The 2017 Tax Act added a new tax on US shareholders of controlled foreign corporations (“CFCs”), the tax on Global Intangible Low-Taxed Income (“GILTI”). GILTI often includes active business income and thus has a widespread impact.
For US C corporations, the regular 21% tax is reduced by a 50% deduction, which lowers the tax rate on GILTI to 10.5%. Corporations also can claim a foreign tax credit (“FTC”) for 80% of the foreign taxes paid by the CFC, which further reduces or eliminates the GILTI tax. By contrast, US individuals (including shareholders of S corporations) received no similar tax breaks, and must pay tax at regular rates (maximum 37% rate).
The IRS recently released proposed regulations that open up a planning option for individuals to similarly reduce the tax rate on GILTI by making a Code §962 election.
Code §962 allows a US individual shareholder of a CFC to make an annual election to pay tax on its related Subpart F income at corporate rates. This section has been a longstanding part of the Code, but was largely ignored until adoption of the 2017 Tax Act. The 2017 Tax Act reduced corporate tax rates to be significantly below individual tax rates. The 2017 Tax Act left unanswered whether this election can yield the same tax benefits as a C corporation gets for GILTI.
The IRS proposed regulations state that an individual making the Section 962 election is subject to the 21% corporate tax rate and can get the special 50% deduction for GILTI income, which lowers its tax on GILTI to 10.5%. The IRS has not yet specifically confirmed that an individual can get a FTC for 80% of foreign taxes paid by the CFC although the IRS’s recent announcement bodes well for confirmation of such position.
The §962 election is made on a year-by-year basis with the tax return filed for that year. As a result, US individual shareholders facing a significant tax on GILTI may wish to consider making this election to lower the taxes due. However, an individual making this election will also be subject to US tax when it receives a dividend from the CFC. If the individual paid tax on GILTI without making this election, then no tax would be imposed on the dividend.
Dividends from a foreign corporation are generally taxed at regular tax rates unless the dividend is from a “qualified foreign corporation” which is taxed at the long term capital gains tax rate of 20%. A qualified dividend is a dividend from a foreign corporation that is eligible for benefits under an income tax treaty between the US and their home country. The US has income tax treaties with many nations (e.g., England, France, Germany), but not with all nations. The US does not have income tax treaties with most “tax haven” countries (eg, BVI, Cayman Islands).
In brief, the ability to make a Code §962 election to reduce the GILTI tax rate is a planning option that individual taxpayers should consider.