An Overview of the IRS Form 5471 Schedule Q

Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) is used by certain U.S. persons who are officers, directors, or shareholders in respect of certain foreign entities that are classified as corporations for U.S. tax purposes. Form 5471 and its schedules are used to satisfy the reporting requirements of Internal Revenue Code Sections 6038 and 6046.

Substantively, Form 5471 backstops various international sections of the Internal Revenue Code, including Sections 901 and 904 (foreign tax credits), Section 951(a) (subpart F income), Section 951A (global intangible low-taxed income or “GILTI”), Section 965 (one-time transition tax on a U.S. shareholder’s deferred foreign income), and Section 482 (transfer pricing). Other forms associated with Form 5471 include Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation), Form 5713 (International Boycott Report), Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund), and Forms 1116 and 1118 (Foreign Tax Credit).

Form 5471 includes 12 schedules. This article discusses the Schedule Q of Form 5471. This schedule is used to report a foreign corporation’s income, deductions, taxes, and assets by CFC income groups for purposes of Section 960(a) and (d). In other words, Schedule Q provides financial data for a foreign corporation so it can claim a foreign tax credit for U.S. tax purposes. Schedule Q also assists U.S. shareholders of a foreign corporation complete IRS Form 1118. This article is based on the instructions to Schedule Q published by the IRS and this article attempts to supplement the instructions published by the IRS.

Key Terms for Form 5471

Form 5471 provides for five general categories of filers, numbered 1 through 5. Two of these general categories are subdivided into three subtypes each, with each subtype being a separate filer category as well. The filer category that a taxpayer falls under dictates the schedule or schedules that the taxpayer must include with the form. In order to understand how these filer categories work, it is helpful to review some basic terms.

U.S. Person

Only U.S. persons who own stock in a foreign corporation can have a Form 5471 filing obligation. A U.S. person is generally a citizen or resident of the United States, a domestic partnership, a domestic corporation, or a domestic trust or estate, each as defined in Internal Revenue Code Section 7701(a)(30)(A) through (E). A tax-exempt U.S. entity may have a Form 5471 filing obligation. In addition, an individual who relies on the residency provision of an income tax treaty to reduce his or her U.S. income tax liability (and files Form 8833) remains a U.S. person for purposes of Form 5471. See Treas. Reg. Section 301.7701(b)-7(a)(3). There are some slight modifications to the definition of a U.S. person which will be discussed in more detail below. All of the Form 5471 filer categories apply to U.S. persons.

U.S. Shareholder

Internal Revenue Code Section 951(b) defines a “U.S. shareholder” as a U.S. citizen, resident alien, corporation, partnership, trust, or estate that owns 10 percent or more of the total combined voting power of all classes of voting stock of a foreign corporation, or 10 percent or more of the total value of all the outstanding stock of a foreign corporation. All forms of stock ownership, — i.e., direct, indirect (ownership through intervening entities), and constructive (attribution of ownership from one related party to another) — are considered in applying the 10 percent test.

Controlled Foreign Corporation (“CFC”)

A foreign corporation is a CFC if, on any day during its taxable year, all of its U.S. shareholders, taken together as a group, own more than 50 percent of the combined voting power of all classes of the foreign corporation’s voting stock, or more than 50 percent of the total value of all of the foreign corporation’s outstanding stock. See IRC Section 957(a). Only U.S. persons who constitute U.S. shareholders are considered in applying the 50 percent test. Just as in the case of the 10 percent test for determining whether a U.S. person is a U.S. shareholder, direct, indirect, and constructive ownership of stock are all considered in applying the 50 percent test for CFCs. The term “foreign,” when applied to a corporation, means a corporation that is not domestic — i.e., a corporation that is not incorporated in a U.S. state or the District of Columbia. See IRC Section 7701(a)(5).

Treasury Regulations 301.7701-2(b)(8) provides a list of foreign entities that are conclusively treated as “per se” corporations for U.S. tax purposes. An individual preparing a Form 5471 should be aware that abbreviations in an entity name such as “Ltd.” and “S.A.” do not always stand for “Limited” or “Sociedad Anonima” (or “Societe Anonyme”). The preparer should confirm what the unabbreviated terms are, preferably from a charter or other official document from the relevant jurisdiction. If a foreign entity is not in the list of per se corporations, Treasury Regulations Section 301.7701-3(b)(2) provides that, unless a contrary election is made, the foreign entity will be treated as (1) an association taxable as a corporation if all its members have limited liability, (2) a partnership it it has two or more members (at least one of which does not have limited liability), or (3) a disregarded entity if it has a single owner who does not have limited liability.

Section 965 Specified Foreign Corporation (“SFC”)

An SFC is a foreign corporation that either is a CFC or has at least one U.S. shareholder that is a domestic corporation. See IRC Section 965(e)(1). The term SFC includes not only CFCs, but also entities commonly referred to as “10/50 corporations.” These foreign corporations have at least one U.S. shareholder, but are not CFCs because U.S. shareholders do not collectively own more than 50 percent of the corporation’s stock either by vote or value.

