The Tax Cuts and Jobs Act contains a tax that’s easy to overlook, but may negatively affect individuals and other non-C corporations that invest in controlled foreign corporations (CFCs).
The new Section 951A Global Low-Taxed Intangible Income (GILTI) provisions effectively impose a US tax on taxpayers who own 10% or more of CFCs. While the GILTI provisions apply to all taxpayers, the effect of the GILTI provisions may be much more detrimental to individual investors than it will be to corporate investors, whether those individual investors directly own foreign entities or own them through a pass-through entity.
Effective for tax years beginning after December 31, 2017, Section 951A subjects US persons owning at least 10% of CFCs to current taxation on the earnings and profits of the foreign corporations. The inclusion is created using the existing Subpart F provisions of the Internal Revenue Code.
The taxable inclusion is reduced by an amount equal to 10% of the tax basis of the qualified tangible property assets owned by the CFC less the CFC’s interest expense. Such qualified assets are essentially limited to the fixed assets of the foreign corporation.
After reducing the current earnings by the 10% amount, the remaining earnings are considered GILTI subject to US taxation under Subpart F. For purposes of these calculations, all of a taxpayer’s investments in CFCs is aggregated together.
Corporate Benefit Denied for Individuals
For C corporations, the GILTI provisions have offsets that may mitigate much of the additional cost of the provision.
Corporate taxpayers may benefit from a 50% reduction in the GILTI inclusion —which would reduce the 21% US corporate tax rate on the foreign income to an effective rate of 10.5%—as well as from indirect foreign tax credits. When combined, these two reductions may eliminate the US tax completely for C corporations, provided the foreign corporations have paid local effective income tax at a rate of at least 13.125% and the C Corporation is able to utilize the foreign tax credits.
For C corporations, the GILTI provisions operate as a minimum tax that is intended to make sure US corporations and their foreign subsidiaries pay at least a 10.5% combined corporate tax rate. There’s currently no clear guidance on how this provision affects subchapter S corporations.
For individuals, neither the 50% deduction nor the indirect foreign tax credit is available. It’s unclear without further guidance from the IRS if the deduction is available to S corporations. Accordingly, US individuals owning 10% or more of controlled foreign corporations may be subject to US tax on much of the foreign corporate earnings at ordinary federal income tax rates, which could be higher than 37%.
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For more information about how the GILTI provisions may affect you or your business, contact your Moss Adams professional or email firstname.lastname@example.org. You can also visit our dedicated tax reform page to learn more.