Section 1248: Selling Your Foreign Company as a US Owner

How is selling shares in a foreign company taxed for a US owner?

Gain on selling shares in a company abroad is normally capital gain: the price minus your cost in the shares. If you held the shares more than one year, the federal rate on the gain is at most 20% (IRS: Publication 544). Capital gains and dividends also count toward the net investment income tax of 3.8% above its income thresholds (IRS: net investment income tax).

Section 1248 changes that for larger owners. If the company was a controlled foreign corporation (CFC) while you held 10% or more of its vote, part or all of the gain is taxed as a dividend instead (26 U.S.C. 1248). Profits the company kept that were never taxed to you are taxed as a dividend inside the sale.

What makes a sale not simple:

• Two countries. The other country may tax the sale too, and the US may not give a full credit for that tax.
• Missing earnings records. Without a year-by-year earnings figure, the whole gain can be treated as a dividend.
• Missed Form 5471 years. The sale needs those years' figures, and missed years often hide CFC income that should have been reported in them.
• Deal shape. A share sale, an asset sale and a liquidation are taxed differently, and the choice is made before signing.

What to gather:

1. Your share purchase records and cost, plus any capital you added.
2. The company's financial statements for every year you owned it while it was a CFC.
3. Your Forms 5471 and the CFC income you already reported each year.
4. Foreign tax the company paid each year, and any foreign tax on the sale.
5. The sale agreement, closing statement and the date the shares changed hands.
6. Who owns the company's shares, including family members and other companies you own.
7. Where you lived and worked in the sale year (your tax home).

When does section 1248 turn gain into a dividend?

Section 1248 applies when two tests are met. You are a US person, and at any time in the 5-year period ending on the sale date you owned 10% or more of the total voting power while the company was a CFC (26 U.S.C. 1248(a)). Shares held through other entities and by certain family members count toward the test, using the CFC ownership rules.

A foreign company is a CFC when US shareholders together own more than 50% of its vote or value (26 U.S.C. 957(a)). A US shareholder is a US person with 10% or more of the vote or value (26 U.S.C. 951(b)). Section 1248 itself counts vote only: an owner with 10% of the value but less of the vote can owe CFC income each year yet sell outside section 1248. A company you own alone or with US family members is usually a CFC. For how ownership is counted, see US owners of foreign companies.

The rule also reaches transactions treated as a sale, such as a complete liquidation, which the law treats as an exchange of your shares (26 U.S.C. 331).

How much of the gain becomes a dividend?

The dividend part is the smaller of your gain and your share of the company's earnings and profits from the years you held the shares while it was a CFC, minus earnings already taxed to you. The rest of the gain stays capital gain.

Earnings and profits are, roughly, the company's profits figured under US tax rules. They are figured under US rules, much like a US corporation's, not from the local accounts as filed (26 U.S.C. 1248(c)). Earnings already included in your income under the CFC rules are left out, so they are not taxed twice (26 U.S.C. 1248(d)(1)). That covers subpart F income (mainly passive and certain related-party income) and net CFC tested income (called global intangible low-taxed income, or GILTI, in earlier years), which the law treats the same way for this purpose (26 U.S.C. 951A).

Earnings from years before you bought the shares, or years when the company was not a CFC, do not count. If the company owns lower-tier foreign companies, their earnings can count too.

In the year of sale, you may also have to include your share of the company's subpart F income and net CFC tested income for the part of the year you owned the shares. That inclusion goes on the return for the year that includes your last day of ownership (26 U.S.C. 951(a)(2) and (3)). It raises your cost in the shares and is left out of the section 1248 dividend, so the same earnings are not taxed twice. This part-year rule applies to company years beginning after 2025. If the company's year began in 2025, the old rule applies: only the owner on the last day of that year includes its subpart F income.

Is a section 1248 dividend taxed at qualified dividend rates?

A section 1248 dividend can be a qualified dividend, taxed at capital gain rates, if the company is a qualified foreign corporation and the other qualified dividend rules are met. The IRS said so in Notice 2004-70. Otherwise it is taxed at ordinary rates, up to 37%.

Broadly, that means a company covered by an approved US income tax treaty, incorporated in a US territory, or traded on a US exchange, and not a passive foreign investment company (PFIC); a company in a non-treaty place such as Hong Kong does not qualify (IRS: Publication 550; 26 U.S.C. 1(h)(11)(C)). For a 10% US shareholder of a CFC, the company is usually not treated as a PFIC, so that exception rarely bites. The full test is in dividends from your foreign company.

When the dividend is not qualified, section 1248(b) can still cap the US tax on it for an individual who held the shares more than one year. Roughly, the cap is the extra US corporate tax the company would have owed on those earnings after its foreign taxes, plus capital gain tax on the rest. Using the cap requires proof of the foreign taxes the company paid (26 U.S.C. 1248(b) and (h)).

What if I can't prove the company's earnings?

If you cannot establish the earnings and profits figure, the whole gain is treated as a dividend (26 U.S.C. 1248(h)). The regulation sets out how to establish it: attach a schedule to your return for the year of sale, filed by the due date including extensions (26 CFR 1.1248-7). If the figures will not be ready by the regular due date, extending the return gives more time.

The schedule shows your name, address and identifying number, the earnings and profits attributable to the shares sold, and, for each company year in your holding period, items such as:

• The company's name, country and year end.
• Earnings and profits for each year, figured under the regulations.
• Shares you held and shares outstanding.
• Amounts already included in income under the CFC rules for those shares.

You must be able to support each number if the IRS asks. An omission or error is excused only if it was inadvertent or due to reasonable cause, you otherwise substantially complied, and you correct it when you prove the figures. If you also want the section 1248(b) cap, the company's foreign taxes must be established the same way.