Stock Ownership

For purposes of Form 5471, a U.S. person can own stock in a corporation in three possible ways. First, the person can own the stock “directly.” For example, owning stock in a brokerage account constitutes direct ownership of the stock. Second, the U.S. person can own the stock “indirectly” through an intervening entity, such as a corporation, partnership, estate, or trust, in which the U.S. person owns an interest. In these cases, the stock owned by the intervening entity is typically considered to be owned proportionately by its shareholders, partners, or beneficiaries, as the case may be. For example, if a U.S. person directly owns 40 percent of the stock of a corporation and that corporation, in turn, directly owns 50 percent of the stock of a second corporation, then the U.S. person is considered to own indirectly 20 percent (i.e., 40% × 50%) of the stock of the second corporation. Indirect stock ownership can extend through several layers of intervening entities, where each intervening entity directly owns an interest in the one immediately below it. The third way that a U.S. person can own stock is by “constructively” owning the stock due to a relationship with another person. This relationship most commonly involves family members. For example, if a U.S. citizen mother directly owns 6 percent of a corporation’s stock and her U.S. citizen daughter directly owns 5 percent of the same corporation’s stock, then each of them is considered to own constructively the shares of the other. As a result, the mother and daughter are each considered to own 11 percent of the corporation’s stock. Another less common relationship involves sister entities. This form of constructive ownership (referred to as downward attribution) arises when an individual or entity parent directly or indirectly owns stock in a corporation and, at the same time, owns an interest in another entity. Under downward attribution, the corporation’s stock that the parent owns is attributed downward from the parent to the second entity. As a result, the second entity is considered to own constructively the same stock owned by the parent. Generally, the stock that is owned constructively by one person due to family or downward attribution cannot be further owned constructively by another.

All three kinds of stock ownership apply when determining which Form 5471 filer category or categories a taxpayer falls under, but there are variations among the categories. For example, in Categories 2 and 3, constructive family ownership includes attribution of stock from siblings, grandparents, and nonresident aliens, whereas the other three categories do not allow for these attributions. Categories 1, 4, and 5 define indirect ownership to mean only indirect ownership through foreign intervening entities, and include indirect ownership through intervening U.S. entities as constructive upward attribution. Categories 2 and 3 specifically provide for indirect ownership, but only through entities that are foreign corporations or partnerships, and refer to this type of non-direct ownership as both indirect and constructive ownership. Constructive ownership in the form of downward attribution does not exist in Categories 2 and 3, but exists in Categories 1, 4, and 5. Category 4’s version of downward attribution prohibits attribution of stock from a foreign entity to a U.S. person. Category 1 and 5’s version, however, contains no such prohibition due to the Tax Cuts and Jobs Act of 2017 (the “TCJA”). All these variations, as well as others not described above, will need to be taken into account when preparing a Form 5471.

Filer Categories

Form 5471, together with its applicable schedules, must be completed (to the extent required on the form) and filed by the taxpayer according to the taxpayer’s filer category. What follows is a description of each filer category.

Category 1 Filer

A Category 1 filer is a U.S. shareholder of a foreign corporation that is an SFC at any time during the corporation’s taxable year. However, to be classified as a Category 1 filer, the U.S. shareholder of the SFC must also own the SFC’s stock on the last day of the SFC’s taxable year.

The stock ownership rules applicable to Category 1 (including Categories 1a, 1b, and 1c) are contained in Internal Revenue Code Section 958, which incorporates and modifies the constructive stock ownership rules of Section 318(a). For Category 1 purposes, if a person does not directly own stock, the person can own stock as follows:

• Indirect stock ownership through an intervening entity. The intervening entity (i.e., a corporation, partnership, estate, or trust) can only be a foreign entity. The person, who is to become the indirect owner of stock through the intervening entity, is not required to hold a minimum ownership interest (i.e., stock, partnership interest, or beneficial interest) in the intervening foreign entity.
• Constructive stock ownership from another person.
  • Attribution from family members. A person can only be attributed stock owned by his or her parent, spouse, child, or grandchild. However, no attribution is permitted from a nonresident alien to a U.S. citizen or resident.
  • Upward attribution from entities. The attributing entity can be either a U.S. or foreign entity. However, if the attributing entity is a corporation, the person to whom the stock is to be attributed must own at least 10 percent (by value) of the attributing entity’s stock. Furthermore, if the stock to be attributed upward constitutes more than 50 percent of a corporation’s voting stock, then the stock is deemed to constitute 100% of the corporation’s voting stock when it gets proportionately allocated among the attributing entity’s owners.
  • Downward attribution from persons. The attributing person can be either an individual or entity. However, if the stock is to be attributed downward to a corporation, the attributing person must own at least 50 percent (by value) of that corporation’s stock.

Category 1a, 1b, and 1c Filers

Category 1 is subdivided into Categories 1a, 1b, and 1c. Category 1a is a catchall category and applies to Category 1 filers who do not otherwise fall under either Category 1b or 1c. Categories 1b and 1c were added to Form 5471 as the result of Revenue Procedure 2019-40, which the IRS issued in response to the repeal of provisions in Section 958(b) that previously disapplied the constructive downward attribution rules of Section 318(a)(3) to the extent that they attributed stock owned by a foreign person to a U.S. person.

Categories 1b and 1c specifically apply to those SFCs that are considered to be foreign-controlled for purposes of Form 5471. Such an SFC, referred to herein as a “Foreign-Controlled SFC,” is a foreign corporation that, although classified as an SFC, would not be so classified if the determination were made without applying Section 318(a)(3)’s downward attribution rules so as to consider a U.S. person as owning the stock owned by a foreign person.

A Category 1b filer is a U.S. shareholder who owns, directly or indirectly under Section 958(a) (but not constructively under Section 958(b)), the stock of a Foreign-Controlled SFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled SFC. Section 954(d)(3) defines two persons as being “related” to each other in terms of “control,” where one person controls or is controlled by the other, or is controlled by the same person or persons who control the other. Here, control over a corporation means directly or indirectly owning more than 50 percent of the corporation’s stock by either vote or value. A Category 1b filer is typically a shareholder who owns, directly or indirectly, stock in a foreign corporation but is not related to the foreign corporation because the common parent of both the shareholder and the foreign corporation does not control the foreign corporation.

A Category 1c filer is a U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled SFC but is related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled SFC. A Category 1c filer is typically a shareholder that owns the stock of a foreign corporation only because of constructive stock ownership under Section 318(a)(3) and the shareholder is related to the foreign corporation because each of them is under the control of a common parent.

A U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled SFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled SFC, is neither a Category 1b nor 1c filer. Such U.S. shareholder is deemed not to fall under the Category 1a catchall and is exempt from the obligation to file Form 5471.

