Section 78 gross-up: what it is, how it works, and GILTI calculations explained

Written by  Susan Turcotte, CPA

Last updated Oct 22, 2026

Section 78 of the Internal Revenue Code requires a US corporation – or an individual making a Section 962 election – to include a deemed dividend equal to the foreign taxes deemed paid under Section 960.

This inclusion is required when claiming a foreign tax credit.

The Section 78 gross-up explained simply: before you can credit foreign taxes your controlled foreign corporation paid, you must first add those taxes back into your US taxable income.

The gross-up prevents a double tax benefit – you cannot both exclude foreign taxes from income and claim a credit for the same taxes. For US expat business owners with CFCs, Section 78 applies every year you have a Subpart F or GILTI inclusion.

The provision affects three groups: US C corporations with CFC subsidiaries, US individuals who elect Section 962 treatment, and certain S corporations or partnerships with CFC interests. If you own 10% or more of a foreign corporation by vote or value, Section 78 is part of your annual compliance.

The legal foundation: IRC Section 78 explained

IRC Section 78 was enacted to eliminate a specific loophole: without it, a US shareholder could exclude foreign taxes from its income and then turn around and claim a credit for those same taxes, effectively getting two bites at the apple.

The statute works in conjunction with Section 960, which governs deemed-paid foreign tax credits for US shareholders of CFCs.

When Section 960 treats certain foreign taxes as if the US shareholder had paid them directly, Section 78 steps in and requires those deemed-paid taxes to be added back to the shareholder’s gross income as a Section 78 dividend – technically classified as a deemed dividend.

This mechanism applies to both Subpart F inclusions under Section 951 and GILTI inclusions under Section 951A. That makes Section 78 relevant to virtually every US shareholder of a CFC, regardless of whether the CFC’s income is classified as Subpart F or GILTI.

Section 78 gross-up formula

Your Section 78 gross-up formula depends on whether the underlying income is Subpart F or GILTI.

For Subpart F inclusions:

Section 78 gross-up = foreign taxes deemed paid under Section 960(a).

The gross-up equals 100% of the foreign taxes properly attributable to the Subpart F inclusion – no percentage reduction.

For GILTI inclusions:

Section 78 gross-up = 100% × inclusion percentage × aggregate tested foreign income taxes

A critical point: the Section 78 gross-up for GILTI is 100% of the deemed-paid amount, not 80%.

The 80% limitation under Section 960(d) caps only the foreign tax credit itself – the gross-up is calculated on the full amount. Section 78 explicitly directs the taxpayer to disregard the “80 percent of” language in Section 960(d)(1) when computing the income inclusion.

The gross-up amount is not a separate tax – it is an income inclusion that increases your foreign tax credit limitation basket.

Section 78 and GILTI: what expat business owners must know

After the Tax Cuts and Jobs Act of 2017, Section 78 applies to GILTI inclusions under Section 951A – not just Subpart F.

This expanded the reach of the gross-up to cover virtually all CFC income that flows through to US shareholders.

The interaction between Section 78 and GILTI has an important nuance. The GILTI Section 78 gross-up equals 100% of the deemed-paid foreign taxes under Section 960(d).

However, the foreign tax credit for GILTI is limited to 80% of those deemed-paid taxes for tax year 2025. Starting in tax year 2026, the One Big Beautiful Bill Act increases the credit limitation to 90%.

What this means in practice:

• The full amount of deemed-paid GILTI taxes is added to your gross income as a Section 78 gross-up
• Only 80% of those taxes can be credited against your US tax liability for tax year 2025
• The remaining 20% represents a permanent cost – you include it in income but cannot credit it

This mismatch is one of the most significant tax costs for US expat business owners with high-tax CFCs. The Section 250 GILTI deduction – 50% for tax year 2025 – partially offsets this, but does not eliminate it.

Section 78 GILTI example: step-by-step calculation

Based on a common TFX client scenario.

A US expat owns 100% of a CFC in France. In tax year 2025, the CFC has $500,000 of tested income and $150,000 of aggregate tested foreign income taxes. The shareholder has no qualified business asset investment, so the full $500,000 is the GILTI inclusion.

