GILTI Tax and Controlled Foreign Corporations
When making a financial decision, it is important to consider tax consequences and any additional tax filing requirements.
Previously before the tax reform act of 2017, to maximize earnings, offshore operations could be used to accumulate earnings. The logic at that time was to create a blocker corporation with regard to foreign operating businesses doing business in foreign jurisdictions. The accumulated earnings would not be subject to U.S. tax until the corporation made distributions in the form of dividends.
Internal Revenue Code IRC Section 965 was enacted as part of the new Tax Reform Act (TCJA). This new law imposes a one-time transition tax (toll charge) on the undistributed, non-previously taxed post-1986 foreign earnings and profits of certain U.S.-owned foreign corporations. IRC Section 965 is seen as part of the transition to what some believe to be a move in the direction of a territorial tax regime.
In general, U.S. shareholders of foreign corporations may elect to pay the toll charge in installments over eight years. Also, in addition to that, U.S. persons may be subject to an additional category of Controlled Foreign Corporation Income, Global Intangible Low-Taxed Income (GILTI) for tax years 2018 and forward. GILTI tax was enacted under the TCJA (new IRC 951A). Taxpayers subject to GILTI tax should include the Form 8992 in their tax return.
GILTI Tax- Individuals
Persons will be subject to GILTI regulations if they are a U.S. shareholder of a Controlled Foreign Corporation. U.S. persons (citizens, residents, substantial presence or green card holders, domestic entities) are treated as a U.S. Shareholder of a Controlled Foreign Corporation (CFC) if such persons own at least 10 percent directly or indirectly of a foreign corporation’s voting stock or value. CFC is any foreign corporation of which more than 50 percent of the vote or value of the stock is owned by U.S. shareholders on any day during a given year.
Basically, U.S. shareholders of one or more CFCs must take into account its pro-rata share of the tested income or tested loss of the CFC(s) in determining the U.S. shareholder’s GILTI tax calculations. It is important to note that other tax forms reflect information for Form 8992 and Section 965 tax withholding.
Generally speaking, when taxpayers meet the requirements to file Form 5471, (Information Return of U.S. Persons with Respect to Certain Foreign Corporations) as a category four and five, the filing should include Schedule I-1, Information for Global Intangible Low-Taxed Income. Information from Form 5471 Schedule I-1 and Schedule C will be reflected on Form 8992 to complete the GILTI tax calculation.
Considering the fact that the GILTI regulations are more favorable to the corporation, the taxpayer could make an IRC Section 962 election which allows an individual who is a U.S. Shareholder of a Controlled Foreign Corporation to elect to be treated as a domestic corporation (U.S. corporation) for the purpose of computing their income tax liability on their pro-rata share of the CFC’s subpart F income.
Significant tax savings opportunities for U.S. domestic corporations could be achieved by filling Form 8993, section 250 for Foreign- Derived Intangible Income (FDII) and GILTI tax. If the corporation has paid or accrued foreign tax in the country it operates, the taxpayer should include that amount on Form 1118, Foreign Tax Credit under section 951.
If the taxpayer does not have voting power and never wanted to participate in CFC management, one of the options to avoid the complexity of GILTI tax is to form a foreign trust and place the CFC stock(s) under the ownership of said foreign trust. Doing this eliminates GILTI tax calculation and reporting.
The downside is that the taxpayer will need to consider the potential gift tax implications and reporting at the time of the transfer of ownership. What’s more, they may be required to calculate Distributable Net Income (DNI) which gets reported on Form 3520 and potentially Form 3520-A. There will be additional tax filing fees, but this strategy will eliminate the complexity of GILTI tax calculations and reporting.
The IRS has issued some guidance related to this topic, and there are still uncertainties existing on how to treat certain items. The international tax provisions are highly complex and will likely continue to increase the tax compliance complexity for even the most straightforward corporations with foreign operations and their shareholders.
A tax professional with international tax expertise should be sought in these matters. If you need assistance, please contact IWTA.