What is Previously Taxed Income (PTI) and how does IRC 959 work for CFC distributions?

IRC Section 959 prevents double taxation of CFC earnings that have already been included in a U.S. shareholder's income under Subpart F (IRC 951(a)) or GILTI (IRC 951A). When a CFC distributes earnings that were previously included in a U.S. shareholder's gross income ("previously taxed income" or PTI), the distribution is excluded from the shareholder's gross income to the extent of the PTI balance. Without this rule, the same income would be taxed once when included under Subpart F/GILTI and again when actually distributed as a dividend.

IRC 959(c) establishes three tiers of CFC earnings for ordering distributions: (1) Section 959(c)(1) — earnings attributable to amounts included under Section 956 (investments in U.S. property); (2) Section 959(c)(2) — earnings attributable to Subpart F and GILTI inclusions that have been previously taxed; (3) Section 959(c)(3) — all other earnings and profits (untaxed E&P). Distributions are treated as coming first from PTI categories (c)(1), then (c)(2), and finally from (c)(3). Only distributions from (c)(3) are taxable as dividends.

U.S. shareholders must maintain detailed PTI accounts for each CFC, tracking: the year the income was included, the category of inclusion (Subpart F vs. GILTI), the amount of PTI and associated foreign taxes, and distributions that reduce the PTI balance. This tracking is done on Form 5471, Schedule J (accumulated E&P) and Schedule P (previously taxed E&P). The final regulations issued in 2023 (T.D. 9982) significantly revised the PTI tracking rules, establishing an annual PTEP (previously taxed earnings and profits) account system with specific ordering rules for distributions and reclassifications.

PTI accounts must be maintained in the CFC's functional currency. When a distribution of PTI is made, the U.S. shareholder must convert the distribution at the exchange rate that applied when the income was originally included. This can result in foreign currency gain or loss — the difference between the exchange rate at inclusion and the exchange rate at distribution. Under the 2023 regulations, detailed rules specify how exchange rates are tracked and applied to each annual PTEP account.

If your CFC distributes a dividend and you have sufficient PTI balance from prior Subpart F and GILTI inclusions, the distribution should be excluded from your income to the extent of PTI. Any distribution in excess of your PTI balance would be taxable as a dividend from the CFC's non-previously-taxed E&P. To properly claim the exclusion, you must have accurate PTI tracking records and complete Schedule P of Form 5471. Your CPA should reconcile the CFC's total E&P with the PTI accounts to determine how much of the planned distribution is tax-free.