How are US Owners of Foreign Companies Taxed?

Prior to 2017, the US had deferred tax system for foreign companies’ income. As long as the profits of foreign companies are not remitted to the US, the owners do not have to pay US income taxes. After the 2017 tax reform, for Non-Controlling Foreign Corporation (NCFCs), the above rules have not changed, that is, generally you don't pay taxes until you receive dividends from foreign companies. However, after 2017 the tax codes completely changed for Controlled Foreign Corporation (“CFC”). Two key points related to personal taxes are noteworthy: 1) US shareholders who hold <10% of the company shares are not subject to these rules; 2) If the total shares owned by all US shareholders (count 10%+ US shareholders only) exceed 50% on an aggregate basis, the foreign company is a Controlled Foreign Corporation (“CFC”).

If you own 10%+ in a CFC, the US tax rules become quite complex, and they differ depending on the types of ownership. If you own CFCs through a US corporation, the current tax law, called Global Intangible Low-Taxed Income Tax “GILTI”, is favorable. First, 10% of foreign depreciable and tangible assets can be deducted from CFC’s income. There are two additional exemptions: 1)50% of GILTI income can be deducted, which means only 50% GILTI income is taxable to the US corporation owner; 2) foreign corporate income tax can be deducted at a rate of 80% of the corresponding US corporate tax (US tax rate 21%). Therefore, when the CFC pays income tax >13.125% in the foreign country (US corporate tax rate 21%x50%/80%), the US company does not have to pay any US GILTI tax. However, when a US company distributes dividends to you, you need to pay an additional personal income tax at 15% or 20% depending on your total income level. If your family’s annual total income exceeds $250,000, you must also pay 3.8% investment income tax (Obamacare Tax).

Next let's review individual ownership that directly owns shares of CFCs. Generally, regardless of whether dividends are distributed to individuals, the net profits of CFCs should all be treated as ordinary income at personal tax rates from 10% to 37%. No GILTI 50% deduction or 80% foreign tax credit is allowed. However, according to tax codes prior to 2017, individuals could potentially receive tax benefits as US corporations by making an election to treat the shares owned by an individual the same as US corporation. If you directly own shares in CFCs, please consult with Easton as to this option. Special conditions also apply variable from individual to individual.

Regarding the filing requirements, when a US citizen or green card holder owns 10%+ of the shares of CFCs, s/he needs to file tax Form 5471 every year. If you own shares in NCFCs, you only need to file Form 5471 in the first year you exceed 10% or your shares increase by 10%. The 5471 filing might require annual financial statements of the foreign companies. Note that Trump's tax reform benefits are expected to expire at the end of 2025, and effective GILTI tax rate may likely return to higher levels, given the current US debt situation.

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Am I Required to Report Foreign Bank Accounts and Companies?

Report of Foreign Bank and Financial Accounts (FBAR) requires U.S. citizens, green cards or tax residents to report their overseas bank and financial accounts to the U.S. Treasury Department on an annual basis. The specific declaration includes the bank name, address and your account number and the highest account balance for the year. April 15th of each year, or October 15th for deferred tax returns is the deadline. In addition to reporting foreign bank accounts directly owned by individuals, you may also need to report foreign bank accounts owned by overseas companies you own. Specifically, there are two situations in which a company account needs to be declared:

• If you own more than 50% of the equity (stock or voting rights) of an overseas company, you need to include the overseas bank account owned by the overseas company in your personal FBAR declaration. Such an account is declared as an account jointly owned by the company (FBAR Part III), so the name and address of the overseas company need to be disclosed.
  
• If you have the right to sign the overseas company's bank account, but only hold 50% or less of the shares, then you also need to disclose the maximum balance of the overseas company's bank account (FBAR Part IV) in your personal declaration. This signing authority account filing excludes accounts of foreign companies that are listed and traded on the US securities market.
  

Individuals who violate the FBAR declaration regulations may face the following penalties:

• Civil penalty of $10,000 (2022 inflation-adjusted penalty of $12,921) for non-intentional violations
• For willful violations, a civil penalty of $100,000, or 50% of the maximum account balance.
  
• For serious cases, a criminal fine of $100,000; or for serious intentional violations, a criminal fine of $500,000
  
• Criminal imprisonment penalty up to 5 years (unintentional); 10 years (intentional violation).​

What to Do with FATCA Letters from My Foreign Banks?

If you are one of the many Americans who have a bank account in a foreign country, you may have received a FATCA letter from your foreign bank.  This letter states that your foreign bank account information will be turned over to the US government. Your bank is doing so to comply with the Foreign Account Tax Compliance Act (FATCA) under the International Governmental Agreement (IGA) between countries. Your bank is required to share your name, social security number, foreign bank name, bank account number, etc. with the US government. Most foreign banks choose to cooperate with the IRS as those financial institutions don't want to receive stiff penalties from the US government.  The US government also has many other sources to call upon to crack down on foreign tax violations, especially since the 2018 reinforced global asset taxation framework.

If you have received a FATCA letter, then you hopefully have disclosed your foreign bank accounts in your tax returns. Willful violations can face up to $500,000 penalty and 10 years jail time. IRS could also criminally prosecute you. Please read more on penalties failing to report foreign financial accounts in the post Am I Required to Report Foreign Bank Accounts and Companies. If you have not received a FATCA letter, it does not mean your bank does not comply with FATCA. You bank may not need to notify you as they continue the disclosure to the US government. 

Some banks also ask you to fill out forms in the FATCA letters. If you don’t submit those forms, the financial institutions may close your accounts. At that point your information has already been shared with the IRS.

If you just realize you have already skipped on reporting foreign financial accounts, we urge you to consider voluntary disclosure to put an end to your past violations. In the past few decades IRS has established several voluntary disclosure programs to help bring people back into compliance. Easton has helped many clients with those offshore voluntary disclosure and received favorable results. Please click to learn more about the IRS Offshore Streamlined Procedures. 

In addition, if you own foreign companies or hold stocks of foreign companies, you likely are required to disclose those companies. You can find specific requirements in the post How are US Owners of Foreign Companies Taxed.  If you have missed reporting your foreign companies, you are at risk of being caught by the IRS. This risk grows greater as your company continues fundraising and advancing towards an IPO or sale, as more and more institutions are reporting your information to the IRS under FATCA.  We recommend you consider voluntary disclosure to end your past violations and start fresh as soon as possible.  Please click to learn more about the IRS Offshore Streamlined Procedures.

IRS are aware of the high costs of enforcement of tax evasion, therefore has become more lenient in the past decade in order to encourage voluntary disclosure.  Easton has helped many clients disclose, as many agree that voluntary disclosure costs them the least in the long run.
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