As a result of the Tax Cuts and Jobs Act (TCJA), U.S. shareholders of controlled foreign corporations (CFCs) could see a significant change in their tax bill beginning in 2018 — and not for the better. Absent strategic tax planning efforts, the new law will currently tax global intangible low-taxed income, or GILTI.
The GILTI provisions are some of the most significant steps taken by the TCJA to broaden the U.S. tax base and prevent taxpayers from shifting value outside the U.S. borders, namely through holding intangible assets, such as patents and tradenames, in foreign subsidiaries. However, the provisions are much broader and also cover “soft” intangibles like workforce in place and general know-how.
GILTI income — which is generally a U.S. shareholder’s pro-rata share of a CFC’s aggregate net income minus its net deemed tangle income return (NDTIR) — will now be included in U.S. income, even though it often was deferred from U.S. tax under the prior tax regime. And since the GILTI provisions apply to all U.S. shareholders of CFCs, they stand to have a widespread impact.
Below are some options and considerations taxpayers with CFCs should discuss with their advisers to mitigate the impact of the GILTI provisions.
How GILTI Works for a C Corporation
To fully understand planning options for non-C Corporations, it’s helpful to know how GILTI operates for C Corporations. C Corporations benefit from two specific GILTI provisions:
- GILTI deduction. Domestic corporations are permitted a 50% deduction for their share of GILTI. For tax years beginning after December 31, 2025, the deduction percentage is reduced to 37.5%.
- Foreign tax credits. Domestic corporate shareholders are permitted an indirect foreign tax credit up to 80% of the foreign taxes paid or accrued by the CFC on GILTI.
The net effect of the GILTI rules results in a U.S. corporate minimum tax of 10.5%. That rate is further reduced by foreign tax credits related to the GILTI amount.
GILTI Planning Options for the Non-C Corporation
It’s not quite as “easy” for non-C Corporation U.S. shareholders, including individuals, S Corporations, LLCs and partnerships. The effective tax rate imposed on GILTI is much higher on this group because they:
- Are subject to a federal tax rate of up to 37%,
- Are not eligible for the 50% GILTI deduction, and
- Cannot claim a foreign tax credit for foreign income taxes paid on GILTI.
As a result, non-C Corporation U.S. shareholders could be subject to U.S. federal tax on GILTI at a 37% rate plus the foreign income taxes imposed on that income, leading to a very high global effective tax rate. Below are three planning options that may help non-C corporation owners of CFCs lessen the GILTI tax burden.
1. Make a Section 962 Election
Section 962 allows a U.S. individual to elect to be treated as a C Corporation for GILTI purposes. The benefit of this election is that it allows the individual to claim a foreign tax credit for taxes paid on the GILTI amount.
A distribution of GILTI for which a Sec. 962 election was made will be subject to a second level of U.S. tax upon distribution, so prior to making this election it is important to consider if and when the money will be repatriated.
2. Use a C Corporation Holding Company for CFCs
Some taxpayers may find it beneficial to hold CFCs through U.S. C Corporations, which would allow them to benefit from both the 50% GILTI deduction and the foreign tax credit regime. It is important to note this income will be subject to a second level of U.S. tax when distributed out of the U.S. C Corporation.
3. Own Foreign Operations in Pass-Through Form
U.S. taxpayers also can consider treating certain foreign entities as either disregarded entities or pass-through entities for U.S. tax purposes by making a check-the-box election (if available). Since the GILTI provisions only apply to CFCs, foreign entities treated as either disregarded entities or pass-throughs will not be subject to GILTI. Furthermore, foreign taxes paid or accrued by the foreign entity would be considered paid directly by the U.S. owner and eligible for the foreign tax credit.
Planning for GILTI for the 2018 tax year and beyond can make a big impact on your tax situation, especially if you are not a C Corporation. Talk with your tax advisers about all of the options as they relate to your own tax situation and goals.
Please contact a member of your service team, or contact Ray Polantz at firstname.lastname@example.org for further discussion.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.