US tax rules for a foreign affiliate turn on one question: do US owners control it? If US Shareholders collectively hold more than half the vote or value, the entity is a Controlled Foreign Corporation (CFC), and its US owners face current tax on certain categories of foreign earnings plus a stack of annual information returns. If the ownership thresholds are not met, the entity may still be a Passive Foreign Investment Company (PFIC), a foreign partnership, or a foreign branch, each with its own regime. Major changes took effect for tax years beginning in 2026, including the replacement of GILTI with a broader “net CFC tested income” (NCTI) regime that pulls more foreign earnings into the US tax base.
When a Foreign Corporation Becomes a CFC
A foreign corporation is a CFC when US Shareholders collectively own more than 50 percent of either the total voting power or the total value of its stock on any day during the tax year.1Office of the Law Revision Counsel. 26 US Code 957 – Controlled Foreign Corporations; United States Persons The 50 percent test does not count every US owner. It counts only those who separately qualify as a “US Shareholder,” which requires owning at least 10 percent of the corporation’s voting power or value.2Legal Information Institute. 26 USC 951(b) – United States Shareholder
The two-step test produces results that surprise people. Five unrelated US individuals each owning 12 percent of a foreign corporation total 60 percent, each clears the 10 percent bar, so the entity is a CFC. Shift those same five to 8 percent apiece and none of them is a US Shareholder; their ownership never counts toward the 50 percent threshold and the entity is not a CFC under this analysis.
How Ownership Gets Counted
Congress expected taxpayers to spread ownership among family members, trusts, and layered entities to stay below the thresholds. Section 958 attribution rules treat stock owned through foreign corporations, partnerships, and trusts as owned proportionally by the US persons behind them.3Office of the Law Revision Counsel. 26 US Code 958 – Rules for Determining Stock Ownership Separate constructive ownership rules also attribute stock between family members, between a partner and a partnership, and between a corporation and its shareholders.
The Tax Cuts and Jobs Act removed a longstanding guardrail that blocked stock from being attributed downward from a foreign person to a US person. Before the change, a foreign parent’s ownership of a foreign subsidiary would not be pushed down to a US subsidiary in the same group. After the repeal, those foreign subsidiaries can now be CFCs, pulling in entities that previously had no US reporting footprint.3Office of the Law Revision Counsel. 26 US Code 958 – Rules for Determining Stock Ownership The IRS has provided limited relief where the foreign parent has no 10 percent US owner, but any multinational group with US entities in the chain should assume broad attribution applies.
How CFC Earnings Are Taxed
The CFC regime exists to stop US Shareholders from parking income in low-tax foreign corporations and deferring US tax. Two overlapping rule sets force current-year inclusion even when the CFC pays no dividend.
Subpart F Income
Subpart F targets what the IRS calls “movable income,” meaning earnings easily shifted to a low-tax jurisdiction without real business substance.4Internal Revenue Service. Overview of Subpart F Income for US Individual Shareholders The biggest category is foreign personal holding company income: dividends, interest, rents, royalties, annuities, and certain gains from property and currency transactions.5eCFR. 26 CFR 1.954-2 – Foreign Personal Holding Company Income Insurance income and certain sales and services income earned outside the CFC’s home country also fall under Subpart F.6Office of the Law Revision Counsel. 26 US Code 952 – Subpart F Income Defined
Each US Shareholder reports a proportional share of the CFC’s Subpart F income for the year the CFC earns it, taxed at ordinary rates, whether or not any cash moves.
Net CFC Tested Income
For tax years beginning in 2026, Global Intangible Low-Taxed Income (GILTI) is renamed net CFC tested income (NCTI). The change is substantive. The old GILTI rules exempted a CFC’s first 10 percent return on its tangible business assets, known as Qualified Business Asset Investment or QBAI. That exemption is gone.7Office of the Law Revision Counsel. 26 USC 951A – Net CFC Tested Income Capital-intensive CFCs that previously showed little or no GILTI can now generate meaningful NCTI inclusions.
NCTI equals the US Shareholder’s share of a CFC’s “tested income” minus the share of “tested losses” from other CFCs. Tested income is broadly the CFC’s gross income minus allocable deductions, after removing Subpart F income and a few categories taxed under their own rules.
Domestic C corporations can claim a Section 250 deduction equal to 40 percent of the NCTI inclusion and the associated deemed-paid foreign taxes, producing an effective federal rate of 12.6 percent before foreign tax credits.8Office of the Law Revision Counsel. 26 USC 250 – Foreign-Derived Intangible Income and Net CFC Tested Income Individuals do not get Section 250 unless they make a Section 962 election.
High-Tax Exclusion
When a particular item of CFC income is already taxed by a foreign country at an effective rate above 90 percent of the US corporate rate, it can be excluded from both Subpart F and NCTI. With the corporate rate at 21 percent, the threshold is 18.9 percent. A CFC operating in a 20 percent corporate tax country can qualify.
Section 962 Election for Individuals
Individual US Shareholders report Subpart F and NCTI at ordinary rates up to 37 percent, but the Section 250 deduction and the full foreign tax credit mechanics are built for corporations. A Section 962 election lets an individual be taxed on CFC inclusions as if they were a corporation, applying the 21 percent rate and the Section 250 deduction. The tradeoff: any later actual distribution exceeding the tax paid under the election is treated as a taxable dividend. The election is annual and covers all of that year’s CFCs.
