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Demystifying the New 2021 IRS Form 5471 Schedule E and Schedule E-1 Used for Reporting and Tracking Foreign Tax Credits

Demystifying the New 2021 IRS Form 5471 Schedule E and Schedule E-1 Used for Reporting and Tracking Foreign Tax Credits

By Anthony Diosdi


Schedule E and Schedule E-1 of Form 5471 is used to report taxes paid or accrued by a foreign corporation for which a foreign tax credit is allowed and taxes for which a credit may not be taken. This article will dive into each column and line of the new 2021 Form 5471 Schedule E and Schedule E-1. We will also attempt to provide guidance as to how to prepare this incredibly complicated return.

Who Must Complete the Form 5471 Schedule E

Anyone preparing a Form 5471 knows that the return consists of many schedules. Schedule E is just one schedule of the Form 5471. Whether or not a taxpayer is required to complete Schedule E depends on what category of filer he or she can be classified as. For purposes of Form 5471, taxpayers are broken down by the following categories:

Key Terms

U.S. person:
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. A tax-exempt U.S. entity may have a Form 5471 filing obligation.

U.S. Shareholder: A U.S. shareholder is a U.S. person who owns (directly, indirectly, or constructively, within the meaning of of Section 958(a) and Section 958(b)), 10% or more of either the total combined voting power of all classes of voting stock of a foreign corporation or the value of all the outstanding shares of a foreign corporation.

Controlled foreign corporation (“CFC”): A CFC is a foreign corporation with U.S. shareholders that own (directly, indirectly, or constructively, within the meaning of Section 958(a) and 958(b)) on any day of its taxable year, more than 50 percent of either 1) the total combined voting power of all classes of its voting stock, or 2) the total value of its stock.

Section 965 Specified Foreign Corporation (SFC): A CFC, or any foreign corporation with one or more 10 percent domestic corporation shareholders. Passive foreign investment companies or (“PFICs”) are not included in this definition.

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 foreign corporation is an SFC if it is either a CFC or a foreign corporation with at least one corporate U.S. shareholder.

Category 2 Filer

A Category 2 filer is a U.S. citizen or resident 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. 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% block, or acquires an additional 10% block, of stock in that corporation. 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% 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.

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 U.S. person’s year:

1. Acquires stock in the corporation, which, when added to any stock owned on the acquisition date, meets the Category 2 filer 10% stock ownership requirement.
2. Acquires additional stock that meets the 10% stock ownership requirement.
3. Becomes a U.S. person while meeting the 10% 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.

Stock ownership is a vote or value test. Constructive ownership includes certain family members, such as brothers or sisters, spouse, ancestors, and lineal descendants.

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. 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.

For Category 4 purposes, U.S. persons include those individuals who make a Section 6013(g) or (h) election to be treated as resident aliens of the United States for income tax purposes.

The constructive ownership rules of Section 318 are applied, with few modifications, to determine if the U.S. person “controls” the foreign corporation.

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. For category 5 purposes, constructive ownership is determined under Section 318 as modified by Section 958(b). Pursuant to Section 958(b), there is no attribution from a nonresident alien relative.

Additional Categories

In January of 2021, the IRS expanded Categories 1 and 5 to 1a, 1b, 1c, 5a, 5b, and 5c in order to separate those filers who are under some relief and may not need to file the same schedules.

1a- Category 1 filer who is not defined in 1b or 1c. This means a greater than 50 percent owner of the SFC.

1b- Unrelated Section 958(a) U.S. shareholder. This means an unrelated person would not control (more than 50% vote or value) the SFC or be controlled by the same person which controls the SFC.

1c- Related constructive U.S. shareholder- This means an entity controlled by (more than 50% vote or value) the same person which controls the SFC and files only due to this downward attribution.

5a- Category 5 filer who is not defined in 5b or 5c – This means a greater than 50% owner of the CFC.

5b- Unrelated Section 958(a) U.S. shareholder- This means an unrelated person would not control (more than 50% vote or value) the CFC or be controlled by the same person which controls the CFC.

5c- Related constructive U.S. shareholder- This Means 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.

These new categories will distinguish those 5471 filers who only need to file a Form 5471 due to downward attribution caused by the repeal of Section 958(b)(4) and will therefore not be required to attach certain schedules to their Form 5471s.

Shareholders that are classified as Category 1a, 1b, 1c, 4, 5a, 5b, and 5c filers must attach a Schedule E to their Form 5471. Shareholders that are classified as Category 1a, 1b, 4, 5a, and 5b must complete Schedule E-1.

Lines a, b, and c

Schedule E begins by asking the taxpayer to complete lines a and b. Line a specifically asks the CFC to determine the category of income and enter the applicable corresponding code. In order to answer the question on Line a, the taxpayer 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 E and assigns codes to each category of income. The taxpayer select from the applicable categories of income and codes listed below:

CodeCategory of Income
951ASection 951A Category Income
FBForeign Branch Category Income
PASPassive Category Income
901jSection 901j Income
RBTIncome Re-Sourced by Treaty
GENGeneral Category Income



Below is a definition of each category of foreign source income:

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:

  1. 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.
  2. 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) income is income earned from a sanctioned country.

Income Re-Sourced by 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.

General Category Income

This category includes all income not described above.

