March 14, 2019
IRS ALLOWS 50% GILTI DEDUCTION TO U.S. SHAREHOLDERS OF FOREIGN CORPORATIONS MAKING THE SECTION 962 ELECTION
Many U.S. citizens and U.S. residents (including those who live outside the U.S.) have waited patiently to learn if they would be subject to U.S. personal income tax of up to 37% on the Global Intangible Low-Taxed Income (GILTI) earned by non-U.S. corporations they own directly. Please see our December 7, 2018, International Tax Alert “U.S. Shareholders of Foreign Corporations Still Await IRS Guidance on GILTI and Section 962”. On March 6th, the IRS issued new proposed regulations1, which describe how such individuals can escape most, if not all, their U.S. personal tax on the GILTI.
Beginning in tax year 2018, such an individual who owns shares in a non-U.S. “controlled foreign corporation” (CFC), has a complex calculation to determine if he/she is taxable personally in the U.S. on specified income earned inside the corporation (the GILTI), even if he/she receives no dividends or other distributions from the CFC. If the individual simultaneously has “Subpart F income” (for example, because of passive income inside the CFC) the computations are further complicated. The U.S. federal tax rate is graduated for individuals but rises as high as 37%. However, there are alternatives.
The Annual Section 962 Election
One alternative for the individual shareholder to consider is referred to as the “962 election”2, which refers to Section 962 of the U.S. Internal Revenue Code. The 962 election allows the individual shareholder to be taxed on the GILTI at the U.S. federal corporate tax rate of 21%, rather than federal individual tax rates up to 37%. The election also permits the individual shareholder to take a personal foreign tax credit to reduce his/her personal U.S. income tax by part of the non-U.S. income tax paid by the CFC itself.
The 962 election is made by filing a statement, with additional information, along with the individual’s U.S. tax return. The election automatically applies to all CFCs of the individual having amounts included in income during the year under the pass-through rules of Section 951(a). The election must be made each year the benefits of Section 962 are requested.
50% Section 250 GILTI Deduction with a Deadline!
The above-mentioned new IRS proposed regulations, issued March 6th, also allow an individual who has made the 962 election to take a deduction of 50% of the GILTI when computing the tax on the GILTI!3 Therefore, most individuals who make the 962 election will use a 10.5% U.S. tax rate on the GILTI (50% of 21%). They will then reduce the resultant tax by 80% of the non-U.S. corporate income tax paid by the CFC. Thus, if the CFC is subject to foreign income tax of at least 13.125%, most individual shareholders could have minimal GILTI tax, or none at all.
Caution: In order to obtain the benefits of Section 250, the individual shareholder must attach new IRS Form 8993 to his/her timely filed U.S. tax return (including extensions). For 2018 calendar year tax returns, the due date is April 15, 2019, excluding extensions. An extension of time for filing returns of income, and for paying any tax shown on the return, is automatically granted to June 17, 2019, in the case of –
- US. citizens or residents whose tax homes and abodes, in a real and substantial sense, are outside the United States and Puerto Rico;4 and
- US. citizens and residents in military or naval service on duty, including non-permanent or short term duty, outside the United States and Puerto Rico5.
Dividends from the CFC after the 962 Election
The 962 election and the benefits of the Section 250 deduction may not be a panacea for all individual shareholders. When a dividend of the GILTI is actually paid from the CFC to the shareholder, a portion of the GILTI is taxed again, but additional new foreign tax credits are available to fully or partially offset this additional income.
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1 Proposed Treasury Regulation §1.250-1
2 Treasury Regulation §1.962-2
3 Proposed Treasury Regulation §1.962-1(b)(1)(i)(B)(3)
4 Treasury Regulation §1.6081-5(a)(5)
5 Treasury Regulation §1.6081-5(a)(6)