9 minute read
At the end of 2017, the Trump Administration passed its first major tax bill: the Tax Cuts and Jobs Act (TCJA). One provision in this tax bill was the 100% dividends received deduction for foreign dividends. By allowing American taxpayers to deduct 100% of foreign dividends, the law gave them the green light to shift profits overseas into lower-taxed jurisdictions.
What does this mean?
When they brought those profits home, they could deduct 100% of those dividends, ensuring that income would never be taxed at the U.S.’s higher tax rates.
However, the TCJA also put rules in place to prevent abuse of this deduction. That rule was called the GILTI (which stands for Global Intangible Low Taxed Income) tax.
The GILTI tax discourages U.S. entities from shifting profits from the U.S. into lower-taxed jurisdictions by effectively setting a worldwide minimum tax between 10.5% and 13.125%. The GILTI tax was intended to only tax income earned from intellectual property, but as the law was written, it taxes almost all foreign earnings.
Section 951A of the tax code introduces the GILTI tax and states, in part:
…certain U.S. shareholders of controlled foreign corporations are required to report and pay taxes on their pro rata share of the controlled foreign corporation’s GILTI.
Let’s break each of these items down into manageable pieces.
A controlled foreign corporation (CFC) is an entity that conducts business in a jurisdiction different than the residency of its controlling owners. For purposes of the GILTI tax (as well as other international provisions of the Code), a CFC is a foreign company that is at least 50% controlled by U.S. entities or American individuals who each own at least 10% or more of the CFC. Many CFCs are international subsidiaries of U.S. corporations.
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The GILTI tax only affects shareholders that own at least 10% of a CFC, either directly or indirectly through familial or business relationships. A shareholder who owns less than 10% of a CFC would not be liable for the GILTI tax.
A CFC’s GILTI is intended to be income earned by the CFC from intangible assets such as copyrights, trademarks, and patents. In actuality, the GILTI inclusion amount (the tax base) includes almost all a CFC’s income.
To calculate GILTI tax, you must first determine the tax base: the GILTI inclusion amount. This requires you to calculate a few things:
This is the CFC’s gross income, less:
Subpart F income is the amount of the CFC’s income that U.S. shareholders are deemed to have earned, even if the CFC does not distribute the income currently.
The CFC’s qualified business asset investment (QBAI) is its investment (or adjusted basis) in depreciable, tangible business assets – generally assets used in the business for which depreciation deductions are allowed under I.R.C. §167..
This is Interest expense associated with the CFC’s tangible asset investment.
The GILTI tax base uses these inputs and is calculated as:
The shareholder’s net CFC tested income (in effect netting income and losses from all CFCs the shareholder owns) minus the shareholder’s “net deemed tangible income return.”
That second part, the “net deemed tangible income return” uses those second two pieces and is determined as the amount by which 10% of QBAI exceeds the interest expense taken into account by the CFC in calculating tested income.
Reducing the tax base by no more than 10% of QBAI shows that the GILTI tax was intended to be a tax on intangible assets. However, as you can imagine, a 10% exemption doesn’t go far and in the end leaves the lion’s share of the CFC’s income included in the tax base.
Once we have determined the tax base, we can determine your GILTI tax by multiplying the proportional share of GILTI by the 21% corporate tax rate. Through the year 2025, taxpayers can deduct 50% of their GILTI tax, making their effective tax rate – their GILTI tax rate – only 10.5%. Starting in 2026, they can deduct 37.5% of their GILTI tax, making their GILTI tax rate 13.125%.
Since the GILTI tax was introduced, the IRS has released a few rounds of proposed and final regulations interpreting the new law.
Some of these regulations and amendments significantly alter how the GILTI tax applies in real-life situations, so you should take the time to explore them more if you are subject to GILTI tax.
And even more changes are on the horizon. President Biden has introduced GILTI tax law changes into his “Made in America Tax Plan.” If his proposed tax law is adopted, it will strengthen GILTI’s restrictions by:
These tax provisions are still in their early phases, so we cannot know what will be adopted when the Made in America Tax Plan is finally signed into law. We will keep close tabs on Biden’s tax plan and update customers on relevant developments.
The GILTI tax will affect many taxpayers that report foreign business income. This includes S corporations, C corporations, partnerships, and individuals. In fact, many business owners might not even know that they have a GILTI tax obligation. Here are some questions to ask:
The GILTI tax may not be the easiest tax law to understand, but we hope that by having a basic understanding of the tax, you can more easily ascertain whether it will affect your returns now and into the future.
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