1. GILTI inclusion amount: $500,000 under Section 951A
2. Section 960(d) deemed-paid foreign taxes: $150,000 × ($500,000 ÷ $500,000) = $150,000
3. Section 78 gross-up: 100% of the deemed-paid amount = $150,000. US gross income is now $500,000 + $150,000 = $650,000.
4. Section 78 gross-up added to income: The $150,000 flows to the Section 951A basket on Form 1118 and is included in gross income on Form 1040 or 1120.
5. Foreign tax credit on Form 1118: The credit is limited to 80% of $150,000 = $120,000. The remaining $30,000 of deemed-paid taxes cannot be credited.
6. Net GILTI tax after credit: The shareholder pays US tax on $650,000 of income, offset by a $120,000 credit. The Section 250 deduction further reduces the GILTI portion, but the $30,000 credit gap remains a permanent cost.

Section 78 and Subpart F income

Section 78 has applied to Subpart F inclusions since long before the 2017 tax reform. For Subpart F, the Subpart F gross-up equals 100% of the Section 960(a) deemed-paid taxes – there is no percentage reduction like the 80% limitation that applies to GILTI.

Subpart F income is included in the US shareholder’s gross income under Section 951, and the Section 78 gross-up is added on top.

The combined amount determines the shareholder’s total foreign-source income in the general limitation basket for Section 904 purposes.

The most common Subpart F categories that trigger a Section 78 gross-up:

• Foreign personal holding company income – dividends, interest, rents, royalties, and capital gains from the CFC’s passive investments
• Foreign base company sales income – income from buying or selling goods involving a related party, where the goods are manufactured and sold for use outside the CFC’s country
• Foreign base company services income – income from services performed outside the CFC’s country for or on behalf of a related party

Subpart F has a de minimis rule under Section 954(b)(3)(A): if the CFC’s total Subpart F income is the lesser of 5% of gross income or $1 million (2025), none of it is treated as Subpart F income. When the de minimis rule applies, there is no Subpart F inclusion and therefore no Section 78 gross-up.

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Who is subject to Section 78? US shareholders of CFCs

The following are subject to the Section 78 gross-up when they have Subpart F or GILTI inclusions:

• US C corporations with one or more CFC subsidiaries – the most common case. The corporation claims deemed-paid credits on Form 1118 and adds the Section 78 gross-up to its taxable income on Form 1120.
• US individuals who make a Section 962 election – this election allows an individual US shareholder to be taxed at corporate rates on Subpart F and GILTI inclusions, access the deemed-paid foreign tax credit, and take the Section 78 gross-up. Without this election, individual shareholders cannot claim deemed-paid credits at all.
• S corporations and partnerships – these entities may have US expats’ CFC tax obligations that pass through to their owners. The Section 78 gross-up flows through to the individual partners or shareholders, though the mechanics depend on whether a Section 962 election is in place.

Individual US expats who own a foreign corporation outright are not automatically subject to Section 78 – but making a Section 962 election opts them into the corporate tax regime, including the gross-up.

Section 78 vs Section 960: understanding the relationship

Section 960 determines how much foreign tax is deemed paid; Section 78 then requires that amount to be included in your gross income before you can claim the credit.

The two statutes work as a pair – Section 960 is the credit mechanism, Section 78 is the income-inclusion counterpart.

Both sections were substantially rewritten by the Tax Cuts and Jobs Act of 2017, replacing the old Section 902 indirect credit rules with the current Section 960 framework.

Section 78 dividend: is it really a dividend?

Despite being called a “deemed dividend,” the Section 78 gross-up is not a dividend in the traditional sense. It does not represent an actual distribution from the CFC – no cash leaves the foreign company, and no distribution resolution is needed.

The deemed dividend Section 78 creates is treated as a dividend received from the CFC for all purposes of the Internal Revenue Code except Sections 245 and 245A. It is sourced as foreign-source income in the same category as the underlying inclusion: passive or general for Subpart F, Section 951A for GILTI.

The Section 78 deemed dividend increases your foreign-source income in the relevant basket, which can actually expand your foreign tax credit limitation.

By raising the numerator in the Section 904 limitation formula, the gross-up gives you more room to credit foreign taxes. This is the mechanism working as designed – the gross-up and the credit are meant to roughly cancel each other.

Section 78 and the foreign tax credit limitation: Section 904 baskets

Placing the Section 78 gross-up in the correct Section 904 basket is critical – a misallocation can cause you to lose foreign tax credits you are legally entitled to claim.

