IRS Proposes Rules on Calculation of GILTI

The IRS has released guidance on the taxation of “global intangible low-taxed income” (GILTI) reported by US shareholders of corporations outside of the U.S. known as “controlled foreign corporations” (CFCs).

A Good First Step On Your Journey To GILTI Compliance Or Avoidance

In a blog post I wrote a few weeks ago, I talked about two new international tax provisions from the Tax Cuts and Jobs Act passed in late 2017: global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII). 

Since then, we’ve fielded a lot of comments and questions from taxpayers asking if they are subject to GILTI, and the analysis that needs to be done to compute its impact.

Freed Maxick’s International Tax Team huddled up and developed a very easy to use calculator that will help you begin to make this determination. In fact, all you need are two numbers from each Form 5471 that you can plug into our complimentary tool. 

While we strongly recommend that you talk to your tax advisor to get more insights and guidance, this tool represents a good first step on your journey. 

We’re also available for a consultation and review of your situation, without fee or obligation. Click on the button below to request a consultation, or contact Susan Steblein, CPA at (716) 847-2651.

For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.

New International Tax Provisions for 2018 and Beyond

With the recently enacted tax reform two new terms have been introduced into the international tax arena: global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII).  

We’re going to spend a few minutes wrapping our heads around what these new provisions are and their potential impact on taxpayers.

Are You GILTI Beyond a Reasonable Doubt?

With the new tax reform, there may be an incentive to shift profits abroad since income earned by a domestic corporation’s foreign subsidiary will now be able to be paid back as a dividend to the US without generating any US tax.  GILTI is a provision which aims to discourage this by imposing tax on foreign sourced intangible income.

Global intangible low-taxed income (or GILTI) provisions can be found in new IRC Section 951A.  Each person who is a US shareholder of any controlled foreign corporation (CFC) must include their share of GILTI in gross income for the tax year.  For C-Corporation shareholders, this ultimately results in an effective US tax rate of 10.5% on the GILTI income. US individual shareholders are subject to GILTI at their regular individual marginal tax rates.

How is GILTI Calculated?

GILTI is the excess of a US shareholder’s net CFC tested income for the tax year over the US shareholder’s net deemed tangible income return for the tax year.  

Net CFC tested income is the excess of the aggregate of the shareholder’s prorata share of the tested income of each CFC of the US shareholder over the aggregate of the shareholder’s prorata share of the tested loss of each CFC.  Tested income of the corporation is the gross income of the corporation less the following:  deductions properly allocable to that gross income, Effectively Connected Income, Subpart F income, dividends received from related parties, foreign oil and gas extraction income, and gross income excluded due to exception for high foreign taxes. In essence, Net CFC tested income is the aggregate annual foreign sourced earnings of your foreign corporations, with some exceptions and adjustments.

Net deemed tangible income return is the excess of 10% of the aggregate of the shareholder’s prorata share of the qualified business asset investment of each CFC over the amount of interest expense taken into account in determining your Net CFC tested income.  The qualified business asset investment is the average of the corporation’s aggregate adjusted bases as of the close of each quarter of the tax year in specified tangible property used in a trade or business of the corporation and which is allowed a deduction under Section 167 (which is determined using ADS depreciation).

Easy enough right?

A GILTI Example

Let’s look at a somewhat basic example.

First we have to figure out the net CFC tested income.  In this example, US C-Corp owns 100% of CFC 1 and CFC 2 which have gross income of $10,000,000 and $8,500,000 and deductions allocable of $6,000,000 and $10,000,000, respectively.  This results in net tested income of $2,500,000 ($10,000,000 - $6,000,000 plus $8,500,000 - $10,000,000).

Now we need to figure out the net deemed tangible income return.  The quarterly average of CFC 1 and CFC 2’s specified tangible property is $10,000,000 and $12,000,000.  10% of the qualified business asset investment is therefore $1,000,000 and $1,200,000.  We end up with a net deemed tangible income return of $2,200,000.

Since GILTI is calculated as the excess of the net CFC tested income over the net deemed tangible income return, we end up with GILTI income of $300,000.

