Demystifying the 2023 IRS Form 5471 Schedule J

By Anthony Diosdi

Form 5471 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. The Form 5471 and schedules are used to satisfy the reporting requirements of Internal Revenue Code Section 6038 and 6046 along with the applicable regulations.

Substantively, it backstops various international sections of the Internal Revenue Code including Sections 901/904 (Code Section 901 and 904 provide rules governing foreign tax credits), Section 951(a) (Section 951a provide rules governing Subpart F income and Section 956. Section 956 is an anomaly and operates differently than the rest of subpart F. Generally, a U.S. shareholder of a foreign corporation must include in income his or her pro rata share of the foreign corporation’s increase in its earnings and profits in U.S. property), Section 951A (Section 951A provides rules governing the Global Intangible Low-Taxed Income or “GILTI”), Section 965 (Section 965 imposes a one-time transition tax on a U.S. shareholder’s share of deferred foreign income of certain foreign corporations), and Section 482 (Section 482 governs transfer pricing. A “transfer price” must be computed for controlled transactions in order to satisfy various financial reporting, tax, and other regulatory requirements). Associated forms with a Form 5471 include Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation), Form 5713 (International Boycott Report), Form 8621 (PFIC), and Forms 1116/1118 (Foreign Tax Credit).

Within the Form 5471, there are 12 schedules. This article discusses Schedule J of the Form 5471. This schedule is used to report a foreign corporation’s accumulated earnings and profits or “E&P.” Schedule J is also used to report the E&P of specified foreign corporations for limited purposes under Section 965(e)(2).

Defining Key Terms For Filing the Form 5471

There are five filing categories (or should I say 12 filing categories) for the Form 5471. The category of filer determines the schedule of the Form 5471 that must be filed. There are a number of key terms that must be defined before determining which category filer a taxpayer is for purposes of the Form 5471. Below are the key terms that should be understood before preparing the Form 5471:

U.S. Person

Only U.S. persons 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 as defined by Section 7701(a)(30)(A) – (E). A tax-exempt U.S. entity may have a Form 5471 filing obligation. In addition, an individual who relies upon the residency provision of an income tax treaty to shed himself of U.S. income tax and files Form 8833 remains a U.S. person for purposes of the 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 categories of filers apply to U.S. persons for purposes of Form 5471 classification.

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, owning directly, indirectly or constructively under the ownership rules of Section 958, ten percent or more of the total combined voting power of all classes of stock of a foreign corporation or the value of all the outstanding shares of a foreign corporation. Categories 1a, 1c, 5a, and 5c apply to U.S. shareholders for purposes of Form 5471 classification.

Controlled Foreign Corporation (“CFC”)

A foreign corporation is a CFC if, on any day during the foreign corporation’s taxable year, U.S. shareholders own more than 50 percent of the combined voting power of all classes of stock, or more than 50 percent of the total value, of the foreign corporation. Only U.S. shareholders are considered in applying for the 50 percent test. All forms of ownership, including direct, indirect (ownership through intervening entities), and constructive (attribution of ownership from one related party to another), are considered in applying the 50 percent test. The term “foreign” means a corporation that is not domestic. In other words, the corporation was not incorporated in a U.S. state or District of Columbia. See IRC Section 7701(a)(5).

An individual preparing a Form 5471 should not interpret terms in an entity name such as “ltd,” or “S.A.” to classify a foreign entity as a corporation for U.S. tax purposes. Instead, Treasury Regulation should be consulted to determine if a foreign entity is a corporation for U.S. tax purposes. Treasury Regulation 301.7701-2(b)(8) provides a list of foreign entities that will be treated as corporations for U.S. tax purposes. If a foreign entity is not in that list. Treasury Regulation Section 301.7701-3(b)(2) should be consulted. This regulation provides a relatively comprehensive list of foreign entities that will be treated as per se corporations, and, unless an election to the contrary is timely filed, the foreign organization may be treated as a partnership or a disregarded entity that is separate from its owner. Categories 1a, 1c, 5a, and 5c to CFCs for purposes of Form 5471 classification. .

Section 965 Specified Foreign Corporation (“SFC”)

An SFC is a foreign corporation that is either a CFC or has at least one U.S. shareholder that is a corporation. The term SFC includes not only CFCs, but also entities commonly referred to as 10/50 companies. These foreign companies have at least one U.S. shareholder, but are not CFCs because U.S. shareholders do not own more than 50 percent of the entity by vote or value. Categories 1a through 1c apply to SFCs.

Category of Filers

The Form 5471 and appropriate accompanying schedules must be completed (to the extent required on the form) and filed by the following categories of persons:

Category 1 Filer

A Category 1 filer is a U.S. shareholder of a SFC at any time during any taxable year of the SFC who owned that stock on the last day in that year on which it was an SFC. A SFC is a CFC, or any foreign corporation with one or more 10 percent domestic corporation shareholders.

Category 1a, 1b, and 1c Filers

Recently, the IRS expanded Category 1 filers to (1a, 1b, and 1c). Category 1a is a so-called catch all category and includes a U.S. shareholder of a Section 965 “specified foreign corporation” at any time during the tax year of the foreign corporation, and who owned that stock on the last day in that year. A Category 1a filer also does not fit into the definition of Categories 1b and 1c. Category 1b and 1c have been added as the result of Rev. Proc. 2019-40 and the repeal of the downward attribution rules.

A Category 1b filer is a U.S. shareholder that owns stock in a foreign corporation directly or indirectly, but the shareholder is unrelated to the foreign corporation within the meaning of Section 954(d)(3). Section 954(d)(3) defines control in a related party context. A Category 1b filer is typically a shareholder that owns a foreign corporation directly or through another entity. For purposes of Section 954(d)(3), control means,
With respect to a corporation, the ownership, directly or indirectly, of stock possessing more than 50 percent of stock entitled to vote or of the total value of the stock of such corporation.

A Category 1c filer is a U.S. shareholder of a foreign corporation only because of constructive stock ownership from a foreign corporation as per Internal Revenue Code Section 318(a)(3) and the shareholder is related to the foreign corporation under the definition of Section 954(d)(3).

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 change in substantial U.S. ownership – even if the change relates to stock owned by a U.S. person who is not an officer or director. For Category 2 purposes, a U.S. person is defined as a U.S. citizen, resident alien, domestic partnership, domestic corporation, domestic estate, and domestic trust. See Treas. Reg. Section 1.6045-1(f)(3)(i). Category 2 modifies the definition of a U.S. person. Under Treasury Regulations 1.6046-1(f)(3)(ii)(A), 1.6046-1(f)(3)(ii)(B), and 1.6046-1(f)(3)(iii) for Category 2 purposes, a U.S. person is a Puerto Rico resident, possessions resident , and Section 6013(g), (h) election (situations where a non-resident alien spouse makes an election to be taxed as a U.S. person). In regards to the definition of an officer or director, there is no clear answer as to what defines an officer or director for purposes of a Category 2 filer. However, Treasury Regulation Section 1.6046-1(d) defines a director or officer as “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.”