The allocation rule follows the underlying income:

• Subpart F gross-up goes in the general limitation basket – the same basket as the underlying Subpart F income
• GILTI gross-up goes in the Section 951A basket – a separate basket created by TCJA specifically for GILTI inclusions
• Foreign branch income, passive income, and Section 901(j) sanctioned-country income each have their own baskets, but Section 78 applies only to deemed-paid credits under Section 960, so only the general and Section 951A baskets are typically involved

The GILTI basket was created by TCJA and is separate from the general limitation basket, requiring careful tracking on Form 1118.

GILTI and Subpart F make CFC returns complex. We handle it.

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Section 78 and Section 245A: the dividends received deduction interaction

After TCJA, US corporations can claim a 100% dividends received deduction for actual dividends received from certain foreign subsidiaries. This DRD effectively eliminates US corporate tax on those dividends.

The Section 245A and Section 78 interaction is a trap for the unwary: The gross-up is not eligible for the Section 245A DRD.

Section 78 itself settles this by treating the gross-up as a dividend for purposes of the Internal Revenue Code “other than sections 245 and 245A.” This carve-out applies to tax years beginning after December 31, 2017. A 2024 Tax Court case, Varian Medical Systems, Inc. v. Commissioner, 163 T.C. No. 4, allowed the deduction – but only because the taxpayer’s fiscal year began before this exclusion took effect. The ruling is a narrow transition-year exception, not a case that denies the deduction generally.

For expats who have made a Section 962 election, this distinction matters: The gross-up increases taxable income, but the DRD cannot reduce it. The full amount remains in income, offset only by the foreign tax credit.

See our TFX guide to the Section 245A dividends received deduction for the full eligibility rules and how the DRD interacts with CFC distributions.

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Historical context: Section 78 before and after TCJA 2017

TCJA fundamentally changed Section 78 by adding GILTI as a new trigger and replacing the pooling method of Section 902 with the annual current-year approach of Section 960.

Before the Tax Cuts and Jobs Act of 2017, Section 78 applied to taxes deemed paid under Section 902 on actual dividends from foreign subsidiaries and under Section 960 on Subpart F inclusions.

Under Section 902, US corporations could claim a credit for a proportionate share of their CFC’s foreign taxes based on an accumulated earnings-and-profits pool – a “look-through” calculation that spanned multiple years.

TCJA repealed Section 902 entirely and replaced it with Section 960, which calculates deemed-paid credits on a current-year, basket-by-basket basis. At the same time, TCJA created the GILTI regime under Section 951A and extended Section 78 to cover GILTI inclusions alongside Subpart F.

The practical impact for US expat business owners: the calculation is simpler under Section 960 than under Section 902, but the scope is wider.

GILTI captures CFC income that previously was not subject to current US taxation.

Common mistakes and misconceptions about Section 78

The single most expensive Section 78 mistake is misunderstanding the GILTI gross-up percentage – a point the brief itself gets wrong, which illustrates how pervasive this error is.

• Believing Section 78 only applies to corporations. Individuals who make a Section 962 election are also subject to the gross-up. Without the election, they have no deemed-paid credit – and no gross-up – but they also lose the benefit of the credit entirely.
• Confusing the GILTI gross-up percentage with the credit percentage. The gross-up is always 100% of the deemed-paid taxes. The 80% limitation applies only to the credit under Section 960(d). Applying 80% to the gross-up understates income and creates an inconsistency on Form 1118.
• Placing the gross-up in the wrong Section 904 basket. GILTI gross-up belongs in the Section 951A basket; Subpart F gross-up belongs in the general basket. Misallocating between baskets distorts the credit limitation in both.
• Failing to include the gross-up in gross income before calculating the foreign tax credit limitation. The Section 904 limitation uses total taxable income as the denominator. Omitting the Section 78 gross-up from income before computing the limitation can cause you to understate your available credit.
• Confusing the Section 78 deemed dividend with an actual CFC distribution eligible for the Section 245A DRD. The Section 78 gross-up is not eligible for the 100% dividends received deduction – treating it as such double-counts the benefit.
• Omitting the gross-up from Form 1118 entirely. This is the most basic error and the easiest to catch – but it still happens, especially in software-prepared returns where the Section 78 amount must be manually entered or verified.

