This blog post was originally published on March 14, 2018. It was updated on November 9, 2018.
Don’t delay tax planning
As year-end 2018 closes in, it’s urgent that U.S. businesses with outbound operations take the time for proper planning with a tax advisor. Many provisions of the 2018 Tax Cuts and Jobs Act are intended to benefit domestic corporations and discourage U.S. businesses from keeping operations in lower-taxed jurisdictions.
The tax law establishes a new quasi-territorial tax system for U.S. businesses with outbound operations, replacing the former worldwide taxation system taxing business income regardless of where it was generated. This quasi-territorial tax system eliminates or minimizes taxes on offshore earnings U.S. businesses return to the U.S., providing businesses an incentive to bring profits back to the U.S.
U.S. taxpayers may find that structures that were once efficient from a U.S. tax perspective should now be reconsidered under the tax law’s international business provisions. These considerations may require actions before year-end, to limit costs or take advantage of benefits. Don’t overlook the following tax changes.
New transition tax on accumulated foreign earnings and profits
The tax law imposes a new transition tax on accumulated foreign earnings and profits that were not previously subject to U.S. taxes. If you completed a special election by October 15, 2018, you can pay this tax in installments across eight years. But you might consider the tax strategy of bringing the cash back to the U.S.
This one-time tax is applicable regardless of whether the foreign corporation in question actually distributed funds to the U.S. taxpayer or owner. The one-time transition tax applies to U.S. shareholders of controlled foreign corporations (CFCs), including partners in partnerships and S corporation shareholders. CFCs with deferred foreign income and non-CFCs with at least one 10% Subchapter C corporation shareholder are also subject to the transition tax.
- U.S. C corporation shareholders are subject to a 15.5% tax rate for cash and cash equivalents and 8% tax rate for noncash assets.
- U.S. individual shareholders are subject to a 17.5% tax rate for cash and cash equivalents and 9.05% for noncash assets.
If you choose to bring these accumulated foreign earnings and profits back to the U.S. now, the only potential tax is the 3.8% Net Investment Tax (also known as the Obamacare Tax). You should discuss the implications of the transition tax and the option of repatriating your earnings with a tax advisor before year-end.
Global Intangible Low-Taxed Income, the new foreign income category
The tax law introduces a new foreign income category, Global Intangible Low-Taxed Income (GILTI), which increases the cost of generating income offshore through a CFC.
GILTI requires U.S. shareholders who own 10% or more of a controlled foreign corporation (CFC) to pay a minimum tax on income generated by the CFC. GILTI includes most of a CFC’s business income, reduced by 10 percent of the adjusted tax basis of the CFC’s depreciable tangible personal property (i.e., factories and equipment) and by interest expenses.
GILTI imposes a significantly higher tax rate on individual U.S. shareholders of CFCs than on Subchapter C corporation shareholders. If a Subchapter C corporation owns the CFC, the GILTI inclusion will be subject to a reduced effective rate of 10.5%, where 80% deemed paid foreign tax credit may be claimed. Note that Subchapter C corporation shareholders are entitled to a 50% deduction of the GILTI inclusion. However, if a U.S. individual shareholder owns the CFC, the GILTI inclusion will be taxed at a 37% rate. Individual shareholders can’t claim a foreign tax credit.
Options for minimizing the impact of GILTI on your tax situation might include considering changes in structure or ownership before year-end. Your tax advisor can help you review potential scenarios.
New deduction for foreign-derived intangible income
The tax law introduces the foreign-derived intangible income (FDII) deduction, which acts as an incentive to keep intangible property onshore.
The deduction applies to income earned from goods sold to non-U.S. citizens for foreign use and services provided to a person or property outside the U.S. It is only applicable to Subchapter C corporations, and the provisions provide a deduction of 37.5% for FDII.
As you review tax strategies with your advisor, options related to maximizing FDII may include structuring decisions or other considerations that must be completed prior to year-end.
Please note that this list is not all-inclusive; other tax changes may affect your international business as well. U.S. taxpayers operating outside the U.S. through foreign corporations should consult their tax advisors to take appropriate actions and plan accordingly. Please reach out to me or another Kaufman Rossin professional with any questions on how these tax changes might impact you.