For a Latin American entrepreneur who has spent years building a business in Brazil, Colombia, or Mexico — and who now holds a U.S. green card or is approaching substantial presence — the U.S. tax system's treatment of foreign corporations can be a significant and unwelcome surprise. The controlled foreign corporation rules exist precisely to prevent U.S. persons from deferring U.S. tax by holding income in foreign entities. When those rules apply, income that was expected to stay offshore until distributed suddenly becomes currently taxable in the United States.

What Is a Controlled Foreign Corporation

A controlled foreign corporation (CFC) is a foreign corporation in which U.S. shareholders — defined as U.S. persons owning 10% or more of the total combined voting power or value — own more than 50% of the total combined voting power or total value of the corporation's stock. Both tests (voting and value) must be considered after the Tax Cuts and Jobs Act of 2017 expanded the value prong.

The 50% threshold is measured by reference to U.S. shareholders only. If U.S. persons collectively own 51% of a foreign corporation, even if 49% is owned by non-U.S. persons, the entity is a CFC and U.S. shareholders face current inclusion obligations regardless of whether any dividends are distributed.

Constructive ownership rules apply — meaning stock owned by family members, partnerships, estates, trusts, and controlled entities is attributed to the U.S. person for purposes of determining whether they are a U.S. shareholder and whether the entity is a CFC. The constructive ownership rules are broad and can create CFC status in situations where direct ownership would not.

Subpart F Income: The Original Anti-Deferral Regime

Subpart F, enacted in 1962, requires U.S. shareholders of CFCs to include certain categories of CFC income in their gross income currently — even if the CFC makes no distribution. The categories of Subpart F income are designed to capture income that is highly mobile (easy to shift to low-tax jurisdictions) or passive in nature:

  • Foreign personal holding company income (FPHCI): Dividends, interest, rents, royalties, and gains from the sale of property that produce such income. This is the most commonly encountered Subpart F category for family-owned foreign holding companies.
  • Foreign base company sales income: Income from buying goods from or selling goods to a related person when the goods are manufactured and sold for use outside the CFC's country of incorporation — designed to prevent routing sales through low-tax jurisdictions.
  • Foreign base company services income: Income from performing services for or on behalf of related persons outside the CFC's country of incorporation.

A CFC that earns primarily active business income — operating revenues from a genuine business in its country of incorporation — typically generates limited Subpart F income. The problem arises when foreign operating companies are structured with holding company layers that collect passive income streams.

GILTI: The TCJA Addition

The Tax Cuts and Jobs Act of 2017 added Global Intangible Low-Taxed Income (GILTI) as a second, broader anti-deferral mechanism. GILTI captures CFC income that exceeds a routine 10% return on the CFC's tangible assets — essentially, income attributable to intangible assets or excess returns.

The mechanics: U.S. shareholders must include in income their pro-rata share of a CFC's net tested income minus a 10% return on qualified business asset investment (QBAI — depreciable tangible assets). For a CFC with minimal tangible assets — a holding company or a services business — essentially all of the CFC's income may be GILTI.

The tax treatment of GILTI differs significantly by taxpayer type:

  • C corporations: Eligible for a 50% deduction (reducing the effective rate to 10.5%) and a partial foreign tax credit. GILTI at the corporate level is manageable with planning.
  • Individuals: No deduction, no foreign tax credit for GILTI unless a Section 962 election is made. Without planning, GILTI is taxed at ordinary income rates for individuals — potentially 37% federal plus state tax.

The GILTI high-tax exclusion allows taxpayers to exclude GILTI subject to an effective foreign tax rate above 18.9% — which is relevant for business income in higher-tax jurisdictions like Brazil or Colombia, but may not help for operations in lower-tax environments.

Previously Taxed Earnings and Profits (PTEP)

Once income is included by a U.S. shareholder under Subpart F or GILTI, it becomes previously taxed earnings and profits. Subsequent actual distributions of PTEP are generally not subject to U.S. tax again — the income has already been included. This prevents double taxation but requires careful tracking of PTEP accounts, which can be administratively complex across multiple CFCs.

Form 5471: The Reporting Obligation

U.S. persons with interests in CFCs must file Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) with their tax returns. The filing requirements vary by category of filer — Category 3 (U.S. persons who acquire a 10% interest), Category 4 (U.S. persons who control a foreign corporation), and Category 5 (U.S. shareholders of CFCs) each have different information requirements.

The penalty for failure to file Form 5471 is $10,000 per form per year, with an additional $10,000 for each 30-day period the failure continues after IRS notification, up to $50,000. Courts have generally upheld these penalties even when the taxpayer otherwise filed a complete tax return, because Form 5471 is a separate informational filing obligation.

CFC vs. PFIC: Why the Distinction Matters

A foreign corporation owned by U.S. persons may be characterized as either a CFC or a passive foreign investment company (PFIC), depending on its income and asset profile. A PFIC is a foreign corporation with 75% or more passive income, or 50% or more passive assets. The PFIC rules are generally punitive — gains are taxed at the highest ordinary income rate with an interest charge — and should be avoided wherever possible.

A foreign corporation that qualifies as a CFC is generally not subject to PFIC treatment for U.S. shareholders who are subject to the Subpart F and GILTI regimes. Maintaining CFC status is therefore generally preferable to PFIC treatment for U.S. shareholders who own a controlling interest in a foreign operating company.

Pre-Immigration Planning Implications

For individuals who own foreign corporations and are planning to become U.S. tax residents, the CFC analysis must be conducted before residency begins. Once an individual becomes a U.S. person, their foreign corporate holdings may immediately trigger Subpart F and GILTI inclusions — income that was expected to remain offshore until distributed becomes currently taxable.

Pre-immigration planning may involve restructuring foreign entities to reduce Subpart F and GILTI exposure, recognizing built-in gains before residency begins (when they are not subject to U.S. tax), or repositioning assets through entities or structures that are treated more favorably under U.S. tax law. The window for this planning closes the day U.S. residency begins.