New GILTI rules - Time to Check-The-Box?
One of the many tax changes introduced into the US tax system with the enactment of the Jobs and Tax Cut Act in December 2017 was the creation of a new category of income called Global Intangible Low Tax Income “GILTI”, and this may potentially affect thousands of US citizens residing abroad who operate their own business through a limited company incorporated in the country of their residence. As a result, US owners of foreign incorporated businesses may need to consider a formal “check-the-box” election to treat their foreign business as a transparent entity for US tax purposes.
Generally, US shareholders who own a foreign corporation are not taxed on the corporation’s profits until they distribute those profits by way of a dividend. That general rule of income deferral applied to all trading profits except certain types of passive/investment income such as interest, dividends and capital gains, etc., income also known as “Subpart F” income. All ordinary operating income of the company was only taxed when distributed in the form of a dividend and in many cases treated as qualified dividend taxable at capital gains rates. The 2017 Tax Cuts and Jobs Act changed this deferral regime forever and many US residents will now be required to include in their US taxable income the profits of their foreign business corporations even if no dividend has been distributed.
Global Intangible Low Tax Income “GILTI”:
The 2017 Tax Cuts and Jobs Act added Section 951A to the Internal Revenue Code establishing a new category of “Subpart F” income called Global Intangible Low Tax Income “GILTI”. The practical result is that unless the foreign corporation has substantial depreciable assets, e.g. physical property and equipment, the historical deferral regime is no longer applicable. Instead, the US shareholders must recognize income in the year earned rather than in the year distributed. There is still an amount of corporation’s income that can be deferred, but this amount is now limited to 10% of the book value of the corporation’s depreciable assets. For business with little or no hard assets, the GILTI rules require the immediate recognition of all business profits.
Summary of GILTI Rules:
GILTI is computed as the excess of:
the shareholder's prorata share of the CFC's net income (after foreign taxes)
the shareholder's prorata share of the CFC's deemed tangible income return (which is basically a return equal to 10% over the corporation's tax basis in tangible property).
GILTI Tax Rates and Foreign Tax Credits – US Individual vs. Corporate Shareholders:
Beginning in 2018, United States shareholder individuals who own a foreign corporation are subject to ordinary income tax rates on the GILTI. However, individual shareholders are not allowed to claim foreign tax credits for taxes paid at corporate level. That may lead to a timing difference between when income is taxed in the US and in the foreign country of residence and effectively resulting in double taxation.
The rules are much more favorable for US corporate shareholders. First, with certain deductions, the effective tax rate for corporate shareholders is 10.5% up to December 31, 2025 and 13.125% for taxable years commenced after December 31, 2025.
In addition, foreign tax credits available upon foreign income tax paid with respect to GILTI, but limited to an 80%, without carry back or carry forward. Therefore, to the extent the foreign corporation pays tax in the country where it operates at a rate of at least 13.125% before December 31, 2025 and 16.41% thereafter, there will be no additional US tax due with respect to GILTI income.
US individual owners of a foreign limited company should act quickly to evaluate the impact of the new GILTI rules on their US tax returns for 2018 and future years. One viable option would be to file an entity classification election with the IRS, also known as the “check-the-box” election, and elect to treat the entity as disregarded for US tax purposes. While that would not defer the income, and it will still be taxable immediately, the effect of such election would be that individual shareholders would be able to claim foreign tax credit for foreign taxes paid at corporate level.
Alternatively, the US individual shareholder may consider incorporating a US corporation and contributing the shares of the foreign corporation, thus creating a blocker US resident entity. The profits of the foreign corporation will flow to the US corporation and to the extent the taxes paid in the foreign country generate sufficient foreign tax credits, there may not be any additional US taxes due in the US until the time when the US shareholder decides to take a dividend.
If you think that the situation described above relates to you, or if you would like to discuss other implications of the tax law changes and how those may impact you, we are here to assist. Get in touch with your Taxential advisor now!
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Disclaimer: The content of this page does not constitute legal advice, and should not be relied upon for tax avoidance purposes. The facts and circumstances specific to your situation are the ones that ultimately determine the application of the rules. The text above is based on Taxential's interpretation of the US tax law from a general perspective only.