Foreign Tax Credits
When a CFC pays foreign income tax, the US Shareholder can generally claim a foreign tax credit to offset the resulting US tax. Individuals use Form 1116; corporations use Form 1118.9Internal Revenue Service. Foreign Tax Credit
The credit is capped at the US tax that would otherwise apply to the foreign-source income, computed separately for different “baskets”: passive income, general business income, foreign branch income, and NCTI.10Internal Revenue Service. Instructions for Form 1118 For NCTI, the credit is further limited to 80 percent of foreign taxes paid. A deduction for foreign taxes is available as an alternative, but the credit is almost always more valuable.
When the Entity Is Not a CFC
Not every foreign interest is a CFC, and the alternative classifications carry their own obligations.
PFIC. A foreign corporation is a Passive Foreign Investment Company if 75 percent or more of its gross income is passive, or at least 50 percent of its assets produce or are held to produce passive income.11Office of the Law Revision Counsel. 26 US Code 1297 – Passive Foreign Investment Company Without a timely election, gains on PFIC stock and certain distributions face an “excess distribution” tax at the highest ordinary rate with an interest charge as if the tax had been owed in prior years. Each US shareholder must file Form 8621 for every PFIC owned directly or indirectly, including PFICs held through other PFICs. A Qualified Electing Fund election or, for publicly traded stock, a mark-to-market election can soften the result. Foreign mutual funds are a common PFIC trap for individuals living abroad. If a US Shareholder is already including Subpart F or NCTI from a CFC that also meets the PFIC definition, the PFIC rules generally do not apply during the qualified portion of the holding period; smaller shareholders below the 10 percent US Shareholder bar do not get that relief.12Internal Revenue Service. Instructions for Form 8621 – Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
Foreign branch. A branch is not a separate legal entity; it is an extension of the US business. All income and expenses flow directly onto the US owner’s return in the year earned. There is no Subpart F or NCTI question because there is no separate foreign corporation, but Form 8858 is required.13Internal Revenue Service. About Form 8858
Foreign partnership. A US person with a controlling interest reports partnership income directly (partnerships are pass-through) and files Form 8865. The reporting detail and the penalties for missing it match the CFC regime.14Internal Revenue Service. Instructions for Form 8865 (2025)
Portfolio holdings below 10 percent. A US person owning less than 10 percent of a foreign corporation is not a US Shareholder, does not file Form 5471, and is not subject to Subpart F or NCTI. The corporation can still be a PFIC, which brings Form 8621 and the harsher PFIC tax treatment.
Required Information Returns
Several separate forms apply depending on the entity type and the US person’s role. Missing even one triggers standalone penalties and keeps the entire return open to audit.
Form 5471 (Foreign Corporations)
Form 5471 is the core disclosure for US persons connected to foreign corporations. Filing categories include Category 4 (US persons who control the corporation) and Category 5 (US Shareholders of a CFC), with additional categories for officers, directors, and persons who acquire or dispose of stock.15Internal Revenue Service. Certain Taxpayers Related to Foreign Corporations Must File Form 5471 The form requires detailed financial statements, an earnings and profits breakdown, and schedules for Subpart F and NCTI.
Form 8858 (Disregarded Entities and Foreign Branches)
A US person who owns a foreign entity treated as disregarded for tax purposes, or operates a foreign branch, files Form 8858 with the entity’s income statement and balance sheet.13Internal Revenue Service. About Form 8858 A foreign single-member LLC and a foreign entity that checks the box to be disregarded both qualify.
Form 926 (Transfers to Foreign Corporations)
Any US person who transfers more than $100,000 in cash to a foreign corporation during a 12-month period must file Form 926. It is also required when the US person holds at least 10 percent of the voting power or value immediately after the transfer, regardless of amount.16Internal Revenue Service. Instructions for Form 926 Property transfers in tax-free reorganizations and capital contributions can also trigger it.
Form 8865 (Foreign Partnerships)
Form 8865 applies to US persons holding interests in foreign partnerships, with four filing categories covering control, 10 percent interests in US-controlled partnerships, property contributions over $100,000, and acquisitions or dispositions of 10 percent interests. If a Category 1 filer exists for the year, Category 2 filing is not required.14Internal Revenue Service. Instructions for Form 8865 (2025)
FBAR
Owning a foreign affiliate often means signature authority over or a financial interest in foreign bank accounts. A US person with an aggregate balance above $10,000 across foreign financial accounts at any point in the year must file FinCEN Form 114, the FBAR.17Internal Revenue Service. Report of Foreign Bank and Financial Accounts (FBAR) It is filed electronically with FinCEN, not the IRS, and carries its own civil and criminal penalties separate from any tax return penalties.
Penalties and the Open Statute of Limitations
Penalties for missing international information returns are steep, and they apply per form, per year.
Failing to file a complete Form 5471 is an automatic $10,000 penalty per foreign corporation. If the IRS sends a notice and the form still is not filed within 90 days, another $10,000 accrues for each 30-day period the failure continues, capped at an additional $50,000 per corporation.18Internal Revenue Service. International Information Reporting Penalties A taxpayer with two CFCs who ignores a notice can see up to $120,000 in penalties before any tax on the underlying income is assessed. Willful failure can also trigger criminal prosecution.
The quieter risk is the statute of limitations. Normally the IRS has three years from filing to audit a return. Under Section 6501(c)(8), failing to furnish required international information keeps the limitations period open for the entire return until three years after the information is finally provided.19Office of the Law Revision Counsel. 26 USC 6501 – Limitations on Assessment and Collection A missing Form 5471 from 2020 can leave every item on that return open to adjustment in 2030 or beyond. A reasonable cause exception can narrow the open window to items related to the missing form, but it requires affirmative evidence that the failure was not due to willful neglect.