Commentators and practitioners often refer to the United States controlled foreign corporation statute (“CFC”) as extremely complex and Byzantine in their construction and application. I would agree with this assessment to a point; if someone is simply trying to learn the pure mechanics of the statute then, yes, it is very difficult to fathom. However, when one looks at the rules after understanding the underlying policy for their implementation and overall effect, the statutory scheme becomes easier to comprehend. So, let’s begin with an explanation of why the United States (and other developed, OECD countries) put these types of rules into place.
To begin we will need to know a few definitions from section 7701. A domestic corporation is Read More
Once a non-US individual is classified for income tax purposes as a “resident” he is subject to income tax in the same manner as a US citizen: i.e., taxed on his worldwide income (meaning income from all sources whether from within or outside the US) at a maximum rate of 39.6 percent. This worldwide income tax covers the period from commencement of the residency period until its conclusion (determination of which is also tricky under the tax laws). Income that is taxed includes but is not limited to wages, interest, dividends, rents, capital gains, royalties, gambling winnings etc. regardless of whether these items arose from outside the US.
The person also becomes responsible for filing tax returns and various information returns (such as foreign bank account reports also known as “FBAR”). Often, foreigners do not understand these rules and do not realize they have a duty to file even if they are only earning wages from an employer in a foreign country. Filing is required even if the salary and / or housing allowance is below the foreign earned income (and / or housing) exclusion amount thresholds permitted for US taxpayers working overseas. Failure to file could result in loss of the ability to claim these exclusions.
Once an individual qualifies as a “resident”, a series of complicated tax rules come into play if that person is a beneficiary of a non-US trust or if he owns stock in a closely held non-US corporation. For example, an individual US resident shareholder can be currently taxed on certain income earned by the corporation, even if no actual corporate distribution has been made to him. The taxation of trust distributions also becomes complex and results in harsh consequences. Read More