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.

Line c

Line c states that if RBT codes are entered on line a, the taxpayer must enter the country code for the treaty country.

Part 1. Taxes for Which a Foreign Tax Credit is Allowed

Section 1 – Taxes Paid or Accrued Directly by Foreign Corporation

Schedule 1 is designed to report any foreign taxes paid or accrued directly by a CFC. The taxpayer must not only disclose the amounts of foreign taxes paid by the CFC, the taxpayer must also properly convert the foreign taxes paid to U.S. dollars.

Column (a)

Column (a) asks the taxpayer to list the name of the foreign corporation or pass-through entity (partnership or disregarded entity) that paid the foreign tax. If the tax is paid or accrued by a pass-through entity, the taxpayer should enter the name of such entity instead of the name of the foreign corporation. If the tax paid or is accrued by the foreign corporation is attributable to a branch or qualified QBU of the foreign corporation, the name of the branch or QBU should be entered. With respect to deemed paid taxes related to dividends received from lower-tier foreign corporations beginning before January 1, 2018, column (a) should include the name of the lower-tier foreign corporation that paid the dividend instead of the recipient foreign corporation. With respect to deemed paid taxes related to previously taxed earnings and profits or (“PTEP”) distributions received from lower-tier foreign corporations in tax years of foreign corporations beginning before January 1, 2018, these amounts should be reported on Part 1, Section 2.

Column (b)

Column (b) asks the taxpayer to enter the employer identification number (“EIN”) or reference ID number of the payor of the foreign tax.A reference ID number is required only in cases in which no EIN was entered for the foreign corporation or pass-through entity owned by the foreign corporation.

Column (c)

Column (c) asks the taxpayer to check the box if the CFC had any unsuspended tax during the year.

Column (d)

Column (d) asks the taxpayer to enter the country code for the country or U.S. possession to which tax is paid.

Column (e)

Column (e) asks the taxpayer to disclose any tax accounting timing discrepancies between the U.S. and foreign tax years. For example, the foreign tax year under foreign law may not be the same as the U.S. tax year of the foreign corporation.

Column (f)

Column (f) asks the taxpayer to disclose the U.S. tax year to which the tax relates. This should be stated as (Year/Month/Day) on the Schedule E.

Column (g)

Column (g) asks the taxpayer to disclose the income subject to tax in the foreign jurisdiction.

Column (h)

Column (h) asks the taxpayer to check the box if foreign taxes are paid on U.S. source income.

Column (i)

Column (h) asks the taxpayer for the three-letter currency code for the local currency in which the tax is payable. Currency codes are available at www.iso.org/iso-427-currency-codes.html or www.currency-iso.org/en/home/tables/tables-a1.html.

Column (j)

Column (j) asks the preparer to enter the tax paid or accrued in the local currency in which the tax is payable and not the functional currency of the CFC. Internal Revenue Code Section 985(b)(1)(A) states the general rule that the functional currency will be “the dollar.”

Column (k) and (l)

Columns (j) and (l) ask the taxpayer to enter the exchange rate in column (k) and the translated dollar amount in column (l). The taxpayer should translate the taxes entered in column (f) into dollars at the average exchange rate for the tax year to which the tax relates unless one of the exceptions below applies:

1. The tax is paid before the beginning of the year to which the tax relates;

2. The accrued taxes are not paid before the date of two years after the close of the tax year to which such taxes relate;

3. There is an election in effect under Section 986(a)(1)(D) to translate foreign taxes using the exchange rate in effect on the date of payment; or

4. The CFC reports on a cash basis, the exchange rate must be reported using the “divide-by conversion rate” (in other words, the units of foreign currency that equals one unit foreign currency).

Column (m)

Column (m) asks the preparer to enter the foreign tax in functional currency. Section 985(b)(1)(A) states the general rule that the functional currency will be “the dollar.” However, the functional currency of a QBU will be “the currency of the economic environment in which a significant part of such a unit’s activities is “conducted and is used by such a unit in keeping its books and records.” On column (l), the preparer will need to enter the foreign taxes paid or accrued in U.S. dollars. However, if a unit of the CFC is a QBU that conducts its business in a foreign currency, the taxes paid or accrued should be determined in the functional currency of the CFC.

Line 5.

For Line 5, the taxpayer should combine Lines 1 through 4 of Column L.

Line 6.

For Line 6, the preparer should combine Lines 1 through 4 of Column M.

Section 2 – Taxes Deemed Paid by Foreign Corporations

The purpose of Section 2 is to track deemed-paid foreign income taxes with respect to current year PTEP distributions from lower-tier foreign corporations to the foreign corporation with respect to the foreign corporation with respect to which Schedule E is being completed. The taxpayer should report a PTEP distribution by a lower-tier foreign corporation in this section if foreign income taxes are deemed paid under Internal Revenue Code Section 960(b) by the foreign corporation (for which the Schedule E is being completed) with respect to such PTEP distribution. The taxpayer should also include deemed paid taxes related to PTEP distributions received from lower-tier foreign corporations in tax years of the foreign corporation beginning before January 1, 2018.

