The purpose of this alert is to give our clients a sense of what the related tax concepts of Subpart F income and GILTI are when it comes to their international transactions and companies.
INTRODUCTORY GUIDE TO SUBPART F AND GILTI
I. OVERVIEW
The purpose of this alert is to give our clients a sense of what the related tax concepts of Subpart F income and GILTI are when it comes to their international transactions and companies. When a taxpayer is a United States shareholder with over certain amounts of undistributed income, this can subject the American taxpayer to GILTI. Similarly, when an American taxpayer is a United States shareholder in certain amounts of foreign corporations and the foreign corporations engage in certain types of transactions, the American taxpayer will have ‘Subpart F’ income. These concepts are important to be aware of in order to limit or avoid the amount of taxes entirely for these two as well as avoid the substantial compliance that is required.
II. WHAT IS A UNITED STATES SHAREHOLDER AND WHY IS IT IMPORTANT?
To be subject to Subpart F income or GILTI, an American person must be a United States shareholder. A United States shareholder is a United States person (which can be a person, corporation, partnership, trust or estate) which owns or is considered as owning 10 percent or more of the total combined voting power of all classes of stock or 10 percent of the total value of the shares of the foreign corporation. If someone is not a United States person or they do not own that amount of the voting power or the total value of the company, they are not subject to Subpart F income or the GILTI regime.
A United States person can include a green card holder and also a person who meets the substantial presence test, which generally means that the person was present in the United States for 183 days or more for any given year.
III. WHAT IS A CONTROLLED FOREIGN CORPORATION?
A controlled foreign corporation is the entity that is subject to Subpart F income and GILTI. A controlled foreign corporation means any foreign corporation if more than fifty percent of the total combined voting power of all classes of stock or 50 percent of the total value is owned by United States shareholders. What is a corporation is not always obvious. Some entities are foreign in nature and are considered as a matter of law to be corporations and simply owning enough interest yourself or with others can make one subject to GILTI, Subpart F or both. The nature of the entity and the amount of the ownership interest owned and the manner in which it is owned (as even indirect ownership is counted) can cause compliance and taxation issues.
IV. WHAT IS GILTI?
GILTI, or Global Intangible Low Taxed Income, is the attempt by the United States government to tax value held offshore which they deem to be above a normal rate of return. It was originally introduced in the 2017 Tax Cuts and Jobs Act. Although the GILTI formula is complicated, the amount tax is roughly equal to the gross income of the foreign corporation minus the ‘deemed tangible income return’. The deemed tangible income return is basically the depreciable assets of the business minus any interest expense attributable to the foreign corporation. If the aggregate earnings in a controlled foreign corporation exceed what Congress thinks is a ‘routine’ profit margin, then that amount is taxed by GILTI here in the United States. The takeaway for the taxpayer is that when they are a United States shareholder and they own over 50 percent of the voting power or value in a foreign corporation, the taxpayer needs to be aware that there are compliance issues due to GILTI.
V. WHAT IS SUBPART F INCOME?
Subpart F income differs from GILTI in that Subpart F income is only triggered when certain conditions are met, along with having interest in a controlled foreign corporation. Subpart F income exists when the United States person has foreign personal holding income, foreign base company sales income or foreign base company services income. Foreign personal holding income has a basic meaning of including passive types of income, including dividends, interest, royalties, rents and annuities, but also includes commodities and things such as personal service contracts executed with the foreign corporation. Foreign base company sales income generally means that there is a purchase from a related person which is then sold to another foreign customer. Finally, foreign base company services income taxes income which is derived from performing services (such as technical skills such as engineering or architecture) outside the country. In order to know whether transactions for your business are under Subpart F and generate income to you as a taxpayer, the entirety of the transactions would have to be discussed.
VI. ARE THERE WAYS TO LIMIT SUBPART F OR GILTI?
There are two primary mechanisms that limit GILTI and Subpart F income. Both Subpart F and GILTI have a ‘high-tax exception’ which allows for persons who are already paying over 90 percent of the corporate tax rate (current at 21%) to exclude those portions of their income from the regime altogether, if certain other conditions are met. Furthermore, with GILTI, domestic corporations (and people who elect to be treated as corporations) can receive foreign derived dividends (if structured correctly) on a 100 percent deductible basis under IRC 245A. The downside with this provision is that no foreign tax credit is available. Secondly, GILTI allows for persons to currently receive a 50 percent deduction on the amount of GILTI tax owed, as well as take nearly 80 percent of the foreign tax credit available due to GILTI derived tax.
VII. CONCLUSION
GILTI and Subpart F are complicated provisions of the tax code and we send this to you in order for you as a responsible taxpayer to be aware of its existence. We at the Flores Group can help you with issues you are currently facing regarding these provisions or structure your businesses in order to limit or avoid them entirely.
As always, thank you so much for being a client of the Flores Group, Attorneys & Advisors, PLLC. If you desire to have more information on the changes to trust law or trusts themselves, or if you desire to make changes to your estate planning situation, feel free to call our office and schedule an appointment.
Should you need additional information it will be our pleasure to assist you.
Sincerely,
Ruben Flores, Attorney & CPA
As requirement of the United States Treasury Regulations, you should be conscious of the fact that this notice has not been written to be used and it should not be used by the recipient to prevent penalties that could be imposed by U.S. Federal Law.
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