If the US shareholder were an individual or S-Corporation we would stop here and include an additional $300,000 of GILTI income which would be taxed at the individual’s regular marginal tax rates. However, if the US shareholder is a domestic C-Corporation, there is a foreign tax credit and/or deduction available to offset some of the GILTI income.

80% Deemed Paid Foreign Tax Credit for GILTI

If a domestic corporation has an amount includible for GILTI, the corporation is deemed to have paid foreign income taxes equal to 80% of the product of the domestic corporation’s inclusion percentage by the aggregate tested foreign income taxes paid or accrued by CFCs.  

To try to keep this post somewhat simple we won’t get into the specifics of calculating the foreign tax credit, but let’s just point out a few key take away points with regard to this credit:

• The credit is limited to 80% of the foreign taxes paid
• The taxes deemed to have been paid are treated as an increase in GILTI income for purposes of Code Sec.78.
• A new separate foreign tax credit basket is used for the GILTI credit
• There is no carryback or carryforward for taxes paid or accrued in the GILTI basket

Deduction for GILTI

A domestic corporation is allowed a deduction equal to the sum of (i) 50% of the GILTI amount included in gross income and (ii) the amount treated as a dividend under Code Sec. 78 attributable to the amount in item (i).  The 50% deduction will be reduced to 37.5% after December 31, 2025.

So, at the end of the day, with the new US federal corporate tax of 21%, the effective US tax rate on GILTI is 10.5%.  If the foreign tax rate is 0%, then the US residual tax rate is 10.5%.  Once the foreign tax rate is at least 13.125%, there should be no residual US tax owed (80% x 13.125% = 10.5%).

The Foreign-derived Intangible Income Deduction (FDII)

The second new provision to touch on is the foreign-derived intangible income (FDII) deduction.  

Where GILTI income and the corresponding deduction looks to CFC income, the FDII deduction is sort of opposite of this whereby it looks to the foreign-derived income of a US corporation in order to determine the corresponding deduction.  Please note that any foreign derived intangible income is already included within the US taxable income of the corporation.  

So this provision is not looking to add any additional income to the return, but rather can just potentially provide a deduction based on the foreign-derived income. The deduction is 37.5% of the foreign-derived intangible income of a domestic corporation for the tax year.  (Note that this deduction will decrease to 21.875% after December 31, 2025). We won’t get into the technical computation of the deduction, but in a nutshell it ends up being a deduction of 37.5% of the computed FDII and the deduction is computed similarly to the GILTI computations.  

Part of computing the FDII involves determining the foreign derived eligible income of the corporation.  Foreign derived eligible income of a taxpayer is deduction eligible income that is derived in connection with property sold to any person who is not a US person for foreign use or services provided to any person not located within the US.  Foreign use is any use, consumption, or disposition which is not within the US.  

So, under this provision a US corporate taxpayer could receive a tax deduction for exports of property used in foreign jurisdiction or for providing services to any person, or with respect to any property, not located in the U.S.

Cutting Through the Complexities of GILTI and FDII

Even though I’ve used shortened examples for purposes of this article, there is no doubt that the computations of GILTI and FDII are often going to be much more complex.  They are going to be time intensive and will require a lot of additional work and information gathering that the taxpayer and their CPA typically haven’t had to do in the past.  

If you have any questions or concerns about how GILTI or FDII may impact you please reach out to the International Tax Team at Freed Maxick for a complementary Tax Situation Review. Call

If you have any questions or concerns, call the Freed Maxick Tax Team at 716-847-2651 to discuss your tax situation or start the process of setting an appointment by clicking here and submitting your contact information.

For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.

The FBAR filing due date will be different next year.

Hopefully you have already submitted your 2015 FBAR filing which is due by June 30^th this year. If not, you still have a little time left to scramble to get those filings submitted timely. And now just when you may have gotten used to the idea that your FBAR filing is due June 30^th, that is all going to change next year. Under the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, which was signed into law during 2015, the due date for the FBAR next year will be different.

