Subpart F Income
US Tax Rules explained
Subpart F Income
Subpart F income is the US tax rule, designed to stop US taxpayers using non-US companies that have income from investments and any other passive sources. This can include interest, gains, rental and also catch certain personal service company income. Where a CFC has passive income, the US can tax the shareholder’s share of the income on them personally. This is Subpart F income.
While it is possible for UK business owners to invest the earnings of their UK company, for US owners the income and gains can be taxable by the US in the calendar year it arises.
This income is taxed at the ordinary income tax rate in the US, irrespective of whether the profit is paid as a dividend or not. This is important as a dividend from a UK company is typically taxed at the lower qualified income rate in the US.
Once taxed as Subpart F income, the US considers this to be ‘Previously Taxed Income’, meaning it will not tax this again as a dividend. However, there may still be UK, or other local tax once the dividend is paid. Meaning the earnings of the UK company being double taxed at a personal level.
Therefore, the advantages that a UK person may have by using a company to defer UK taxes until a dividend is paid, will not apply to American owners of CFCs which generate passive income.
Example: Assuming top rates of tax
Company Profit = £100
UK Corporation Tax at 25% = £25
Net earnings = £75
US personal tax on subpart F Income at 37% = £27.75
Future UK personal tax at 39.35% on £75 dividend = £29.51
Future US personal tax on £75 dividend.
Net investment income tax 3.8% = £2.85
Net cash = £14.89. Effective double tax rate on earnings of 85.11%
What should you do next?
Subpart F applies to the annual net earnings of the CFC. There can be some relief should the CFC pay a ‘high’ rate of foreign Corporation Tax when compared to the US corporate tax rate. This is defined as at least 90% of the US rate. However, with changing UK and US corporate tax rates and differing rules, this needs to be analysed each year.
Planning is advised as to whether there are any elections or alternative structures which can eliminate double taxation or reduce the tax rate. However, for US owners of CFCs with passive income, where advice has not been taken, the existing company may not be the most tax efficient structure.
If you would like to discuss any of the above and how it relates to your business, please get in touch with your usual Blick Rothenberg contact or Alex or Michael using the form below.