The only foreign taxes of the distributing foreign corporation that may be treated as deemed paid under Internal Revenue Code Section 960(b) are foreign taxes paid, accrued, or deemed paid by the distributing foreign corporation with respect to the receipt of a PTEP distribution from another lower-tier foreign corporation below the distributing foreign corporation. Accordingly, there can be no deemed-paid foreign taxes with respect to a PTEP distribution from a lower-tier foreign corporation that is the lowest foreign-tier foreign corporation in a chain, and therefore no such distributions will be reported in Section 2.

Any foreign income taxes paid or accrued (but not deemed paid) by the foreign corporation with respect to a PTEP distribution from a lower-tier foreign corporation (whether or not such PTEP distribution is reported in Section 2), such as withholding taxes imposed on the PTEP distribution, are reported in Section 1.

Column (a)

Column (a) asks the taxpayer to name each lower-tier foreign corporation that made a PTEP distribution eligible with respect to which a deemed-paid tax is determined in the current year by the foreign corporation with respect to which this Schedule E is being completed.

Column (b)

Column (b) asks the taxpayer to enter the EIN or reference ID number of the lower-tier foreign corporation listed in column (a).

Column (c)

Column (c) asks the preparer to enter the two-letter codes of the foreign country the foreign taxes were paid. Country Codes are available at irs.gov/countrycodes.gov. If taxes were paid or accrued to more than one country with respect to the same income, the preparer should include an attachment listing the applicable countries.

Column (d)

Column (d) asks the taxpayer to disclose each applicable PTEP group for the associated foreign tax paid. Where the E&P of a CFC consists in whole or in part of PTEP, special rules under Section 959 will determine the ordering and taxation of each distribution of PTEP. Column (d) requires the taxpayer to classify the income associated with each Section 960(b) foreign tax credit into a PTEP and disclose the PTEP in column (d). The PTEP groups and codes are as follows:


Taxes related to
Previously taxed E&P
PTEP Group Code
Reclassified 965(a) PTEPR965a
Reclassified Section 965(b) PTEPR965b
General Section 959(c)(1) PTEP959c1
Reclassified Section 951A PTEPR951A
Reclassified Section 245(d) PTEPR245Ad
Section Section 965(a) PTEP965a
Section 965(b) PTEP965b
Section 951A PTEP951 A
Section 245A(d) PTEP245Ad
Section 951(a)(1)(A)
PTEP
951a1A
Column (e)



Column (e) asks the taxpayer to enter the year in which it included income of the lower-tier foreign corporation under Section 951(a) (Subpart F income) or Section 951A (GILTI) and establishes the PTEP account to which the distribution is attributed. This is the annual PTEP account as per Treasury Regulation Section 1.9060-3(c)(1). If there is a PTEP distribution related to more than one PTEP distribution

Column (f)

Column (f) asks the taxpayer to state (in functional currency) the PTEP distribution with respect to the PTEP group within the annual PTEP account identified in column (d) and (e) of the distributing lower-tier foreign corporation. If there is a PTEP distribution related to more than one PTEP group within an annual PTEP account, the taxpayer should complete a separate line for each PTEP group within each annual PTEP account.

Column (g)

Column (g) asks the taxpayer to enter the total amount of the lower-tier foreign corporation’s PTEP in the PTEP group within the annual PTEP account identified in column (d) and column (e). The taxpayer should enter these amounts in the functional currency of the distributing lower-tier foreign corporation.

Column (h)

Column (h) asks the taxpayer to enter the amount of the lower-tier foreign corporation’s PTEP group taxes with respect to the PTEP group within the annual PTEP account identified in column (d) and column (e). These amounts should be entered in U.S. dollars using the translation rates stated in Internal Revenue Code Section 986(a) and its regulations.

Column (i)

Column (i) asks the taxpayer to enter the U.S. dollar amount of the recipient foreign corporation’s income taxes deemed paid that are properly attributed to the PTEP distribution reported in column (f) and not deemed to have been paid by the domestic corporation for any prior tax year. Expressed formulaically

(column (f) divided by column (g) x column (h))

Part II Election

Part II asks if Section 986(a)(1)(D) has been made to translate taxes using the exchange rate on the date of payment. The 2004 JOBS Act added a new election in Section 986(a)(1)(D) for a taxpayer that otherwise is required under Section 986(a)(1)(A) to translate foreign taxes into U.S. dollars using the average exchange rate for the tax year. This provision allows such a taxpayer to elect to use the exchange rate at the time the foreign taxes are paid instead of the average exchange rate for the tax year. Once elected, this provision applies to the tax year for which it was made and all later years unless revoked with the IRS’s consent. Note, however, that this election applies only to the translation of foreign taxes and foreign tax adjustments; it does not apply to the translation of a foreign corporation’s earnings and profits or to the translation of dividends through constructive inclusions. Part II asks the taxpayer to state the date of the election if a Section 986(a)(1)(D) election has been made.

Part III. Taxes for Which a Foreign Tax Credit is Disallowed

Part III of Schedule E asks the taxpayer to report foreign taxes of a CFC that were paid but for which no foreign tax credits were allowed. The purpose of disclosing foreign tax on Part III of Schedule E is to disclose foreign taxes of the CFC’s E&P. However, foreign taxes that cannot be claimed as a foreign tax credit due to the anti-splitter or foreign deficit rule should not be disclosed on Part III of Schedule E. These rules will be discussed in more detail below.

