patrickbland, jd, mba, llm

Previously Taxed Income and Ordering Rules

• Previously Taxed Income and Ordering Rules   p.546

1. Three levels of possible income recognition:

• Subpart F
• §956 - investment in U.S. property
• Actual dividend distribution.
• See §959(c) re order of distributions - (§956 income first, then Subpart F income).

1. If previously taxed, nontaxable distributions not carrying out foreign tax credits.
2. Consider an upstream dividend from a 2nd tier subsidiary (CFC) to a first tier subsidiary (CFC). Subpart F (FPHC) income? Yes, unless previously included in shareholder income under §951(a). See §959(b).   P. 548
3. Consider a sale of stock and CFC income previously included as Subpart F income in seller’s income. Inclusion again? No,   §959(a).   P. 548

• Treatment of Stock Sale Gain as Ordinary Income

1. Gain realized on the disposition of the CFC stock investment is (partly) treated as dividend income.
2. §1248 transforms cap gain into a dividend distribution to the extent of 10% shareholder's allocable E&P, limited to amount of stock gain.
3. Is §1248 treatment preferred? Yes, for a corporate shareholder, since the deemed paid FTC is available.   Reg. §1.1248-1(d).
4. And, no foreign withholding tax if a stock sale (rather than if an actual dividend distribution)?
5. Avoiding §1248 by individual – hold until death.
6. §1248(b) limits the tax attributable to the deemed dividend.
7. Deemed dividend under §1248 does not reduce the CFC’s E&P.
8. §959(e) treats §1248 deemed dividend as previously taxed E&P and, therefore, not subject to tax on a later distribution.
9. E&P reduced when a subsequent nontaxable distribution is actually made. §959(e).

Problems at 6235

• (1)—FACTS: Delft, N.V., a Dutch corporation, all of the voting stock of which is owned by US, Inc., a U.S. corporation, is engaged in manufacturing and selling plastic kitchen utensils in the Netherlands. Consider the possible U.S. tax consequences if a portion of Delft’s surplus earnings is loaned to US Inc or is invested in stock of an unrelated corporation listed on the NYSE. What are the U.S. tax consequences if Delft purchases from an unrelated party the exclusive right to use, manufacture, and sell in the U.S. an invention protected by a U.S. patent for the life of the patent?

1. Online Notes:

• Loan to a related person treated as an investment in U.S. property under §951(a)(1)(B) and §956.
• Similar treatment for purchase of U.S. patent, but not for stock of a NYSE listed company.
• (2)—FACTS: Review the facts of the alternative transactions in Problems 2 and 3 at 6195. What are the tax consequences of those transactions under §951(a)(1)(B) and §956?

1. Online Notes:

• 1) Amount paid by Matterhorn from earnings to USM is an investment in U.S. property to the extent of U.S. obligations. §956(c)(3) and §864(d).
• 2) Loan to unrelated foreign customers of USM is not an investment in U.S. property since not acquiring a trade or business receivable from a related U.S. person. §956(c)(3)(A).

Problem at 6250

• FACTS: Heavy Metal Manufacturing, a U.S. company, owns 80% of the stock of Foreign Base Company, Inc., a controlled foreign corporation within the meaning of §957(a). The other 20% of Foreign Base Company’s stock is owned by Mary, a U.S. citizen. Heavy Metal and Mary have owned all of the stock of Foreign Base Co since its incorporation in 1987. Since that time, Foreign Base Co has $1,200,000 of net earnings from foreign business and investment activities on which it has paid foreign income taxes of $120,000. Only $200,000 of that income and $20,000 of the foreign income taxes paid on the income are attributable to amounts that have been previously included in Heavy Metal’s and Mary’s gross incomes under §951 by reason of the income being Subpart F income. Foreign Base Co has not made any dividend distributions to Heavy Metal or Mary.
  
  During the current year, Heavy Metal sells 1/4^th of its stock interest in Foreign Base Co (i.e., a 20% stock interest), in which Heavy metal has an adjusted basis of $50,000, for $300,000 (its FMV at the time of the sale). Mary sells all of her stock in Foreign Base Co, in which she has an adjusted basis of $50,000, for the same price, $300,000. What are the federal income tax consequences to Heavy Metal and Mary on account of these stock sales? (Do NOT attempt to compute the §1248(b) limitation on Mary’s tax liability. Assume no foreign country imposes income tax on these stock sales.)

1. Online Notes:

• Heavy Metal Tax Consequences
  • Corp. shareholder sells 20% interest in FC for 300k; basis is 50k.   250k cap gain? No.
  • Prior 40k (20% of 200k) included as Subpart F income, and tax of $4,000 (20% of 20k).
  • No prior actual dividends assumed.
  • Stock sale gain is 300k less 50k basis = 250k.
  • §1248 amount: 1.2 mil less 120k tax = 1.08 mil. earnings times 20% = 216k less 40k prior deemed distribution = (i) 176k ordinary income (§1248) and (ii) 74k cap gain & FTC.
  • Mary Tax Consequences
    • Individual sells 100% interest in FC for 300k; basis is 50k. 250k cap gain? No.
    • Prior 40k (20% of 200k) included as Subpart F income, and tax of $4,000 (20% of 20k).
    • No prior actual dividends assumed.
    • Stock sale gain is 300k less 50k basis = 250k.
    • §1248 amount: 1.2 mil less 120k tax = 1.08 mil. earnings times 20% = 216k less 40k prior deemed distribution = (i) 176k ordinary income (§1248) & (ii) 74k cap gain. No FTC.

Missed this class –

• Next class: 6265-6330; Problems: 6330