The Tax Cuts and Jobs Act brought about many changes for multinational businesses. One of the more significant changes was the application of Global Intangible Low-Taxed Income (“GILTI”) to foreign subsidiaries.
Prior to 2018, income earned by foreign corporations controlled by U.S. shareholders (also known as “controlled foreign corporations” or “CFCs”) was typically deferred from U.S. tax until repatriated to the U.S. through dividends. As a result of 2017 TCJA tax reform, and under IRC 951A (GILTI), U.S. shareholders are now generally required to include a certain portion of CFC earnings in U.S. taxable income regardless of whether cash is distributed.
The amount subjected to U.S. taxation under GILTI is generally the CFC’s annual earnings over and above 10% of the CFC’s tangible depreciable assets less interest expense.
U.S. corporations are typically able to exclude 50% of the GILTI inclusion due to an IRC 250 deduction. Other shareholders, such as individuals & trusts, typically do not benefit from the 50% exclusion unless they make an IRC 962 election which allows the individual/trust to tax GILTI income as if they were a corporation.
For U.S. corporations and taxpayer’s making the IRC 962 election, the CFC’s foreign income taxes attributed to GILTI are generally eligible to be claimed as a credit against U.S. federal tax; the credit is reduced by 20% under IRC 960(d).
CFC income may be excluded from GILTI if the income is subject to a foreign effective tax rate of more than 90% of the U.S. corporate tax rate (which is currently 21%). Thus, if a CFC’s foreign effective tax rate is greater than 18.9% the U.S shareholder may make a high-tax election and exclude that CFC’s income from GILTI.
When a high-tax election is made, it applies to all of the taxpayer’s commonly controlled CFCs that exceed the 18.9% threshold. Moreover, the election is made on a year-by-year basis, thus giving taxpayer’s flexibility to choose which years to make the election.
Examples of GILTI’s Impact on Individual U.S. Shareholder
|No Elections||IRC 962 Election||High Tax Election||No GILTI - Foreign Entity Treated as a Flow Through|
|Foreign Income Before Taxes||1,000,000||1,000,000||1,000,000||1,000,000|
|Foreign Tax Rate||20%||20%||20%||20%|
|Foreign Income Tax||200,000||200,000||200,000||200,000|
|Foreign Net Income / E&P to Distribute||800,000||800,000||800,000||800,000|
|IRC 962 Tax Liability||N/A||-||N/A||N/A|
|US Taxable Income||800,000||800,000||800,000||1,000,000|
|U.S. Individual Federal Tax Rate (Regular Tax and, as applicable, NIIT)||40,80%||23.80%||23.80%||37.00%|
|U.S. Indvidual Tax Before Foreign Tax Credits||326,400||190,400||190,400||370,000|
|Foreign Tax Credit||-||-||-||(200,000)|
|Residual Individual U.S. Tax||326,400||190,400||190,400||170,000|
|Total Income Tax Liability (U.S. & Foreign)||526,400||390,400||390,400||370,000|
|Effective Tax Rate||52.64%||39.04%||39.04%||37.00%|
**Simplified model assumes no foreign withholding tax and that all cash is distributed annually.
Understanding the tax impact of GILTI will help you make a knowledgeable decision about taxing foreign activity.
Understand the impact of GILTI.