Let’s Talk About the Sec 962 Election

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With that said, Section 962 requires that subpart F and NCTI inclusions be included in the individual CFC shareholder income again to the extent that it exceeds the amount of the U.S. income tax paid at the time of the Section 962 election. In other words, depending on the CFC’s E&P, a 962 election generates a second layer of tax as if the CFC shareholder received a dividend from a C corporation. Whether or not a 962 election will leave the U.S. shareholder in a “better place” in the long run depends on a number of factors.

Translation of Foreign Currency Issues

Anyone considering making a 962 election must understand there will likely be foreign conversion issues. A CFC will probably use a foreign currency as its functional currency. Anytime a 962 election is made for a CFC which has a functional currency that is not the dollar, the rules stated in Section 986 of the Internal Revenue Code must be used to translate the foreign taxes and E&P of the CFC. Section 986 uses the average exchange rate of the year when translating foreign taxes.

Making a 962 Election on a Tax Return

The IRS must be notified of the Section 962 election on the tax return. There are no special forms that need to be attached to a tax return. However, the individual making a 962 election file the federal tax return with an attachment. According to the 962 regulations, the attachment making the 962 election must contain the following information:

1. Names, address, and taxable year of each CFC to which the taxpayer is a U.S. shareholder.
2. Any foreign entity through which the taxpayer is an indirect owner of a CFC under Section 958(a).
3. The Section 951(a) income included in the Section 962 election on a CFC by CFC basis.
4. Taxpayer’s pro-rata share of E&P and taxes paid for each applicable CFC.
5. Distributions actually received by the taxpayer during the year on a CFC by CFC basis with details on the amounts that relate to 1) excludable Section 962 E&P 2) taxable Section 962 E&P and 3) E&P other than 962.

The IRS does not challenge the validity of a Section 962 election itself, as it is a Congressionally sanctioned statutory right. However, the IRS frequently audits and challenges procedural compliance, underlying calculations, and the eventual taxation of distributions.

Because Section 962 allows individual shareholders to access corporate tax rates and foreign tax credits (FTCs), it is heavily scrutinized during international tax audits.

Common Ways the IRS Challenges a 962 Election

1. Procedural Defects & Timeliness

• Late Filing: A Section 962 election must be made annually and attached to a timely filed individual tax return (including extensions). The IRS will invalidate an election if it is attached to a late return without formal reasonable cause relief.

• Missing Disclosure Statements: There is no official IRS form for a Section 962 election; instead, taxpayers must attach a detailed, customized statement. The IRS can challenge the election if the statement fails to itemize critical data, such as your pro-rata share of earnings & profits (E&P), foreign taxes paid, or a clear CFC-by-CFC breakdown.

2. Substantiation of Foreign Tax Credits (FTCs)

• Loose Bookkeeping: Under a Section 962 election, individuals claim indirect foreign tax credits under Section 960 as if they were a corporation. During an audit, the IRS will scrutinize local tax receipts, corporate E&P calculations, and allocations to ensure you are actually entitled to the credits claimed.[1, 2, 3]

• Failure to File Supporting Schedules: A common mistake that triggers an IRS audit is electing Section 962 but failing to attach corporate-style documentation, such as Form 1118 (Foreign Tax Credits—Corporations), to support the corporate tax treatment.

3. Miscalculating the Section 250 Deduction

• Substantiation of NCTI/GILTI: The IRS will verify your Net CFC Tested Income (NCTI) figures and how you applied the Section 250 deduction (which is reduced to 40% starting in 2026). If the underlying numbers on your Form 8992 are inaccurate, the IRS will adjust the deduction and assess deficiencies.

Summary for Taxpayers

The IRS will not deny you the right to treat your CFC income under a Section 962 corporate framework. However, they will challenge you if your administrative paperwork is incomplete, if your foreign tax records are weak, or if you improperly characterize distributions later on.

Anyone considering making a 962 election should have hypothetical computations of federal tax liabilities with and without the Section 962 election prepared before the election is actually made. Only through a hypothetical computation can a CFC shareholder know if he or she will reduce his or her federal tax liability through a 962 election. If a CFC is more interested in deferring his or her tax liability than obtaining tax savings, a 962 election may provide a deferral of tax. However, the deferral of tax should be weighed against a potential increase in tax liability as a result of a 962 election. Anyone considering a 962 election should also consider an election to defer tax under Section 954 of the Internal Revenue Code.