Tax Strategy
Subpart F Income Explained for Expats with Foreign Corporations
Subpart F forces US shareholders of CFCs to include passive and mobile income currently. Learn the categories, attribution rules, and planning strategies for expats.
If you own a foreign corporation and you are a US citizen or green-card holder, the US tax code treats you with deep suspicion. Congress assumes that without aggressive rules, you will stash passive income offshore, defer US tax indefinitely, and repatriate it on your own terms. Subpart F is the primary weapon against that strategy.
This post explains what Subpart F income is, which categories matter for expats, and how the rules force current inclusion of income that would otherwise be deferred.
The History: Why Subpart F Exists
Before 1962, a US shareholder of a foreign corporation could defer US tax on all corporate income — active and passive — until it was distributed as a dividend. This created obvious incentives to move passive income (dividends, interest, rents) to low-tax jurisdictions. The Kennedy administration proposed ending deferral for passive and mobile income. Congress enacted Subpart F as a compromise: active business income could still be deferred, but passive and easily shifted income would be taxed currently.
Subpart F has been expanded many times since 1962. The 2017 Tax Cuts and Jobs Act added GILTI, which goes further by taxing active business income above a 10% return on tangible assets. But Subpart F remains the foundational anti-deferral rule for foreign corporations.
What Is a CFC?
Subpart F applies only to Controlled Foreign Corporations (CFCs). A CFC is a foreign corporation where US shareholders own more than 50% of the total combined voting power or value.
US shareholder for CFC purposes means a US person who owns at least 10% of the foreign corporation's voting stock. Attribution rules apply — stock owned by family members and related entities is treated as owned by the US person.
If your foreign corporation is not a CFC, Subpart F does not apply. But if you are a US expat who owns or co-owns a foreign business, it is very likely a CFC.
The Main Categories of Subpart F Income
Passive Income
The most common Subpart F category for expats is passive income, defined in IRC Section 954(c). It includes:
- Dividends and dividend equivalents.
- Interest and interest equivalents.
- Rents and royalties (with limited exceptions).
- Capital gains from the sale of property that produces passive income.
- Gains from commodities transactions and foreign currency transactions.
- Income from notional principal contracts.
- Income equivalent to interest (payment delays, factoring income).
Example: Your Mexican corporation runs a restaurant. It generates $200,000 in operating profit and keeps $50,000 in a local bank account earning 5% interest. The $2,500 in interest is passive income and is Subpart F income. You, the US shareholder, must include your pro-rata share of the $2,500 on your US return currently, even though the corporation retains the cash.
Base Company Sales Income
This applies when a CFC acts as a middleman, buying goods from a related party in one country and selling them to a related party in another country, without substantial activity in its own country of incorporation.
Example: A Hong Kong CFC owned by a US person buys electronics from a related factory in Shenzhen and sells them to a related distributor in Singapore. The Hong Kong CFC has no office, no employees, and no real activity in Hong Kong. The profit from the sales is base company sales income and is included currently under Subpart F.
For expat small business owners, this category is less common but relevant if you structure supply chains through holding companies.
Base Company Services Income
Similar to base company sales, but for services. If a CFC performs technical, managerial, or similar services for a related party outside its country of incorporation, and the services are substantially performed by related parties, the income is Subpart F.
Insurance Income
Insurance income from related-party reinsurance or insurance is Subpart F. This is niche for most expats but relevant for those in the insurance industry.
Other Categories
Subpart F also includes certain shipping income, oil-related income, and income from certain boycott operations. These are specialized and outside the scope of most expat returns.
The High-Tax Exception
Subpart F income is not included currently if it is subject to foreign tax at an effective rate greater than 90% of the maximum US corporate rate. In 2026, the maximum US corporate rate is 21%, so the threshold is 18.9%.
If your foreign corporation pays at least 18.9% foreign tax on the passive income, the high-tax exception may apply and Subpart F inclusion is avoided. This requires documentation of the foreign tax paid and a proper election.
Look-Through Rules for Related Parties
If a CFC receives dividends, interest, rents, or royalties from a related CFC, those payments are generally not Subpart F income to the recipient under the look-through rules. This prevents double Subpart F inclusion when income moves between related CFCs.
Example: CFC A (a holding company) receives a dividend from CFC B (an operating company). The dividend from CFC B was already taxed as Subpart F income when earned by CFC B. Under the look-through rules, the dividend to CFC A is not Subpart F income again.
This is essential for holding company structures but requires careful tracking to ensure the original income was properly characterized.
Current Inclusion: How It Works on Your Return
When a CFC has Subpart F income, each US shareholder includes their pro-rata share on their personal return in the year the CFC earns the income. This happens even if no distribution is made.
The inclusion is treated as ordinary income (or as specified category income for foreign tax credit purposes). The shareholder can claim a deemed-paid foreign tax credit for foreign taxes paid by the CFC on that income.
Example
- You own 50% of a Panamanian CFC.
- The CFC earns $20,000 in interest income (passive/Subpart F).
- The CFC pays $2,000 in Panamanian tax on the interest.