Category 2 Filer

A Category 2 filer is a U.S. person who is an officer or director of a foreign corporation in which there has been a substantial change in its U.S. ownership. A U.S. person can be a Category 2 filer even if the change relates to stock owned by another U.S. person and regardless of whether or not that other U.S. person is an officer or director of the foreign corporation. For Category 2 purposes, a U.S. person is defined as a U.S. citizen, resident alien, corporation, partnership, estate, or trust. However, Category 2 also expands the definition of a U.S. person to include a bona fide Puerto Rico resident, a bona fide possessions resident, and a nonresident alien as to whom a Section 6013(g) or (h) election is in effect (i.e., where a nonresident alien spouse has made an election to be taxed as a U.S. person). In regard to the definition of an officer or director, there is no clear answer as to what constitutes an officer or director for purposes of a Category 2 filer. Treasury Regulations Section 1.6046-1(d) provides that “persons who would qualify by the nature of their functions and ownership in such associations, etc., as officers, directors, or shareholders thereof will be treated as such for purposes of this section without regard to their designations under local law.”

For purposes of Category 2, a substantial change in U.S. ownership in a foreign corporation occurs when any U.S. person (not necessarily the U.S. citizen or resident who is the officer or director) either (1) acquires stock that causes that U.S. person to own a 10 percent block of stock in that foreign corporation (by vote or value) or (2) acquires an additional 10 percent block of stock in that corporation (by vote or value). More precisely, if any U.S. person acquires stock that, when added to any stock previously owned by that U.S. person, causes the U.S. person to own stock meeting the 10 percent stock ownership requirement, the U.S. officers and directors of that foreign corporation must report. A disposition of shares in a foreign corporation by a U.S. person, however, does not create filing obligations under Category 2 for U.S. officers and directors of that foreign corporation.

The stock ownership rules applicable to Category 2 are contained in Internal Revenue Code Section 6046(c) and Treasury Regulations Section 1.6046-1(i). For Category 2 purposes, if a person does not directly own stock, the person can own stock as follows:

• Constructive stock ownership from another person.
  • Attribution from family members. A person can only be attributed stock owned by his or her brother, sister, spouse, ancestors, and lineal descendants. Attribution from nonresident aliens is permitted.
  • Upward attribution from entities. The attributing entity can be either a foreign corporation or a foreign partnership. The person, who is to become the constructive/indirect owner of stock through the attributing foreign corporation or partnership, is not required to hold a minimum ownership interest (i.e., stock or partnership interest) in the attributing foreign corporation or partnership. By negative implication, there is no attribution of stock from U.S. entities, or from foreign estates or trusts. Nevertheless, stock owned by U.S. entities that are not treated as entities separate from their owners for U.S. income tax purposes (i.e., grantor trusts and disregarded entities) should be attributable to their owners.

Category 3 Filer

A U.S. person who owns stock in a foreign corporation is a Category 3 filer if any one of the following events occurs during the taxable year:

1. The U.S. person acquires stock in the corporation that, when added to any stock already owned by the person, causes the person to own at least 10 percent (by vote or value) of the corporation’s stock.
2. The U.S. person acquires stock that, without regard to any stock already owned by the person, constitutes at least 10 percent (by vote or value) of the corporation’s stock.
3. The U.S. person becomes a U.S. person while owning at least 10 percent (by vote or value) of the corporation’s stock.
4. The U.S. person disposes of sufficient stock in the corporation to reduce the person’s interest to less than 10 percent (by vote or value) of the corporation’s stock.
5. The U.S. person owns at least 10 percent (by vote or value) of the corporation’s stock when the corporation is reorganized.

For Category 3 purposes, a U.S. person is defined as a U.S. citizen, resident alien, corporation, partnership, estate, or trust. However, Category 3 also expands the definition of a U.S. person to include a bona fide Puerto Rico resident, a bona fide possessions resident, and a nonresident alien as to whom a Section 6013(g) or (h) election is in effect (i.e., where a nonresident alien spouse has made an election to be taxed as a U.S. person).

The stock ownership rules applicable to Category 3 are the same as the ones applicable to Category 2, as described above under “Filer Categories–Category 2 Filer.” These rules are contained in Internal Revenue Code Section 6046(c) and Treasury Regulations Section 1.6046-1(i).

Category 4 Filer

A U.S. person is a Category 4 filer with respect to a foreign corporation for a taxable year if the U.S. person controls the foreign corporation. For Category 4 purposes, a U.S. person is defined as a U.S. citizen, resident alien, corporation, partnership, estate, or trust. However, Category 4 also expands the definition of a U.S. person to include a bona fide Puerto Rico resident, a bona fide possessions resident, and a nonresident alien as to whom a Section 6013(g) or (h) election is in effect (i.e., where a nonresident alien spouse has made an election to be taxed as a U.S. person). See Treas. Reg. Section 1.6038-2(d).

A U.S. person is considered to “control” a foreign corporation for purposes of Category 4 if at any time during the person’s taxable year, such person owns more than 50 percent of the combined voting power of all classes of the foreign corporation’s voting stock, or more than 50 percent of the total value of all of the foreign corporation’s outstanding stock. See IRC Section 6038(e)(2). It is important to note that the concept of control here for Category 4 filers is distinct from the one in the definition of CFC, a term used for Category 1 and Category 5 filers. There, control over a foreign corporation exists when more than 50 percent (by vote or value) of the corporation’s stock is owned by one or more U.S. shareholders, each of whom individually owns at least 10 percent of the corporation’s stock. By contrast, a Category 4 filer is a single U.S. person who individually owns more than 50 percent (by vote or value) of the foreign corporation’s stock.

