How to Make a 962 Election on Form 1040

A Section 962 election allows an individual shareholder of a foreign corporation to be taxed on certain foreign income as if they were a U.S. corporation. This choice can be advantageous when the U.S. corporate tax rate is lower than the individual’s personal income tax rate. The election is made annually, providing flexibility based on each year’s tax situation. It primarily applies to income generated by a Controlled Foreign Corporation (CFC), which is subject to current U.S. taxation even if the cash is not brought back to the United States.

Determining Eligibility and Applicability

To make a Section 962 election, an individual must be a “United States shareholder” of a Controlled Foreign Corporation (CFC). A U.S. shareholder is a U.S. person, including individuals, trusts, and estates, who owns 10% or more of the shares of a foreign corporation. The election is specifically for these individual shareholders, not for corporate shareholders.

The election applies to amounts the shareholder must include in gross income under Section 951(a), which primarily covers Subpart F income and Global Intangible Low-Taxed Income (GILTI). Subpart F income includes certain passive income and related-party transactions, while GILTI is income earned by CFCs exceeding a certain return on tangible assets.

The election is most beneficial when the 21% U.S. corporate tax rate is lower than the shareholder’s individual rate, which can be as high as 37%. For GILTI inclusions, the election also allows a 50% deduction of the GILTI amount; this is scheduled to be reduced to 37.5% for tax years after 2025. Another benefit is the ability to claim a credit for foreign taxes paid by the CFC.

Information and Calculations Required for the Election

Preparing to make a Section 962 election involves gathering financial data and performing tax calculations. The taxpayer must have detailed information about the CFC, including its name, address, and employer identification number (EIN). The shareholder needs their pro-rata share of the CFC’s Subpart F income and GILTI, and the amount of foreign income taxes paid by the CFC attributable to that income. This data is often compiled when preparing Form 5471.

The next step is to calculate the hypothetical corporate tax liability. This is done by applying the 21% U.S. corporate tax rate to the shareholder’s Subpart F income and the deductible portion of their GILTI inclusion. After determining this tax, the shareholder calculates the allowable foreign tax credit, which mimics the process a corporation would use on Form 1118. For GILTI, this credit is generally limited to 80% of the foreign taxes paid.

A formal election statement must be prepared and attached to the tax return. The statement must contain:

• A declaration that the taxpayer is making the election under Section 962.
• The name and address of the taxpayer.
• The names of the CFCs the election applies to.
• The shareholder’s income inclusions from each CFC.
• The foreign taxes associated with that income.

How to File the Election with Your Form 1040

The tax amount calculated under Section 962 rules is not paid separately but is integrated into the individual’s overall tax liability. The calculated tax is reported on Schedule 2 (Form 1040), “Additional Taxes.” Taxpayers report the amount on the line for “Other taxes” and enter “SEC 962” in the space provided.

To prevent the income from being taxed twice, an offsetting deduction must be taken on Schedule 1 (Form 1040) to remove the Subpart F and GILTI amounts from the individual’s regular income calculation. The formal election statement must be attached to the Form 1040.

For individuals filing electronically, the statement should be saved as a PDF and attached to the e-filed return following the tax preparation software’s instructions. For those filing a paper return, the statement should be printed and attached to the completed Form 1040.

Post-Election Tax Consequences

A Section 962 election affects the taxation of future distributions by reclassifying the income taxed at corporate rates as “Section 962 Previously Taxed Earnings and Profits (PTEP).” This creates a distinct category of earnings within the CFC that must be tracked separately.

When the CFC later distributes its earnings, distributions are first considered to come from Section 962 PTEP. These distributions are tax-free up to the amount of U.S. tax that was previously paid. Any portion of a distribution exceeding the U.S. tax previously paid is included in the shareholder’s gross income and taxed as a dividend.

This dividend may be eligible for lower long-term capital gains rates if the CFC is a “qualified foreign corporation.” The election is made annually and generally cannot be revoked for that year without IRS consent.