U.S. Tax Rules for Individuals Who Own Foreign Corp.
Key Rules for Foreign Corporations
Controlled Foreign Corporation (CFC) Rules:
- A foreign corporation is considered a Controlled Foreign Corporation (CFC) if U.S. shareholders (each owning 10% or more of the voting power or value) collectively own more than 50% of the corporation.
- If the foreign corporation is a CFC, Subpart F income, Global Intangible Low-Taxed Income (GILTI), or other specified income might be included in the shareholder's taxable income in the U.S., even if it is not distributed.
- Losses from a CFC generally do not pass through to the U.S. shareholder.
Non-CFC Foreign Corporations:
- If the foreign corporation is not a CFC, its earnings (or losses) are typically not reportable on the U.S. shareholder’s tax return unless distributed as a dividend or unless the corporation is liquidated or sold.
- Losses cannot directly offset the shareholder's U.S. taxable income unless the foreign corporation makes a distribution or is liquidated in certain cases.
Foreign Losses and U.S. Tax Law:
- Net Operating Loss (NOL) of the Foreign Corporation:
- A foreign corporation’s net operating loss (NOL), such as Brian's €40,000, is not deductible on the U.S. shareholder’s tax return. The foreign corporation is treated as a separate entity for tax purposes, and its losses do not flow through to the individual.
- Effect on Earnings and Profits (E&P):
- The NOL reduces the corporation's earnings and profits (E&P). This means that future distributions to shareholders may not be taxable as dividends if E&P is negative.
- Net Operating Loss (NOL) of the Foreign Corporation:
Elections and Special Considerations:
- Check-the-Box Election:
- If Brian elects to treat the foreign corporation as a disregarded entity (check-the-box election), the corporation’s income, expenses, and losses are treated as if they occurred directly on Brian’s personal tax return. This may allow the €40,000 loss to flow through to his return, but it also brings all foreign activity into the U.S. tax system, which has compliance costs and complexities.
- Foreign Tax Credit (FTC):
- If the foreign corporation pays taxes in its home country, the U.S. owner might claim a foreign tax credit for those taxes, though this would only apply if there was net taxable income to offset.
- Check-the-Box Election:
Specific Example: Brian’s Situation
- Ownership >10%: Since Brian owns more than 10% of the foreign corporation, the rules for CFCs may apply if other U.S. shareholders also hold interests, or if Brian’s total ownership causes the foreign corporation to qualify as a CFC.
- Net Loss Treatment (€40,000):
- If the corporation is a separate entity (default treatment): Brian cannot deduct the €40,000 loss on his U.S. tax return. The loss remains within the foreign corporation and may offset its future profits.
- If the corporation is a disregarded entity (via a check-the-box election): The €40,000 loss could flow through to Brian’s personal tax return, but this requires an affirmative election.
Summary
Under default rules, Brian cannot take the €40,000 net loss into account on his U.S. tax return because foreign corporations are generally treated as separate entities. The loss remains within the foreign corporation and affects its future tax attributes, such as earnings and profits.
If Brian wants to use the loss personally, he would need to make a check-the-box election to treat the foreign corporation as a disregarded entity. However, this could have other tax implications and complexities that need to be carefully considered.