rules is higher than the income taxed in Germany. The effective rate falls.
  • Loss carryforwards. In a year when local tax is reduced by prior-year losses, the effective rate can drop well below the headline rate, sometimes below 18.9%.
  • Non-income taxes. Only foreign income taxes count. Payroll taxes, VAT and some local business taxes do not.
German GmbH~30% combined headline rate

Usually passes

Ireland / Cyprus12.5% / 15%

Will not pass

How the election works:

  • It is made by the controlling U.S. shareholders and binds all U.S. shareholders of the company.
  • It applies to all CFCs in a commonly controlled group, not one company at a time.
  • It is made year by year. You can make it for one year and not the next.

Subpart F income has its own high-tax exception under §954(b)(4), which also uses the 18.9% threshold and also requires an election. The NCTI regulations exclude income that qualifies for the Subpart F exception, so for a high-tax company the two work together to remove both kinds of income.

Combine them

You can combine Options 1 and 2. Exclude the income of your high-tax units, then make a §962 election for whatever NCTI or Subpart F income remains.

See our guides to the GILTI high-tax exclusion and Subpart F income.

Option 3

Change the structure

Elections deal with the tax each year. Structural changes can remove the problem, but they have one-off costs.

Pay yourself a salary

Salary is deductible to the company, which reduces its tested income. To you it is earned income, which you can exclude up to the annual FEIE limit or offset with credits for the personal income tax you pay abroad. The trade-off: salary is usually taxed more heavily abroad than corporate profit and carries local social security contributions. Run the numbers in both countries.

Elect disregarded or partnership treatment

If the company is an eligible entity, a check-the-box election takes it out of the CFC regime.

Benefits
  • The profit appears on your own return.
  • Foreign corporate tax is treated as paid by you and is directly creditable at 100%, without the §962 haircut or the later dividend tax.
  • Earned income from your own work may qualify for the FEIE.
Costs
  • The conversion is taxable. It is treated as a liquidation, which can trigger U.S. tax on accumulated earnings and built-in gains.
  • Self-employment tax can apply unless a totalization agreement assigns your coverage abroad.
  • Not available to every entity. Per se corporations such as a German AG cannot elect.

Ownership with a nonresident alien spouse

Under §958(b)(1), stock owned by a nonresident alien individual is not attributed to a U.S. citizen or resident alien individual through the family attribution rules.

Example

You own 40% of a foreign company and your spouse, a nonresident alien, owns the remaining 60%. Your spouse’s shares are not attributed to you merely because you’re married. Assuming neither spouse holds additional shares through another entity, there are no other U.S. shareholders, and no other attribution rules apply, the company is not a CFC.

Before relying on this, check three things
  1. Joint filing changes the answer. If you elect to file jointly under §6013(g) or (h), your spouse is treated as a U.S. resident. Their 60% then counts, and the company becomes a CFC.
  2. A company that is not a CFC can be a PFIC. If at least 75% of its gross income is passive, or at least 50% of its assets produce passive income, it is a passive foreign investment company. The PFIC rules are often harsher, and the CFC rules switch them off only for CFCs.
  3. Moving shares to a spouse has its own consequences. A transfer can trigger foreign gift or transfer taxes. Gifts to a non-citizen spouse above the annual exclusion are reportable on a U.S. gift tax return. Corporate law and your bank may also require documentation.

Renunciation

For U.S. citizens who intend to stay abroad permanently, renouncing U.S. citizenship ends the CFC rules for future years. Shares in a CFC are part of the net worth test for the exit tax and can produce a large deemed gain, so the company’s value must be part of that planning.

Worked example

A U.S. citizen with a German GmbH

You live in Germany and own 100% of a German GmbH. In 2026 the GmbH has these results:

Profit before German tax $1,000,000
German corporate and trade tax (about 30%) $300,000
Profit after tax (tested income) $700,000

Assume all the income is NCTI (no Subpart F income), the company keeps all its profit, and U.S. and German taxable income are the same.

Scenario A: No election

NCTI inclusion (tested income) $700,000
Section 250 deduction Not available
Credit for German corporate tax Not available
U.S. tax at a 37% marginal rate up to about $259,000

Your actual tax depends on your brackets and other income, but most of this inclusion would fall in the top brackets. On top of the $300,000 paid in Germany, the combined tax on $1 million of profit approaches 56%, and the company has not distributed anything.

Scenario B: Section 962 election

Tested income $700,000
§78 gross-up (German tax added back) $300,000
NCTI inclusion $1,000,000
Section 250 deduction (40%) ($400,000)
Taxable amount $600,000
U.S. tax at 21% $126,000
Foreign tax credit available (90% × $300,000 = $270,000), limited to ($126,000)
U.S. tax $0

The unused $144,000 of credit is lost; it cannot be carried to another year.

When the GmbH later distributes the $700,000: because no U.S. tax was paid under the election, the whole distribution is taxable as a dividend. Germany is a treaty country, so the U.S. rate is at most 20%, plus 3.8% NIIT if it applies. German personal tax on the dividend is generally creditable against the 20%, and it is usually higher than 20%. In most cases the main remaining U.S. cost at distribution is the NIIT.

Scenario C: High-tax exclusion

The GmbH’s effective rate under U.S. rules is 30%, above 18.9%. With the election, the $700,000 is excluded from NCTI, and there is no U.S. inclusion and no U.S. tax for 2026.

When the GmbH later distributes the $700,000: it is an ordinary dividend from earnings that were never taxed in the U.S. As in Scenario B, it qualifies for the treaty dividend rate, German tax on it is creditable, and NIIT may apply.