Columns (a) and (b)

Column (a) asks the taxpayer to list the name or names of the foreign corporation or pass-through entity (partnership or disregarded entity) that paid the foreign tax and a foreign tax credit was disallowed.

Column (b) asks the taxpayer to enter the EIN or reference number of the payor of the foreign tax.

Column (c)

Column (c) asks the taxpayer to enter the foreign income taxes that are disallowed under Section 901(j), which generally applies to certain sanctioned countries.

Column (d)

Column (d) asks the taxpayer to enter the foreign taxes that are disallowed under Internal Revenue Code Section 901(k). This generally applies to certain foreign taxes paid on dividends if the minimum holding period is not met with respect to the underlying stock, or if the CFC is obligated to make related payments with respect to positions in similar or related property. Section 901(k) cross-reference the rules of Section 246(c). This generally means a deduction for a dividend is not allowed if the dividend was paid in the next preceding taxable year of the corporation or the corporation is tax exempt under Section 501.

Column (e)

Column (e) asks the taxpayer to list any foreign taxes on a covered asset acquisition and enter the disqualified portion of the tax. A covered asset involves three types of transactions: 1) a qualified stock purchase with a Section 338 election (Section 338 provides that if a purchasing corporation (“P”) purchase 80 percent or more of the stock of a target corporation (“T”) within 12 months or loss, it may elect within a specified time period to treat the target as having sold all of its assets for their fair market value in a single transaction); 2) any acquisition treated as a purchase of assets for U.S. tax purposes, but an acquisition of stock is disregarded for foreign tax purposes; or 3) the purchase of a partnership interest with a Section 754 election (to avoid taxing the buying partner on the appreciation of his proportionate  share of partnership assets prior to the date of purchase, the partnership may make an election under Section 794 of the Internal Revenue Code.

Column (f)

Column (f) asks the taxpayer to enter the amount of taxes paid or accrued by the foreign corporation to the United States. Column (f) is reserved for taxes for which no credit is permitted under Internal Revenue Code Section 901(b).

Column (g)

Column (g) asks the taxpayer to report the foreign corporation’s current year foreign income taxes paid or accrued with respect to the E&P described in Internal Revenue Code Section 959(c)(3) that are attributable to the residual income group discussed in Treasury Regulation Section 1.960-1(d)(2)(ii)(D).

Below, please see Illustration 1. based on the IRS instructions discussing how to report the foreign corporation’s current year foreign income taxes paid or accrued with respect to the E&P described in Section 959(c)(3) of the Internal Revenue Code.

Illustration 1.

CFC1, a foreign corporation, wholly owns the only class of stock of CFC2, a foreign corporation. CFC2 does not have PTEP. CFC2 distributes Section 959(c)(3) E&P to CFC1 which is treated as a dividend for U.S. tax purposes. For foreign tax purposes, the distribution is also characterized as a dividend. As CFC1 and CFC2 are located in different countries, a withholding tax is levied by CFC2’s country of residence on the distribution. Under the principles of Treasury Regulation Section 1.904-6, the distribution is assigned to the statutory or residual grouping to which the corresponding U.S. item is assigned. In this case the corresponding U.S. item is Section 959(c)(3) E&P, which is in the residual group. Therefore, the withholding taxes are properly attributable to the residual group. Under Treasury Regulation Section 1.9060-1(e), such taxes are not deemed for any taxable year and therefore are reported in Column (g). 

Column (h)

Column (h) asks the taxpayer to enter the taxes for which a foreign tax credit is disallowed other than those stated in columns © through (g). Such taxes may include, but are not limited to, certain taxes on the purchase or sale of oil and gas, certain taxes used to provide subsidies, and taxes for which no credit is allowed because of the boycott provisions of Internal Revenue Code Section 908.

Column (i)

Column (i) asks the taxpayer to enter the total amounts in columns (c) through (h).

Line 3.

Line 3 asks the taxpayer to total each amount in column (h) and enter the total in functional currency.

Line 4.

Line 4 asks the taxpayer to translate the amount listed on Line 3 in U.S. dollars (translated at the average annual exchange rate) as defined by Internal Revenue Code Section 989(b)(3).

Schedule E-1 Taxes Paid, Accrued, or Deemed Paid on Earnings and Profits of Foreign Corporation

Schedule E-1 is used to report the cumulative balance of foreign income taxes paid or accrued by a CFC by a separate category. In order for a taxpayer to correctly prepare Schedule E-1, the taxpayer should have an understanding of the ordering rules of Internal Revenue Code Section 959.  Where the E&P of a CFC consists in whole or in part of PTEP”, 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.

Under the proposed regulations, PTEP taxes are as follows: 1) foreign taxes deemed paid by the CFC under Internal Revenue Code Section 960(a) for a current year income inclusion in a PTEP group; 2) the foreign income taxes paid or accrued by a CFC as a result of a Section 959(b) distribution that was allocated and apportioned to a PTEP group; and 3) for a reclassified PTEP group of foreign income taxes that were paid, accrued, or deemed paid for an amount that was initially included in a Section 959(c)(2) PTEP group which was reclassified as a Section 959(c)(1) PTEP group. PTEP group taxes are reduced by the amount of foreign taxes in that particular group paid by the U.S. shareholder under Section 960(b)(1) or by another CFC under Section 960(b)(2) that have been reclassified to a Section 959(c)(1) PTEP.

