Basis adjustments in CFC stock held by partnerships for subpart F inclusions, PTI distributions.

• Author: Yu, Hui
• Position: Controlled foreign corporations, previously taxed income

Under subpart F (Secs. 951-964) of the Internal Revenue Code, subpart F income of a controlled foreign corporation (CFC) is included in its U.S. shareholders' income before the income actually is distributed to the U.S. shareholders. A CFC is a foreign corporation of which more than 50% in vote or value of the stock is owned, directly or by attribution, by U.S. shareholders. Sec. 951(b) defines "United States shareholder" as a U.S. person (including a domestic partnership--see Secs. 957(c) and 7701(a)(30) (B)) that owns, directly or indirectly, 10% or more of the foreign corporation by voting power.

Because subpart F income has been included in the U.S. shareholder's income when earned, the CFC's earnings attributable to the subpart F inclusion are commonly referred to as previously taxed income (PTI). When subpart F income is included in income of the U.S. shareholder, Sec. 961(a) increases the U.S. shareholder's basis in the CFC stock (or the basis in the property through which the U.S. shareholder is treated as owning the CFC stock under Sec. 958(a)(2)) by the amount of the subpart F inclusion. This adjustment prevents the U.S. shareholder from incurring a second tax on the same earnings if the U.S. shareholder sells its CFC stock before distribution of the PTI. Pursuant to Sec. 959(a), distributions out of PTI are not included in the U.S. shareholder's income. Once the PTI amounts actually are distributed, Sec. 961(b) reduces the U.S. shareholder's basis in the CFC stock (or other property) to reverse the basis increase under Sec. 961(a).

Application of these rules to partnerships can be tricky, in part because domestic partnerships are treated as U.S. persons, but foreign partnerships are not. Therefore, a domestic partnership can be a U.S. shareholder of a CFC and entitled to a Sec. 961(a) basis adjustment for the CFC stock it owns, but a foreign partnership, even if owned by U.S. persons, is not so entitled.

Basis Adjustments in Cases of CFC Stock Held by a Domestic Partnership

Example 1: US1 and US2, U.S. corporations, each own 50% of Domestic Partnership (DP). DP owns 100% of the outstanding stock of CFC, which earns subpart F income of $10 in year 1. In year 2, CFC distributes $10 to DP.

DP is a U.S. person and U.S. shareholder of CFC and, therefore, is required to have a subpart F inclusion of $10 for year 1. US1 and US2 take into account their distributive shares of DT's subpart F inclusion, in the amount of $5 each. Pursuant to...