Rebuilding US-basis earnings for many years from local accounts is the slow part. It goes faster when the earlier Forms 5471 were complete.

Does my earlier CFC income raise my cost in the shares?

Yes. Amounts you included in income under the CFC rules increase your cost (basis) in the shares, which lowers the gain (26 U.S.C. 961(a)). Net CFC tested income counts for this too (26 U.S.C. 951A).

Distributions of those already-taxed earnings reduce the basis again. So your cost generally starts with your purchase price and capital you added, rises by past inclusions, and falls by distributions of already-taxed earnings. If you made a section 962 election for a year, that year's inclusion raises your basis only by the US tax you paid on it (26 U.S.C. 961(a)). Form 5471 Schedule P tracks these previously taxed earnings (IRS: Instructions for Form 5471). For dividends paid before the sale, see dividends from your foreign company.

Can I credit foreign tax paid on the sale?

Often not in full. For a US citizen or resident whose tax home is in the US, gain on selling shares is US-source income (26 U.S.C. 865(a)). The foreign tax credit limit allows credit only against US tax on foreign-source income, so foreign tax on a US-source gain may not be usable.

Three situations can change this:

Whether a treaty re-sources the gain depends on that treaty's gains article. For categories, limits and carryovers, see foreign tax credit limits and carryovers.

What changes if the buyer wants the company's assets, not the shares?

In an asset sale, the company sells and owes local tax on its own gain. For the US, the gain becomes part of the company's income for that year, and some or all of it may be included on your return under the CFC rules. Getting the cash out afterward is a dividend or a liquidation, and a liquidation is treated as a sale of your shares, so section 1248 can apply then (26 U.S.C. 331).

An entity classification election (Form 8832) made before a sale changes what is sold. If the company elects to be treated as a disregarded entity (one owner) or a partnership, the IRS treats that as the company distributing all its assets to its owners in liquidation (IRS: Form 8832 and instructions). That deemed liquidation can itself trigger section 1248 on the company's earnings, before the buyer pays anything. After that, selling a company treated as disregarded is a sale of its assets, each with its own character; selling an interest in a company treated as a partnership follows the partnership rules. The foreign country still taxes the company and the sale under its own rules.

Whether and when a foreign company can still elect is covered in information forms for a foreign company.

Compare the after-tax result of each structure before signing. For a US business sale, see selling your business.

What do I file for the year of sale?

The sale year usually needs these:

Missing Form 5471 information carries a penalty of $10,000 for each company and year (IRS: Instructions for Form 5471), and can keep the return open to assessment. If earlier years were never filed, see late foreign company information returns before filing the sale year. For final-year forms when the company is wound up, or when the business abroad is a branch or partnership, see information forms for a foreign company.

What if I own a small stake or the company is not a CFC?

Section 1248 then does not apply, and the gain is capital gain under the normal rules, unless the company is a PFIC, where gain can be taxed as ordinary income with an interest charge. See PFIC rules for investing abroad.

Example

All figures are in US dollars and illustrative.

Sole owner of a company in China

A US citizen sells 100% of a Chinese operating company for $1,500,000. Her cost is $200,000, so the gain is $1,300,000. While she owned it, the company was a CFC and built up $500,000 of earnings and profits never included in her income (for example, because the high-tax exclusion was elected each year).

• Section 1248 dividend: $500,000. China's treaty with the US is on the approved list, so the dividend can be a qualified dividend if the other rules are met.
• Capital gain: $800,000, on Form 8949 and Schedule D.
• She attaches the section 1248 schedule and files Form 5471 with Schedule O.

Hong Kong company already taxed each year

A US resident owns 100% of a Hong Kong trading company. Over five years, $900,000 of its profits were included in his income under the CFC rules, and $100,000 of other earnings were never taxed. He sells for $1,600,000; his purchase cost was $100,000.

• Year 1 to year 5: nothing was paid out, so inclusions raise his basis from $100,000 to $1,000,000.
• Sale year: gain is $600,000, not $1,500,000.
• Section 1248 dividend: $100,000, the untaxed earnings only. Hong Kong has no US income tax treaty, so this dividend is not qualified and is taxed at ordinary rates, subject to the section 1248(b) cap.
• Capital gain: $500,000.

No earnings records

An owner sells a CFC he has held for 10 years for a $400,000 gain. The company's books were kept only for local filings, and no Forms 5471 were filed. He does not rebuild the earnings figures before the extended due date of the sale-year return.

• The whole $400,000 is treated as a dividend, and without proof of the company's foreign taxes the section 1248(b) cap is not available.
• The missed Forms 5471 often hide missed income too, such as subpart F income or GILTI. Correcting those years changes both the dividend part and his cost in the shares.

Different for you?

• You have an offer and have not signed. Share sale, asset sale or a pre-sale election lead to different US and foreign tax; compare them first through cross-border tax help.
• The other country taxes the gain, for example you live in Canada and sell a company there. Your tax home, treaty re-sourcing and credit limits decide whether that tax is usable: see foreign tax credit limits and carryovers and cross-border tax help.
• Forms 5471 were never filed. Fix the earlier years before or with the sale-year return: see late foreign company information returns and cross-border tax help.
• The company's books were kept only for local filings. Rebuilding US earnings and profits year by year decides how much of the gain is a dividend; start before the return is due through cross-border tax help.
• The company paid you dividends before the sale. See dividends from your foreign company.
• You are closing the company, or it is a branch or partnership. See information forms for a foreign company.
• You own a small stake or a fund-like company. See PFIC rules for investing abroad.
• It is a Canadian company and you are moving across the border. See moving across the border with a company.
• The business you are selling is in the US. See selling your business.