The stock ownership rules applicable to Category 4 are contained in Internal Revenue Code Section 6038(e)(2), which incorporates and modifies the constructive stock ownership rules of Section 318(a). For Category 4 purposes, if a person does not directly own stock, the person can own stock as follows:

• Constructive stock ownership from another person.
  • Attribution from family members. A person can only be attributed stock owned by his or her parent, spouse, child, or grandchild. Attribution from nonresident aliens is permitted.
  • Upward attribution from entities. The attributing entity can be either a U.S. or foreign entity. However, if the attributing entity is a corporation, the person to whom the stock is to be attributed must own at least 10 percent (by value) of the attributing entity’s stock. Furthermore, because Section 6038(e)(2) defines control for purposes of Category 5 as owning more than 50% (by vote or value) of a corporation’s stock, if a person controls a corporation that, in turn, owns more than 50% (by vote or value) of the stock of a second corporation, then such person will be treated as in control of the second corporation as well.
  • Downward attribution from persons. The attributing person can be either an individual or entity. However, if the stock is to be attributed downward to a corporation, the attributing person must own at least 50 percent (by value) of that corporation’s stock. Furthermore, no downward attribution is allowed if it results in a U.S. person constructively owning stock that is owned by a foreign person (as the attributing person).

Category 5 Filer

A Category 5 filer is a U.S. shareholder of a foreign corporation that is a CFC at any time during the corporation’s taxable year. However, to be classified as a Category 5 filer, the U.S. shareholder of the CFC must also own the CFC’s stock on the last day of the CFC’s taxable year.

The stock ownership rules applicable to Category 5 (including Categories 5a, 5b, and 5c) are the same as the ones applicable to Category 1 (including Categories 1a, 1b, and 1c), as described above under “Filer Categories–Category 1 Filer.” These rules are contained in Internal Revenue Code Section 958, which incorporates and modifies the constructive stock ownership rules of Section 318(a).

Category 5a, 5b, and 5c Filers

Category 5 is subdivided into Categories 5a, 5b, and 5c. Category 5a is a catchall category and applies to Category 5 filers who do not otherwise fall under either Category 5b or 5c. Categories 5b and 5c were added to Form 5471 as the result of Revenue Procedure 2019-40, which the IRS issued in response to the repeal of provisions in Section 958(b) that previously disapplied the constructive downward attribution rules of Section 318(a)(3) to the extent that they attributed stock owned by a foreign person to a U.S. person.

Categories 5b and 5c specifically apply to those CFCs that are considered to be foreign-controlled for purposes of Form 5471. Such a CFC, referred to herein as a “Foreign-Controlled CFC,” is a foreign corporation that, although classified as a CFC, would not be so classified if the determination were made without applying Section 318(a)(3)’s downward attribution rules so as to consider a U.S. person as owning the stock owned by a foreign person.

A Category 5b filer is a U.S. shareholder who owns, directly or indirectly under Section 958(a) (but not constructively under Section 958(b)), the stock of a Foreign-Controlled CFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled CFC. Section 954(d)(3) defines two persons as being “related” to each other in terms of “control,” where one person controls or is controlled by the other, or is controlled by the same person or persons who control the other. Here, control over a corporation means directly or indirectly owning more than 50 percent of the corporation’s stock by either vote or value. A Category 5b filer is typically a shareholder who owns, directly or indirectly, stock in a foreign corporation but is not related to the foreign corporation because the common parent of both the shareholder and the foreign corporation does not control the foreign corporation.

A Category 5c filer is a U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled CFC but is related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled CFC. A Category 5c filer is typically a shareholder that owns the stock of a foreign corporation only because of constructive stock ownership under Section 318(a)(3) and the shareholder is related to the foreign corporation because each of them is under the control of a common parent.

A U.S. shareholder who does not own, either directly or indirectly, the stock of a Foreign-Controlled CFC and is not related (within the meaning of Section 954(d)(3)) to that Foreign-Controlled CFC, is neither a Category 5b nor 5c filer. Such U.S. shareholder is deemed not to fall under the Category 5a catchall and is exempt from the obligation to file Form 5471.

Schedule Q

Category 4, 5a, and 5b filers are required to file Schedule Q to Form 5471, which is used to report a CFC’s income, deductions, taxes, and assets by CFC income groups for purposes of Section 960(a) and (d).

Schedule Q should also be completed by individual U.S. shareholders that have an income inclusion under either Subpart F or GILTI and makes an election pursuant to Section 162 of the Internal Revenue Code to be taxed at corporate tax rates. The Section 962 election allows U.S. shareholders to claim indirect foreign tax credits under Section 902 for a pro rata portion of any foreign taxes paid by the CFC. Specifically, Section 962 provides that under regulations prescribed by the Treasury or IRS, in the case of a U.S. shareholder who is an individual and who elects to have the provisions of that section apply for the taxable year: 1) the tax imposed under this chapter on amounts which are included in his gross income under Section 951(a) and 951A shall (in lieu of the tax determined under Sections 1 and 55) be an amount equal to the tax which would be imposed under Sections 11 and 55 if such amounts were received by a domestic corporation, and 2) for purposes of applying the provisions of Section 960 (relating to foreign tax credit) such amounts shall be treated as if they were received by a domestic corporation.

The U.S. federal income tax consequences of a U.S. individual making a Section 962 election are as follows. First, the individual is taxed on amounts included in his gross income under Section 951(a) and 951A at corporate rates. Second, the individual is entitled to a deemed-paid foreign tax credit under Section 960 as if the individual were a domestic corporation. Third, when the CFC makes an actual distribution of earnings that has already been included in gross income by the shareholder under Sections 951(a) or 951A, Section 962(d) requires that the earnings be included in the gross income of the shareholder again to the extent they exceed the amount of U.S. income tax paid at the time of the Section 962 election.

Schedule Q determines the amount of foreign tax credit under Section 960 an individual making a 962 election is entitled to claim.

