A U.S. C Corporation owns 100% of a Foreign Subsidiary. The Foreign Subsidiary earns $100,000 of 'Subpart F income' (passive investment income) in Year 1. It distributes $0 to the U.S. parent. How is this taxed?

Answer options:

The U.S. Corporation recognizes income only when a dividend is paid.

The U.S. Corporation must include the $100,000 in taxable income in Year 1.

The income is exempt from U.S. tax under the participation exemption system.

The U.S. Corporation pays a 10% penalty tax but no income tax.

How to approach this question

Identify 'Subpart F income' as a trigger for immediate taxation. It pierces the corporate veil of the foreign sub for tax purposes.

Full Answer

B.The U.S. Corporation must include the $100,000 in taxable income in Year 1.✓ Correct

Under IRC §951(a), a U.S. shareholder of a Controlled Foreign Corporation (CFC) must include in gross income their pro rata share of the CFC's Subpart F income for the year, regardless of whether it is distributed.

Common mistakes

Applying the general rule of deferral to Subpart F income.

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