Controlled Foreign Corporations (CFCs): Definition, rules, and tax implications

Written by  Andrew Coleman, CPA

Last updated Dec 10, 2025

Running a business in another country can feel exciting and confusing. Tax rules from the US still apply, even when the company is formed overseas, and some of those companies fall under a special label called a controlled foreign corporation (CFC). When a company is treated as a CFC, the rules can affect how money is taxed, including passive income, that you will report on your 2026 tax return.

This guide, brought to you by Taxes for Expats, explains:

• When a foreign company becomes a CFC under US tax law.
• How CFC rules interact with Subpart F, GILTI, and other anti-deferral regimes.
• What changed for 2025 income (including new IRS guidance and form changes).
• What US expats must actually file – especially Form 5471 – and what happens if you don’t.
• Practical planning ideas to reduce double taxation and avoid penalties.

Clear guidance makes a world of difference, so feel free to contact us today for support.

What is a CFC (Controlled Foreign Corporation)?

Many expats set up companies abroad and are surprised when the IRS still wants a say. What they may not realize is that a controlled foreign corporation (CFC) has a very specific meaning under US tax rules, and that meaning affects how 2025 income must be reported on a 2026 tax return. A CFC is a foreign corporation where US shareholders together own more than 50% of the voting power or the value at any point during the year.

To make this clearer, think of an American living overseas who owns all the shares of a small local business. Even though the company is fully active and pays tax in its home country, it will also be treated as a CFC under US law because one US person holds full control.

The IRS also counts someone as a US shareholder when they own at least 10% of the vote or the value in that business, which means both direct and indirect ownership can matter. When these tests are met, the CFC rules step in, and the owner will see that the company’s details flow into the US tax return through filings like Form 5471, which is required for CFC reporting.

Purpose of CFC rules

CFC rules exist so countries can trace income earned outside their borders while keeping the global tax system fair and stable. It mainly:

• Prevents tax avoidance through offshore companies.
• Makes sure profits earned abroad are taxed in a way that lines up with the law at home and overseas.
• Supports a fair tax system so that cross-border income does not disappear in places with little or no tax.

NOTE! Many advanced tax systems now use CFC rules, including the United States, United Kingdom, Germany, Japan, Australia, New Zealand, Brazil, and Sweden. Together, these CFC regimes show that monitoring income inside a foreign corporation is now standard practice rather than an exception.

How CFC rules work

Many expats run businesses abroad and feel caught off guard when the IRS steps in. What they may not know is that the law cares more about control than where a company is formed. In Garlock Inc. v. Commissioner, a US company tried to push profits into a Panamanian foreign corporation, but the court saw that the US owners still pulled the strings.

Because of that control, the setup became a CFC, and the income was taxed back to the owners. That case shows how quickly the CFC rules operate.

1. Explanation of “control” and “ownership tests.”
   Ownership is about how many shares a person has. Control is about who can make choices for the company. A business becomes a CFC when US owners together pass 50%, even if no single person owns that much. Think of a group of friends who each own a small slice – together they run the show, so the IRS treats them as controlling the company.
2. How the IRS views voting power.
   Voting power shows who makes key decisions, like setting direction or signing big deals. Even when money stays in the business, control guides how CFC rules apply. Think of one founder who has special voting rights – that single feature can tip the scale toward control.
3. Passive vs. active income.
   Passive income comes from interest, dividends, or gains, while active income comes from real work like selling goods or offering services. Under these tax rules, passive income is more likely to be taxed right away because it’s easy to shift across borders. In a company earning only bank interest – the IRS may tax that sooner, even if the owner takes no pay.
4. Why does the type of income matter.
   Active income tied to real work may stay inside the company, but passive income can trigger faster taxes in the US. The IRS looks at what the company does each day to decide how the income fits. Imagine a repair shop abroad – its daily work is active income and treated differently from interest sitting in the bank.
5. When income becomes taxable for shareholders.
   Some income gets taxed before the company pays anything out. Subpart F and GILTI rules make the owner include certain profits on a tax return in the same year the company earns them. Picture a holding company in a low-tax place – the owner may see that interest appear as income in the US even though the company keeps every dollar.

Need a clearer checklist for CFC ownership tests and US shareholder rules?

Learn more

How are CFCs taxed

It is not much help to understand the purpose of this structure without seeing how key tax rules pull its profits into US income in real life.