FBAR filings due in 2017 (for the 2016 FBAR) will be due April 15^th. There will now be an extension available in order to extend the due date for a maximum of 6 months until October 15^th. The official guidance as to how the extension will actually be applied for has not yet been issued but it has been speculated that it will be extended with an extension for your income tax return.

Additionally, there will be a provision for an automatic two month extension for a taxpayer residing outside of the country similar to the rules for income tax returns, and there is supposed to be some penalty relief available for first-time filers who fail to timely request or file an extension.

Recap: Who Has to Report?

I’ve talked about it in a previous post, but here’s a quick reminder of who is required to file an FBAR.

If you are a United States person that has a financial interest in or signature authority over foreign financial accounts, you must file an FBAR if the aggregate maximum value of those foreign financial accounts exceeds $10,000 (U.S. dollars) at any point during a calendar year. Interestingly, this also includes accounts of your employer that you might have signing authority over.

Let’s break this down even further. A “U.S. person” includes all of the following…

• U.S. citizens
• U.S. Green Card holders or U.S. residents
• Foreign nationals or Individuals who spend a significant amount of time in the U.S.

Therefore, there are many times we see individuals who might live in another country, but spend time in the U.S., whether it be traveling for work or for vacations. Many of these individuals may unknowingly trip up a tax filing obligation based on the amount of time they spend in the U.S.

To meet the substantial presence test, you must be physically present in the U.S. on at least 31 days during the current year, and 183 days during the 3-year period that includes the current year and the 2 preceding years.

The test is calculated by counting the following:

• All of the days you were present during the current year,
• 1/3 of the days you were present in the first year before the current year, and
• 1/6 of the days you were present in the second year before the current year

If you meet the test described above you have an FBAR filing requirement.

What Should You Do If You Were Supposed to File an FBAR But Didn’t?

There are options available if you find that you should have filed an FBAR but didn’t. The IRS has made a few different programs available in order to file your delinquent FBAR filings such as the Delinquent FBAR Submission Procedures, the Offshore Voluntary Disclosure Program (OVDP), or one of two Streamlined Filing Compliance Procedures.

Which program you should use will depend on your specific facts and circumstances. Since the penalties for the failure to file an FBAR can be extremely severe, it’s important to consult with a professional who is experienced in this area. An experienced professional can help you to determine which path is right for you in order to get into compliance. Our international tax team here at Freed Maxick has a depth of experience in this area and we encourage you to contact us to assist in determining the best way to proceed with submitting your filings.

Many people who receive income from passive foreign investment companies, or “PFICs,” have no idea that they hold an interest in an investment that may trigger additional filing requirements and tax payments on their U.S. returns.

Most Americans work hard to file accurate tax returns and pay the correct amount owed to the government. They may not be happy about taxes, they may complain about them, but some combination of patriotism and fear of consequences keeps most taxpayers in line.

One of the most serious tax problems that can arise for people who make an honest effort to comply with U.S. tax obligations is a tax that they didn’t know existed. Passive foreign investment companies, or “PFICs,” are an excellent example of this problem, and there are steps you can take to protect yourself against it.

What Is a PFIC?

A PFIC is a business or fund based outside of the United States that generates passive investment income to its owners/shareholders. If the business or investment meets either of 2 tests, it should be treated as a PFIC for U.S. tax purposes.

• The first test is an “income test.” The investment meets the income test if 75% or more of the income it generates in a given year is passive income, such as dividends, interest, rents and royalties.
• The second test is an “asset test.” The investment meets the asset test if more than 50% of the business’ average asset value consists of assets held to produce passive income.

The most common type of PFIC that causes problems for U.S. taxpayers is a foreign, or non-U.S., mutual fund. When a mutual fund is based in the U.S., the government requires it to report information about what it pays to its investors in order to match that against the tax returns those investors file. The government also maintains certain requirements on what the funds must distribute annually. Non-U.S. mutual funds aren’t subject to these reporting and distribution requirements. So, in an effort to avoid income deferral, these foreign mutual funds are treated as PFICs for U.S. tax purposes. Therefore, taxpayers who own foreign mutual funds may be subject to additional taxation and reporting under the PFIC regime.

Who Has to File?

