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Why a Section 962 Statement is Necessary

Portrait of Phil Hodgen

Phil Hodgen

Attorney, Principal


On July 10, 2020 I will  present a live Section 962 webcast that goes into excruciatingly painful detail about preparing a Section 962 tax return.

This is the first draft of my notes for the part of the presentation that talks about where the rubber meets the road:  the Section 962 Statement.

I probably won't publish the notes as part of the webcast, but I will be sharing drafts on the blog. Later, there will be a complete recorded webcast/course materials package available.

Sign up to get the early-bird pricing here.

Part 5 describes how you prepare the Section 962 Statement. There is no tax form created just for the individual taxpayer making a Section 962 election, so the Section 962 Statement requirement is the government's way of telling you to do the government's job at your expense.


Let's look at why a statement is needed at all. The answer, in brief, is to fill an information gap.

The IRS wants to see tax data connecting gross income to tax liability computations. The IRS would love to see the underlying data as well, but at the moment this is not feasible for all types of income. By having access to information from transaction to tax return, the IRS reduces the opportunity for taxpayers to fib.

Form 1099 income is an example of a "raw data to tax liability" data trail available to the IRS. Computers can easily check for omitted gross income, simply by cross-checking the issuance of a Form 1099 by the payor against the existence of a gross income item on the payee's tax return.

The Section 962 election creates an information gap. The Section 962 Statement bridges that gap.

Example 1. No Section 962 Election

To show why a Section 962 Statement is needed and required, let's look a taxpayer who does not make a Section 962 election. Let's see how Subpart F income flows from one tax form to another, providing the government with a clear view of the taxpayer's taxable income -- and therefore, the correct tax liability.

From Data to Form 5471, Schedule I

Assume an individual U.S. shareholder of a controlled foreign corporation prepared his/her Form 1040 and does not make the Section 962 election.

The controlled foreign corporation's financial data will be invisible to the IRS without a hands-on audit. That's the cloud-shaped mystery at the far left of the diagram, and this is what the IRS expects.

It is your job to take the raw financial data and fill in the blanks on Form 5471, Schedule I, lines 1a - 1f. This is where the controlled foreign corporation's Subpart F income is revealed to the IRS. Other items are reported on Schedule I, but they are not important for this example.

From Form 5471, Schedule I to Form 1040, Schedule 1

Next, the United States shareholder's pro rata share of the controlled foreign corporation's Subpart F income items calculated from the total values on Form 5471, Schedule I, then reported on Form 1040, Schedule 1, line 8.

You can see a possible discontinuity. Form 5471, Schedule I shows 100% of the total Subpart F income. What if the United States shareholder owns less than 100% of the controlled foreign corporation? Prudence suggests filling in gaps like these with a "roll your own" statement, even when not required. Your tax returns will be more coherent.

From Form 1040, Schedule 1 to Form 1040

Gross income from Form 1040, Schedule 1 -- including Subpart F income listed on line 8 -- is inserted on Form 1040 on line 7a. As a result, the pro rata share of Subpart F income is part of the individual shareholder's gross income.

After various adjustments and deductions, the taxpayer's taxable income is calculated at Form 1040, line 11b.

This information chain -- from Form 5471, Schedule I, to Form 1040, Schedule 1, to Form 1040 -- gives the IRS a complete picture. The only opaque part of the picture (to the IRS) is the raw financial data at the controlled foreign corporation level. Penalties (and worse) are used to encourage the taxpayer to tell the truth there.

Tax Liability

Calculating income tax liability is a trivial exercise. Tax is reported at Form 1040, line 12a.

Now the government does not have a tax liability question to answer. The gross income information has been reported, and the tax calculation formula is mechanical. The government just has an accounts receivable problem to solve. :-)


A United States shareholder who does not make the Section 962 election will prepare and file a tax return that gives the IRS enough information to assure that the correct tax liability has been computed by the taxpayer.

The threat of audit (and its consequences) is used to keep the taxpayer honest with the underlying accounting data at the controlled foreign corporation level.

Example 2. Section 962 Election, No Statement

Now let's assume the individual United States shareholder makes the Section 962 election. Let's see how Subpart F income data will flow from one form to the next.

Diagram 02

Again, start with the controlled foreign corporation's financial data. The tax professional -- you! -- will take the financial data and prepare Form 5471, Schedule I to show the corporation's total Subpart F income.

From here, the train goes off the tracks:

  • Section 962 tells the electing individual United States shareholder to NOT include the Subpart F income in gross income -- the normal way of computing tax liability.
  • Instead, the taxpayer computes tax liability using corporate tax principles, and include *only the tax liability* on his/her income tax return, at Form 1040, line 12a.

How can the IRS follow the data trail from Form 5471, Schedule I (the controlled foreign corporation's total Subpart F income) to the individual United States shareholder's tax liability? There are obvious missing steps.

  • How can the IRS easily verify that the correct amount of gross income was taken into account for the United States shareholder?
  • How can the IRS verify that the taxpayer computed the tax liability correctly?

The Section 962 Statement solves that problem.

Example 3. Section 962 Election, With Statement

Reg. §1.962-2(b) requires the taxpayer to prepare and attach a statement. The statement bridges that critical data gap to make the government's job easier.

Diagram 03

The Section 962 Statement includes gross income inclusions and tax liability computations. Other basic information is provided. The IRS has a complete picture of how the controlled foreign corporation's Subpart F income ends up creating that precise income tax liability reported by the individual United States shareholder on his/her Form 1040.


That's the simple explanation. Now you know why the Section 962 Statement exists.

In the next chapters we will talk about what information is required for the Section 962 Statement. And, just as importantly, we will talk about how to prepare a good Section 962 Statement.