Lincoln Corporation,which has a 34% marginal tax rate,owns 50% of the stock of a controlled foreign corporation (CFC).At the beginning of the year,Lincoln's basis in its CFC stock was $100,000.The CFC's current year income was $1 million,$600,000 of which was subpart F income.The CFC paid no foreign income tax and distributed no dividends.What is Lincoln's tax basis in its CFC stock at the end of the taxable year?

Question

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Under the Subpart F rules, U.S. shareholders of a controlled foreign corporation (CFC) are required to include their pro-rata share of the CFC’s subpart F income in their taxable income for the year, regardless of whether or not the income is distributed. However, they are allowed a deemed paid foreign tax credit for the foreign income taxes that would have been paid on that income.

In this case, Lincoln Corporation owns 50% of the CFC, so it must include 50% of the CFC's subpart F income in its taxable income, which is $300,000 ($600,000 x 50%). Since the CFC paid no foreign income tax, Lincoln is not entitled to a deemed paid foreign tax credit. Therefore, Lincoln's taxable income for the year includes the full $300,000 of subpart F income.

However, Lincoln's basis in its CFC stock is also increased by the same amount as its income inclusion, which means that Lincoln's basis in its CFC stock will be $400,000 ($100,000 beginning basis + $300,000 income inclusion). Therefore, the correct answer is (C) $400,000.

Lincoln Corporation,which Has a 34% Marginal Tax Rate,owns 50% of the Stock