Section 962 Election: Taxing CFC Income Inclusions at Corporate Rates

Overview 

In our previous blog on Section 956, we discussed how US individual shareholders of Controlled Foreign Corporations (CFCs) can be subject to additional income inclusions on top of the more commonly known Net CFC Tested Income (NCTI, formerly Global Intangible Low Taxed Income, GILTI) and Subpart F income regimes. A common and often frustrating feature of these regimes is that the deemed income inclusions are taxed at the individual shareholder’s marginal rate, which can be as high as 37%, with no direct ability to offset the US tax with the Canadian corporate tax already paid by the CFC.

Section 962 of the Internal Revenue Code provides an elective relief mechanism. By making a Section 962 election, an individual US shareholder of a CFC can elect to be taxed on these income inclusions as if they were a domestic C corporation. This can significantly reduce the immediate US tax cost, particularly for US citizens living in Canada who own Canadian operating companies, but it also comes with its own complications that should be carefully considered before the election is made.

General Rule

Under Section 962, an individual who is a US shareholder of one or more CFCs may elect, for any taxable year, to be taxed on amounts included in gross income under Section 951(a) – which captures Subpart F income and Section 956 inclusions – and under Section 951A (NCTI inclusions) as if the shareholder were a domestic corporation. The election effectively does three things for the year in which it is made:

• The Subpart F, Section 956, and NCTI inclusions are taxed at the US corporate tax rate of 21%, rather than at the individual’s marginal rate of up to 37%.
• The shareholder is treated as a domestic corporation for purposes of the Section 250 deduction, which provides a deduction against NCTI inclusions and further reduces the effective US tax rate on those inclusions.
• The shareholder is treated as a domestic corporation for purposes of the Section 960 indirect foreign tax credit, which allows the foreign income tax paid by the CFC (such as Canadian corporate tax) to be credited against the US tax on the inclusion.

For US citizens living in Canada who own a Canadian operating company, the third point is often the most impactful. Without the Section 962 election, the Canadian corporate tax paid by the company generally cannot be used to offset the US individual tax on the NCTI or Subpart F inclusion, which can lead to significant double taxation. With the election, the indirect foreign tax credit can often reduce, and in some cases eliminate, the US tax owing in the year of inclusion.

Mechanics of the Election

The Section 962 election is made on an annual basis by attaching a statement to the shareholder’s timely filed (including extensions) US individual income tax return for the year. The statement must include certain prescribed information, such as the name and identifying information of each CFC, the amounts of income included from each CFC under Section 951(a) and Section 951A, the foreign income taxes deemed paid under Section 960, and the distributions received from the CFC during the year.

The election applies only to the year for which it is made. The shareholder can re-evaluate each year whether continuing to make the election remains beneficial. Once made for a given year, the election generally cannot be revoked for that year without IRS consent.

The Trap on Distribution

The Section 962 election is not a permanent free pass. The deemed inclusions, having been taxed in the year of inclusion, become part of the CFC’s previously taxed earnings and profits (PTEP). For regular US shareholders who did not make a Section 962 election, a subsequent actual distribution of PTEP is generally not taxable, because the income was already taxed at the shareholder level.

For a shareholder who made the Section 962 election, the treatment is different. Under Section 962(d), when the CFC actually distributes the previously taxed Section 962 earnings, only the portion of the distribution equal to the US tax actually paid in the year of inclusion is excluded from gross income. Any excess is treated as a taxable dividend in the year of distribution.

This second layer of tax is intended to approximate the result the shareholder would have faced had they actually held the CFC through a US C corporation – a corporate-level tax in the year of earning, followed by a shareholder-level tax on the eventual distribution. The dividend on distribution is taxed at the shareholder’s regular dividend rates. For US citizens living in Canada, the dividend from a Canadian corporation generally qualifies for the lower qualified dividend rates because Canada has a comprehensive income tax treaty with the US, and Canadian withholding tax on the dividend (typically 5% or 15% under the treaty) can generally be credited against the US tax on the distribution.

Illustration

Mike, a US citizen living in Canada, owns 100% of a Canadian corporation that is treated as a CFC for US tax purposes. The Canadian corporation earns $200,000 of active business income in 2025 and pays Canadian corporate tax of approximately $25,000, leaving $175,000 of after-tax earnings retained in the company. Mike does not take any dividend out of the corporation during the year. He is in the highest US marginal tax bracket of 37%.

Assume, for simplicity and ignoring the Section 250 deduction and other adjustments, that the $175,000 of after-tax earnings is fully included in Mike’s US income as an NCTI inclusion.

Without a Section 962 election: The $175,000 inclusion is taxed at Mike’s marginal rate of 37%, resulting in US tax of $64,750. The Canadian corporate tax paid by the company is not creditable at the individual level, so Mike ends up paying close to $90,000 of combined Canadian and US tax on $200,000 of corporate income.

With a Section 962 election: The $175,000 inclusion is taxed at the 21% corporate rate, resulting in pre-credit US tax of approximately $36,750. The $25,000 of Canadian corporate tax paid by the company is deemed paid by Mike under Section 960 and is creditable against the US tax. After the credit, and after applying any available Section 250 deduction, the residual US tax in the year of inclusion is significantly reduced, and depending on the specific facts, the residual tax may be eliminated entirely.

When the Canadian corporation later distributes the $175,000 of after-tax earnings to Mike, the portion of the distribution equal to the US tax actually paid in the year of inclusion is treated as a non-taxable return of PTEP under Section 962(d). The remaining portion is treated as a taxable dividend in the year of distribution, generally subject to qualified dividend rates and reduced by any Canadian withholding tax on the dividend that is creditable in the US.

The result is that the Section 962 election generally defers and reduces the overall US tax cost, but does not eliminate the second layer of US tax on the eventual distribution. The total US tax over the life of the investment depends on the relative size of the corporate-level tax in the year of inclusion and the shareholder-level tax in the year of distribution.

When the Election Makes Sense

The Section 962 election tends to be most beneficial in situations where:

• The CFC pays meaningful foreign corporate tax that would otherwise be stranded at the corporate level without the indirect foreign tax credit.
• The shareholder is in a high individual marginal tax bracket, so the spread between the individual rate and the 21% corporate rate is significant.
• The CFC’s earnings are expected to be retained or distributed gradually, allowing the shareholder-level dividend tax on later distributions to be planned around.

The election is less attractive where the CFC has low or no foreign tax (such that there is no indirect FTC benefit to capture), where the earnings will be distributed in the same year as the inclusion (eliminating the deferral benefit), or where the shareholder anticipates being in a much lower marginal bracket in the future.

It is also worth noting that the recent changes under the One Big Beautiful Bill Act, including the renaming of the GILTI regime to NCTI and adjustments to the Section 250 deduction, have not changed the fundamental availability of the Section 962 election but have affected the precise rate calculations and planning trade-offs that go into deciding whether to make it.

The Section 962 election is one of the most important planning tools available to US individual shareholders of Canadian corporations, but the analysis is highly fact-specific. To discuss whether a Section 962 election makes sense for your Canadian corporation and your particular US tax situation, we strongly recommend reaching out to schedule a cross-border tax and financial planning consultation.