The most important part of Form 5471 is not on the Form. The Form is merely the tip of an iceberg.
You maximize your tax savings by knowing the loopholes found in the IRS regulations. Let me say that again. The income tax regulations contain the complex rules of Subpart F income (which is the income that you do not want if you own a small business) that will save you money.
You will find a summary of these tax breaks on the overlooked IRS worksheet (I have it below). This worksheet ties into the IRS regulations.
The worksheet has a section for each type of subpart F income. As you study the international income tax regulations, you will see that most active foreign income is not subpart F. However if your foreign corporation has related party transactions, then it may have subpart F income. The IRS has many exceptions to this general rule in their regulations. Related party transaction includes related party purchases of inventory or services and related party sales of inventory or services.
As you will see on the image of the worksheet, you need to complete page one and two.
On the worksheet, you enter the total of each category of your subpart F income. The worksheet then guides your arithmetic in computing the total subpart F income.
But here is the problem. You must compute the total gross subpart F income yourself. Next, you allocate your overall expenses related to each category.
For example, your foreign corporation manufactures and sells products worldwide. Some of the sales are to a related corporation. Related party sales are often subpart F income (see an exception for contract manufacturing on this link). You compute your gross income (this is the sale price minus the cost of the good sold).
You enter this amount on the form on line 3 (regarding foreign base company sales income). Next, you get some special tax breaks on line 15. On page 2 of the worksheet, you complete line 19 by including the amount from line 15.
And there are more tax savings to come on page 2 of the Form 5471 worksheet.
Lines 26, 27, 28 and 29 involve heavy duty tax planning. They include the concept of “earnings and profits“. U.S. corporate taxation (for both a domestic corporation and a foreign corporation) focuses on earnings and profits.
To save taxes, you need to be an expert in this concept. You want your CPA to know this concept like the back of his hand. You can test your CPA by asking him about this. If the answer is vague, this means you need someone else to prepare the Form 5471.
Lastly, you take the amount from page two line 38(b) to line 1 of Form 5471 Schedule I.
Smart tax planners use this worksheet to monitor their taxable subpart F income. This means you should be preparing a proforma worksheet after the six months of your year. As you read the worksheet, your will see other IRS tax saving ideas such as related party interest expense.