What Is a 962 Election and How Does It Affect Your Taxes?

U.S. taxpayers with ownership in foreign corporations may face additional tax burdens due to anti-deferral rules under Subpart F and the Global Intangible Low-Taxed Income (GILTI) provisions. To mitigate this, some individuals can make a Section 962 election, allowing them to be taxed similarly to a U.S. corporation rather than as individual shareholders. This election can impact both tax rates and available credits, potentially reducing overall liability.

Who May Use This Election

Individuals and certain trusts that are U.S. taxpayers with direct or indirect ownership in a controlled foreign corporation (CFC) can make a Section 962 election. This option is particularly relevant for those who would otherwise be taxed at individual income tax rates on their share of the CFC’s earnings. By electing this treatment, they can access benefits typically reserved for domestic corporations, such as lower tax rates and the ability to claim indirect foreign tax credits.

This election is commonly used by U.S. shareholders who own foreign businesses through pass-through entities like S corporations or partnerships. Since these structures do not pay corporate tax at the entity level, income from a CFC flows directly to the individual, potentially leading to higher tax liabilities. By making the election, the taxpayer is treated as if they operated through a U.S. corporation, which can result in a lower effective tax rate.

Trusts that qualify as U.S. persons can also use this election if they meet the ownership requirements. However, estates and non-grantor trusts must evaluate whether the election aligns with their tax planning strategies, as the benefits may vary depending on the trust’s structure and distribution policies.

Calculating Taxable Amount

When a taxpayer makes a Section 962 election, taxable income from a CFC is determined using corporate tax principles rather than individual tax rules. Instead of being taxed on the full amount of Subpart F income or GILTI at personal rates, the taxpayer calculates tax as if they were a domestic corporation, applying corporate deductions and exclusions.

One major advantage is the ability to deduct 50% of GILTI under Section 250, a benefit normally reserved for U.S. corporations. This deduction reduces the amount of income subject to tax before applying the corporate tax rate, which is 21% as of 2024. Without the election, an individual could face tax rates as high as 37% on the same income. Additionally, undistributed earnings remain untaxed at the individual level until an actual dividend is received, at which point further tax implications arise.

Foreign tax credits also factor into the final taxable amount. Under Section 960, taxpayers making a 962 election can claim an indirect foreign tax credit for taxes paid by the CFC, but only to the extent that a U.S. corporation would be eligible. While the election allows access to credits otherwise unavailable to individuals, the 80% cap on foreign tax credits for GILTI income still applies. If the foreign jurisdiction’s tax rate is high enough, these credits can significantly reduce or even eliminate U.S. tax liability on CFC earnings.

Rate Differentials

The Section 962 election changes how foreign earnings are taxed by applying the corporate tax rate instead of individual income tax brackets. For taxpayers in the highest marginal bracket, this can mean a substantial reduction in tax rates, as corporate tax rates have remained significantly lower since the Tax Cuts and Jobs Act (TCJA).

However, earnings are still subject to taxation when repatriated as dividends. This creates a two-step tax process: first at the corporate level and then again at the qualified dividend rate, which is generally 15% or 20% depending on the taxpayer’s income level. For taxpayers in lower brackets, this additional layer of taxation may offset some of the initial benefits of the election.

Timing also affects the overall tax impact. If a taxpayer reinvests foreign earnings rather than distributing them immediately, the election can provide a deferral advantage by keeping funds within the foreign entity without triggering additional U.S. tax until distributions occur. However, if profits are regularly repatriated, the cumulative tax burden may resemble or even exceed what an individual would have paid without making the election.

Foreign Tax Credit Implications

The Section 962 election changes how foreign tax credits (FTCs) are calculated and applied, influencing overall tax liability. Normally, individuals can only claim FTCs directly attributable to their income, but by electing to be treated as a corporation for certain tax purposes, they gain access to additional credit mechanisms that can reduce double taxation.

One advantage is the ability to utilize deemed paid FTCs under Section 960, allowing taxpayers to credit a portion of foreign taxes paid by the CFC against their U.S. tax liability. However, individuals making a 962 election are still subject to the GILTI-specific 80% limitation on foreign tax credits. This means that even if a CFC has already paid substantial taxes in its home country, only a fraction of those taxes can be credited against U.S. obligations, potentially leaving residual U.S. tax liability. Additionally, FTCs under the election must be applied within separate foreign tax credit limitation categories, requiring careful tracking to ensure compliance with IRS rules.

Filing Steps

Making a Section 962 election requires following specific IRS procedures. Taxpayers must indicate their choice on their annual tax return by attaching a statement explicitly declaring the election for that tax year. This statement should include the taxpayer’s name, Social Security number or Taxpayer Identification Number, and a declaration that they are electing to be taxed under Section 962 for all applicable foreign income. Since the election applies on a yearly basis, it must be made anew each year if the taxpayer wishes to continue using it.

The election is typically reported on Form 1040 using Form 8993 to calculate the deduction for GILTI and Form 1118 or 1116 to claim foreign tax credits. If Subpart F income is involved, taxpayers must also complete Form 5471, which provides detailed information on their controlled foreign corporation. Accuracy is essential, as errors in reporting could lead to additional tax liability or penalties. Taxpayers should maintain thorough records of foreign earnings, taxes paid, and any prior-year elections to support their filings in case of an IRS audit.

Ending the Election

Once a taxpayer makes a Section 962 election, they are not locked into it permanently. The election is made on an annual basis, meaning taxpayers can choose to discontinue it in any subsequent tax year. This flexibility allows individuals to reassess their tax situation each year and determine whether continuing the election remains beneficial.

Ending the election does not require formal revocation; the taxpayer simply omits the election statement from their tax return for the year in which they no longer wish to apply it. However, once discontinued, any previously deferred income taxed under the corporate framework may face additional tax consequences when distributed. If a taxpayer later decides to reinstate the election, they must file a new statement for that tax year, as prior elections do not carry forward automatically. Given the complexity of these decisions, consulting a tax professional can help ensure that discontinuing or reinstating the election aligns with long-term financial goals.