Schedule Q – Categories of Income

Schedule Q begins by asking the filer to complete Lines A. Line A requires the filer to determine the category of foreign source income applicable to the income in question and to enter its corresponding code. The filer must select from the following income categories:

Code                          Category of Foreign Source Income

PAS                            Passive Category Income

901j                            Section 901(j) Income

RBT PAS                   U.S. Source Passive Category Income Resourced by Treaty as Foreign Source Passive Category Income

RBT GEN                  U.S. Source General Category Income Resourced by Treaty as Foreign Source General Category Income

RBT FB                      U.S. Source Foreign Branch Income Resourced by Treaty as Foreign Source Foreign Branch Category Income

RBT 951A                  U.S. Source Section 951A Category Income Resourced by Treaty as Foreign Source Section 951A Category Income

GEN                           General Category Income

Passive Category Income

Passive income is generally the following:

1. Any income received or accrued that would be foreign personal holding company income (“FPHCI,” as defined in Section 954(c)) if the corporation were a CFC. This income includes any gain on the sale or exchange of stock that is more than the amount treated as a dividend under Section 1248.
2. Any amount includible in gross income under Section 1293, which relates to certain passive foreign investment companies (“PFICs”).

Passive income generally excludes certain types of income, such as export financing interest (see IRC Section 904(d)(2)(G) and Treas. Regs. Section 1.904-4(h)(3)), high-taxed income (see Treas. Regs. Section 1.904-4(c)), and active rents or royalties (see Treas. Regs. Section 1.904-4(b)(2)(iii)).

Section 901(j) Income

Section 901(j) income is income that is earned from a country sanctioned by the U.S. If Code “901j” is entered on Line a of the schedule, the two-letter country code for the sanctioned country (obtained from IRS.gov/countrycodes).

General Category Income

The general category income includes all income not described in one of the above categories.

In addition to the separate category codes stated above, if the filer has more than one category of income, the filer must complete the Schedule Q using code “TOTAL” that aggregates all the amounts listed for each line and column in all other Schedule Q.

Line B.

For Line B, if the category code for Line A is “PAS,” a separate Schedule Q must be filed for each grouping of income.

The grouping rules of Treasury Regulation Section 1.904-4(c)(3) through (iv) apply separately to income attributable to each tested unit of CFC. This is one reason that, in the case of a CFC, tested-unit-by-tested unit of a CFC, tested-unit-by-tested-unit reporting is required with respect to the income groups on lines 1a through 1j and Lines 3 and 4. A foreign corporation that is not a CFC but is a noncontrolled 10% owned foreign corporation must report this information on a foreign-QBU-by-QBU basis. This would be the case, for example, if the filer was completing Schedule Q for purposes of attaching it to Schedules K-2 and K-3 for purposes of Section 1293(f).

To determine the amounts to enter on lines 1a through 1j, on lines (1),(2), etc, under each line 1a through 1j, the filer should enter the name of each unit of the foreign corporation (the relevant unit being each tested unit in the case of a CFC and each QBU in the case of a 10% owned foreign corporation, including the foreign corporation itself, and the information required in each subpart F income group within each category for each unit.

On lines (1), (2), etc, under line 4, enter the name of each unit and enter the information required for columns (i) through (xvi) for each unit, but do not enter amounts excluded from subpart F income under subpart F high-tax exception (those amounts are reported on lines (1), (2), etc., under lines 1a through 1(j) or tested income under GILTI high tax exclusion (those amounts are reported on lines (1), (2), etc., under line 3).

Line C.

If Code 901j is entered on Line A, enter the country code from the list of sanctioned countries using the two-letter code from the list at IRS.gov/CountryCodes.

Line D.

Filers are generally required to complete a separate Schedule Q for foreign source income in each separate category and U.S. source income in each separate category. On a given Schedule Q, filers are generally required to check the box for either foreign source income or U.S. source income, as applicable. However, if the filer has entered code “TOTAL:” on line A and the total reported on that Schedule Q includes both foreign source income and U.S. source income, the filer may check both boxes on line D.

Line E.

A separate Schedule Q is required for foreign oil and gas extraction income (FOGEI) and foreign oil related income (FORI). If the Schedule Q is being prepared to report the FORGEI or FORI of a CFC, check the box for line E. Indicate the amount of FOGEI and FORI in each income group.

Line 1. Subpart F Income Groups

The filer discloses on line 1 Subpart F Income Groups. The separate subpart F income groups within each applicable Section 904 category of a CFC are on Line 1 (“subpart F income groups). Each single item of foreign base company income (as defined in Regulations Section 1.954-1(c)(1)(iii)) is a separate subpart F income group.

Foreign base company income is “Foreign base company sales income.” It is defined as income derived from the purchase and sale of personal property (1) if the property is either purchased from (or on behalf of) a related person or sold to (or on behalf of) a related person and (2) if the property purchased is manufactured, produced, grown or extracted outside of the country where the CFC is organized and the property also is sold for use, consumption or disposition outside that country.

With respect to a CFC, Regulations Section 1.954-1(c)(1)(iii)(A)(2) identifies as a single item of income all foreign base company income (other than foreign personal holding company income) that falls within both a single separate category (typically, general category income) and a single category of foreign base company income described in each of Regulations Section 1.954-1(c)(1)(iii)(A)(2)(i) through (v). For example, with respect to line 1g, there is a single subpart F income group within the general category that consists of all of a CFC’s foreign base company sales income.

The filer uses Line 1a through 1f to enter the passive category foreign personal holding company income of the CFC under the appropriate income group (dividends, interest, rents, royalties, and annuities; net gain from certain property transactions; net gain from commodities transactions; net foreign currency gain; income equivalent to interest; and other passive category income of the CFC), each of which is also treated as a separate subpart F income of the CFC), each of which is also treated as a separate subpart F income group under Treasury Regulation Section 1.960-1.

Enter the following passive category foreign personal holding company income of the CFC on line 1F (other foreign personal holding company income).

