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Foreign Income & Taxpayers
Under Secs. 951-964, certain income of a controlled foreign corporation (CFC), referred to as Subpart F income, is included in the income of its U.S. shareholders as earned before the income is actually distributed to the U.S. shareholders. Sec. 952(c)(1)(A) limits this Subpart F income inclusion by the U.S. shareholders to the extent of the CFC's current-year earnings and profits (E&P).
When a Subpart F income inclusion is limited by the CFC's current-year E&P, Sec. 952(c)(2) requires establishment of a recapture account whereby Subpart F income is recaptured in subsequent years during which the CFC has current-year E&P exceeding Subpart F income. Specifically, if Subpart F income was reduced by Sec. 952(c)(1)(A), any excess of the CFC's E&P in a subsequent tax year over its Subpart F income for that year is recharacterized as Subpart F income.
Regs. Sec. 1.952-1(f) provides that the amount of Subpart F income in each separate category of income (as defined in Regs. Sec. 1.904-5(a)(l), which refers to Sec. 904(d)(1)) that is reduced by Sec. 952(c)(1)(A) constitutes a recapture account. In any subsequent year in which E&P exceeds Subpart F income, the recapture account in each separate category will be recharacterized, on a proportionate basis, as Subpart F income to the extent of the excess. An amount that is recharacterized is treated as income in the same separate category as the recapture account from which it was derived. Under Regs. Sec. 1.952-l(f)(2)(iii), each recapture account (and post-1986 undistributed earnings for calculating foreign tax credits) will be reduced either (1) by amounts recaptured or (2) by "any distribution" out of that account (as determined under the ordering rules of Sec. 959(c) and Regs. Sec. 1.952-1 (f)(3)(ii)).
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