The Category 2 filing requirements do apply to just foreign corporations that are CFCs. Category 2 filing requirements apply to all foreign corporations.

For purposes of Category 2, a substantial change in U.S. ownership is when any U.S. person (not necessarily the U.S. citizen or resident who is the officer or director) acquires stock that causes him or her to own a 10 percent block, or acquires an additional 10 percent block, of stock in that corporation by vote or value. More precisely, if any U.S. person acquires stock, which, when added to any stock previously owned, causes him or her 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 does not create filing obligations under Category 2 for U.S. officers and directors. Stock ownership is a vote or value test.

Stock ownership for purposes of Category 2 is direct or indirect. For indirect ownership, stock owned by members of a shareholders family shall be taken into account for purposes of substantial change in ownership rules. Under Section 6046(c), the family of an individual shall be considered as including his or her brothers and sisters (whether by whole or half blood), his or her spouse, ancestors, and lineal descendants. Attribution from nonresidents is allowed.

Indirect ownership- for purposes of Category 2 filing obligations, a shareholder can have an ownership interest in an entity, and the entity is a direct owner of stock of a foreign corporation. For Category 2 filer purposes, the attribution rules apply only to foreign corporations and partnerships. A filer owns their proportional share of a foreign corporate stock owned by a foreign corporation. A Category 2 filer owns its proportional share of foreign corporate stock owned by a foreign partnership. See Treas. Reg. Section 1.6046-1(i)(1).

The regulations provide no inference of attribution of ownership through a foreign nongrantor trust, U.S. corporation, U.S. partnership, or disregarded entities. See Treas. Reg. Section 1.6046-1(i)(1).

Category 3 Filer

A U.S. person is a Category 3 filer with respect to a foreign corporation for a year if the U.S. person does any of the following during the tax year:

1. Acquires stock in the corporation, which, when added to any stock owned on the acquisition date, meets the Category 2 filer 10 percent stock ownership requirement.
2. Acquires additional stock that meets the 10 percent stock ownership requirement.
3. Becomes a U.S. person while meeting the 10 percent stock ownership requirement.
4. Disposes of sufficient stock in the corporation to reduce his or her interest to less than 10 percent stock ownership requirement.
5. Meets the 10 percent stock ownership requirement with respect to the corporation at a time when the corporation is reorganized.

For Category 3 purposes, a U.S. person is defined as a U.S. citizen, resident alien, domestic partnership, domestic corporation, domestic estate, and domestic trust. See Treas. Reg. Section 1.6045-1(f)(3)(i). Category 3 modifies the definition of a U.S. person. Under Treasury Regulations 1.6046-1(f)(3)(ii)(A), 1.6046-1(f)(3)(ii)(B), and 1.6046-1(f)(3)(iii) for Category 3 purposes, a U.S. person is a Puerto Rico resident, possessions resident, and Section 6013(g), (h) election (situations where a non-resident alien spouse makes an election to be taxed as a U.S. person).

Stock ownership for purposes of Category 3 is a vote or value test. Section 958 applies direct, indirect, and constructive ownership rules to determine stock ownership in the foreign corporation. The direct, indirect, and constructive ownership rules for purposes of a Category 3 filer can be defined as follows:

Direct ownership- an example of direct ownership is when a corporate shareholder’s name is on the stock certificate.

Indirect ownership- for purposes of Category 3 filing obligations, a shareholder can have an ownership interest in an entity, and the entity is a direct owner of stock of a foreign corporation. For Category 3 filer purposes, the attribution rules apply only to foreign corporations and partnerships. A filer owns their proportional share of a foreign corporate stock owned by a foreign corporation. A Category 3 filer owns its proportional share of foreign corporate stock owned by a foreign partnership. See Treas. Reg. Section 1.6046-1(i)(1).

The regulations provide no inference of attribution of ownership through a foreign nongrantor trust, U.S. corporation, U.S. partnership, or disregarded entities. See Treas. Reg. Section 1.6046-1(i)(1).

Constructive ownership- An individual is considered as owning stock owned by his spouse, children, grandchild, and parents. An individual shall be considered as owning the stock owned directly or indirectly by or for his brothers and sisters (whether by the whole or half blood), his spouse, his ancestors, and his lineal descendants. Treas. Reg. Section 1.6046-1(i)(2). Attribution from nonresidents is permitted for both Category 2 and 3 filers. This can result in unexpected Form 5471 filing obligations for U.S. persons. For example, let’s assume a nonresident alien who is married to a U.S. person establishes a foreign corporation. Let’s also assume that the U.S. person does not own any shares of the newly established foreign corporation and the U.S. person is not a director or officer of the foreign corporation. Even though the U.S. person does not own any shares of the U.S. corporation or can be classified as an officer or director of the foreign corporation, under the Category 3 attribution rules, the U.S. person has a Category 3 filing obligation. See IRC Section 6046(c); Treas. Reg. Section 1.6046-1(i)(2). In other words, if a nonresident alien spouse acquires 100 percent shares of a newly formed foreign corporation, for purposes filing a Form 5471, the U.S. resident spouse has constructively acquired 100 percent of the shares in the foreign corporation.

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, domestic partnership, domestic corporation, domestic estate, and domestic trust. See Treas. Reg. Section 1.6045-1(f)(3)(i). Category 4 modifies the definition of a U.S. person. Under Treasury Regulations 1.6046-1(f)(3)(ii)(A), 1.6046-1(f)(3)(ii)(B), and 1.6046-1(f)(3)(iii) for Category 4 purposes, a U.S. person is a Puerto Rico resident, possessions resident, and Section 6013(g), (h) election (situations where a non-resident alien spouse makes an election to be taxed as a U.S. person).

A U.S. person is considered to control a foreign corporation if at any time during the person’s taxable year, such person owns: 1) stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote; or 2) more than 50 percent of the total value of shares of all stock of the foreign corporation. See Treas. Reg. Section 1.6038-2(b). For purposes of Category 4, a U.S. person need only have control over the foreign corporation at any time in the tax year of the corporation.
See IRC Section 6038(a). The definition of “control” for Category 4 purposes is different from Section 957(a) which defines a “controlled foreign corporation.” Section 957(a) defines a “controlled foreign corporation” as a foreign corporation of which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned, directly, indirectly or constructively under the Section 958 ownership rules by “U.S. shareholders” on any day during the foreign corporation’s tax year or more than 50 percent of the total value of the shares of the corporation. Under this definition. a controlled foreign corporation may potentially have multiple U.S. shareholders who collectively own more than 50 percent of a foreign corporation.