- Your Subpart F inclusion: $10,000 (50% of $20,000).
- Your foreign tax credit: $1,000 (50% of $2,000).
- You report $10,000 on your 1040 and claim the $1,000 credit against your US tax.
Subpart F vs. GILTI
Subpart F and GILTI are separate but overlapping regimes:
| Feature | Subpart F | GILTI |
|---|---|---|
| Applies to | CFCs | CFCs |
| Income type | Passive, base company, insurance | All tested income above 10% return on QBAI |
| Active business income | Generally excluded | Included if above QBAI threshold |
| Corporate deduction | None | 50% Section 250 deduction |
| Individual rates | Yes, ordinary income | Yes, ordinary income (unless Section 962) |
| Foreign tax credit | Yes, deemed-paid | Yes, with Section 962 election |
For individual shareholders, both regimes hurt. Subpart F hits passive income. GILTI hits everything else. Between the two, there is little room for deferral.
Planning Strategies
Strategy 1: Avoid CFC Status
If US shareholders can keep ownership at 50% or below, the corporation is not a CFC and Subpart F does not apply. This is difficult for family businesses but possible with non-US partners or investors. Be careful of the attribution rules — a spouse or child who is a US citizen counts toward the 50%.
Strategy 2: Use the High-Tax Exception
If the foreign country taxes the passive income at a high rate, document the foreign tax and make the high-tax exception election. This eliminates Subpart F inclusion.
Strategy 3: Keep Passive Assets Out of the CFC
If the operating business generates cash, distribute it to the shareholders rather than letting it sit in the corporation earning interest. Or hold passive investments in a separate non-CFC structure if feasible.
Strategy 4: Increase Foreign Tax Payments
If the foreign tax rate is close to the high-tax exception threshold, consider structuring to increase local taxable income (for example, by reducing local deductions or accelerating local income recognition). This is a blunt instrument and requires local tax analysis.
Strategy 5: Do not assume a partnership is a simpler conversion
A change from corporate to partnership or disregarded treatment is not a generic simplification strategy. It can create deemed transactions, gain, local-law consequences, and different information returns. Compare the current and proposed classifications, ownership, assets, liabilities, earnings, foreign taxes, and exit plan with qualified U.S. and local advisers before any election or restructuring. If the resulting entity is a foreign partnership, use the Form 8865 filing guide; its reporting remains category- and fact-specific.
How FileAbroad Helps
FileAbroad handles CFC compliance for expat business owners:
- CFC analysis: We determine whether your foreign corporation is a CFC under attribution rules.
- Subpart F calculations: We identify and calculate Subpart F inclusions by category.
- High-tax exception: We document foreign taxes and prepare the election.
- GILTI modeling: We model the combined effect of Subpart F and GILTI.
- Restructuring advice: We evaluate partnership, corporate, or hybrid structures.
For CFC and Subpart F questions, start with the free intake and describe the corporation's jurisdiction, ownership, and income types.
Disclaimer: This article is for informational purposes only and does not constitute tax, legal, or investment advice. Tax laws change frequently, and individual circumstances vary. Consult a qualified tax professional before making decisions based on this content.
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Frequently Asked Questions
What types of income are classified as Subpart F income?
Subpart F income includes several categories, but the most common are: (1) passive income such as dividends, interest, rents, royalties, and capital gains from passive investments; (2) base company sales income — income from selling goods manufactured or produced outside the CFC's country of incorporation to related parties; (3) base company services income — income from performing services for related parties outside the CFC's country; (4) insurance income from related-party insurance; and (5) certain shipping and oil-related income. For most expat-owned small foreign corporations, the relevant categories are passive income and, less commonly, base company sales or services income.
Does Subpart F apply to active business income?
Generally, no. Subpart F is designed to tax passive and easily movable income, not active operating business income. If your foreign corporation runs a real business — a restaurant, a construction firm, a consulting practice, a manufacturing plant — the active business income is generally not Subpart F income. However, if the corporation holds excess cash that generates interest, or owns a rental property separate from its main business, that passive income may be Subpart F. Also, note that GILTI (created in 2017) does tax active business income above a 10% return on tangible assets, so the protection for active income is narrower than it once was.
How does the CFC constructive ownership rule work?
Under IRC Section 958, ownership of a CFC includes not only direct ownership but also indirect ownership through other entities and constructive ownership through family members. For example, if a US citizen owns 30% of a foreign corporation and her US-citizen husband owns 30% of the same corporation, they are treated as owning 60% together for CFC purposes, making the corporation a CFC. Similarly, if a US person owns 100% of a foreign holding company that owns 60% of an operating company, the US person is treated as owning 60% of the operating company. These attribution rules prevent US persons from splitting ownership among family members or entities to avoid CFC status.
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About the Author
Chip Moreno is an American expat and PTIN holder based in Cuenca, Ecuador. He files his own FBAR and US return from Ecuador every year. For accepted engagements, you work directly with Chip through preparation and filing. Start with a short inquiry so Chip can review your situation and follow up.