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GILTI Tax – How Will it Affect Your Clients?

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.

GILTI Tax Brief Overview

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.

More About the GILTI Tax

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.

Controlled Foreign Corporation

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.

Certain U.S. Shareholders

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.

Controlled Foreign Corporation’s GILTI

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.

GILTI Tax Calculation

To calculate your client’s GILTI tax, you must first determine their tax base: their GILTI inclusion amount. This requires you to calculate a few things:

  • The CFC’s tested income

This is the CFC’s gross income, less:

  • Income that is effectively connected with a U.S. trade or business
  • Subpart F income
  • Related party dividends
  • Oil and gas extraction income

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.

  • Qualified business asset investment

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..

  • Interest expense associated with QBAI

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 client’s GILTI tax by multiplying their 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%.

GILTI Tax Legislative Changes

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 your client is 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:

  • Increasing the corporate tax rate to 28%, effectively raising the GILTI tax base for U.S. multinationals.
  • Eliminating the 10% exemption for tangible asset investment, further broadening the GILTI tax base.
  • Reducing the GILTI tax deduction. With the deductions as they are now, the GILTI effective tax rate is between 10.5% and 13.125%. Biden’s tax plan would raise this effective tax rate to 21%.

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.

How GILTI Will Affect Your Clients

The GILTI tax will affect many taxpayers that report foreign business income. This includes your clients who are S corporations, C corporations, partnerships, and individuals. In fact, your clients might not even know that they have a GILTI tax obligation. Talk to your clients about their activity at your next meeting. You can ask:

  • Are they shareholders in a foreign entity?
  • Are they shareholders or partners in an entity that has international affiliates?
  • How much income do they report from those entities?
  • If they are a new client: How have they applied GILTI in prior tax years?

Any information you gather can help you estimate their liability.

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 clients’ returns now and into the future.

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