On the other hand, for purposes of Category 4 filers, the Internal Revenue Code examines whether a U.S. person owns more than 50 percent of a foreign corporation. Under Internal Revenue Code Sections 6038(a)(1), (e)(2), a U.S. person shall be deemed to be in control of a foreign corporation if at any time during that person’s taxable year it owns more than 50 percent of the total combined voting power of the total combined voting power of all classes of stock entitled to, or more than 50 percent of the total value of shares of all classes of stock of the foreign corporation. Section 6038(e)(2) refers U.S. persons to Section 318(a) to determine if the U.S. person directly, indirectly, or constructively owns enough shares to have “control” of a foreign corporation.

The attribution rules for Category 4 filers are different compared to Category 2 and 3 filers. This is because Section 6038(e)(2)(A) modifies Section 318(a)(3)(A), (B), (c) so that downward attribution from foreign persons to United States persons is prohibited. However, Section 6038(e)(2)(B) modifies Section 318(a)(2)(C) for upward attribution from a corporation, changing the default 50 percent ownership threshold to 10 percent.

For Category 4 purposes of the constructive ownership rules, no attribution from grandparent, there is no sibling attribution. There however is parent and child attribution under Section 318(a)(1)(A)(ii) and spousal attribution under Section 318(a)(1)(A)(ii).

For Category 4 purposes, there is upward attribution from entities other than corporations. For example, partners own a proportional share of partnership-owned stock, beneficiaries own a proportional share of estate-owned stock, beneficiaries own their actuarially computed share of non grantor trust owned stock. See IRC Sections 318(a)(2)(A), IRC Section 318(a)(2)(A), IRC Section 318(a)(2)(B)(i). There is also upward attribution from corporate structure for purposes of Category 4 filers. However there are limits. There is no attribution of stock of a subsidiary to a shareholder if the shareholder owns less than 10 percent of the outstanding shares of the entity. See IRC Section 318(a)(2)(C); IRC Section 6038(e)(2)(C). If the shareholder owns more than 10 percent of the stock in a subsidiary corporation, the shareholder will own a proportional share of the stock for purposes of determining control. See IRC Section 318(a)(2)(C), IRC Section 6038(e)(2)(C). If the shareholder owns subsidiary stock and owns more than 50 percent of the outstanding stock in the entity, there is automatic control for purposes of Category 4 filing. See IRC Section 318(a)(2)(C), IRC Section 6038(e)(2)(C).

Unlike other categories of filers, under Section 6038(e)(2)(A), there is no downward attribution from a foreign person to a Category 4 filer. Section 318(a)(3) shall not be applied so as to consider a U.S. person as owning stock which is owned by a person who is not a U.S. person.

Category 5 Filer

A person is a Category 5 filer if the person: 1) is a U.S. shareholder of a CFC at any time during the CFC’s taxable year; and 2) owns stock of the foreign corporation on the last day in the year in which that corporation is a CFC. Category 5 uses the standard definition of a U.S. person under Section 7701(a)(30).

For category 5 purposes, partners own a proportional share of partnership-owned stock, beneficiaries own a proportional share of estate-owned stock, beneficiaries own their actuarially computed share of non grantor trust owned stock. See IRC Sections 318(a)(2)(A), IRC Section 318(a)(2)(A), IRC Section 318(a)(2)(B)(i). There is also upward attribution from corporate structure for purposes of Category 5 filers. However there are limits. There is no attribution of stock of a subsidiary to a shareholder if the shareholder owns less than 10 percent of the outstanding shares of the entity. See IRC Section 318(a)(2)(C); IRC Section 6038(e)(2)(C). If the shareholder owns more than 10 percent of the stock in a subsidiary corporation, the shareholder will own a proportional share of the stock for purposes of determining control. See IRC Section 318(a)(2)(C), IRC Section 6038(e)(2)(C). If the shareholder owns subsidiary stock and owns more than 50 percent of the outstanding stock in the entity, there is automatic control for purposes of Category 5 filing. See IRC Section 318(a)(2)(C), IRC Section 6038(e)(2)(C). For purposes of Category 5 filers, consider the ownership value of the shares of the CFC in determining the value of the corporate subsidiary stock.

Category 5a, 5b, and 5c Filers

Recently, the IRS expanded Category 5 filers to (5a, 5b, and 5c). Category 5a is a so-called catch all category and includes a U.S. person who is a ten percent or greater shareholder in a corporation that was a controlled foreign corporation for an uninterrupted period of thirty days during its annual accounting period and who owned stock in the controlled foreign corporation on its last day of its accounting period.

A Category 5b filer is an unrelated Section 958(a) U.S. shareholder who would not control (more than 50 percent vote or value) the CFC or be controlled by the same person which controls the CFC.

Category 5c filer is a related constructive U.S. shareholder. A Category 5c filer is typically an entity controlled by (more than 50% vote or value) the same person which controls the CFC and files only due to this downward attribution.

Why Category of Filers Matter

The category of filer will determine the Form 5471 schedule that is required to be attached to the Form 5471. Category 1a, 4, and 5a filers are required to file Schedule J.

Schedule J

We will now review the lines and columns of the Schedule J for the Form 5471. Schedule J begins by asking the filer to complete Lines a and b. Line a specifically asks the filer to determine the category of income and enter the applicable corresponding code. In order to answer the question on Line a, the filer must reference the instructions to IRS Form 1118. IRS Form 1118 states that there are six categories of foreign source income to be reported on Schedule J and assigns codes to each category of income. The filer may select from the applicable categories of income and codes listed below:

Code Category of Income

951A Section 951A Category Income

FB Foreign Branch Category Income

PAS Passive Category Income

901j Section 901(j) Income

RBT Income Re-Sourced by Treaty

GEN General Category Income

Below is a definition of each category of foreign source income provided by the instructions to Schedule J:

Section 951A Category Income

Section 951A (GILTI inclusions) category income is any amount includible in gross income under Section 951A (other than passive category income).

Foreign Branch Category Income

Foreign branch income is defined under Internal Revenue Code Section 904(d)(2)(j)(i) as the business profits of a U.S. person which are attributable to one or more Qualified Business Units (“QBUs”).

Passive Category Income

Passive income is generally the following:

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

Section 901(j) Income

Section 901(j) is income that is earned from a country sanctioned by the U.S..

