Press Room: Tax Release

November 10, 2011

Opportunities for Individuals Selling Stock in Controlled Foreign Corporations

Planning opportunities exist for individuals selling stock in controlled foreign corporations in the next few years—executing a sale prior to 2013 may provide significant tax savings.

Individuals planning to sell controlled foreign corporation (CFC) stock at a substantial gain in the near future have both potential opportunities and challenges – uncertainty. With many legislative proposals being considered, it is uncertain what the tax rates will be in 2013 and whether new rules will facilitate or hamper the sale of CFC stock. Notwithstanding this uncertainty, there are opportunities to minimize the tax on the sale of CFC stock.

  • Sell the CFC stock sooner rather than later: Gain on sales of stock before 2013 of CFCs located in qualifying jurisdictions will qualify for the dividend tax rate of 15% on the selling shareholder’s share of earnings and profits (E&P). Any gain in excess of the selling shareholder's share of E&P is taxed at the 15% capital gain rate (if held more than 12 months) or offset against any unused capital losses. However, this opportunity is limited to sales of CFCs in jurisdictions with a comprehensive income tax treaty with the U.S.[1]
     
  • Consider the benefits of favorable accounting methods: Favorable accounting methods may be available to push E&P to years before the company became a CFC, before the shareholder became a shareholder, or before the shareholder became a U.S. resident. By reducing E&P, the amount of taxable dividends is reduced and the total tax is reduced regardless of the date of sale. 
     
  • A special provision for individual shareholders of a CFC: Individual shareholders of a CFC can apply a special provision that would generally limit the tax on dividends to the tax a domestic corporation eligible for a foreign tax credit would have paid on the same historic E&P and the same sale transaction.[2] Depending on the facts, this provision may reduce the current tax on a sale.

After 2012, the benefit of utilizing favorable accounting methods or of utilizing the special provision may be significantly greater by virtue of the much higher tax rate on dividends, potentially 39.5%. However, the special 15% rate that may apply to gains from sales of stock may be gone after 2012.

Conclusion

Even though all would agree that uncertainty with respect to the tax consequences of a transaction is bad, planning around those uncertainties is always a good idea. WTAS can assist with the intricacies of planning for the sale of stock in a CFC and help you determine the best strategy.

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1The dividend rates for CFCs that are not in a qualifying jurisdiction is 35% prior to 2013 and 39.5% thereafter, assuming the Bush-era tax cuts are allowed to expire.

2This computation is complicated where the CFC has been in existence for a number of years.