Under the proposed regulations, a CFC’s current year taxes are associated with a PTEP group for Section 960(b) purposes only if the receipt of Section 959(b) distribution causes an increase in a PTEP group. The increased PTEP group is treated as an income group to which current-year taxes are imposed solely by reason of the Section 959(b) distribution. Taxes that are allocated and apportioned to a PTEP group by reason of a CFC’s receipt of Section 959 distribution are allocated and apportioned to the PTEP group under Treasury Regulation Regulation 1.904-6 principles.

Section 960- Deemed Paid Credits on Distributions of PTEP

For any distributions of PTEP, the ordering rule determines the type of PTEP that is distributed. Such determination is particularly important for purposes of determining the creditability of any foreign taxes that are imposed by the CFC’s country on the PTEO distributions.

Prior to the enactment of the TCJA, former Internal Revenue Code Sections 902 and 960(a)(1) permitted a corporate U.S. CFC shareholder to claim a credit for foreign taxes paid by a CFC when the related income was either distributed to the shareholder as a dividend or included in the shareholder’s income as a subpart F inclusion. This would result in the amount of paid foreign taxes based on multi-year “pools” of E&P, with the shareholder generally deemed to have paid the same proportion of the CFC’s post-1986 foreign income taxes as the amount of the dividend or subpart F inclusion as it related to the CFC’s post-1986 undistributed earnings.

TCJA repealed Section 902 and modified Internal Revenue Code Sections 904 and 960. TCJA eliminated the multi-year pooling system and introduced a “properly attributable standard” for the purposes of crediting foreign taxes. Under Section 960(a) and (b), a corporate U.S. shareholder can claim a deemed paid credit for foreign income taxes that are properly attributable to current subpart F and GILTI inclusions. In addition, under Section 960(b), a CFC shareholder is deemed to have paid foreign income taxes that are properly attributable to distributions of PTEP received from a first-tier CFC or from a lower-tier CFC.

Treasury and the IRS determined that adherence to Treasury Regulation 1.904-6 created the need to track and account for several new groups of PTEP because Section 959(c)(2) PTEP (and related deemed paid foreign tax credits) may arise by reason of income inclusions under Sections 951(a)(1)(A), 245A(e)(2), Section 951A(f)(1), 959(E), 964(e)(4), and 965(a), or by reason of the application of Section 965(b)(4)(A). Also, because Section 959(c)(c)(2) PTEP may be reclassified as Section 959(c)(1) PTEP as a result of Sections 956 and 959(a)(2), PTEP groups for Section 959(c)(1) PTEP must be maintained. Finally, PTEP subaccounts must be maintained for each Section 904 foreign tax credit category. See Curtail U.S. PTEP Reporting Complexity: Know Your P’s and Q’s, by Lewis J. Greenwald, Brainard L. Patton, and Brendan Sinnott, Volume 172, Number 5, August 2, 2021.

IRS Notice 2019-01

Notice 2019-01 announced Treasury and IRS’s intention to withdraw prior proposed regulations under Internal Revenue Code Section 959 and issue new proposed regulations under Internal Revenue Code Sections 959 and 961.The proposed regulations discussed in Notice 2019-01 included rules related to the maintenance of PTEPs in annual accounts, in specific groups, and the ordering of PTEPs when distributed or reclassified. Notice 2019-01 added an additional six PTEP groups to the ten PTEP groups described in the proposed regulations. Thus, within each basket, PTEP is allocated up to sixteen groups to be determined on an annual basis.

Notice 2019-01 describes regulations that the Treasury intended to propose that involve PTEP ordering upon distribution. Generally, and subject to a special priority rule for PTEP arising from Section 965(a) and (b), the notice applies a LIFO approach to the sourcing of distributions from annual PTEP accounts. Thus, subject to the special priority rule, Section 959(c)(1) PTEP in the most recent annual PTEP account is treated as distributed first, followed by the second most recent PTEP account, and continued through each annual PTEP account under Section 959(c)(1) until each account is exhausted. The same approach will then apply to Section 959(c)(2) PTEP. Finally, the remaining amount of any distributions are sourced from Section 959(c)(3), to the extent thereof.

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), 965(b)(4)(A), 951A(f)(2), 245A(d), and 951(a)(1)(A). 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.

The post TCJA Form 5471 Schedule J serves the same purposes as its pre TCJA predecessor. However, the post TCJA version greatly expanded E&P tracking requirements. The post TCJA Form 5471 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.

Column (a)

Column (a) is entitled “Subpart F Income.” Subpart F income is defined in Internal Revenue Code Section 952 as the sum of the corporation’s: 1) insurance income (as defined in Section 953 of the Internal Revenue Code); 2) foreign base company income; and 3) international boycott income and income equal to illegal bride/kickbacks paid on behalf of the CFC and income derived from any foreign country for which Internal Revenue Code Section 901(j) denies a foreign tax credit for taxes paid to such country. Internal Revenue Code Section 965 transition tax inclusions is also treated as additional subpart F income. In column (a), the taxpayer should report only the foreign income taxes the foreign corporation pays or accrues attributable to subpart F income.

