Where to Report Subpart F Income on Form 1040?
As a U.S. shareholder, you must report income from a foreign corporation, even if not received. Learn the correct process for your Form 1040 tax return.
U.S. tax law requires certain shareholders to pay taxes on income from foreign corporations, even if they have not received any cash payments. This income, known as Subpart F income, is a provision designed to prevent U.S. taxpayers from deferring taxes on certain types of “movable” income, like dividends and interest, by holding them in a foreign company. For an individual shareholder, correctly reporting this income involves recognizing your status as a U.S. shareholder of a Controlled Foreign Corporation (CFC) and knowing where to find the specific income figures.
Identifying Your Subpart F Income Inclusion
The requirement to report Subpart F income applies if you are a U.S. Shareholder of a Controlled Foreign Corporation (CFC). A CFC is a foreign corporation where U.S. persons, each owning at least 10% of the voting stock, collectively own more than 50% of the company. As a U.S. Shareholder, you are subject to rules that tax certain passive income, like dividends and interest, as if you had received it directly.
You do not calculate the specific amount of Subpart F income yourself. This information is provided by the foreign corporation on Schedule K-3, an attachment to its information return, Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” Within Schedule K-3, you must locate the line that details your pro rata share of the CFC’s Subpart F income, which is the figure you will transfer to your tax return.
The income reported on Schedule K-3 is limited by the foreign corporation’s overall earnings and profits for the year, meaning your inclusion cannot exceed your share of the company’s total earnings. The schedule you receive will have already taken this limitation into account, presenting you with the final, taxable amount.
Reporting Subpart F Income on Form 1040
After identifying the income amount from your Schedule K-3, you must report it on your Form 1040. This income is reported on Schedule 1 (Form 1040), “Additional Income and Adjustments to Income.” On Schedule 1, you will use the line for “Other income” in Part I, “Additional Income.”
On the “Other income” line, you must provide a clear description of the income, such as “Subpart F inclusion,” for your records and for the IRS. Next to this description, enter the exact dollar amount of the Subpart F income from your Schedule K-3. This figure is then combined with any other items of additional income on Schedule 1, and the total flows to your main Form 1040 to be included in your gross income.
Claiming Foreign Tax Credits for Subpart F Income
The income you report may have already been taxed in the foreign country where the corporation operates, leading to potential double taxation. To address this, U.S. tax law allows you to claim a foreign tax credit for the foreign taxes paid or accrued on that income. This credit is a dollar-for-dollar reduction of your U.S. tax liability.
You claim this credit using Form 1116, “Foreign Tax Credit,” which is filed with your Form 1040. The necessary information to complete Form 1116 is provided on the same Schedule K-3 you receive from the foreign corporation. The Schedule K-3 will detail the foreign taxes “deemed paid” by you, which is your pro rata share of taxes paid by the CFC on the income being reported.
Completing Form 1116 involves calculating limitations to ensure the credit does not exceed the U.S. tax attributable to the foreign income. The form requires you to report the gross foreign source income, the foreign taxes deemed paid, and any direct foreign taxes paid. The final calculated credit from Form 1116 is then carried to your Form 1040 to offset your U.S. tax liability.
Tracking Previously Taxed Income
Paying tax on Subpart F income requires careful record-keeping for the future. Once you include the Subpart F amount in your income, it is considered “Previously Taxed Income,” or PTI. This designation prevents you from being taxed on that same income a second time when the foreign corporation eventually distributes it to you as a cash dividend.
Your PTI balance acts as a tax-free account of earnings within the foreign corporation. When you receive a distribution, it is treated as a non-taxable return of your PTI before it is considered a taxable dividend. This makes future cash payments from the corporation tax-free up to your accumulated PTI.
It is your responsibility as the taxpayer to track your PTI balance from year to year. The IRS requires you to maintain these records, which involves adding the current year’s Subpart F income inclusion to your PTI balance. You must also subtract any distributions received during the year that were treated as a tax-free return of PTI. Without accurate tracking, you could pay tax on the same income twice.