Income Re-Sourced by Treaty

Certain U.S. treaties provide a “resourcing” rule, under which a U.S. taxpayer may treat as foreign source any income that the other contracting state may tax under the treaty.
If a sourcing rule in an applicable income tax treaty treats any U.S. source income as foreign source, and the corporation elects to apply the treaty, the income will be treated as foreign source. The U.S. source income reclassified as foreign source as a result of a treaty comes under this category.

General Category Income

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

New Category

Last year, there was a new code “TOTAL” for the 2021 tax year that is required for Schedule J filers if a foreign corporation has more than one category of income. In this case, the filer must complete and file a Schedule J using code “TOTAL” that aggregates all amounts listed each line and column in Part 1 of all other Schedule J. In addition, a separate Schedule J should not be completed for Section 951A category. Section 951A PTEP that is in the Section 951A category should be reported on the general category Schedule J.

Line b

Line b states that if Code 901j is entered on Line a, the country code for the sanctioned country using the two-letter codes (from the list at IRS.gov/countrycodes) must be entered.

Part 1- Accumulated E&P of Controlled Foreign Corporation

Check the Box if Person Filing Return Does Not Have all U.S. Shareholders’ Information to Complete an Amount in Column (e)

After completing Lines a and b, the filer will move onto Part 1 of Schedule J. The first question asks the filer to “check the box if [the] person filing [the] return does not have all U.S. Shareholders’ information to complete columns (e)(ii)-(e)(iv) and (e)(vii)-(ix).” Anyone preparing Schedule J must understand checking this box will likely invite an IRS audit. Thus, the filer of the J should do everything possible to obtain all the CFC books and records needed to accurately prepare the Schedule J.

The Importance of Categorizing Accumulated E&P of a CFC

Anyone who wishes to complete Schedule J must understand the 959 categorization and ordering rules. This section of this article discusses the basketing and ordering rules that are necessary to complete the Schedule J. Virtually all CFCs annually generate Subpart F income or, more likely, GILTI which becomes recharacterized previously taxed earnings and profits or (“PTEP”). However, not all PTEP is treated equally. PTEPs must be allocated into four separate Section 904(b) categories, known as baskets, depending on how the PTEP was generated. PTEPs are also subject to a certain set of ordering rules that clarifies how distributions of such PTEP are treated to the recipient.

This matters in large part for the purpose of the calculation of available foreign tax credits that would reduce a dollar-for-dollar basis the amount of U.S. income tax owed, and the credibility of foreign taxes allocable to each Section 904(d) basket is subject to the Section 904(a) limitation with respect to the specific basket. Income categorized in one basket cannot offset income in another basket. There are baskets for passive income, GILTI, foreign branch income, and a catchall basket for active business income. For example, any foreign taxes paid or accrued on GILTI income are allocated to the GILTI basket. If a U.S. shareholder is in an excess credit position with respect to its GILTI basket and excess limitation position with respect to its general basket, any excess foreign taxes that have been allocated to the GILTI basket generally cannot be reallocated to the general basket.

Where the E&P of a CFC consists in whole or in part of previously tax earning and profits, special rules under Section 959 apply in determining the ordering and taxation of distributions of such PTEP. Amounts included in the gross income of a U.S. shareholder as GILTI or subpart F income are not included in gross income again when such amounts are distributed to the shareholder, directly, indirectly, or through a chain or ownership. A PTEP distribution is generally allocated in the following order: 1) PTEP attributable to investments in U.S. property under Section 959(c)(1); 2) PTEP attributable to subpart F income under Section 959(c)(2); and (3) general current and accumulated E&P under Section 959(c)(3). For Section 959 purposes, a distribution is generally attributable to E&P according to the “last in first out” method (“LIFO”).

On November 28, 2018, the Department of Treasury and the IRS released proposed regulations related to the determination of the foreign tax credit (the Proposed Regulations). Under the Proposed Regulations, CFCs are required to establish an annual account for PTEP for each of the Section 904 baskets. Within each account, a CFC is required to assign a PTEP to one of ten different PTEP groups in each of the relevant Section 904 basket based on the U.S. shareholder’s underlying income inclusion, while also taking into account PTEP reclassifications as a result of a Section 956 inclusion.

A CFC accounts for a Section 959(b) distribution that it receives by adding the distribution amount to an annual PTEP account and PTEP group from which the distributing CFC made the distribution. A CFC that makes a Section 959 distribution must similarly reduce the annual PTEP group from which the distribution is made by the distribution amount. A CFC must also reduce PTEP groups that relate to Section 959(c)(2) PTEP to account for reclassifications of amounts into those groups as Section 959(c)(1) PTEP (reclassified PTEP) and increase the PTEP group that corresponds to the reclassified amount.

Notice 2019-1

Immediately after issuing the proposed regulations, Treasury and the IRS released Notice 2019-1, 2019-3 IRM 275, announcing their intention to issue regulations on foreign corporations with PTEP. Notice 2019-1 affirmed the requirement to maintain annual PTEP accounts but expanded the number of PTEP groups from 10 to 16 and provided that the rules would be coordinated with Prop Reg Section 1.960-1 and 3.

The Final Section 960(b) Regulations

On December 17, 2019, the Treasury and the IRS issued final regulations under Internal Revenue Code Section 960(b) which finalized the proposed regulations. The final Section 960(b) regulations modified the proposed regulations. The PTEP groups have consolidated the 959(c)(2) PTEP groups into five. The five PTEP groups arise under Internal Revenue Code Sections 965(a),(Section 965(a) requires U.S. shareholders to include in income an amount based on the accumulated post- 1986 deferred foreign earnings of SFCs) 965(b)(4)(A), (Under Section 965(b)(4)(A), the deferred foreign earnings that would have been included in a U.S. shareholder’s income under Section 965(a), but were not so included because of the sharing of an E&P deficit pursuant to Section 965(b), increases PTEP for the SFC that had positive earnings. Section 965(b)(4)(B), in turn, increases the E&P of a E&P deficit foreign corporation by the amount of the E&P deficit taken into account under Section 965(b), 951A(f)(2), (Allocation of GILTI to a CFC), 245A(d), (Section 245A(d) prohibits taxpayers from claiming credits or deductions for foreign income taxes paid or accrued on dividends for which a Section 245A deduction is allowed), and 951(a)(1)(A) (Subpart F income). Although Section 956 has virtually no significance following the availability of the 100 percent dividends received deduction of Section 245A, the final regulations state the the distribution-ordering rule of Section 959(c) requires U.S. shareholders to reclassify Section 959(c)(2) PTEP as Section 959(c)(1) PTEP whenever the CFC has a Section 956 investment in U.S. property that was included in the U.S. shareholder’s gross income under Section 951(a)(1)(A) or would have been included except for Section 959(a)(2). In that case, the Section 959(c)(2) PTEP group is reduced by the functional currency amount of the reclassified PTEP, which is added to the corresponding Section 959(c)(1) PTEP group described in the Section 904 category and same annual PTEP account as the reduced Section 959(c)(2) PTEP group. See Curtail U.S. PTEP Reporting Complexity: Know Your P’s and Q’s by Lewis J. Greenwald, Brainard L. Patton, and Brendan Sinnott, Tax Notes Federal, Aug. 2, 2021, p. 731.