The first requirement is that the taxpayer needs to be a “U.S. tax person,” as discussed in a previous post, Know Before You Go—The 3 Ways That Nonresidents Incur U.S. Tax Obligations. An individual or business that qualifies as a U.S. person then needs to determine if they have ownership of any companies or investments that meet either of the two tests discussed above. If yes, the taxpayer may be subject to additional reporting requirements and taxation.

There are some exceptions to PFIC reporting. For example, in some circumstances there may be an exception to the annual reporting requirements if the total value of all PFICs owned is $25,000 or less ($50,000 or less for married filing jointly) at the end of the year. Other exceptions exist, including an exemption for the first year of a corporation that might otherwise be treated as a PFIC, if certain conditions are met. This exception helps certain start-up businesses that begin operations with a significant investment but have yet to spend as much capital on operating assets as planned by the end of the tax year. Without this exception, these businesses might be PFICs under the asset test because cash is considered to be a passive asset under the test.

What Has to Be Filed?

The short answer to this question is, if you think that you might have a filing requirement based on the discussion above, you should probably consult a tax professional with experience in the area before trying to figure out this part of your tax return. The information you report and the calculation of any tax you might owe can be very complicated. There are several different ways a PFIC may be taxed depending on elections that can be made for treatment of the PFIC.

If you believe that you may have an obligation related to a PFIC, you should contact our International Tax Team at Freed Maxick for additional information about these rules.

If you or your business qualifies as a U.S. tax person, you might have to file tax returns and you might have to pay taxes. Or you might not.

In a previous post, we focused on the 3 ways an individual business can qualify as a “U.S. person” for tax purposes. Once someone crosses that threshold, there are 3 important questions to answer:

1. Am I required to file anything in the U.S. and if so, what?
2. Am I required to pay anything to the U.S. and if so, how much?
3. If I’m not required to file and pay in the U.S., is there any reason I would still choose to do so?

Filing Obligations in the U.S.

Once you show up on the Internal Revenue Service’s radar as a “person” for U.S. tax purposes, what do you have to file? That can vary based on individual circumstances and is best determined by consulting with a tax professional familiar with your specific situation. Here are a few possibilities, but this list is by no means exhaustive.

• An application for some type of tax i.d. number. The U.S. system cannot function on names alone. Anybody who needs to file tax forms in the States will need to have some type of identifying number registered with the IRS in order to track filings and payments accurately.
• An income tax return. Keep in mind that there is a difference between filing an income tax return and paying income tax. That will be discussed in the next section. For now, understand that your main interaction with the U.S. tax system is likely to be through the filing of income tax forms, regardless of whether income tax is owed or not.
• Information reports. If you’re required to file a tax return in the U.S., you may very well be subject to information reporting requirements regarding non-U.S. bank accounts. This report goes through the “Financial Crimes Enforcement Network” (“FinCEN”) on the network’s form 114, “Report of Foreign Bank and Financial Accounts” (FBAR). The general rule states that U.S. persons, including individuals and businesses, must file an FBAR if:
  1. The U.S. person has a financial interest or signature authority over at least one financial account located outside the U.S., and
  2. The aggregate value of all financial accounts in number 1 above exceeded $10,000 at any time during the calendar year reported.

Payment Obligations in the U.S.

Not everybody who is required to file forms in the U.S. incurs an obligation to pay taxes there. You might meet the requirements for filing a U.S. income tax return but not have the necessary income to owe taxes. This list describes some (but not all) of the common types of taxes owed once you meet the thresholds:

• Income taxes. The U.S. system allows a credit for taxes paid in foreign countries. It’s not unusual for a business or individual to meet the requirements to be a U.S. tax “person” and to report income in the states, but to wind up owing nothing in the U.S. due to tax obligations in another country.
• Payroll Taxes. If you hire U.S. employees and withhold federal income, social security and Medicare taxes from their wages, the government expects the money withheld to be paid to the Treasury in relatively short order. Depending on the number of employees or the amounts withheld, an employer may be required to pay as frequently as every 2 weeks.
• Penalties. This area is perhaps the biggest “trap for the unwary.” A failure to file any tax form required by the government can lead to the assessment of a penalty. Often the penalty is calculated based on a percentage of the amount owed, so those who don’t have a balance due may not accrue significant obligations in this area. Failure to file an FBAR, however, can lead to penalties up to $10,000 for non-willful violations or $100,000 or more in the case of willful failures to file.