Subpart F income – current tax on certain categories

Subpart F takes some types of a CFC’s income and makes the US owner pay tax on it right away, even when the company sends no dividend at all. It focuses on income that is easy to move, like interest, dividends, rents, royalties, and on sales or services that shift profits across borders. These CFC rules stop long delays in US tax when a foreign corporation holds cash or other passive assets instead of running a real local business.

GILTI – ongoing tax on business profits

GILTI takes the owner’s share of CFC-tested income and adds it to US income each year, even if the company saves the money overseas. Under these rules, a US person with at least 10 percent of the vote or value must include that slice of profit on a tax return. The math is done on Form 8992, where tested income is reduced by tested losses and a set return on certain business assets before the final amount is taxed.

Section 956 investments – using CFC cash in the United States

Section 956 treats some uses of a CFC’s money as if the company had paid a dividend, such as loans, pledges, or guarantees that bring its earnings into the United States. This applies when a foreign corporation puts its money into things like United States real estate, stock in a related United States company, or certain related United States debts. These amounts are still picked up on a US tax return and appear with other CFC income on forms like Form 5471.

Reporting and compliance requirements

Once a company falls under CFC rules, the focus shifts to clear reporting, accurate numbers, and staying ahead of IRS follow-up. Every CFC owned by a US citizen abroad sends its story to the IRS through two core forms that work together.

Think of these forms as the way you walk the IRS through your company’s year.

1. Form 5471
   This is the information return for a CFC, and it sits with the same tax return you file, on the same due date, including extensions. It shows who owns the company, what the money flow looks like, and how the business sits inside US tax rules. The IRS uses it to match your ownership to the foreign corporation and make sure the details are right.
2. Form 8992
   This form handles the GILTI calculation. It takes items like tested income, tested loss, QBAI, and interest, and turns them into one number the IRS can tax.
   The formula is:
   GILTI = Net CFC tested income − Net DTIR, and Net DTIR = 10% × QBAI − specified interest expense.
   It looks technical, but in practice, it is simply the IRS asking, “How much profit came from the business that should not be left untaxed each year?”

Filing triggers

Life abroad moves in chapters. A new partner joins the company. Shares shift. A director changes. Moments like these matter because the IRS uses them to decide who has to file based on control of a foreign corporation.

Here is how it works:

1. When a US officer or director sees a US person reach a 10% ownership stake, or add another 10% block, a filing is triggered. This is Category 2.
2. When a US person reaches or drops below 10% of the vote or value, directly or through family or entities, the IRS calls this Category 3, and a filing is needed.
3. When a US person controls more than 50% of the vote or value, or is a 10% shareholder of a CFC at any point in the year, they fall under Categories 4 and 5, and the form attaches to the same return and deadline they already follow.

If her ownership were yours, the same rules would apply. The IRS only needs the connection to know a CFC exists, and the filings follow from there.

NOTE! Before looking at the penalties, it helps to know they exist to push people toward complete and timely forms, not to punish honest expats. Still, the numbers are real and worth understanding.

• A missing or incomplete Form 5471 can bring a $10,000 penalty for each annual accounting period for each foreign corporation, with an extra $10,000 charge for each 30-day period (or part) after 90 days from an IRS notice. These can grow up to $50,000 more per entity.
• The IRS can also cut up to 10% of the foreign taxes used for credit, with an extra 5% reduction for each three-month period the failure continues after notice, within section 6038 limits.
• These penalties work alongside normal tax rules, and the statute of limitations can stay open until every missing detail is filled in, which can stretch a simple oversight into a longer issue.

One foreign company, many forms – see which CFC filings you actually need.

Learn more

Tax strategies for CFC shareholders

Once a foreign corporation counts as a CFC, careful planning can ease the tax load while staying within US tax rules.

• Bring in non-US partners so that more of the company is held by foreign shareholders, which can reduce CFC exposure when this is structured correctly.
• Paying a fair salary from the CFC can shift part of the profit into wages that may qualify for the Foreign Earned Income Exclusion, lowering the combined tax bill.
• Large asset purchases and choices like the high-tax exception or a Section 962 election are often timed for years when they create the best mix of local and US tax savings.
• Move your tax home to the country where the CFC operates, so more income ties to that country and may benefit from extra exclusions or treaty relief.

Need help navigating CFC rules? Talk to a tax expert today

Understanding CFC rules matters because they decide how your foreign corporation fits into your US tax picture, and getting them right can save a lot of stress. When the filings feel heavy or the rules get confusing, having the right guidance makes all the difference.

Our specialists at Taxes for Expats walk you through each step with clarity and care so you can stay compliant and stay focused on the life you’re building abroad.

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