The Schedule J increased the 959(c)(2) PTEP categories to be disclosed on the schedule from one to five. It also expanded 959(c)(1) PTEP categories from one to five. In addition, Schedule J requires untaxed E&P to be allocated into E&P subject to the Section 909 anti-splitter rules, E&P carried over from certain nonrecognition transitions, and hovering deficits under Section 959(c)(3). In addition, the Treasury Regulations under Section 1.960-3 requires that CFC shareholders report PTEP attributions attributable to Section 965 inclusions, 965(b) deficit offsets, Section 956 investments in U.S. property, GILTI inclusions, subpart F inclusions, Section 245A hybrid dividends, and Section 1248 amounts. Within these categories, CFC shareholders must state whether or not the PTEP should be allocated to a Section 959(c)(2) or Section 959(c)(1) PTEP. CFC shareholders must separately track each PTEP according to its foreign tax credit category. In addition, CFC shareholders must track movements of PTEPs between Setions 959(c)(2) and Section 959(c)(1) categories.

Part 1 Columns- Accumulated E&P of Controlled Foreign Corporation

Part 1 of Schedule J contains a number of columns. The CFC shareholder must complete each relevant column in the CFC’s functional currency. Section 985(b)(1)(A) of the Internal Revenue Code states the general rule that the functional currency will be “the dollar.” However, the functional currency of a “qualified business unit” (“QBU”) which could be a CFC will be “the currency of the economic environment in which a significant part of such a unit’s activities” is “conducted and which is used by such a unit in keeping its books and records.” See IRC Section 985(b)(1)(B).

Column (a)

Column (a) shows 959(c)(3) earnings and profits (E&P that has yet to be taxed). Column (a) asks for a CFC’s opening balance, current year additions and subtractions, and the closing balance in the foreign corporation’s E&P described in Section 959(c)(3) must be disclosed. In general, this is E&P of the foreign corporation which has not been included in gross income of a U.S. person under Section 951(a)(1). Thus, any post 2017 E&P that has not been taxed which is classified as a Section 959(c)(3) balance, that E&P should be reported under column (a).

Column (b)

Column (b) shows 959(c)(3) earnings and profits (E&P that has yet to be taxed). Column (b) requires the shareholder to report undistributed post 1986 and pre-2018 Section 959(c)(3) balances. This is the opening balance, current year additions and subtractions, and the closing balance in a CFC’s post 1986 undistributed earnings pool. In order to report Section 959(c)(3) balances in column (b), it is necessary for the preparer to determine the “post-1986 undistributed earnings pool.” The “post-1986 undistributed earnings pool” of a foreign corporation is the total earnings for years starting in 1987 through the end of 2017 in which a dividend was distributed, undiminished by any dividend distribution made during the year. See Former IRC Section 902(c)(1). The corporation’s pool of post-1986 foreign income taxes were reduced to reflect the portion of taxes deemed with respect to such dividends for purposes of computing foreign tax credits in subsequent years.

Please see Illustration 1 below for a simple example for calculating a “post-1986 undistributed earnings pool.”

Illustration 1.

Gamma S.A., a corporation under the laws of Country M, is a wholly owned subsidiary of American Gamma Corporation, a US corporation. Gamma S.A.’s post-1986 undistributed earnings (after payment of foreign taxes) and foreign taxes paid for years 1 through 3 were as follows:

	Post – 1986 Undistributed Earnings Pool	Foreign Taxes
Year 1	$100,000	$30,000
Year 2	$200,000	$60,000
Year 3	$300,000	$90,000
Pools as of 12/31 or Year 3	$600,000	$180,000

Gamma S.A. paid a dividend of $400,000 to American Gamma on December 1 of year 3.

Undisclosed Earnings Pool Foreign Taxes Paid Total

$600,000 – $180,000 = $20,000

Gamma S.A.’s post-1986 “undistributed earnings pool” as of year 4 would be $20,000.

Column (c) Pre-1987 E&P Not Previously Taxes

Column (c) shows 959(c)(3) earnings and profits (E&P that has yet to be taxed). In column (c), the shareholder should report pre-1987 E&P not previously taxed Section 959(c)(3) balances. In order to correctly report Section 959(c)(3) pre-1987 E&P accumulated earnings, it is necessary to understand how earnings and profits of a CFC were determined prior to 1987. Before 1987, the earnings and profits of a foreign corporation were calculated year by year. If a dividend exceeded the earnings of a specified year, the excess of the dividend was deemed to be paid out of the after-tax accumulated earnings of the preceding year. If the remaining portion of the dividend exceeded the after-tax accumulated earnings of the preceding year, the dividend was treated as paid from the accumulated earnings of the next preceding year and so on until the dividend had been completely covered by accumulated earnings to the extent available.

Column (d)

Column (d) is used to report hovering deficits and deductions for suspended taxes. Column (d) applies to the carryover of the E&P and foreign income taxes in certain foreign-to-foreign nonrecognition transactions. Historically, a hovering deficit arose when two foreign corporations engaged in a transaction in which E&P and taxes carried over under Section 381 and either corporation had a deficit in Post-1986 undistributed earnings in one or more foreign tax credit baskets.

If immediately prior to the foreign Section 381 either the foreign acquiring corporation pr the foreign target corporation has a deficit in one more separate categories of post-1986 undistributed earnings or an aggregate deficit in pre-1987 accumulated profits, such deficit will be a hovering deficit in pre-1987 accumulated profits, such deficit will be a hovering deficit of the foreign surviving corporation. A hovering deficit in a separate category of post-1986 undistributed earnings shall offset only E&P accumulated by the surviving corporation after the foreign Section 381 transaction (post-transaction earnings) in the same separate category of post-1986 undistributed earnings.

Post-1986 foreign taxes that are related to a hovering deficit in a separate category of post-1986 undistributed earnings shall only be added to the foreign surviving corporation’s post-1986 foreign income taxes in that separate category on a pro rata basis as the hovering deficit is absorbed.

