GILTI Pleasures – High Tax Exclusion Among Other Planning Opportunities
8.6.20 | Client Alert
The IRS recently issued regulations related to an exclusion of taxable income under the global intangible low-taxed income (GILTI) regime – namely the High Tax Exclusion. The High Tax Exclusion under Subpart F rules is a long-standing regime, and the IRS’ proposal to exclude GILTI income when high tax rates are imposed in a foreign country was a welcomed application of these rules.
A key component of 2017’s Tax Cuts and Jobs Act (TCJA) was the implementation of GILTI as a new taxing regime for Controlled Foreign Corporations (CFC). GILTI taxes U.S. shareholders currently on income earned through their CFC even when profits are not repatriated. Unlike long-standing Subpart F income inclusion, the GILTI inclusion is based on the aggregate of a shareholder’s pro-rata share of income from their CFCs, rather than the CFC by CFC approach used for calculating Subpart F income inclusions. This aggregated approach enables CFC’s with net losses to offset other entities with income within the group.
High Tax Exclusion under GILTI
This final regulation would exclude, from a U.S. shareholder’s GILTI amount, certain items of income of its CFC that are subject to a foreign effective tax rate of at least 18.9% (90% of the U.S. corporate tax rate, which is currently 21%). Initially, the statute permitted high-tax income to be excluded from GILTI only if the income was excluded from the Subpart F regime due to qualifying for the high-tax exception. Therefore, CFCs that had high-taxed income but did not have Subpart F income were still subject to GILTI.
However, under these final rules, the IRS created an exclusion of so called “high-tax” GILTI from U.S. shareholder’s inclusion amount, (for income of CFCs that are subject to a foreign effective tax rate of at least 18.9%.) This exclusion is applied on an elective basis to all tested gross income subject to the minimum effective tax rate. The election is made by the CFC’s controlling domestic shareholders with respect to the CFC (U.S. shareholders that collectively own, directly or indirectly, more than 50% of the CFC’s stock).
The regulations define whether a CFC’s income is subject to the requisite effective rate of foreign tax on a so called “tested unit” basis. The tested unit approach is intended to eliminate “blending” of a CFC’s high-tax and low-tax income. This “anti-blending philosophy” only applies when a CFC has income that is directly or indirectly subject to the laws of more than one foreign country’s taxing authority. A CFC can have up to three types of tested units, including:
- The CFC itself,
- An interest in a pass-through entity that is a tax resident of a foreign country, and
- A branch of a CFC that gives rise to a taxable presence under the laws of the foreign country.
The final regulations provide a mandatory combination rule where the tested units of a CFC must be treated as a single consolidated tested unit if they are tax residents of a single foreign country.
The election to exclude high-tax income is made on an annual basis by the CFC’s controlling shareholders. The election applies to every CFC in which the U.S. taxpayer holds, or is treated as holding, a majority equity interest (a CFC group). If an election is made for a CFC, the election is binding on all U.S. shareholders of the CFC. The final regulations include a notice of election or revocation requirement for non-controlling domestic shareholders. The election is available to individuals, trusts, and entities.
Effective Date and Retroactive Applicability – Planning Opportunity and Deadline
The GILTI high tax exclusion applies to tax years of foreign corporations beginning on or after July 23, 2020. A taxpayer may, however, apply the GILTI high tax exclusion to any tax year beginning after December 31, 2017 on an amended federal income tax return. The CFC’s U.S. shareholders must file amended federal income tax returns within 24 months of the unextended due date of the original return. Amended returns for all U.S. shareholders of each CFC subject to the election must be filed within a single six-month period (to ease IRS administrative burden).
High Tax Exclusion under Subpart F – Parity in Application
The IRS, in a desire to apply consistency among these rules, issued new proposed rules that would radically change the old high tax exclusion rules for Subpart F income by incorporating the tested unit principles described above. In addition, the GILTI high tax exclusion election and the Subpart F income high tax exclusion election would be combined into a single election – creating “an all or nothing” approach. Therefore, these proposed rules would conform to the GILTI high tax exclusion rules, including the requirement that they be applied to every CFC in a CFC group. The IRS’ proposed rules would generally apply to tax years beginning after the date final regulations are issued.
Other Final GILTI Regulations Issued
Recently, the IRS issued final regulations on the Section 250 deduction. The Section 250 deduction permits corporate taxpayers to deduct 50% of their GILTI inclusion from income. The final regulations enable individuals and trusts to take advantage of this “corporate” deduction through the use of IRC Section 962.
IRC Section 962 creates consistency between U.S. shareholders that invest directly in CFCs with U.S. shareholders that invest in CFCs through a domestic corporation. Consistent with the intent of IRC Section 962, the final Section 250 regulations extend the 50% deduction of GILTI inclusions to more U.S. taxpayers—including S corporations’ shareholders, partners in a partnership, individuals and trusts—to apply the U.S. corporate income tax rate, instead of individual tax rates, to their Subpart F or GILTI inclusions when an IRC Section 962 is made.
The final regulations were issued retroactively to the end of 2017. Taxpayers who made a 962 election and did not take the 50% GILTI deduction may file an amended return to claim it. Further, the final regulations provide previously missing guidance on whether a U.S. shareholder may make a Section 962 election on an amended return. Based on the final regulations, taxpayers are now permitted to make a Section 962 election on an amended 2018 or 2019 tax return.
All of these proposed and final rules provide more tools in the toolbox to help taxpayers with their tax planning strategies. More specifically, they expand the opportunities for taxpayers to manage the timing of income inclusions under GILTI.
To learn more about these opportunities and how the proposed and final rules may impact you, please contact Lisa Goldman at 212.699.8808 | firstname.lastname@example.org or your Berdon advisor.
Berdon LLP New York Accountants