Column (b)

Column (b) is entitled “Tested Income.”  The tested income of a CFC is the excess (if any) of the gross income of the CFC determined without regard to certain items over deductions properly allocable to that gross income. The items excluded from tested income are:

1) Any item of income described in Section 952(b) of the Internal Revenue Code (generally any U.S. source income effectively connected with the conduct by such corporation of a trade or business within the United States);

2) Any gross income taken into account in determining subpart F income of such corporation;

3) Any gross income excluded from the foreign base company income (as defined in Internal Revenue Code Section 954) and the insurance income (as defined in Internal Revenue Code Section 953) of such corporation by reason of the high-tax exception of Internal Revenue Code Section 954(b)(4);

4) Any dividend received from a related person (as defined in Internal Revenue Code Section 954(d)(3)), and

5) Any foreign oil and gas extraction income (as defined in Internal Revenue Code Section 907(c)(1)) of such corporation. In column (b), the taxpayer should report only the foreign income taxes the foreign corporation pays or accrues attributable to tested income.

Column (c)

Column (c) is entitled “Residual Income” Residual income is income that one continues to receive after the completion of the income-producing work. Examples of residual income include royalties, rental income, interest and dividend income. In column (c), the taxpayer should report only the foreign income taxes the foreign corporation pays or accrues attributable to residual income

Column (d)

Column (d) is entitled “Suspended Taxes.” Column (d) is used to report taxes suspended under Internal Revenue Code Section 909. 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 the taxpayer, the foreign income tax is not taken into account for U.S. tax purposes before the tax year in which the related tax is taken into account by the taxpayer. 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 event” arises with respect to a foreign income tax if the related income is (or will be) 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 interest (determined by vote or value); any person that holds, directly or indirectly, at least a 10 p;ercent ownership (by vote or value) in the payor; and “any other person specified by the Secretary.” Internal Revenue Code Section 909 applies with respect to foreign income taxes paid or accrued in tax years beginning after December 31, 2010. Any “suspended taxes” under Section 909 are reported under column (d). 

Column (i)

A taxpayer will use Column (i) to report previously taxed income reclassified as Section 965(a) PTEP under Section 959(c)(1)(A). Section 965(a) imposed a one-time transition tax on a US shareholder’s share of deferred foreign income of certain foreign corporations (“accumulated deferred foreign income” or ADFI or “aggregate ADFI” for a combined ADFI). The ADFI equals post-1986 E&P other than that attributed to effective connected income or Section 959 previously taxed income. For Column (e)(i), the preparer must state previously taxed Section 965(a) E&P reclassified under Section 959(c)(1)(A). 

Column (e)(ii)

A taxpayer will use Column (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) allows U.S. shareholders to reduce the Section 965(a) inclusion amount based on deficits in E&P accumulated by other SFCs. Under Section 965(b), the deferred foreign earnings that would have been included in U.S. shareholder’s income under Section 965(a), but were not so included because of 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 an E & P deficit foreign corporation by the amount of the E&P deficit taken into account under Section 965(b).

Below, please see Illustration 2. which illustrates these rules.

Illustration 2.

USP, a domestic corporation, owns all of the stock of foreign corporations CFC1 and CFC2. USP, CFC1, and CFC2 are calendar year taxpayers. On all measurement dates, CFC1 has accumulated post-1986 deferred foreign earnings of $100, and CFC2 has an E&P deficit of $20. USP in aggregate will have an $80 Section 965(a) inclusion amount ($100 from CFC1 less CFC2’s $20 deficit allocated to CFC1 under Section 965(b)). CFC1’s PTEP account will increase by $100 ($80 for the Section 965(a) inclusion amount and $20 for the Section 965(b) deficit allocated to CFC1). CFC2 will have $0 of PTEP, and its E&P will increase by the $20 of deficit taken into account under Section 965(b)

Column (iii)

A taxpayer will use Column (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 (iv)

A taxpayer will use Column (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 (v)

A tax will use Column (v) to report PTEPs attributable in three subgroups discussed below (which are aggregated into a single PTEP group).

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 dividend received deduction (“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). Any deductions disallowed under Section 245A(d) classified as Section 959(c)(1) PTEP (investment in U.S. property should be disclosed under Column (v)).

2. PTEP that is attributable to Section 1248 amounts under Section 959(e) and reclassified as investments in U.S. property. 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 and reclassified as investments in U.S. property. 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”). For example, if a Cayman Islands CFC has $100 of income and pays $0 of foreign tax, and assuming the CFC would be in the 21% income tax bracket for U.S. federal income tax purposes under Section 11 based on its taxable income levels, the hypothetical corporate tax would be $21.

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”). Continuing with the same example and assuming the shareholder’s gain on the sale is $100, this hypothetical shareholder tax would be 23.8% of 79 ($100 Section 1248(a) amount less the hypothetical corporate tax of $21), or $18.80.

