The Deemed Dividend Problem

The current position of the IRS is that it has the authority to tax foreign corporations controlled by US residents directly on foreign source income. Moreover, the deemed dividend approach has led to significant complexity and given rise to tax planning opportunities. It is argued that the deemed dividend approach in subpart F is obsolete and should be abandoned in favor of direct taxation of controlled foreign corporations on whatever Congress determines is the appropriate scope of subpart F income. The historical origin of why the deemed dividend approach to subpart F was adopted in 1962 is discussed. Three examples of problems resulting from the deemed dividend approach are examined. An alternative approach based on taxing controlled foreign corporations directly on subpart F income is developed.