Please see Illustration 2 below that illustrates the hovering deficit rules. Foreign corporations A and B are CFCs that were incorporated after December 31, 1986, have always been pooling corporations, and have always had calendar taxable years. None of the shareholders of foreign corporations A and B are required to include any income under Treasury Regulation 1.367(b)-4 as a result of the foreign Section 381 transaction. Foreign corporations A and B (and all of their respective qualified business units as defined in Section 989) maintain a “u” functional currency. Unless otherwise stated, any post-1986 undistributed earnings in the passive category resulted from a look-through dividend that was paid by a lower-tier CFC out of earnings accumulated when the CFC was a noncontrolled Section 902 corporation and that qualified for the subpart F same-country exception under Section 954(c)(3)(A).

On December 31, 2006, foreign corporations A and B have the following post-1986 undistributed E&P and post-1986 foreign income taxes.

Separate Category	E&P	Foreign Taxes
Foreign Corporation A
General	300u	$60
	15
Passive	100u	40
	400u	$100
Foreign Corporation B
General	300u	$70

On January 1, 2007, foreign corporation B acquires the assets of foreign corporation A in a reorganization described in Section 368(a)(1)(C). Immediately following the foreign Section 381 transaction, foreign surviving corporation is a CFC. Under the rules described in Treasury Regulation Section 1.367(b)-7, the foreign surviving corporation has the following post-1986 undistributed E&P and post-1986 foreign income taxes.

Separate Category	E&P	Foreign Taxes
General	600u	$130
Passive	100u	40
	700u	$170

During 2007, foreign surviving corporation does not accumulate any E&P or pay or accrue any foreign taxes. On December 31, 2007, foreign surviving corporation distributes 350u to its shareholders. Under the rules described in Section 1.902-1(d)(1) and Section 1.367(b)-7, the distribution is out of, and reduces, post-1986 undistributed E&P foreign income taxes in separate categories on a pro rata basis, as follows:

Separate Category	E&P	Foreign Taxes
General	300u	$65
Passive	50u	20
	350u	$85

The foreign income taxes deemed paid by qualifying shareholders of foreign surviving corporation upon the distribution are subject to generally applicable rules and limitations, such as those of Sections 78, 902, and 904(d). Immediately after the distribution, foreign surviving corporation has the following post-1986 undistributed earnings and post-1986 foreign income taxes:

Separate Category	E&P	Foreign Taxes
General	300	$65
	16
Passive	50u	20
	350u	$85

Column (e)

Column (e) is used to report the running balance of the foreign corporation’s PTEP, Section 964(a) E&P accumulated since 1962 that have resulted in deemed inclusions under subpart F, or amounts treated as PTEP under Internal Revenue Code Section 965(b)(4).

Column (e)(i)

A CFC shareholder will use Column (e)(i) to report previously taxed income reclassified as Section 965(a) PTEP under Section 959(c)(1)(A) as investments in U.S. property. The most frequent investment in U.S. property is a loan from the CFC to the U.S. shareholder or a person related to the U.S. shareholder. Section 965(a) requires U.S. shareholders to include in income an amount based on the accumulated post-1965 foreign earnings of specified foreign corporations or (“SFC”) as if those earnings had been repatriated to the U.S. Any foreign earnings that are taxed under Section 965(a) become Section 965(a) PTEPs for purposes of Schedule J. For Column (e)(i), the filer must state previously taxed Section 965(a) E&P reclassified under Section 959(c)(1)(A).

Column (e)(ii)

A CFC shareholder will use Column (e)(ii) to report previously taxed income reclassified as Section 965(b) under Section 959(c)(1)(A) (reclassified as investments in U.S. property). Section 965(b) permits U.S. shareholders to reduce Section 965(a) inclusions based on deficits in E&P accumulated by other SFCs. Under Section 965(b)(4)(A), the deferred foreign earnings that would have been included in the U.S. shareholder’s income under Section 965(a), but were not included because of the sharing of an E&P deficit pursuant to Section 965(b), increases PTEP for the SFC that had positive earnings. Section 965(b)(4)(B) increases the E&P of a deficit foreign corporation by the amount of the E&P deficit taken into account under Section 965(b).

Column (e)(iii)

A CFC shareholder will use Column (e)(iii) to report general Section 959(c)(1) PTEPs. Recall that Section 959(c)(1) are PTEPs attributable to investments in US property or reclassified investments in U.S. property. Investments in US property include most tangible and intangible property owned by a CFC that has a US situs such as stock of a domestic corporation; an obligation of a US person; and a right to use a patent, copyright, or other forms of intellectual property in the United States if acquired or developed by the CFC for that use. A CFC is also treated as owning a proportionate interest in US property owned by a partnership in which the CFC is a partner.

Column (e)(iv)

A CFC shareholder will use Column (e)(iv) to report PTEP originally attributable to inclusions under Internal Revenue Code Section 951A GILTI, or GILTI reclassified as investments in U.S. property under Section 959(c)(1)(A).

Column (e)(v)

A CFC shareholder will use Column (e)(v) to report PTEPs attributable in three subgroups discussed below (which are aggregated into a single PTEP group) reclassified as Section 959(c)(1)(A) PTEP.

1. PTEP that is attributable to hybrid dividends under Section 245(e)(2) and reclassified as investments in U.S. property. Internal Revenue Code Section 245A(d) generally prohibits taxpayers from claiming credits or deductions for foreign income taxes paid or accrued (or treated as paid or accrued) on dividends for which an Internal Revenue Code Section 245A deduction is allowed.Under Section 245A, an exception is allowed for certain foreign income of a domestic corporation that is a US shareholder by means of a 100 percent DRD for the foreign source portion of dividends received from “specified 10-percent owned foreign corporations” by certain domestic corporations that are US shareholders of those foreign corporations within the meaning of section 951(b). Section 245A generally denies the DRD for hybrid dividends (i.e., amounts received from a CFC if the dividend gives rise to a local country deduction or other tax benefit).
2. PTEP that is attributable to Section 1248 amounts under Section 959(e). Under Section 1248(a), gain is recognized on a U.S. shareholder’s disposition of CFC stock in cases where there is a deferral of E&P. For purposes of Section 959(e), any amount included in the gross income of any person as a dividend by reason of subsection (a) or (f) of Section 1248 shall be treated as an amount included in the gross income of such person.
3. PTEP that is attributable to Section 1248 amounts from gain on the sale of a CFC by a CFC. With respect to individual U.S. shareholders who sell stock in a CFC recharacterized under Section 1248(a), the gains are realized at ordinary rates. Section 1248(b) provides for a ceiling on the tax liability that may be imposed on the shareholder receiving a Section 1248(a) dividend if the taxpayer is an individual and the stock disposed of has been held for more than one year. The Section 1248(b) ceiling consists of the sum of two amounts. The first amount is the U.S. income tax that the CFC would have paid if the CFC had been taxed as a domestic corporation, after permitting a credit for all foreign and U.S. tax actually paid by the CFC on the same income (the “hypothetical corporate tax”). The second amount is the addition to the taxpayer’s U.S. federal income tax for the year that results from including in gross income as long-term capital gain equal to the excess of the Section 1248(a) amount over the hypothetical corporate tax (the “hypothetical shareholder tax”).

