CFC Definition: Ownership Tests, Shareholder Tax, and Form 5471

A controlled foreign corporation is a foreign corporation in which U.S. shareholders collectively own more than 50% of the voting power or stock value on any day of the corporation’s tax year. Once a foreign company meets that test, its U.S. shareholders can owe U.S. tax on certain categories of the company’s income in the year it’s earned, even if no cash is ever distributed. The rules shifted meaningfully in 2025 and 2026: Congress renamed the GILTI inclusion, removed the tangible-asset return exclusion, and reinstated an old limit on how ownership is attributed across related entities.

The Two Ownership Tests

Two separate thresholds decide whether a foreign corporation is a CFC and who has to care.

The first is the 10% test. A “U.S. shareholder” is a U.S. person who owns at least 10% of the foreign corporation’s total voting power or 10% of its total stock value.¹ U.S. persons include citizens, resident aliens, domestic partnerships, corporations, estates, and trusts. Someone holding 5% doesn’t count as a U.S. shareholder, no matter how American the ownership base looks in total.

The second is the 50% test under Section 957. Add up the stock held by everyone who qualifies as a U.S. shareholder; if that group collectively holds more than 50% of the voting power or more than 50% of the stock value on any day of the year, the corporation is a CFC.² Either prong is enough. And because measurement runs on “any day,” a brief period of majority U.S. ownership taints the whole year.

A foreign company could have dozens of American investors and still not be a CFC if none of them individually reaches 10%. Nobody qualifies as a U.S. shareholder, so nobody’s holdings feed the 50% test.

How Ownership Is Counted

Both tests use the attribution rules in Section 958, which pull in far more than the shares in your own name. Direct ownership is simple. Indirect ownership reaches through foreign entities: if a foreign partnership owns CFC stock, each partner is treated as owning a proportional slice.³

Constructive ownership goes further still. Stock held by your spouse, children, grandchildren, and parents can be attributed to you. If a partnership, trust, or corporation owns more than 50% of a company’s voting stock, that entity is treated as owning all the voting stock for attribution. The 50% threshold drops to 10% when attributing stock from a corporation down to its shareholders.³

The 2025 Downward Attribution Change

The Tax Cuts and Jobs Act of 2017 had repealed the limitation on “downward attribution,” which meant a foreign parent’s stock could be treated as owned by a U.S. subsidiary below it. That repeal swept many foreign corporations into CFC status by accident. The One Big Beautiful Bill Act, signed in July 2025, put the limitation back: under the restored Section 958(b)(4), stock owned by a foreign person cannot be attributed downward to a U.S. person for purposes of determining CFC status.³

Congress didn’t stop there. The same legislation added Section 951B, a parallel regime for “foreign controlled foreign corporations” that aren’t technically CFCs under the restored rules but would have been under the old ones. Section 951B applies Subpart F and the tested-income inclusion to U.S. shareholders of these entities for tax years of foreign corporations ending after December 31, 2025. Corporations freed by the 958(b)(4) fix can still be pulled back in this way.

Income Taxed to Shareholders Before Any Distribution

CFC status matters because it forces U.S. shareholders to pay tax on certain foreign income in the year the corporation earns it, without waiting for a dividend. The income is treated as received on the last day of the CFC’s tax year. Two categories drive most of the exposure.

Subpart F Income

Subpart F targets income that’s easy to shift between countries. The largest bucket is foreign personal holding company income: dividends, interest, royalties, rents, annuities, and gains from selling assets that generate those. Subpart F also reaches foreign base company sales income (buy-sell transactions routed through a CFC to exploit lower rates) and foreign base company services income (services performed outside the CFC’s country of incorporation for or on behalf of a related party).⁴ Insurance income, boycott-related payments, and illegal bribes are also covered but come up rarely.

Net CFC Tested Income (Formerly GILTI)

For tax years beginning after December 31, 2025, what used to be called Global Intangible Low-Taxed Income (GILTI) is now “net CFC tested income,” or NCTI. It captures the active business earnings of a CFC that Subpart F doesn’t already reach. The concept survived; the math changed. Under the old GILTI rules, shareholders subtracted a deemed 10% return on the CFC’s tangible depreciable assets (Qualified Business Asset Investment, or QBAI) before computing the inclusion. That exclusion is gone starting in 2026. Every dollar of tested income counts, no matter how much equipment or property the CFC owns.⁵

Rate Mechanics for Corporate Shareholders in 2026

Corporate U.S. shareholders can claim a Section 250 deduction against NCTI. For tax years beginning after 2025, that deduction is permanently set at 40% of NCTI.⁶ At the 21% corporate rate, the effective U.S. tax on NCTI works out to 12.6%, higher than the 10.5% rate that applied when the deduction was 50% under the original GILTI.

