IRS Section 956: What Is an Investment in U.S. Property?

United States tax law allows U.S. owners of foreign corporations to defer paying U.S. tax on foreign earnings until the money is distributed as a dividend. Section 956 of the Internal Revenue Code prevents the indefinite deferral of tax on foreign profits that are effectively being used in the United States. This rule can trigger a U.S. tax liability for American owners even when no formal cash dividend has been paid.

When a foreign corporation’s earnings are repatriated to the U.S. in substance, they are taxed as if they were repatriated in form. This occurs when the corporation invests its earnings in U.S. assets or provides a financial benefit to its U.S. owners. The result is a “deemed dividend” that must be included in the owner’s taxable income.

Determining Applicability to Your Foreign Corporation

The rules of Section 956 apply to a structure known as a Controlled Foreign Corporation (CFC). A foreign corporation is a CFC if “U.S. shareholders” collectively own more than 50 percent of its stock, measured by either total combined voting power or total value.

A U.S. person, such as a citizen, resident, or domestic corporation, qualifies as a “U.S. shareholder” only if they own 10 percent or more of the foreign corporation’s stock by vote or value. Only when a U.S. shareholder owns a stake in a CFC do the rules concerning investments in U.S. property become a direct concern.

Identifying Investments in United States Property

An investment in United States property triggers a Section 956 income inclusion. The term covers actions where a CFC’s earnings are made available for use within the U.S. Common examples of U.S. property include:

• Tangible property physically located in the U.S., such as real estate or machinery.
• Stock of a domestic corporation or an obligation of a U.S. person.
• Direct loans from the CFC to its U.S. shareholder, which are viewed as economically equivalent to a dividend.
• Pledges or guarantees for a U.S. shareholder’s loan; the tax code treats this as if the CFC made a direct loan to the shareholder.

These rules capture both direct and indirect methods of bringing foreign earnings back to the U.S. The Treasury Department has the authority to issue regulations to prevent the avoidance of Section 956 through complex arrangements.

Calculating the Deemed Dividend Amount

Once a CFC holds U.S. property, the U.S. shareholder must calculate the deemed dividend. The inclusion is limited to the shareholder’s pro rata share of the lesser of two amounts. The first limitation is the average amount of U.S. property held by the CFC, calculated by averaging the adjusted basis of the property at the close of each quarter of its taxable year. This quarterly average prevents avoidance of the rule by holding property for only a short period.

The second limitation is the CFC’s “applicable earnings,” which are its current and accumulated earnings and profits (E&P) not yet subject to U.S. tax. A U.S. shareholder’s inclusion amount is further reduced by their share of the CFC’s previously taxed income (PTI). This prevents double taxation on earnings already included in a shareholder’s income under anti-deferral rules like Section 956 or the Global Intangible Low-Taxed Income (GILTI) regime.

Statutory Exceptions for United States Property

The Internal Revenue Code provides several exceptions, carving out certain assets from the definition of “United States property.” For instance, deposits with banks and obligations of the United States, such as Treasury bonds, are not considered U.S. property. This allows CFCs to hold cash and liquid investments in the U.S. without triggering a deemed dividend.

Another exception applies to the stock or obligations of an unrelated domestic corporation, permitting portfolio-style investments. The law also excludes property acquired in normal business transactions, such as accounts receivable from the sale of inventory to a U.S. person.

An exception introduced by the Tax Cuts and Jobs Act of 2017 (TCJA) applies to U.S. shareholders that are C corporations. Under post-TCJA regulations, a deemed dividend is reduced to the extent the corporate shareholder would be entitled to a 100% dividends received deduction under Section 245A if the CFC had made an actual cash distribution.

This change effectively neutralizes the impact of Section 956 for many U.S. parent corporations of CFCs. Because the Section 245A deduction would make an actual dividend from the CFC tax-free, the law provides parallel treatment for a deemed dividend. This allows corporate-owned CFCs to invest in their U.S. parent operations without triggering a U.S. tax inclusion.

Reporting a Section 956 Inclusion

A U.S. shareholder must report a taxable inclusion under Section 956 on Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” The calculated amount is detailed on schedules within the form, such as Schedule I, which summarizes the shareholder’s income from the foreign corporation. Other schedules provide the necessary background for the calculation, including Schedule J for the CFC’s E&P and Schedule P for the shareholder’s PTI balance.

Failure to file Form 5471 accurately can result in a penalty of $10,000 for each year the form is not filed. If the failure continues for more than 90 days after an IRS notice, an additional $10,000 penalty is imposed for each 30-day period, up to a maximum of $50,000 in additional penalties.

The final taxable amount flows through to the U.S. shareholder’s main income tax return. An individual shareholder reports this amount on Form 1040, while a corporate shareholder reports it on Form 1120.