Section 78 planning strategies for expat business owners

The GILTI high-tax exclusion is the most powerful tool for eliminating Section 78 gross-up exposure – but it requires a formal election and careful annual review.

1. Consider the GILTI high-tax exclusion election. Under Treas. Reg. §1.951A-2(c)(7), if the CFC’s effective foreign tax rate exceeds 18.9% for tax year 2025, the GILTI inclusion can be excluded entirely. No inclusion means no Section 78 gross-up and no residual US tax on that income. The election is made annually on a CFC-by-CFC basis.
2. Evaluate a Section 962 election gross-up strategy. For individual US shareholders, the Section 962 election provides access to the corporate GILTI deduction under Section 250, the deemed-paid foreign tax credit under Section 960, and the Section 78 gross-up mechanism. Without it, GILTI is taxed at ordinary individual rates with no credit. The election must be attached to the timely filed return.
3. Structure CFC income to maximize foreign tax credit utilization in each Section 904 basket. Because cross-crediting between baskets is not allowed, managing the mix of Subpart F and GILTI income – and the foreign taxes in each basket – directly affects how much credit you can use.
4. Time Subpart F distributions to manage the interaction between actual dividends and deemed inclusions. An actual dividend from a CFC is generally not taxable to the extent it is paid from previously taxed earnings and profits. Coordinating the timing of distributions with Section 78 gross-up years can improve cash flow.
5. Review treaty positions that may affect the foreign tax credit available under Section 960. Some tax treaties reduce or eliminate withholding taxes on dividends, which can change the amount of creditable foreign taxes and, by extension, the Section 78 gross-up.

See our TFX guide to the Section 962 election for detailed examples of how the election affects GILTI tax and foreign tax credits.

Section 962 can lower your GILTI tax. See how the election works.

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Section 78 for small business expats with foreign subsidiaries

A US expat who owns 100% of a foreign company must apply Section 78 if that company generates even a small amount of Subpart F income. The rules are triggered by the type of income, not the amount – with one exception.

When does CFC status trigger Section 78?

Many expat entrepreneurs are unaware that a single-member foreign LLC or a wholly owned foreign corporation can trigger CFC status and Section 78 obligations.

If you are a US person who owns more than 50% of a foreign corporation by vote or value, the corporation is a CFC, and you are subject to Subpart F and GILTI inclusion rules.

The Subpart F de minimis rule under Section 954(b)(3)(A) provides limited relief: if the CFC’s total Subpart F income is the lesser of 5% of its gross income or $1 million (2025), none of it is treated as Subpart F income – and there is no Section 78 gross-up on that amount.

This exception does not apply to GILTI, which has no de minimis threshold.

Section 78 income: how it affects your effective tax rate

The Section 78 gross-up is a rare tax provision that increases your income but is designed to be fully offset by the foreign tax credit it enables – when calculated correctly, the net tax cost should be zero or near zero for Subpart F inclusions.

The gross-up increases US gross income, which raises the foreign tax credit limitation under Section 904. This is actually beneficial: by adding foreign-source income to the limitation’s numerator, the gross-up gives you more room to credit foreign taxes.

For Subpart F, where the credit is 100% of deemed-paid taxes, the gross-up and the credit should cancel completely.

For GILTI, the math is less forgiving. Because only 80% of deemed-paid taxes are creditable for tax year 2025, the remaining 20% represents a permanent income increase without a corresponding credit. This gap means GILTI typically produces a net US tax cost, even with the Section 250 deduction.

AGI impact and the net investment income tax

The gross-up also increases adjusted gross income, which can affect other tax calculations.

The net investment income tax under Section 1411 imposes a 3.8% surtax on investment income above $200,000 (2025) for single filers or $250,000 (2025) for joint filers.

A large Section 78 gross-up can push AGI above these thresholds, triggering NIIT on income that would otherwise be below the line.

GILTI vs Subpart F gross-up: key differences

Both Subpart F and GILTI trigger a 100% Section 78 gross-up, but only Subpart F allows a full 100% foreign tax credit – GILTI’s 80% credit cap for tax year 2025 creates a permanent cost gap.

The fundamental difference: Subpart F allows a full credit against the full gross-up, so the Section 78 mechanism is truly cost-neutral.

GILTI’s 80% credit limitation creates a structural mismatch that costs real money – particularly for CFCs in high-tax jurisdictions where the uncredited 20% can be substantial.

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