Gilti Calculations For Individual Cfc Shareholders
Shareholder of a CFC with GILTI income that is subject to a 25% foreign income tax would incur tax in excess of 55% after considering federal, state, and Net Investment Income taxation. The 962 election and the benefits of the Section 250 deduction may not be a panacea for all individual shareholders. When a dividend of the GILTI is actually paid from the CFC to the shareholder, a portion of the GILTI is taxed again, but additional new foreign tax credits are available to fully or partially offset this additional income. To the extent that GILTI is earned overseas, U.S. foreign subsidiaries may have paid foreign tax on that income.
This may trigger US tax in respect of any unrealized gains on the corporation’s assets, but if there are not any significant gains the conversion to a ULC should not result in significant US taxes. Under this option, Dr. Smith would be required to include all of Medco’s income in his income for US tax purposes every year but would be able to claim a foreign tax credit for the Canadian corporate tax paid by the corporation.
Consistent with other elements of the TCJA and prior tax law, taxpayers may claim credits against foreign taxes paid, but the TCJA limits foreign-tax credits against GILTI income to 80 percent of taxes paid. This limitation has the effect of increasing the effective tax rate that firms face compared to if they could claim credits for all of their paid foreign taxes. Because an S corporation’s taxable income is computed in the same manner as an individual, and because an S corporation is treated as a partnership for purposes of the CFC rules, neither the "50-percent deduction" nor the 80-percent FTC apply to S corporations or their shareholders. Thus, an individual USS is treated more harshly by the GILTI inclusion rules than is a USS that is a C-corporation.
Individual shareholders should pay close attention to their amount of GILTI because making an election to have their CFC income taxed at the corporate level could result in significant tax savings. IRC §962 defines a special rule which allows an election for individual shareholders to be taxed at corporate rates on the earnings of their CFC. This means that the GILTI will be eligible for the new corporate tax rate of 21% along with eligibility for foreign tax credits to reduce the overall tax burden.
Shareholders of CFCs must consider the potential impact of the new GILTI inclusion rules. The 2018 proposed regulations generally determined tested income and tested loss by reference to the existing section 952 regulations, which generally treat a CFC as a domestic corporation for purposes of determining gross income and taxable income for subpart F purposes.
Individuals who make a section 962 election are taxed as if there was a fictional domestic corporation interposed between them and the foreign corporation. However, the section 962 does not result in all the benefits of an actual US corporation. For example, as was decided in a 2018 Tax Court case, the election does not convert non-qualified dividends into qualified dividends.
Despite the name Global Intangible Low-Taxed Income, the GILTI inclusion amount is a formulaic approach that does not consider intangible assets and does not consider the amount of foreign taxes paid on such foreign earnings. The GILTI inclusion amount can be summarized as the CFC’s income in excess of 10 percent of the CFC’s adjusted basis in its tangible fixed assets increased by the CFC’s net interest expense. This is an oversimplified statement and there are many complexities and nuances that are beyond the scope of this summary, but it is important to note that all U.S.
Proper planning and structuring can help mitigate the impact of GILTI, and U.S. taxpayers should review their options for dealing with GILTI prospectively. However, the commonalities do not include a high taxed exception which, as of now, only belongs to Subpart F. This rule generally excludes from US taxable income any Subpart F income already taxed at a sufficiently high rate in foreign jurisdictions. The kicker here is that it does not apply to GILTI that is already taxed at a high rate offshore and any related foreign tax credits are useless to individuals or corporate taxpayers in an excess foreign tax credit position. Unintended application of the Subpart F high taxed exception to GILTI is an error until the GILTI proposed regulations containing a GILTI high taxed exception become law. Dr. Smith could convert Medco into an unlimited liability company under the laws of BC, Alberta or Nova Scotia.
78 (gross-up for deemed paid foreign tax credit), 861 , and 965 relating to certain foreign tax credit aspects of the transition to an exemption system for income earned through foreign corporations. Global Intangible Low-Tax Income inclusion under the Tax Cuts and Jobs Act is something that every owner of a controlled foreign corporation should be analyzing during 2018 in order to make the best tax planning decisions before year-end. Certain corporations may find it beneficial to increase the amount of tangible property in their CFC while others may decide to restructure their CFC all-together.
The final rules do not contain any additional guidance on the application of the section 952 regulations to compute tested income and tested loss. Treasury intends to provide additional guidance in a future guidance project. TCJA’s international provisions have dramatically impacted U.S.-international taxation. The new reporting requirements and calculations, which are extremely complex, will put a significant burden on U.S. taxpayers.
Of course, future dividends from the C-Corporation to the individual owner would be taxed, but the overall tax cost to the individual would be lower, particularly on a present value basis. Shareholders, whether directly or through a pass-through entity such as a partnership or an S-Corporation, are ineligible for both the 50% GILTI deduction and the deemed paid foreign tax credit. This means that without tax planning, such individuals will pay federal income tax on GILTI at a rate up to 37% plus state income tax, if applicable, regardless of the amount of income tax paid by the CFC on its GILTI income. The individual now must fund a significant tax liability, although the CFC might not have distributed any profits to the individual. Although the individual can receive the income taxed as GILTI without further tax — because it was "previously taxed" — by that time the tax damage has been done.
Thus, if the CFC is in a non-tax treaty jurisdiction, dividends paid from the CFC to the individual would be subject to taxation at ordinary individual income tax rather than lower qualified dividend rates. Further, prior to the Proposed Regulations, the section 962 election did not permit application of the section 250 deduction. Thus, depending on applicable foreign income tax rates, individuals remained at a significant disadvantage compared to those investing in a CFC via a US corporation and would now have to weigh potential US corporate taxation against deferral of the US individual tax. In order to reduce or eliminate double taxation, we need to understand how a §962 election works.
American taxpayers now have to determine very quickly how to file and report GILTI on their 2018 returns. Unfortunately, U.S. individuals and trusts are particularly impacted by these new rules and are subject to higher tax rates than U.S. corporations are—even if those corporations have the same income.
However, there is an election to have their CFC income taxed at the corporate level which provides them a 21 percent flat tax rate along with offsetting foreign tax credits. The second potential solution consists of the interposition of a C-Corporation between the individual U.S. Shareholder that is subject to the GILTI tax and can avail itself of the 50% GILTI deduction, as well as the deemed paid foreign tax credit. If the CFC is subject to a foreign income tax at 13.125% or more, the C-Corporation pays no residual GILTI tax and can receive tax-free distributions of GILTI earnings from the CFC (potentially subject to local withholding tax and/or foreign exchange gain or loss recognition). If the C-Corporation can redeploy those earnings into business activities, the adverse GILTI tax provisions on individuals can be postponed.
In a nutshell, the election allows individual US Shareholders of CFCs to compute their foreign tax credit as if they were a domestic corporation and use the corporate tax rate. The cost of this election is potentially higher US tax when dividends are paid.