Can Domesticating a Foreign Corporation Provide Tax Benefits?

 Posted on January 20, 2025 in Taxation Law

The requirements that apply to U.S. taxpayers who own foreign assets can be complex. Steps may need to be taken to ensure that offshore income and assets are reported correctly to the IRS. By reporting information correctly and paying all required taxes, taxpayers can avoid penalties or other issues that could result in financial losses. In some cases, taxpayers may benefit by converting a foreign corporation into a domestic corporation. This may be done by completing an "F reorganization," which is also known as a "domestication transaction."

Understanding the procedures that must be followed and the requirements that must be met when completing an F reorganization can be difficult for those who are not well-versed in the tax laws of the United States. A California tax attorney with experience handling tax issues and an understanding of business formation can provide assistance during this process, ensuring that the correct steps are taken to realize the available tax benefits.

Benefits of Domesticating a Foreign Corporation

U.S. taxpayers and other shareholders of a foreign corporation may prefer to incorporate the company in the United States in order to pursue opportunities that may be available. This may allow them to more easily raise capital in the United States while ensuring that the company can manage domestic assets and grow successfully. Domestic corporations may also be able to take advantage of certain tax benefits, including tax deductions on foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI).

Requirements for an F Reorganization

While there are several types of reorganizations recognized in the Internal Revenue Code, an F reorganization is a reorganization that involves a change in form, identity, or place of organization. A foreign corporation can complete an F reorganization by converting to an equivalent corporation in the United States without making any other substantial changes. In general, the following requirements will apply to complete the domestication of a foreign corporation through an F reorganization:

• Shares of the old foreign corporation must be exchanged for shares of the new domestic corporation.

• The same shareholders must own shares of the new domestic corporation in the same proportions as the shares they held of the old foreign corporation. Shares cannot be issued to new investors as part of the reorganization.

• The new domestic corporation cannot hold any assets prior to the reorganization aside from what may be needed to establish the initial organization of the corporation.

• The old foreign corporation must be fully liquidated.

• The new domestic corporation is the only entity that can hold assets that were previously held by the old foreign corporation.

• The old foreign corporation is the only corporation that may be acquired by the new domestic corporation during the reorganization process.

How an F Reorganization Will Affect Taxes for a Corporation and Its Shareholders

When assets are transferred from an old foreign corporation to a new domestic corporation, this usually will not trigger a taxable gain. However, if a United States real property interest (USRPI) is transferred from the old foreign corporation to the new domestic corporation, and the USRPI has appreciated in value, the transfer may be taxable under the Foreign Investment in Real Property Tax Act (FIRPTA).

Foreign shareholders of a foreign corporation generally will not be required to pay taxes in connection with the corporation’s domestication. U.S. shareholders with a stake of at least 10% in the corporation must include their share of the corporation’s earnings and profits in their taxable income. U.S. shareholders with a stake of less than 10% may include any gain in the value of their stock as part of their income, or their income may include their share of the corporation’s earnings and profits. However, gains will not need to be recognized if the total value of a shareholder’s stock is less than $50,000.

Contact Our San Jose Tax Attorney for Foreign and Domestic Corporations

Understanding when it may be beneficial to domesticate a foreign corporation is not always easy. In these situations, shareholders will need to understand the proper steps to realize tax benefits while avoiding potential penalties. At John D. Teter Law Offices, our San Jose, CA tax lawyer can help shareholders of foreign corporations determine the best steps to take to minimize their tax burdens. Contact us at 408-866-1810 to set up a consultation and learn more about how we can assist with these and other tax-related matters.