1) Income from notional principal contracts.
2) Payments in lieu of dividends;
3) Personal service contracts.

The filer should attach a statement that includes all of the information requested by Schedule Q, line 1f, delineating the amount on line 1f for each of the three groups reporting on line 1f. For example, if both payments in lieu of dividends and income from notional principal contracts are included on line 1f, on the statement, on the statement, identify the amount related to each of those income groups for each column of line 1f.

Use lines 1g through 1j to enter the foreign base company sales income, foreign base company services income, full inclusion income, and insurance income described in Section 952(a)(1) of the CFC.

To figure the amounts to enter on lines 1a through 1j, on lines (1), (2), etc, under each line 1a through 1j, the filer should enter the names of each QBU of the CFC, including the CFC itself, and the information required in each column (i) through (xvi) with respect to the amount in each subpart F income group within each category for each QBU. On lines 1a through tj, enter for each column by adding the amounts on lines (1), (2), etc., excluding from such total any amounts reported with respect to income excluded from subpart F income under the high-tax exception in Section 954(b)(4) (“subpart F high-tax exception).  (An item of income of a CFC that would otherwise be characterized as foreign base income will not be treated as subpart F income if it was subject to an effective foreign tax rate greater than 90 percent of the maximum U.S. corporate tax rate specified in Section 11 of the Internal Revenue Code).

These amounts are included in the total amount of residual income, which is reported on line 4. As a result, the amounts, included on lines 1a through 1j for each column may not equal the sum of the amounts reported on lines (1), (2), etc. for each column because any item excluded from subpart F income by reason of the high-tax election is included in the summation on line 4 instead of the summations on lines 1a through 1j.

Please see Illustration 1 below discussed in the Schedule Q instructions discussing subpart F income grouping.

Illustration 1.

For line 1a(1), gross income of $50 is reported in column (i), foreign tax of $20 is reported in each column (x) and (xii), and the checkbox in column (xiv) is checked. For line 1a(2), gross income of $100 is reported in column (ii), $5 of foreign tax is reported in each of columns (x) and (xii), and the checkbox in column (xiv) is not checked. For line 1a(3), gross income of $75 is reported in column (ii), $3 of foreign tax is reported in each of columns (x) and (xii), and the checkbox in column (xiv) is not checked. As a result, the amount reported in column (ii) on lines 1a(2) and 1a(3), which is equal to $175 ($100 + $75). The amounts reported in columns (x) and (xii) on line 1 are the sum of the amounts reported in each column on lines 1a(2) and 1a(3), which is equal to $8 ($5 + $3). The items reported on line 1a(1), gross income of $50 and $20 of foreign tax, are not included in the totals for each respective column on line 4. As a result, the amount reported on line 4, column (ii), is increased by $50 and the amount reported in column (x) on line 4m column (xii), because foreign income taxes attributable to high-tax exception or high-tax exclusion income are not creditable.

On lines 1k through 1m, the filer enters international boycott income described in Section 952(a)(3); illegal brides, kickbacks, and other payments described in Section 952(a)(2); and income included in Section 901(j) separate category described in Section 952(a)(5).

Line 2. Recaptured Subpart F Income

The filer enters line 2 recaptured subpart F income. When a subpart F income inclusion is limited by the CFC’s current-year E&P, Section 952(c)(2) requires establishment of a recapture account whereby subpart F income is recaptured in subsequent years during which the CFC has current-year E&P exceeding subpart F income. Specifically, if subpart F income was reduced by Section 952(c)(1)(A), any excess of the CFC’s E&P in a subsequent year over its subpart F income for that year is recharacterized as subpart F income. Treasury Regulation Section 1.952-1(f) provides that the amount of subpart F income in each separate category of income (as defined in Treas. Reg. Section 1.904-5(a)(1), which refers to Section 904(d)(1)) that is reduced by Section 952(c)(1)(A) constitutes a recapture account. In any subsequent year in which E&P exceeds subpart F income, the recapture account in each separate category will be recharacterized, on a proportional basis, as subpart F income to the extent of the excess. An amount that is recharacterized is treated as income in the same separate category as the recapture account from which it was derived. Under Treasury Regulation Section 1.952-1(f)(2)(iii), each recapture account will be reduced either (1) by amounts recaptured or (2) any distribution out of that account (as determined under the ordering rules of Internal Revenue Code Section 959(c) and Treas. Reg. Section 1.952-1(f)(3)(ii).

Line 3. Tested Income Group

Use line 3 to report tested income in the tested income group of the CFC (a “tested income group”). Tested income is the gross income (or loss) of a CFC minus the CFC’s income that is effectively connected with a U.S. trade or business and subpart F income. On lines (1), (2), etc., under line 3, the filer should enter the name of each tested unit of the CFC and enter for each tested unit the information required in columns (ii) through (xvi), based on the tentative gross tested income attributable to each tested unit (without regard to any amounts excluded under the GILTI high-tax exclusion). If the GILTI high-tax exclusion applies with respect to any tested unit of the CFC, the filer should include the amounts reported for columns (ii) through (xii) and (xvi) in the total line on line 4.

Line 4. Residual Income Group

Use line 4 to report the information required in columns (i) through (xvi) that is in Section 904 category but that is not of a type that is included in one of the subpart F income groups or a tested income group and is therefore assigned to the residual income group. The filer should enter the name of each QBU and enter the information required for columns (i) through (xvi) for each QBU on lines 4(1), 4(2), etc, but not income derived from the subpart F high-tax exception. These amounts are reported on lines (1), (2), etc., under lines 1a through 1(j) or tested income from the GILTI high-tax exclusion is reported on lines 3(1), 3(2), etc. The filer enters the sum of the amounts excluded from subpart F income under the subpart F high-tax exception and tested income under the GILTI high-tax exception in the appropriate column on line 4.