The foreign tax credit rules shifted in parallel. For NCTI, corporate shareholders can now credit up to 90% of the foreign taxes the CFC pays, up from 80%. A CFC paying foreign tax at roughly 14% or more will generate enough credits to fully offset the residual U.S. tax on its tested income.

Reducing the Hit

Section 962 Election for Individuals

Individual U.S. shareholders would otherwise pay Subpart F and NCTI inclusions at ordinary rates up to 37%. A Section 962 election lets an individual be taxed on those inclusions as if a domestic corporation had received the income, at the 21% corporate rate, with access to the Section 250 deduction and indirect foreign tax credits.⁷ That can bring the effective rate on NCTI down to the same 12.6% a real domestic corporation would pay.

The trade-off comes later. When the CFC eventually distributes those earnings, the distribution is taxable to the extent it exceeds the tax already paid under the election.⁷ The election defers part of the tax rather than erasing it. It’s made annually and applies to all of the shareholder’s CFCs for that year; you can’t pick and choose.

High-Tax Exclusion

If a CFC’s income is already taxed abroad at an effective rate above 18.9% (90% of the 21% U.S. rate), U.S. shareholders can elect to exclude that income from both Subpart F and NCTI. It’s a per-item election for Subpart F and a per-tested-unit election for NCTI. For CFCs operating in higher-tax jurisdictions, the exclusion often wipes out the U.S. inclusion entirely.

How Actual Distributions Are Treated

Income already taxed under Subpart F or NCTI becomes “previously taxed earnings and profits.” When the CFC later pays out those earnings, Section 959 prevents a second layer of tax by excluding the distribution from the shareholder’s gross income.⁸

Corporate U.S. shareholders get another break on dividends that weren’t previously taxed. Section 245A gives a 100% deduction for the foreign-source portion of dividends received from a foreign corporation in which the domestic corporation holds at least a 10% stake.⁹ Individual shareholders don’t get Section 245A, which is one reason the Section 962 election is so widely used.

Form 5471 Filing

Every U.S. person with a reporting obligation tied to a CFC files Form 5471 as an attachment to their income tax return, on the same due date as the underlying return, extensions included.¹⁰

The IRS splits filers into five categories keyed to different levels of ownership or control, ranging from a U.S. officer or director who has acquired a 10% stake, to a U.S. person who acquires a 10% or greater stake, to a U.S. person who controls the foreign corporation (more than 50% by vote or value), to a U.S. shareholder of a CFC.¹⁰ Most CFC shareholders land in Category 5. The form calls for financial statements restated to U.S. accounting standards and converted to dollars, an organizational chart showing the ownership chain, details on each stock class, and an EIN or reference ID for the foreign entity.

Penalties for Not Filing

The initial penalty for failing to file a complete and timely Form 5471 is $10,000 per foreign corporation, per annual accounting period. If the IRS sends a failure notice and the form still isn’t filed within 90 days, another $10,000 accrues for each 30-day period the failure continues, capped at an additional $50,000.¹¹ Total exposure runs to $60,000 per form per year, assessed separately for each CFC. Failure to file can also cut foreign tax credits tied to the CFC. Reasonable-cause defenses and administrative relief exist but aren’t automatic.

1
Office of the Law Revision Counsel. 26 U.S. Code 951 – Amounts Included in Gross Income of United States Shareholders
2
Office of the Law Revision Counsel. 26 U.S. Code 957 – Controlled Foreign Corporations; United States Persons
3
Office of the Law Revision Counsel. 26 USC 958 – Rules for Determining Stock Ownership
4
Office of the Law Revision Counsel. 26 USC 954 – Foreign Base Company Income
5
Office of the Law Revision Counsel. 26 USC 951A – Net CFC Tested Income
6
Office of the Law Revision Counsel. 26 U.S. Code 250 – Foreign-Derived Deduction Eligible Income
7
Office of the Law Revision Counsel. 26 USC 962 – Election by Individuals To Be Subject to Tax at Corporate Rates
8
Office of the Law Revision Counsel. 26 USC 959 – Exclusion From Gross Income of Previously Taxed Earnings and Profits
9
Office of the Law Revision Counsel. 26 USC 245A – Deduction for Foreign Source Portion of Dividends Received by Domestic Corporations
10
Internal Revenue Service. Instructions for Form 5471
11
Office of the Law Revision Counsel. 26 USC 6038 – Information Reporting With Respect to Certain Foreign Corporations and Partnerships