Prior to the Tax Cuts and Jobs Act, in order to qualify as a controlled foreign corporation (CFC), U.S. persons had to control the foreign corporation for an uninterrupted period of 30 days. Classification as a CFC is very important because it requires certain informational reporting and subjects the taxpayer to tax rules such as Subpart F income. By allowing this 30 day window, taxpayers had the opportunity for planning. A common scenario of this type of planning under the old rules was when a potential CFC was inherited there were 30 days for a restructuring to avoid CFC status. In many cases, the need for this restructuring was unrelated to avoiding CFC status but was just part of a larger international asset or estate plan. In general, this is no longer possible.
Under the new law, a foreign corporation that meets the test for any period of time, even one day, will be considered a CFC. This has become a major problem for international estate planning, but also creates several other problems because anyone controlling a CFC for even a day must report. For example, with acquisitions or dispositions of stock through gifts or sales, if these do not happen during the hypothetical period between December 31st and January 1st, then technically there would never be a time a transaction could take place that would avoid reporting in an additional year. Also, prior to the Tax Cuts and Jobs Act, this may have only meant a Form 5471, but now it may also mean it is necessary to go through the hassle of the entire GILTI reporting exercise for one day of ownership…..one day.
Overall, the problem is with reporting. Paying taxes on potential Subpart F income is likely not substantial for such a short period. However, many taxpayers may find themselves subject to informational reporting that was not expected or contemplated, and pay the heavy penalties that entails. Hopefully, the IRS will have leniency on a taxpayer that owns a CFC for only a day, but that still means preparing a 5471, possibly a GILTI calculation, and requesting reasonable cause for penalty relief.
This is another example of the importance of making sure compliance is not overlooked in tax planning.