Please see Illustration 2 below discussed in the Schedule Q instructions discussing residual income grouping.

Illustration 2.

For line 1a(1), $100 of gross income is reported in each column (x) and (xiii), and the checkbox in column (xiv) is checked. For line 1a(2), $75 of gross income is reported in column (ii), $5 of foreign tax is reported in each of columns (x) and (xii), and the checkbox in column (xiv) is not checked. For line 3(1), $200 of gross income is reported in column (ii), $70 of foreign tax is reported in each column (x) and (xii), and the checkbox in column (xiv) is checked. For line 3(2), $150 of gross income is reported in column (ii), $10 of foreign tax is reported in each columns (x) and (xii), and the checkbox in column (xiv) is not checked. For line 4(1), $300 of gross income is reported in column (ii) and $105 of foreign tax is reported in column (x). On line 4(1), both columns (xii) and (xiv) should be blank in all cases. As a result, the amount reported on line 4 for column (ii) is the sum of the amounts reported in column (ii) on lines 1a(1), 3(1), and 4(1), which equals $600 ($100 + $200 + $300). The amount reported in column (x) of line 4 is the sum of the amounts reported in column (x) on lines 1a(1), 3(1), and 4(1), which equals $210 ($35 + $70 + $105). On line 4, column (xii) should be blank because foreign tax on residual amounts is not creditable. The amounts reported on line 1a(1) would not be included in the total for line 1a, but the amount reported on line 1a(2) would be included in the total reported on line 1a. Similarly, the amounts reported on line 3(1) would not be included in the total reported on line 3, but the amounts reported on line 3(2) would be reported in the total reported on line 3.

Column (i).

Consistent with the reporting requirement on Form 1118, the filer should enter the two-letter code (from the list at IRSgov/CountryCodes) of each foreign country and U.S. territory within which income is sourced and/or to which taxes are paid or accrued.

Column (ii).

The filer should enter the amount of gross income in functional currency of each CFC that is assigned to each income group within each Section 904 category. Section 904 provides for the following income groups:

1) Passive income. This category includes passive income and specified passive category income. Passive income includes: interest, dividends, rents, royalties, gains from the sale of real or personal property, and income inclusions relating to passive foreign investment companies (“PFICs”), which are qualifying electing funds. Passive income also includes dividends from a domestic international sales corporation (“DISC”) and distributions from a former foreign sales corporation (“FSC”).

2) General income. Section 904 defines general category income as income other than Section 951A category income, foreign branch income, or passive category income. General income includes: wages, salary, other compensation and overseas allowances of an individual as an employee, income earned in the active conduct of a trade or business, gains from the sale of inventory or depreciable property used in a trade or business, and financial services income derived by a financial services entity.

3) Section 951A income. Section 951A category income includes GILTI income.

4) Foreign Branch income. Foreign branch income includes income of a U.S. person that is: income attributable to a foreign branch, a distributive share of partnership income attributable to a foreign branch, and income of other pass-through entities attributable to a foreign branch.

Columns (iii) through (vii). Expenses

The filer should enter the deductions of the CFC for related expenses for related interest expenses, other interest expenses, research and experimental expenses, and other expenses, including for current year taxes, are allocated and apportioned to the income groups to determine net income (or loss) in such income group and to identify the current year foreign income taxes that relate to the income in each income group for Section 960 purposes in functional currency.

In regards to interest expense, Temp Reg Section 1.861-9T provides that interest may be apportioned either using the asset method or the modified gross income method. In regards to research and experimental expenses, the Regulations permit: (i) an election to capitalize and amortize IRC Section 174 research and experimental expenses and advertising expenses for purposes of allocating and apportioning interest expense under Treas. Reg. Section 1.861-9; and (ii) special rules for allocating and apportioning interest expense to foreign branch category income for financial institutions.

Column (viii). Current year tax on reattribution income from disregarded payments.

The filer uses this column to report current year tax imposed solely by reason of the receipt of a disregarded payment that is a reattribution payment. The current year tax is allocated and apportioned to the income group to which an amount of gross income is assigned by reason of the receipt of the reattribution payment. The filer should enter the expenses allocated and apportioned to the item of gross income reported for each QBU or tested unit as well as the aggregate amount of such expenses allocated and apportioned to each group.

A reattribution payment is the portion of a disregarded payment equal to the sum of all reattribution amounts that are attributed to the recipient of the disregarded payment. A reattribution amount is an amount of gross income that is, by reason of a disregarded payment made by that taxable unit, attributed to another taxable unit. Generally, a disregarded payment causes gross income to be attributed to another taxable unit to the extent that a deduction for the payment, if regarded, would be allocated against the payor tested unit’s U.S. gross income.

A payee taxable unit’s foreign gross income arising from the disregarded payment is then assigned to categories based on the federal income tax characterization of the reattribution amount. For example, passive category gross income of a payor taxable unit is reattributed to a payee taxable unit if the payor taxable unit makes a disregarded payment that, if regarded, would have been allocated to that passive category gross income. The payee taxable unit’s foreign gross income (and ultimately the foreign income taxes) arising from the disregarded payment is then assigned to the same categories as the payor taxable unit’s US gross income that was reattributed (entirely passive category income in this example). Disregarded payments made by the payor taxable unit, however, do not affect the allocation and apportionment of the payor’s taxes. In other words, the foreign gross income and associated foreign income taxes of a payor taxable unit are categorized before giving effect to reattribution amounts.

The Regulations simplify the definitions of the terms “contribution” and “remittance” so that, together, they describe all payments that are not reattribution payments. A contribution is defined as the excess of a disregarded payment made by a taxable unit to another taxable unit that the first taxable unit owns over the portion of the disregarded payment that is a reattribution payment. For example, if a CFC made a $100x disregarded payment to a disregarded entity that it owned, and $90x of the disregarded payment would reattribute gross income from the CFC to the disregarded entity, the remaining $10x is treated as a contribution. Foreign income taxes arising from disregarded payments treated as contributions are allocated to the residual grouping, meaning a credit is effectively denied if the taxpayer is a CFC.

