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Estimated tax planning opportunity available for subpart F income.

In Letter Ruling (TAM) 9233001, the IRS held that a large corporation was not required to include subpart F income when computing its quarterly installments under the annualized income installment method for estimated tax purposes. This clarification provides a planning opportunity for U. S. shareholders of controlled foreign corporation (CFC) shares when determining the appropriate amount of estimated tax payments to avoid underpayment of tax penalties.

In general, corporations must make quarterly estimated tax payments equal to 25% of the lesser of 90% of the current year's tax liability or 100% of the prior year's tax liability, to avoid the imposition of underpayment penalties under Sec. 6655. However, the ability to make payments based on the prior year's liability is not available to a corporation earning more than $1 million of taxable income in any of the three preceding years (a "large corporation") with the exception of the first quarter installment if certain conditions are met. (The 90% is increased to 93% for tax years beginning after Jan. 1, 1992 and before July 1, 1992. For tax years beginning after June 30, 1992 through Dec. 31, 1997, the percentage is 97%.)

A corporation may be able to reduce its required installment payment for any quarter below the amount determined above by using the annualized income installment method provided by Sec. 6655(e). The annualized income installment method is determined based on 90% (or 93% or 97%, as noted) of the amount the corporation would owe if its estimated tax was computed on annualized taxable income for certain months preceding an installment due date. For example, the fourth required installment for the tax year would be determined by placing income for the first nine or 11 months of the tax year on an annualized basis. Accordingly, income earned in the twelfth month of the tax year is not taken into account under the annualized income installment method.

Under Sec. 951, a 10% U.S. shareholder that owns stock in a CFC on the last day of the CFC's tax year (or the last day in such year that the corporation was a CFC) must include its pro rata share of the CFC's subpart F income for that tax year in its gross income, regardless of whether the CFC actually makes a distribution to the U.S. shareholder. Subpart F income generally includes, among other things, passive income and certain categories of income earned outside the CFC's local country. Since this inclusion is generally dependent on the taxpayer being a shareholder of the CFC on the last day of the CFC's tax year, the Service held that the related income inclusion was deemed to occur on that date.

Under the facts of Letter Ruling 9233001, in which the CFC's tax year coincided with the shareholder's tax year, the subpart F income was included in gross income on the final day of the shareholder's tax year. Therefore, such income did not have to be considered in computing the shareholder's fourth-quarter estimated tax payment (or any prior quarterly payment), determined using the annualized income installment method, because it was earned after the eleventh month of the taxpayer's tax year.

Corporations deemed to receive subpart F income during the tax year should consider analyzing their income for estimated tax purposes. Doing so may provide the opportunity to defer the payment of the tax liability associated with such income without the imposition of an underpayment penalty. For example, a more-than-50% U.S. shareholder, whose CFC's required tax year-end must either coincide with or begin no earlier than one month before the majority shareholder's tax year, can benefit from this deferral technique, by basing its fourth installment payment on annualized nine-month or 11-month income in the case of coinciding year-ends or annualized nine-month income in situations with a one month "lag." In this case, the payment of tax can be deferred until the original due date of the income tax return reflecting such income. For CFCs owned 50% or less, but at least 10%, deferral opportunities may also exist, depending on the CFC's year-end. As in the case of the more-than-50% stockholder with a one month "lag," however, caution must be exercised in choosing the proper annualization period to insure the deferred benefits.
COPYRIGHT 1993 American Institute of CPA's
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Author:Andres, David K.
Publication:The Tax Adviser
Date:Jul 1, 1993
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