Column (e)(vi)

A CFC shareholder will use Column (e)(vi) to report PTEPs attributable to Section 965(a) classified under Section 959(c)(2) (attributable to Sections 951 or 951A). Under the Section 965 transition tax, U.S. shareholders of CFCs in existence at the end of 2017 were typically required to include in their income all of the CFC’s E&P these earnings were generally taxed at a reduced rate through a sliding scale deduction allowable under Section 965(c).

Column (e)(vii)

A CFC shareholder will use Column (e)(vii) to report PTEPs attributable to Section 965(b)(4)(A) classified under Section 959(c)(2) (attributable to Section 951 or 951A) .
Column (e)(vii) will apply if the U.S. shareholder owned multiple CFC prior to the 2018 tax year and some of the CFCs had positive E&P and others had negative E&P.

Column (e)(viii)

A CFC shareholder will use Column (e)(viii) to report PTEPs attributable to Section 951A classified under Section 959(c)(2). Column (e)(viii) will represent PTEPs related to GILTI inclusions.

Column (e)(ix)

A CFC shareholder will use Column (e)(ix) to report PTEPs attributable to Section 245A(d) classified under Section 959(c)(2). This type of PTEP is created when a CFC is owned by a domestic corporation and the CFC receives a hybrid dividend from another CFC. In general, a dividend received by a domestic corporation from a CFC is a hybrid dividend if the dividend received by a domestic corporation from the CFC (or a related person) is or was allowed a deduction (“Hybrid deduction”) or other tax benefit under a relevant foreign law.

Column (e)(x)

A CFC shareholder will use Column (e)(x) to report PTEPs attributable to Section 951(a)(1)(A) or subpart F income. Column (e)(x) will represent PTEPs related to Subpart F inclusions.

These last three columns are the most frequently used PTEP columns on the Schedule J.

Column (f)

Column (f) is used to report the opening and closing balance of the foreign corporation’s accumulated E&P. This amount is the sum of post-2017 E&P not previously taxed, post-1986 undistributed earnings, pre-1987 E&P not previously taxed, and PTEP.

Specific Instructions Related to Lines 1 Through 14

Line 1a

Line 1a asks the filer to enter the balances for each column at the beginning of the tax year. These balances should equal the amounts reported as the ending balances in the prior year Schedule J.

Line 1b

Line 1b states if there is a difference between last year’s ending balance on Schedule J and the amount which should be last year’s ending balance, include the difference for the difference. If there are multiple differences, the preparer should include the explanation and amount of each such difference on the attachment.

Line 2a

Line 2a asks the filer to disclose unsuspended taxes under Section 909 of the Internal Revenue Code. Under Internal Revenue Code Section 909, where there is a “foreign tax credit splitting event” with respect to foreign income tax paid or accrued by a taxpayer, the foreign income tax is not taken into account for U.S. tax purposes. The definition of “foreign tax credit splitting event” is broad and could reach a variety of situations such as disregarded payments, transfer pricing adjustments, contributions of property resulting in a shift of deductions and timing differences under U.S. and foreign law. Specifically, a “foreign tax credit splitting event” arises with respect to a foreign income tax if the related income is taken into account for U.S. tax purposes by a “covered person.” A “covered person” is defined as any entity in which the payor holds, directly, or indirectly, at least 10 percent ownership ownership (determined by vote or value); any person that holds, directly, or indirectly, at least a 10 percent ownership interest (by vote or value) in the payor.

This line of column (b) is the unsuspended taxes under Section 909 of the Internal Revenue Code as a result of related income taken into account by the foreign corporation, certain U.S. corporate owners of the foreign corporation, or a member of such U.S. corporate owner’s consolidated group. The filer should report the unsuspended taxes on line 2a of column numbers on line 2a of column (a), (b), (c), or (e), as applicable.

Line 2b

Line 2b asks the filer to disclose foreign taxes that are suspended in the current tax year. These amounts should be reported as negative numbers. This includes taxes suspended under Section 909 or under “hybrid instrument splitter arrangements.” One example of such a situation is a “hybrid instrument splitter arrangement,” which involves a U.S. hybrid equity instrument that is treated as equity under US law but as debt for foreign purposes, which permits a deduction for foreign purposes for interest expense but not a corresponding taxable interest payment in the US. Another splitter arrangement is a “reverse hybrid splitter arrangement,” in which an entity that is a corporation for US purposes is treated as a fiscally transparent entity or a branch under the laws of the foreign country imposing the tax.

Line 2b of column (d) accounts for foreign income taxes that are suspended in the current tax year. These amounts should be reported as negative numbers.

Line 3

Line 3 asks the filer to disclose the current year E&P (or deficit in E&P) amount from the applicable line 5c of Schedule H. For example, if the preparer is completing Schedule J, enter the current year E&P (or deficit in E&P) amount from Schedule H, line 5C(ii), in the applicable column. Line 3 should never have an amount entered in column (e).

Line 4

For Line 4, the filer should report as a positive number E&P attributable to previous taxed income distributions from lower-tier foreign corporations. The E&P of a CFC attributable to amounts which are, or have been, included in the gross income of a U.S. shareholder under Section 951(a), are not, when distributed through a chain of ownership described in Section 958(a), also included in the gross income of another CFC. (Under Section 958(a), stock owned directly or indirectly by or for a foreign corporation, foreign partnership, foreign trust or foreign estate is considered as being owned proportionately by its shareholders, partners or beneficiaries. Stock considered as owned is treated as actually owned for purposes of applying the direct and indirect ownership rules).

Line 5a

Line 5a asks the filer to enter earnings carried over to a surviving corporation after an acquisition by a foreign corporation of the assets by a foreign corporation described in Section 381. The tax attributes of a target corporation (e.g., earnings and profits and net operating losses) generally carry over to the acquiring corporation under Section 381. The amounts carried over to the reporting CFC may be negative or positive.

Line 5b.

Line 5b asks the filer to list any deficit of a foreign surviving corporation. If the foreign surviving corporation had a deficit prior to the transaction, the deficit should be recharacterized as a hovering deficit. This hovering deficit should be disclosed in columns (a),(b), or (c) as a positive number.