A remittance means a disregarded payment that is neither a contribution nor a reattribution payment. For example, if a disregarded entity made a $100x disregarded payment to a CFC owner of the disregarded entity, and $90x of the disregarded payment would reattribute gross income from the disregarded entity to the CFC, then the remaining $10x of the disregarded payment is treated as a remittance. Finally, a foreign law income item arising from a disregarded sale or exchange of property is assigned to statutory or residual groupings by reference to the grouping to which a corresponding US item (i.e., built-in gain in the property) would have been assigned if the sale were recognized under Federal income tax law.

Column (ix). Current year tax on all other disregarded payments.

This column is used to report current tax imposed solely by reason of the receipt of a disregarded payment other than a reattribution payment, and which is therefore either a remittance or a contribution. A disregarded payment is a payment between a disregarded entity and its owner, or between two disregarded entities owned by the same person. A disregarded payment is generally treated as a payment between divisions of a company and therefore is not taken into account, or is “disregarded,” for U.S. tax purposes. Foreign tax imposed by reason of a disregarded payment that is remittance is assigned to the income groups based upon the assets of the payor. The filer should report current year taxes allocated and apportion them to the item of gross income reported for each QBU or tested unit as the aggregate amount of such foreign taxes allocated and apported to each group.

Column (x). Other current year taxes.

The filer uses Column (x) to report any other current year tax is allocated and apportioned among the Section 904 categories under the rules of Treas. Reg. Section 1.904-6(a) based on the portion of the foreign taxable income (as characterized under federal income tax principles) that is assigned to a particular Section 904 category. Any other current year foreign tax is allocated to the CFC income group to which the items of foreign gross income are assigned under Treas. Reg. Section 1.861-20. The filer should report current taxes allocated and apportion them to the item of gross income reported for each QBU or tested unit as well as the aggregate amount of such foreign taxes allocated and apportion them to each group.

Column (xii), Foreign taxes for which is allowed (U.S. dollar).

The filer reports any amount reported in column (xii) that is not be the same as the sum of the amounts in columns (viii) through (x) if columns (viii) through (x) include taxes that are not credible, including taxes paid or accrued to sanctioned countries, taxes disallowed under Section 901(k), (m), and (l); and taxes paid or accrued to the United States. Sections 901(k), (m), and (i) denies a foreign tax credit in situations when Section 338, 754 or a check-the-box election results in the creation of additional asset basis eligible for recovery for U.S. tax purposes where there is no corresponding increase in the basis of the asset for foreign tax purposes. A foreign tax credit is denied to the extent of the aggregate basis difference allocable to a partial tax year with respect to all relevant foreign assets divided by the income on which the foreign income is determined.

Column (xiii). Average asset value.

The filer reports foreign gross income that arises from a disregarded payment that is treated as a remittance for U.S. tax purposes is assigned to an income group by reference to the income groups to which the assets of the payor taxable unit are assigned for purposes of apportioning interest expenses on Column (xiii). This rule uses the payor’s asset apportionment percentages as a proxy for the accumulated earnings of the payor’s taxable unit from which the remittance is made. For this purpose, the assets of the taxable unit making the remittance are determined in accordance with Treasury Regulation Section 1.987-6(b) that apply in determining the source and separate category of exchange gain or loss on a Section 987 remittance.

Section 987 prescribes the regime for dealing with a foreign branch that is a QBU using a foreign functional currency. The basic approach is to determine profit or loss of the foreign branch for the tax year in its functional currency and then translate the profit or loss at the “appropriate exchange rate.” The appropriate exchange rate is the average exchange rate for the tax year. See IRC Section 989(b)(4).

When there is a remittance from the foreign branch to the U.S. parent entity (or another QBU having a different functional currency), the taxpayer recognizes gain or loss to the extent that the dollar value of the foreign currency at the time of its remittance differs from its dollar value when earned. To calculate Section 987 gain or loss on remittances, the CFC must establish and maintain two pools for the branch: the equity pool and the basis pool. The equity pool is the CFC’s investment in the branch maintained in the branch’s functional currency. The basis pool is the CFC’s investment in the branch maintained in the CFC’s functional currency.

The CFC has Section 987 gain or loss on a remittance from the branch to the extent that the amount of the remittance translated into U.S. dollars at the spot rate on the date of the remittance exceeds or is less than the portion of the basis pool attributable to the remittance.

Column (xiv). High-tax election.

The filer checks the box in column (xiv) of the line corresponding to any item of income with respect to which the subpart F high-tax exception applies. If any amount is excluded under subpart F high-tax exception, the filer should not include it in the total for lines 1a through 1j, but instead add the amount to the total for line 4. If a GILTI high-tax exclusion has been utilized, the filer should check the box in column (xiv) that corresponds to the item(s) of income to which the exception applies. If an amount reported on line 3(1), 3(2), etc., the filer should exclude it from gross income under the GILTI high-tax exclusion. This amount should not be included in the total amount for line 3. Instead, the filer should include the amounts in the total for line 4.

Column (xv). Loss allocation.

This column is used by the filer to report a reduction to subpart F income in each applicable income group when the foreign corporation’s subpart F income exceeds current year E&P.

Conclusion

The IRS Form 5471 is an incredibly complicated return. Each year an international tax attorney should review direct, indirect, and constructive ownership of the reporting CFC to determine the impact of any changes in percentages, filer categories, and CFC status. Workpapers should also be prepared and maintained for each U.S. GAAP adjustment and foreign exchange. In addition, an accounting should be made for adjustments to prior and current year previously taxed E&P that become PTEPs on Schedule J, E-1, and P.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to tax professionals.

Anthony has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or [email protected].

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.