Adding together the hypothetical corporate tax and the hypothetical shareholder tax in this example thus yields $39.80 in tax on the $100 gain, for an effective tax rate of 39.8%. The CFC in this example is not a resident in a treaty country (the United States does not have an income tax treaty with the Cayman Islands), the amount of gain that is recharacterized as a dividend under Section 1248(a). The $100 would be taxable at a maximum federal rate of $40.80 (37% federal rate + 3.8 percent NIT = 40.80 percent). Because this amount is greater than the Section 1248(b) ceiling of $39.80, the ceiling will apply. If these Section 1248 gains can be attributable to the reclassification as investments in U.S. property, the PTEP generated from the sale would be reported in Column (v).

Column (vi)

A CFC shareholder will use Column (vi) to report PTEPs attributable to Section 965(a) classified under Section 959(c)(2).

Column (vii)

A CFC shareholder will use Column (viii) to report PTEPs attributable to Section 965(b) classified under Section 959(c)(2). For purposes of applying Section 959 in any taxable year, an amount equal to such shareholders of a deferred foreign income corporation.

Column (viii)

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

Column (ix)

A CFC shareholder will use Column (ix) to report PTEPs attributable to Section 245A(d) classified under Section 959(c)(2) (Subpart F income or GILTI). Column (e)(ix) is PTEP described in the following three subgroups (which are aggregated into a single PTEP group).

1. PTEP attributable to hybrid dividends under Section 245A(e)(2). Section 245A(e) generally denies a dividends received deduction (the “DRD”) under Section 245A for hybrid dividends (i.e., amounts received from a CFC if the dividends give rise to a local country deduction or other tax benefit). The final regulations provide that the determination of whether a relevant foreign law allows a deduction (or other tax benefit) is made without regard to foreign hybrid mismatch rules, provided that the amount gives rise to a dividend for U.S. tax purposes or is reasonably expected for U.S. tax purposes to give rise to a dividend that will be paid within 12 months after the taxable period in which the deduction would otherwise be allowed.

Congress enacted Section 245A to neutralize the double non-taxation effects of certain hybrid arrangements. But when a U.S. shareholder has a subpart F or GILTI inclusion with respect to a CFC and the Section 245A provisions also apply, double taxation can occur. To mitigate this concern, Treasury issued proposed regulations that allow for an adjustment of a CFC’s hybrid deduction account to the extent that the CFC’s earnings are included in income under subpart F or GILTI rules. Rather than providing for a dollar-for-dollar reduction in the hybrid deduction account by the amount of the inclusion, the proposed rules require taxpayers to perform a complex calculation that takes into account the potential benefit of foreign tax credits and the Section 250 deduction.

The proposed regulations generally reduce a hybrid deduction account with respect to a share of stock by an “adjusted subpart F inclusion” or an “adjusted GILTI inclusion” with respect to the share. This reduction, however, cannot exceed the hybrid deduction allocated to the share for the taxable year multiplied by the ratio of the subpart F income or tested income, as applicable, of the CFC to the CFC’s taxable income. The regulations also provide ordering rules for when adjustments are required under multiple provisions.

To calculate the adjusted subpart F inclusion, a taxpayer must first determine two amounts, on a share-by-share basis: 1) its pro-rata share of the CFC’s subpart F income included in income in the taxpayer’s current year; and 2) the “associated foreign income taxes” with respect to that subpart F inclusion (determined by allocating foreign taxes to the subpart F income groups under Section 960 and the regulations thereunder). The taxpayer must then follow a two-step process. First, the taxpayer adds the pro share of the subpart F inclusion and the associated foreign income taxes, which is intended to reflect the Section 78 gross-up. From that amount, the taxpayer then subtracts the quotient of the associated foreign income taxes divided by the corporate tax rate (currently 21%), which is intended to equal the amount of income offset by the foreign taxes. The calculation can be expressed as the following equation:

Adjusted Subpart F Inclusion = Subpart F inclusion + Associated Foreign Income Taxes

Associated Foreign Income Taxes
              0.21

The adjusted GILTI inclusion calculation follows a similar approach, but has three key differences. First, associated foreign income taxes are calculated by allocating foreign taxes to the tested income group and then multiplying by the taxpayer’s “inclusion percentage.” Second, after the first step, there is an interim step in which the taxpayer multiples the grossed-up inclusion by the difference between 100 and the percentage in Section 250(a)(1)(B)(currently 50%). Third, in the final step, the taxpayer also multiplies the associated foreign income taxes by 80% to account for the GILTI haircut to foreign taxes. See 245A/267A Structures Available and Planning Ideas. (2021), Jeff Rubinger and Summer LePree. The calculation can be expressed as the following equation:

Adjusted GILTI Inclusion = ((GILTI Inclusion + Associated Foreign Income Taxes x 0.5) –
0.8 x Associated Foreign Income Taxes
          0.21

Depending on the PTEP attributable to hybrid dividends can be classified as subpart F or GILTI, will determine which of the above discussed formulas should be utilized to determine the tax liability and associated PTEP.

2. PTEP attributable to Section 1248 amounts under Section 959(e). Any PTEP attributable under Section 1248 amounts to 959(e) reported under Column (e)(ix).

3. PTEP attributable to Section 1248 amounts from the gain of a CFC by a CFC. Any PTEP attributable under Section 1248 from gain of a CFC by a CFC is reported under Column (ix).

