U.S. persons are taxed in the U.S. on their worldwide income. Foreign persons (nonresident aliens and foreign corporations) are only taxed by the U.S. on income originating in the U.S. In addition, foreign persons are not taxed by the U.S. on certain types of investment income originating in the U.S., such as interest income earned on bank deposits and U.S. nonbusiness capital gains (other than gains on real property). As a result, some U.S. persons may attempt to structure their income earning activities through foreign entities, hoping to take advantage of the differences in the way we tax U.S. persons as compared to foreign persons.
Congress has adopted several complex sets of rules to keep U.S. persons from using foreign entities to defer or avoid U.S. taxes in ways Congress deemed improper. Those sets of rules include special tax consequences for U.S. persons who transfer property to or own the following:
- Controlled foreign corporations (IRC §§ 951-964)
- Passive foreign investment companies (IRC §§1291-1298)
- Controlled foreign partnerships (§ 6038 & § 6038B)
- Foreign grantor trusts (IRC §§ 671-679)