The Section 962 Election: Accessing Corporate Tax Rates on CFC Income as an Individual

Individual US shareholders of controlled foreign corporations face a brutal disparity: when a US corporation holds CFC stock, it pays 21% on Subpart F and NCTI inclusions and can take a 40% Section 250 deduction on NCTI. When an individual holds the exact same CFC stock, they pay up to 37% on those same inclusions with no Section 250 deduction. The Section 962 election is the individual's mechanism to opt into corporate-level tax treatment for those inclusions - but it comes with a second-layer tax on subsequent distributions that must be carefully modeled before electing.

What the Section 962 Election Does

IRC §962 allows an individual US shareholder of a CFC to elect to be taxed on their Subpart F income inclusions (IRC §951) and NCTI inclusions (IRC §951A, as renamed by OBBBA) as if they were a domestic corporation. The consequences of the election are:

• 21% corporate rate applies to the inclusions instead of up to 37% individual rate.
• Section 250 deduction for NCTI inclusions is available (40% deduction, reducing the effective rate on NCTI to approximately 12.6% before foreign tax credits).
• Deemed-paid foreign tax credit under IRC §960 is available to offset the US tax on the inclusions, just as it would be for a domestic corporation.
• Second-layer tax applies when the CFC later distributes earnings that were previously included under the election, to the extent the distribution exceeds the US income tax paid on the inclusion (§962(d)). See below.

The Second-Layer Tax: The Critical Catch

The §962 election does not permanently cap the tax on CFC income at the corporate rate. When the CFC later distributes earnings that were previously taxed under the §962 election, the individual shareholder pays a second layer of tax - but only to the extent the distribution exceeds the US income tax already paid on the inclusion (§962(d)).

Under IRC §962(d), when a distribution is made out of earnings previously included under the §962 election, those earnings are included in the individual's income again - but reduced by the §962 tax already paid on those earnings. The mechanism effectively collects the difference between the 21% corporate rate paid at inclusion time and what the individual would have paid on a dividend from a US corporation (qualified dividend rate of 20% + 3.8% NIIT = 23.8% for high earners).

This simplified example (it ignores the §78 gross-up and the 10% haircut on the §960(d) credit) shows that the election can eliminate the current US tax through the FTC but defers rather than eliminates the individual-level tax on distributions: the later distribution is taxed at $238,000 here, versus $370,000 of US tax on the inclusion without the election, where no §960 credit is available. The comparison depends on whether and when the CFC distributes, the individual's rate on the dividend, and the foreign tax rate.

When the §962 Election Wins

The §962 election produces a clear benefit when:

• The CFC is in a low-tax jurisdiction and the FTC does not fully offset the US tax. The §250 deduction on NCTI (reducing the inclusion by 40%) directly reduces the tax burden at inclusion time.
• The individual does not expect the CFC to distribute earnings in the near term. Deferring the second-layer tax has a time value of money benefit.
• The individual expects to be in a lower tax bracket in the future (retirement, change in circumstances) when distributions are eventually made.
• The CFC earnings will be reinvested offshore or in subsequent transactions rather than distributed - in which case the second-layer tax may never be triggered during the individual's lifetime (though the estate will eventually face it).

Mechanics of Making the Election

The §962 election is made on the individual's timely filed US federal income tax return (Form 1040) for the year in which the Subpart F or NCTI inclusion is reported. Treas. Reg. §1.962-2(b). The election is made by attaching a statement to the return specifying:

• The name and address of each CFC with respect to which the election applies;
• The amount of Subpart F income and NCTI included for each CFC;
• The earnings and profits of each CFC; and
• The foreign income, war profits, excess profits and similar taxes paid on or with respect to those earnings and profits, and the distributions received from each CFC (Treas. Reg. §1.962-2(b)).

The election applies to all CFCs for which the shareholder has a §951(a) inclusion for the year; it cannot be limited to some CFCs (Treas. Reg. §1.962-2(c)(1)). It is binding for that year and can be revoked only with Commissioner approval (Treas. Reg. §1.962-2(c)(2)). The election is also year-by-year: making the election in one year does not bind you to make it in subsequent years. However, once you have made the election for a given year's inclusions, those inclusions are locked into the §962 regime for purposes of the second-layer tax on future distributions.

Post-OBBBA: §962 and the New NCTI Rate Structure

OBBBA modified the §250 deduction from 50% to 40% for NCTI (formerly GILTI). At the 21% corporate rate with a 40% §250 deduction, the effective rate on NCTI under §962 is approximately 12.6% before foreign tax credits. This is more favorable than the pre-OBBBA §250 deduction of 50% would suggest - OBBBA also eliminated the QBAI (Qualified Business Asset Investment) exemption, meaning all tested income (except Subpart F) is now NCTI, but the 40% §250 deduction provides partial relief.

For high-income individuals with CFC investments in jurisdictions with effective tax rates below 12.6%, the §962 election with the §250 deduction can significantly reduce the current-year US tax burden on NCTI inclusions - at the cost of the future second-layer tax on distributions.