Foreign Branch vs Foreign Subsidiary — U.S. Tax Differences
Reviewed by the Fairlight Accounting cross-border tax team — U.S. & Canadian Tax Desks
A foreign branch is a business a U.S. person operates abroad directly — or through an entity the U.S. disregards — so the foreign income is part of the owner's own return. A foreign subsidiary is a separate foreign corporation the U.S. person owns. The local country may see both as "a company." The U.S. treats them in opposite ways on timing, losses, forms, and credits.
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When is the foreign income taxed in the U.S.?
- Branch: immediately. Profit is included on the owner's return in the year earned, as if the business were in Ohio. For an individual, that means Schedule C and self-employment tax, with the foreign earned income exclusion available for services income.
- Subsidiary: also largely immediately for an individual or small owner, through net CFC tested income (formerly GILTI) and subpart F — but as an inclusion with different character, no exclusion, and by default no credit for the company's foreign tax unless the Section 962 election is made. The deferral that subsidiaries once offered is mostly gone; what remains is a difference in mechanics and rate.
What happens to losses?
- Branch: losses flow through to the owner's return and offset other income, subject to normal limits. For corporate owners, the dual consolidated loss rules can restrict using a foreign branch loss that is also used abroad.
- Subsidiary: losses stay in the foreign corporation. They can reduce the company's future local tax, but a tested loss isn't carried forward for the U.S. net CFC tested income computation, and losses never reach the owner's return directly.
For a new venture expected to lose money at first, this difference alone often decides the structure.
Which U.S. forms apply?
- Branch / disregarded entity: Form 8858, attached to the owner's return; Schedule C (individual) or the corporate return (company owner). FBAR and Form 8938 for the branch's accounts.
- Subsidiary: Form 5471 with its schedules, Form 8992 for the GILTI computation, Form 1116 or 1118 for credits, and the same account reporting. Materially more work every year.
How is foreign tax credited?
- Branch: foreign income tax paid on branch profit is creditable to the owner directly, in the foreign branch basket on Form 1116 — a separate limitation from general and passive income.
- Subsidiary: the company pays foreign corporate tax; the individual owner gets no credit for it unless the Section 962 election is made, and corporate owners credit it under the GILTI rules with a haircut. Foreign withholding on dividends is creditable when distributions are made.
How does each handle the owner's compensation?
With a branch, the owner's income is the profit; there is no salary. With a subsidiary, the owner can be paid a salary — foreign earned income eligible for the exclusion, deductible by the company, and subject to local payroll and social charges rather than U.S. self-employment tax where a totalization agreement applies. For many owner-operators, the salary channel is the subsidiary's real advantage.
Which structure fits?
| Situation | Usual fit |
|---|---|
| One-person service business abroad, modest profit | Branch / disregarded entity |
| Early losses expected | Branch |
| Local law requires a company and liability protection matters | Subsidiary with check-the-box election (disregarded) if eligible |
| Non-U.S. co-owners or outside investors | Subsidiary |
| High foreign corporate tax, owner wants salary and credits | Subsidiary with Section 962 election |
| Appreciated assets already inside a foreign company | Stay as subsidiary; converting triggers deemed liquidation |
Can I switch later?
From subsidiary to branch, through the check-the-box election — but that is a deemed liquidation and can be taxable if the company holds appreciated assets or untaxed earnings. From branch to subsidiary, by contributing the business to a new foreign corporation, which has its own reporting (Form 926) and potential gain recognition. Both are easier before the business has value.
Frequently asked questions
Does "branch" require registering a branch locally?
Not for U.S. purposes. A local company you've elected to disregard is a branch to the IRS even though it's a company to the local registry.
Is a branch always simpler?
For U.S. compliance, yes. Locally, operating without a company may be impossible or expose you to personal liability — the decision is made on both sides.
Which costs more in U.S. tax?
For a profitable company in a high-tax country, the subsidiary with a 962 election and a salary often comes out lower. For a low-tax country, the branch with the exclusion often does. Model it.
Do both report bank accounts on the FBAR?
Yes, if you own more than half of the entity or have signature authority.
Next step
Fairlight Accounting handles U.S. domestic, cross-border (U.S.–Canada), and international tax returns, plus bookkeeping, payroll, and CFO advisory. If you're setting up operations abroad — or already have a structure and want to know whether it's the right one — our team can compare both paths against your country and your numbers. See pricing or book a free fit call.
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