Line 6

Line 6 asks the filer to attach a statement detailing the nature and amount of any adjustments not accounted for in the E&P determined before reduction for reductions for distributions. See Illustration 3 for an example (taken from the IRS instructions for the 2019 Schedule J) of an adjustment on Line 6 regarding a distribution of a PTEP from a lower-tier foreign corporation.

Illustration 3

Domestic Corporation, a US shareholder, wholly owns the only class of stock of CFC1, in turn, wholly owns the only class of stock of CFC 2, a foreign corporation. CFC2, in turn, wholly owns the only class of stock of CFC3, a foreign corporation. The functional currency of Domestic Corporation, CFC1, CFC2, and CFC3 is the US dollar. During Year 1, Domestic Corporation reports an inclusion under Section 951(a)(1) of $100 as a result of subpart F income of CFC3. During Year 2, CFC3 distributes $40 to CFC2. CFC2 pays withholding tax of $4 on the distribution from CFC3. Such tax is related to previously taxed subpart F income. Domestic Corporation reports on CFC2’s Form 5471, Schedule J, line 3, as a positive number, the $40 PTEP distribution. Domestic Corporation reports on line 6, on a column (e) a negative number of $4 on the PTEP distribution.

Line 7

Line 7 asks the filer to enter on Line 7 E&P as of the close of the tax year before actual distributions or inclusions under Section 951(a)(1) or Section 951A during the year. For dividends paid by certain foreign corporations in US tax years beginning before January 1, 2018, this number in column (b) generally is the denominator of the deemed paid credit fraction under Former Section 902(c)(1) used for foreign tax credit purposes.

Line 8

Line 8 asks the filer to enter amounts included in gross income of the U.S. shareholder(s) under Section 951(a)(1)(A) or Section 951A with respect to the CFC.

Line 9

Line 9 asks the filer to report actual distributions as negative numbers.

Line 10

Line 10 asks the filer to use line 10 to report reclassifications of Section 959(c)(2) PTEP in columns (e)(i) through (e)(x) to Section 959(c)(1) PTEP in columns (e)(i) through 9(e)(x). A potential Section 951(a)(1)(B) inclusion results in a reclassification of Section 959(c)(2) PTEP before reclassification out of the Section 959(c)(3) E&P balance. The amounts reclassified are reported as negative numbers in the appropriate column (e).

Line 11.

Line 11 asks the filer to use this line to report E&P not previously taxed, which is treated as earnings invested in U.S. property and therefore, reclassified as Section 959(c)(1) PTI (column (e)(i)). The amounts reclassified are reported as negative numbers in columns (a) through (d) and positive numbers in the appropriate column (e).

Line 12

Line 12 asks the filer to attach a statement detailing the nature and amount of any adjustments in E&P not accounted for on lines 8 through 11.

Line 13

Line 13 asks the filer to list any hovering deficit offset included in column (d) as reported as a positive number. The same amount entered in column (d) is reported as a negative number in line 13 of column (a) or (b), as appropriate.

Line 14

For Line 14, the filer must state the balance at the beginning of the next year.

Part II Nonpreviously Taxed E&P Subject to Recapture as Subpart F Income

Part II of Schedule J asks the filer to disclose nonpreviously taxed E&P subject to recapture as subpart F income in functional currency. In order to complete Part II of Schedule J, the filer must understand how subpart F income is calculated. The Internal Revenue Code allocates a pro rata share of subpart F income as a constructive dividend. Section 952(c)(1)(A) limits a CFC’s subpart F income to its current E&P. in other words, a corporation’s subpart F income for a tax year is reduced to the amount of its current E&P, thus reducing the amount of the current inclusions to its U.S. shareholders under Section 951(a)(1)(A). Under this rule, a CFC current losses from an activity that would not generate subpart F may, in certain limited circumstances, reduce its subpart F income.

If a CFC has an excess of current earnings and profits over subpart F income, Section 952(c)(2) may recharacterize that excess of current E&P over subpart F income, Section 952(c)(2) may recharacterize that excess as subpart F income to the extent of the prior reductions in subpart F income. Consequently, the US shareholder may have additional current inclusions of income under Section 951(a) in a later year as a result of this recharacterization rule. See illustration 4 below.

Illustration 4

DC, a US corporation, owns all of the stock of FC, a foreign corporation that is a controlled foreign corporation. During the current year, FC has foreign base company sales income of $100 (determined under Section 954), but its current earnings and profits (as calculated under Section 964) is $80. Thus, Section 952(c)(1)(A) limits FC’s subpart F income to $80 for year 1. Thus, Section 952(c)(1)(A) limits FC’s subpart F income to $80 for year 1 and DC would include the $80 in gross income under Section 951(a)(1)(A).

In year 2, FC has foreign base company sales income of $75 (determined under Section 954) and its current earnings and profits are $85. Under the recharacterization rule in Section 952(c)(2), the $10 excess of current earnings and profits of $85 over the subpart F income of $75 is recharacterized as subpart F income. Thus, FC is treated as having subpart F income of $85 and DC must include the $85 in gross income under Section 951(a)(1)(A).

In year 3, FC has foreign base company sales income of $50 (determined under Section 954) and its current earnings and profits are $80. Under the recharacterization rule in Section 952(c)(2), only $10 of the $30 excess of current earnings and profits of $80 over the subpart F income of $50 is recharacterized as subpart income. This is because the total amount recaputed under Section 952(c)(2) ($10 in year 2 and $10 in year 3) cannot exceed the reduction of subpart F income in year 1 by reason of the limit in Section 952(c)(1)(A) (i.e., $20).

Accumulated deficits in a CFC’s E&P from prior years generally do not reduce its subpart F income for the current tax year, except to the limited extent provided in Section 952(c)(1)(B). Moreover, a deficit of one CFC generally may not be used to reduce the subpart F income of a related CFC. Congress enacted these rules to prevent taxpayers sheltering passive investment income from US tax by moving the passive investments into a CFC with prior deficits. Congress also wanted to restrict loss trafficking be preventing deficits in E&P incurred by a foreign corporation before its acquisition by a US corporation from sheltering post-acquisition subpart F income of the foreign corporation from tax and by preventing a CFC from reducing its subpart F income with deficits of related CFCs attributable to different activities. See Staff of Joint Comm. on Tax’n, 100th Cong., 1st Sess, General Explanation of the Tax Reform Act of 1986, at 972 (1987).

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 Ching & 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 other tax professionals.

He 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 adiosdi@sftaxcounsel.com.

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.