Which option is better here?

For a profitable German GmbH, B and C produce the same result: $0 U.S. tax now, and essentially the same treatment when the profit is paid out. They diverge in three situations:

A low-tax year

If a loss carryforward or timing difference pushes the effective rate below 18.9% in one year, the exclusion is unavailable that year. A §962 election still produces $0 as long as the rate stays at or above 14%. Some owners make both elections so the §962 election covers any year that fails the high-tax test.

Other shareholders or other CFCs

The high-tax exclusion applies across all commonly controlled CFCs and binds all U.S. shareholders. The §962 election is personal to you.

A low-tax country

For a company in a 12.5% or 15% country, the exclusion is not available at all. The §962 election leaves a small residual tax (about 1.35% of profit at 12.5%) instead of 37%.

Reporting: who must file Form 5471?

Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, is filed by each U.S. person who meets one of its filing categories. It is attached to your own Form 1040. The foreign company does not file it.

If you own 100% of your foreign company, you are normally:

Category 4

A U.S. person who controls the company (more than 50% by vote or value).

Category 5

A U.S. shareholder of a CFC.

Together these require nearly the full form:

  • Ownership details.
  • The income statement and balance sheet in U.S. format.
  • Schedules tracking earnings and profits, previously taxed earnings, related-party transactions and foreign taxes.
  • Schedules I-1 and Q for NCTI and Subpart F computations.

You also file Form 8992 for the NCTI computation. If you make a §962 election or claim credits, you file Form 1118 or Form 1116 with the election statement as applicable.

Other common filers: Categories 2 and 3 cover U.S. officers and directors, and persons who acquire or dispose of 10% or more of a foreign corporation, even one that is not a CFC.

Don’t confuse the thresholds

The 10% threshold for filing is not the same as the 50% threshold for CFC status. A U.S. person who owns 10% of a CFC files as a Category 5 filer even if they personally own far less than 50%.

Penalties for not filing

Even when no tax is due

$10,000
per Form 5471, per year, under §6038(b), subject to applicable exceptions and reasonable-cause relief.
Up to $50,000 more: a further $10,000 for each 30 days of continued non-filing that starts 90 days after an IRS notice.
10% reduction of foreign tax credits under §6038(c).
The statute of limitations stays open. Under §6501(c)(8), the assessment period generally does not close until three years after the missing information is provided. If the failure was due to reasonable cause and not willful neglect, the extended period applies only to the related items, not the whole return.

For a full walkthrough, see our guide to filing Form 5471.

Where the answer is still uncertain

Most of the rules above are settled law. These are the points where the answer can still change or depends on facts that need checking:

Pro rata share mechanicsProposed

The day-by-day allocation for shares that change hands during the year comes from regulations proposed in August 2026. They can be relied on now, but the final version may differ.

Which expenses reduce NCTI for credit purposesProposed

The statute allocates only “directly allocable” expenses (plus the §250 deduction) to NCTI. Proposed regulations from September 2026 define that term narrowly, which generally helps credit-heavy taxpayers. They are not yet final.

Your effective foreign tax rateFact-specific

The high-tax exclusion turns on a calculation under U.S. tax principles, tested unit by tested unit, not on the headline local rate. A company near 18.9%, or one using loss carryforwards, needs the calculation done each year.

Whether a foreign tax is creditableSuspended

Regulations issued in 2022 tightened the definition of a creditable foreign income tax. The IRS has suspended most of the new tests until further notice (Notices 2023-55 and 2023-80). Some local business taxes could become non-creditable if that relief ends.

Dividends from non-treaty countriesCase law

For a company in a non-treaty country, the Smith case means later §962 dividends are taxed at ordinary rates. This makes the election less attractive there.

2026 formsIn revision

Form 8992 and the Form 5471 schedules are being revised to reflect NCTI. Use the 2026 versions and instructions when they are finalized.

How to work out which strategy applies to you

Step 1

Is the company a corporation for U.S. tax purposes?

Check whether it is a per se corporation or an eligible entity, and whether a check-the-box election was ever filed.

Step 2

Is it a CFC?

Add up the stock held by U.S. persons who each own 10% or more, including stock attributed to them. Remember the rule for nonresident alien spouses, and the joint filing exception to it.

Step 3

What does it earn?

Separate Subpart F income (mainly investment income and certain related-party income) from operating income (NCTI).

Step 4

What is its effective foreign tax rate under U.S. rules?

Above 18.9%, look at the high-tax exclusion. At or above 14%, a §962 election alone generally eliminates current U.S. tax on NCTI. Below 14%, compare §962 with restructuring.

Step 5

Will you take the profit out, and when?

Under both §962 and the high-tax exclusion, later dividends are taxed. The treaty status of the company’s country decides the rate.

Step 6

Are your filings complete?

Form 5471 for every year you met a filing category, plus Form 8992 and the §962 statement where they apply.

Get help with your CFC

The 2026 rules reward planning.

The same German company can cost an individual owner about $259,000 in U.S. tax with no election, or nothing at all with the right one. Our Enrolled Agents prepare Form 5471 and evaluate §962 and high-tax elections for Americans who own businesses abroad.

The consultation costs $50. If you decide to work with us, the fee is credited toward our services.

Kasia Strzelczyk, EA

Kasia Strzelczyk, EA

A certified accountant and IRS enrolled agent with over 8 years of experience working with US expats. With a deep understanding of the unique financial challenges faced by expats, Kasia is dedicated to helping clients navigate complex tax laws and regulations.

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