International Tax Basics for CPAs: CPA REG Exam Overview
Essential guide to international tax concepts for the CPA REG exam. Covers worldwide taxation, foreign tax credits, GILTI, Subpart F, and transfer pricing fundamentals.
International Tax Fundamentals for CPA Candidates
International tax law has become increasingly important on the CPA REG exam following the Tax Cuts and Jobs Act (TCJA) of 2017, which fundamentally restructured the U.S. international tax regime. CPA candidates need a working knowledge of how the U.S. taxes cross-border transactions, the foreign tax credit mechanism, and the anti-deferral regimes that apply to controlled foreign corporations. While the REG exam does not test international tax at the same depth as a specialized practitioner would encounter, a solid understanding of the foundational concepts is essential.
Worldwide Taxation and the Participation Exemption
U.S. Taxation of Worldwide Income
The United States taxes its citizens, resident aliens, and domestic corporations on their worldwide income, regardless of where it is earned. This creates the potential for double taxation when income earned abroad is also taxed by the foreign country. The U.S. mitigates this through the foreign tax credit (discussed below) and, for corporations, through a participation exemption system enacted by the TCJA.
Section 245A: Dividends Received Deduction
Under Section 245A, a U.S. corporate shareholder that owns 10% or more of a foreign corporation (a "specified 10-percent owned foreign corporation") is entitled to a 100% deduction for the foreign-source portion of dividends received. This effectively creates a territorial system for repatriated earnings, meaning that foreign-source dividends are not taxed at the U.S. corporate level. This deduction does not apply to individual shareholders or to dividends from passive foreign investment companies (PFICs).
Foreign Tax Credit: IRC Sections 901-909
Purpose and Mechanics
The foreign tax credit (FTC) allows U.S. taxpayers to credit income taxes paid to foreign countries against their U.S. tax liability, preventing double taxation. Taxpayers may elect to either credit or deduct foreign taxes; the credit is almost always more beneficial because it provides a dollar-for-dollar reduction in U.S. tax, while a deduction only reduces taxable income.
The FTC Limitation
The credit is limited to the U.S. tax attributable to foreign-source income. The limitation formula is: FTC Limitation = U.S. tax liability x (foreign-source taxable income / worldwide taxable income). This prevents the credit from offsetting U.S. tax on domestic income. Excess credits can be carried back one year and forward ten years.
Separate Basket Limitation
Foreign tax credits must be computed separately for different categories ("baskets") of income: general category income (active business income), passive category income (dividends, interest, rents, royalties), and other specified categories. Credits in one basket cannot offset U.S. tax on income in another basket.
Anti-Deferral Regimes
Subpart F Income: Sections 951-965
Subpart F prevents U.S. shareholders of controlled foreign corporations (CFCs) from deferring U.S. tax on certain types of passive and mobile income. A CFC is a foreign corporation in which U.S. shareholders (owning 10% or more of voting power or value) collectively own more than 50% of the corporation's voting power or value. U.S. shareholders must include their pro rata share of the CFC's Subpart F income in their gross income currently, regardless of whether the income is distributed.
Subpart F income includes foreign base company income (such as foreign personal holding company income, foreign base company sales income, and foreign base company services income) and insurance income. The same-country exception and the high-tax exception may exclude certain income from Subpart F.
GILTI: Section 951A
The Global Intangible Low-Taxed Income (GILTI) provision, enacted by the TCJA, requires U.S. shareholders of CFCs to currently include their share of the CFC's income that exceeds a routine return on tangible assets. GILTI is computed as the CFC's tested income minus 10% of its qualified business asset investment (QBAI, essentially the average adjusted basis of depreciable tangible property). Corporate shareholders receive a 50% deduction under Section 250 (reduced to 37.5% after 2025), and the foreign tax credit for GILTI is limited to 80% of the taxes paid.
FDII: Section 250
Foreign-Derived Intangible Income (FDII) is the domestic counterpart to GILTI, providing a deduction for U.S. corporations on income derived from serving foreign markets. The FDII deduction is 37.5% (reduced to 21.875% after 2025), resulting in a lower effective tax rate on export-type income.
CPA Exam Tips
- Know the FTC limitation formula and the separate basket requirement.
- Understand the basic structure of Subpart F: who is a U.S. shareholder, what is a CFC, and what types of income are included.
- GILTI = tested income minus 10% of QBAI; corporate shareholders get a 50% deduction.
- Section 245A provides a 100% dividends received deduction for corporate shareholders of specified foreign corporations.
- The REG exam tests concepts and computations, not highly technical international tax planning.
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