Filing When Not Required

In most cases, people don’t want to file any tax form that they don’t have to. In the U.S. tax system, there is a situation that might make the filing of an income tax return worthwhile even if it’s not required. Non-U.S. taxpayers who invest in U.S. businesses, particularly partnerships, might get an information report back that says the partnership lost money. The taxpayer might not meet any requirement for filing a U.S. income tax return under those circumstances, but the U.S. system allows for losses that cannot be deducted in a particular year to be carried forward. So even though the only entry on the tax form is a report of the loss from the partnership, that loss can serve to reduce taxable income in future years if and when the investment starts to make money.

In addition, we often advise businesses that have sales in the U.S. but no other significant presence to begin filing returns proactively even before required. It’s important to establish a track record of compliance from the earliest days of your presence in the U.S.

The key to effective tax compliance for non-U.S. businesses and individuals is solid advice and planning from the start. If you’re contemplating starting operations in the U.S., it’s never too early to contact a tax professional who is familiar with the intricacies of the tax obligations facing non-U.S. taxpayers.

You may think you’re just friends with Uncle Sam, but he may have a deeper commitment in mind…

We spend a lot of our time talking with non-U.S. residents who spend significant amounts of their time in the United States. Far too often, we wind up talking with people who incurred some type of U.S. tax or filing obligation without knowing it. Those conversations frequently include statements like, “Well, it’s not like I obtained my citizenship, or pledged allegiance or anything. I just spent the winter in Florida!” In some cases, that can be enough.

Are You a U.S. Tax “Person”?

To figure out whether you are required to file a U.S. tax return, you first need to determine if you are a “person” for U.S. tax purposes. Federal law describes 3 categories of individuals that qualify as “persons” for U.S. taxes:

• U.S. Citizens—You would think that most people who incur a U.S. tax obligation because they are U.S. citizens would know that up front, and for the most part that’s true. However, every now and then, we do encounter people who may have been born in the U.S. and lived out of the country most of their lives, or someone with a parent who has U.S. citizenship. In some cases, these people may have an obligation without even realizing it.
  
  
• U.S. Green Card Holders—One of the most frequently asked questions from non-U.S. citizens who hold Green Cards is, “Do I have to file a U.S. tax return?” Basically, unless you relinquish the Green Card, you still need to file a Federal return even if you leave the U.S. You may not owe money, but the government will still be looking for a return from you as long as you hold the card.
  
  
• The Substantial Presence Test—Most non-U.S. citizens who unknowingly incur a tax obligation in the States qualify under this category. To meet the test, you must be physically present in the U.S. on at least:
  1. 31 days during the current year, and
  2. 183 days during the 3-year period that includes the current year and the 2 years immediately prior.
     
     The calculation of the 183 days is weighted toward the most recent days in the measurement period by counting:
     • All the days you were present during the current year,
     • 1/3 of the days you were present in the first year before the current year, and
     • 1/6 of the days you were present in the second year before the current year. 

Even if you meet the substantial presence test, it is possible that you may still not qualify as a U.S. tax “person.” Depending on the purpose of your visit and your visa status, you may qualify as an “exempt individual” on some or all of the days you were physically present in the U.S. Also, under certain conditions, you may be eligible for treatment as a nonresident alien if you qualify for an exception given to individuals with a “closer connection to a foreign country” or by reason of a treaty.

If you spend significant time in the United States, or you’re planning to do so in the near future, you should consult a tax professional who is familiar with the filing obligations of non-residents before you go. If you have spent significant time in the U.S. previously and haven’t filed any income tax returns, you should consult a tax professional who is familiar with U.S. rules quickly. People who have a filing obligation in the States but do not file a return or other informational filings that may be required, such as FBARs, can be subject to penalties and interest that grow larger over time.