Americans Abroad: Taxpayer GILTI Victory Just Announced in Proposed Regulations!

The Internal Revenue Service (IRS) just issued proposed Regulations dealing with the “Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income (“GILTI”)”.  The proposed regulations mark a big win for Americans running their businesses through foreign corporations.  The regulations are scheduled to be published in the Federal Register tomorrow.  In part, they address the unintended and unfair tax consequences befalling individual taxpayers who own foreign corporations.  The onerous tax consequences were a result of the so-called “GILTI” tax enacted in December 2017 with the Tax Cuts and Jobs Act (“TCJA”).

Brief Background

A very significant change wrought by TCJA was the introduction of the “GILTI” tax. GILTI, a brand new category of income, stands for “Global Intangible Low Tax Income”, and as the acronym implies, it is not good to have!  This is so because GILTI income is deemed repatriated in the year it is earned. In other words, the tax law “pretends” that the GILTI income is paid out to its US shareholder, even though no actual distribution was made.  (Of course, the result is US taxation on this “pretend” income distribution to the shareholder).

The GILTI tax is applicable to US shareholders that own 10% or more of a “controlled foreign corporation” (“CFC”) and essentially imposes a minimum level of US tax on foreign profits.  Due to how the rules work, GILTI will more severely impact the shareholders of CFCs having low levels of depreciable assets as compared to income. This means the impact will be felt most harshly by tech companies and service providers which typically have a significant amount of intangible assets and low levels of fixed and depreciable assets.  The impact is greater when little or no foreign taxes are paid by the corporation.  As relevant to many of my readers, since the United Arab Emirates does not impose tax on (most) corporations, GILTI will be a significant issue for US persons owning CFCs in the United Arab Emirates.

Proposed Regulations to the Rescue

An individual taxpayer is permitted under the GILTI provisions, to make what is called a Section 962 election.  This election permits the individual to be treated for tax purposes as a “corporation” and in doing so, it provides several unique benefits. First, making the election allows the individual shareholder to be taxed at the more beneficial lower federal corporate tax rates (flat rate of 21%, versus the maximum federal individual tax rate of 37%).  Second the election permits the individual shareholder to take a personal foreign tax credit to reduce his personal US income tax by part of the foreign income tax that has been paid by the CFC itself.

Finally, under the proposed Regulations, making this special election permits the individual American taxpayer with an overseas business that is covered by the GILTI regime, to receive a deduction of 50% on their business income that is defined as “GILTI” income. Prior to the issuance of these proposed Regulations, the 50% deduction was not available to individual taxpayers owning CFCs.  The regulation is consistent with Congressional intent, in that the purpose of permitting the Section 962 election was to ensure that an individual taxpayer’s tax burden with respect to its CFC’s undistributed foreign earnings would not be any greater than if the individual owned such CFC through a domestic corporation.  In other words, the proposed Regulation allows the American expat shareholder of a CFC to reduce the amount of GILTI on which the individual would otherwise have had to pay the GILTI tax.

Tax Return Complexity to be Expected

New reporting rules requiring the filing of new IRS Form 8993, Section 250 Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income, are also described in the proposed regulations.  As to be expected, taxpayers who plan to take advantage of this corporate election option will face significantly more paperwork when preparing their US tax returns.

In order to obtain the benefits of Section 250, the new IRS Form 8993 must be attached to a timely filed US income tax return (including extensions). For 2018 calendar year tax returns, the regular due date is April 15, 2019, for many Americans residing abroad, an automatic extension of time for filing the return is granted to June 17, 2019.

For those interested in understanding the more technical aspects of the election please see proposed Regulation §1.962-1(b)(1)(i)(B)(3) and Part IV of explanation of the Proposed Regulations. Part IV provides that, “for purposes of section 962, ‘taxable income’ as used in section 11 of an electing individual is reduced by the portion of the section 250 deduction that would be allowed to a domestic corporation with respect to the individual’s GILTI and the section 78 gross-up attributable to the shareholder’s GILTI.”

Posted: March 5, 2019

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