Prior to the Tax Cuts and Jobs Act (TCJA), income earned by U.S. shareholders of a foreign corporation has generally not been subject to U.S. tax until the income is distributed as a dividend to U.S. shareholders.
The TCJA however, has introduced two significant changes to the taxation of income earned by a foreign corporation owned by U.S. shareholders.
Sec. 965 Deemed Repatriation Tax (Toll Tax)
Under Section 965 of the TCJA, a one-time tax has been enacted for all accumulated foreign income earned during tax filing years ending on or before 31st of December 2017. This tax is labeled the ‘deemed repatriation’ tax, that is, the earnings are considered already repatriated despite them not being distributed to U.S. shareholders.
Note that taxpayers have an option to make an election to pay the repatriation tax in installments over eight years. The election must be made by the extended due date of the individual tax returns of the shareholders, and involves attaching a statement to the individual tax return. The IRS provides a template for this installment election, which can be downloaded from their website.
With regards to NY State and NYC, there is no deemed repatriation tax, and the law remains as is, that the foreign earned income is not taxed until distributed to shareholders.
Global Intangible Low-Tax Income Tax (GILTI)
Under the TCJA, a new tax on foreign income referred to as the GILTI has been enacted. This tax applies to tax years beginning 2018. It applies to Controlled Foreign Corporations (CFC), meaning foreign corporations that are majority owned by U.S. shareholders.
The GILTI applies to the regular business income earned by the corporation in the foreign country, reduced by 10% of the tax basis of the company’s depreciable tangible personal property. In the case of a foreign company owned by a U.S. Corporation, the GILTI tax rate is 10.5%. This relatively low rate, combined with foreign tax credits, can result in the tax being fairly low or at times non-existent.
However, when the company is owned by individual U.S. shareholders and not corporations, the tax is significantly higher. This is due to several factors including:
- Individuals being subjected to a higher tax rate than corporation under the TCJA
- The 50% reduction in GILTI tax rate only applying to corporations
- Individuals not receiving the benefits of foreign tax credits the same way corporations do
The sole way individuals can receive more favorable treatment, is by making a Section 962 election. This is an election by an individual to be taxed at corporate rates. The GILTI rules expressly provide that a Sec. 962 election can be utilized. The election provides taxpayers with the GILTI corporate tax rate of 21%, and enables them to receive the 80% foreign tax credits. The 50% reduction under Sec. 250 however does not apply to individuals even if the election is made. Therefore the tax will be steeper for individuals than corporations even with the Sec. 962 election.
Note that a Sec. 962 election will only be effective for the tax year it is made for. It must be made separately each year, and need not be made consistently from year to year. Thus, making the election for 2018 does not have a retroactive effect on prior years nor future years.
With regards to NYS and NYC taxation, the laws have not all been clearly finalized yet. It seems however, that the GILTI income will also be taxed to NYS/NYC the same as it to federal. The rate should be the regular state and local tax rates that apply to the taxpayer.
The TCJA has generated buzz across the country, and all businesses are impacted by the changes it brings. Roth&Co remains at the forefront of the newest tax developments and will continue to keep you updated as the full ramifications of the tax reform become clear.
