Did you know that starting in 2018, US shareholders face a new US tax on the annual active earnings of certain foreign corporations, whether or not the earnings are distributed? This is known as the tax on Global Intangible Low-taxed Income (“GILTI”), which was enacted as part of the Tax Cuts & Jobs Act of 2017. The calculation of GILTI income is rather complex. The following is an overview and captures what actions should be taken before year end.
GILTI has very broad applications, especially to those US shareholders who had been able to defer US income tax on active offshore corporate earnings until those earnings were repatriated. Among the foreign corporations generally impacted by GILTI, are those that are in service industries, those that have small investments in tangible property, or those that do business in low-taxed foreign countries.
You Are Presumed GILTI
GILTI is applicable to US shareholders who own 10% or more of foreign corporations, which are controlled by US persons (i.e., corporations whose ownership is more than 50% US persons). These affected US shareholders will need to include in their annual US taxable income, their share of GILTI income. For reporting purposes, New IRS Forms 8992 (US Shareholder Calculation of Global Intangible Low Taxed Income) and 8993 (IRC Section 250 Deduction for GILTI) will be attached to the US income tax returns and used to calculate GILTI.
The GILTI provisions generally allows foreign corporations to earn no more than a 10% return on the US adjusted tax basis of depreciable tangible property, without incurring the GILTI tax, as long as the tangible property is used in the active conduct of the foreign corporation’s business. Income earned by foreign corporations in excess of this 10% permitted return is subject to GILTI tax.
US Corporate Shareholders
Affected US corporate shareholders of foreign corporations are allowed a 50% deduction from their share of GILTI income, which essentially reduces their effective GILTI tax rate from the general 21% to 10.5%. US corporate shareholders are also allowed to take deemed paid foreign tax credits of 80% of the income taxes paid by foreign corporations. Thus, in foreign countries where the effective income tax rate is at least 13.125%, US corporate shareholders will be able to avoid the GILTI tax, since they are permitted to take 80% of the deemed paid foreign income.
US Individual Shareholders
By contrast, based on current proposed GILTI regulations, US individual shareholders will pay their share of GILTI income at the maximum income tax rate of 37%. To date, the IRS has not officially announced whether US individuals will be allowed the 50% deduction, which makes the GILTI tax burden higher for individuals than for corporations.
To mitigate the higher burden, individuals may make a complex election under IRC Section 962 to be taxed as corporations for purposes of GILTI income inclusion. By making the Section 962 election individual shareholders will be able to take advantage of the 80% deemed paid foreign tax credit and be taxed at the corporate income tax rate of 21%, instead of the 37% individual income tax rate. Generally, US individuals shareholders who make the Section 962 election, and otherwise are not allowed to claim the 50% deduction afforded C Corporations, will not be subject to GILTI tax, so long as the effective foreign income tax rate is at least 26.25% (i.e., 80% of 26.25% is 21%).
Individuals may consider interposing a C corporation holding company by December 31, 2018, to hold their stock ownership in the foreign corporations and, thereby, take full advantage of the 50% deduction, 80% deemed paid foreign tax credit, and 21% lower corporate tax rate. The C corporation blocker model should take into account the pre-2018 foreign corporations’ accumulated earnings that were previously taxed under the IRC Section 965 Transition Tax. That is, prior to interposing a C corporation, US individual shareholders should consider whether some or all of the Section 965 earnings ought to be repatriated back to the US.
An implementation of a new C Corporation tax structure before year end or making a Section 962 election at the time that the US income tax return is filed next year, requires very careful consideration. Both have significant US tax impacts beyond the calculation of the tax on GILTI income, and in the case of the C Corporation structure, may have non-US tax and non-tax impacts as well, that must be considered.
How MBAF Can Help
As soon as possible before year end, US shareholders are urged to project their 2018 year GILTI tax exposure and review their current offshore foreign corporate structures. It is better to be prepared for GILTI tax and avoid unpleasant surprises when the time comes in 2019 to prepare your 2018 US income tax returns. The time is now to meet with your tax advisors and to calculate GILTI tax under different scenarios to determine the steps that should be taken before December 31, 2018, to mitigate, as best as possible, the new US tax on GILTI.
Compliance with and understanding the changes and implications of the Tax Cuts and Jobs Act can be very complex. If you would like to benefit from our expertise in these areas, or if you have further questions on this Advisory, do not hesitate to contact our Tax and Accounting Specialists, or call us at 1-800-239-1474.