Column (x)

A CFC shareholder will use Column (x) to report PTEPs attributable to Section 951(a)(1)(A) or subpart F income. Subpart F income is defined as the sum of the corporation’s: 1) Insurance income (as defined in Section 953); 2) Foreign base company income; and 3) International boycott income and amounts equal to illegal bribes/kickbacks paid on behalf of the CFC.

Specific Instructions Related to Lines 1 Through 16

Line 1a

Line 1a asks the taxpayer 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 E-1.

Line 1b

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

Line 1c

Line 1c requires that the taxpayer combine lines 1a and 1b.

Line 2

Except for columns (a), (b), and (c), the taxpayer should use line 2 to reflect adjustments to a U.S. person’s foreign tax credit as a result of redetermined foreign taxes.

Line 3a

Line 3a asks the taxpayer 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 CFC, the foreign tax is not taken into account for U.S. purposes before the tax year in which the related income is taken into account by the CFC. The taxpayer should disclose on line 3a reductions for taxes under the appropriate column that have become unsuspended as a result of the anti-splitter rule. In other words, if the CFC took the foreign source income into account for US tax purposes, the associated foreign tax liability may become eligible for a foreign tax.

Line 3b

Line 2b asks the taxpayer 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 Internal Revenue Code 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 4

Line 4 asks the taxpayer to report the total reported on Schedule E, Part 1, Section 1, line 5, column (i). This should be separated into columns (a) through (e) according to the type of income or E&P to which the tax relates.

Below, please see Illustration 3, which discusses how to answer Line 4.

Illustration 3.

Domestic Corporation, a U.S. shareholder, wholly owns the only class of stock of CFC1, a foreign corporation. CFC1, in turn, wholly owns the only class of stock of CFC2, 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 U.S. dollar. During Year 1, CFC3 has subpart F income, after foreign income tax, of $100 with respect to which it pays $20 of foreign income tax. Such tax is properly attributable to subpart F income of CFC 3 and is reported on line 4, column (a) of Schedule E-1 of CFC 3’s Form 5471. During Year 1, Domestic Corporation reports an inclusion under Section 951(a)(1) of $100 and deemed paid taxes of $20 under Section 960(a) 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 a tax related to previously taxed earnings and profits that were included as subpart F income and is reported on line 4, column(e)(x), of Schedule E-1 of CFC2’s Form 5471.

Line 5

Line 5 asks the taxpayer 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 6

Line 6 asks the taxpayer enter foreign income taxes properly attributable to 

PTEP and not previously deemed paid (from Schedule E, Part 1, Section 2, line 5, column (i)).

Line 7

Line 7 asks the taxpayer to attach a statement with a description and the amount of any adjustments before taking into account taxes deemed paid by the foreign corporation.

Line 8

Line 8 asks the taxpayer to combine lines 1c through 7.

Line 9

Line 9 requires that the taxpayer disclose any foreign income taxes attributable to inclusions under Internal Revenue Code Section 951(a)(1). Amounts reported on line 9 should be negative. If a domestic corporation includes a GILTI inclusion, the domestic corporation is deemed to pay foreign taxes equal to 80 percent of the inclusion percentage.

Line 10

Line 10 requires a domestic corporation to report deemed paid foreign income taxes with respect to distributions of previously taxed E&P. These amounts should be reported as negative numbers. The taxpayer should report on line 10, column (e), the taxes that relate to PTEP of the foreign corporation that are deemed paid by a shareholder of the foreign corporation, either an upper-tier foreign corporation or a U.S. shareholder, with respect to a distribution of PTEP made by the foreign corporation.

Below, please see Illustration 4, which discusses how to answer Line 10.

Illustration 4.

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. In Year 4, CFC1 distributes $36 to Domestic Corporation. Domestic Corporation is deemed to pay $4 of withholding taxes by CFC2 in Year 2. A negative $4 will be recorded on line 10, column(e)(x), of CFC1’s Form 5471, Schedule E-1.

Line 11

Line 11 requires the taxpayer to report foreign income taxes reclassified from Section 959(c)(2) previously taxed E&P to Section 959(c)(1) previously taxed E&P should be reported as negative numbers in columns (e)(vi) through (e)(x) and as positive numbers in columns (e)(i) through (e)(v).

Line 12

Line 12 requires the taxpayer to attach a statement with a description and amount of any required adjustments to taxes of the foreign corporation not already taken into account on Schedule E-1.

Line 13

Line 13 requires the taxpayer to combine lines 8 through 12 in columns (a), (b), and (c).

Line 14

Line 14 is reserved for future use by the IRS.

Line 15

For line 15, the taxpayer should enter the reduction to column (b) tested income group for tested income not deemed paid. This includes taxes attributable to the column (b) tested income group that were not deemed paid as a result of the domestic corporation’s inclusion percentage or as a result of the applicable 80 percent limit.

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.

It is extremely important to work with an international tax specialist to ensure accurate preparation of your Form 5471. Having the wrong professional complete your Form 5471 can result in significant penalties. The Internal Revenue Code authorizes the IRS to impose a $10,000 penalty for failure to file substantially complete and accurate Form 5471 returns on time. An additional $10,000 continuation penalty may be assessed for each 30 day period that noncompliance continues up to $60,000 per return, per tax year. In addition, the IRS can assess a 40 percent accuracy penalty on incorrectly reported income and reduction of foreign tax credits by 10 percent.
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.

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