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Sale of Stock of a CFC – Example of the Potential Benefit of Code §1248(b)


Code §1248(a) generally provides that gain recognized on the sale or exchange by a United States person of stock in a foreign corporation must be included in the gross income of the U.S. person as a dividend to the extent of the foreign corporation’s earnings and profits that were accumulated while the stock was held by the U.S. person and the foreign corporation was a CFC. The amount of U.S. tax due on the Code §1248(a) dividend amount is subject to a limitation found in Code §1248(b).

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In the above example, Individual A has owned 100% of CFC's stock since its date of incorporation. CFC is not located in a country that is a party to a comprehensive income tax treaty with the U.S. CFC has not made any distributions, nor has Individual A had any Code §951 inclusions ("Subpart F Income") related to CFC.

Individual A sells all of the stock of CFC to USS, a U.S. corporation. On the date of sale, CFC has accumulated earnings and profits of $70. Individual A's gain on the sale of CFC stock is greater than $70. Consequently, Individual A is required to recharacterize $70 of the gain as dividend income under Code §1248(a).

The following is a calculation of a Code §1248(b) limitation. For simplicity, it is assumed that CFC was subject to a flat foreign tax rate of 30%, and CFC would have been subject to a flat 35% tax rate in the U.S. (had it been a U.S. corporation). It is further assumed that Individual A would be subject to a 39.6% tax on dividend income from CFC and would be subject to a 20% tax on capital gains related to CFC stock.

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Individual A would pay $28 of tax on the $70 Code §1248(a) amount. However, the Code §1248(b) limitation is $18 and saves Individual A $10 of tax related to the Code §1248(a) amount.

Note that the Code §1248(b) limitation would provide no savings to Individual A if CFC had been located in a country that has an income tax treaty with the U.S. In that circumstance, Individual A's Code §1248(a) amount would likely be qualified dividend income (taxed at capital gains rates, up to 20%). The U.S. tax on the Code §1248(a) amount would be $14 ($70 x 20%). Consequently, the Code §1248(b) limitation of $18 would provide no benefit.

In many ways the Code §1248 limitation is similar to a Code §962 election, in that the calculations assume a hypothetical U.S. C corporation is owned by the U.S. individual.

The Code §1248(b) limitation is likely to apply to sales of CFCs located in non-treaty countries that have a moderate or high corporate income tax. Individuals disposing of stock of CFCs located in countries such as Brazil, Argentina, Colombia, Ecuador, Peru, and Uruguay, for example, should investigate whether Code §1248(b) can provide any benefit.

Tags: 1248 Sales of CFCs