Your Taxes: GILTI until proven innocent

July 25, 2019 22:34
4 minute read.

money. (photo credit: REUTERS)

The Trump reform (Tax Cuts & Jobs Act) made a number of changes for US citizens living overseas, including olim to Israel, and how they do business.

In 2017 there was the one-time Section 965 repatriation tax on retained earnings.

The second is a new annual tax for 2018-on called the Global Intangible Low Tax Income (GILTI).

Until GILTI, if the company (e.g. an Israeli company owned by an immigrant from the US) had active income, it would stay in the company and be deferred until the shareholder took out dividends. Now, even if the money is not withdrawn, it is taxed in the US on the individual shareholder level.

As a quick example to show the impact of this new tax, if you net $100,000 in your Israeli corporation for the year, you will pay an Israeli corporate tax of 23%, and pay a US tax on the individual level of up to 37%. Then, when you pull dividends out the next year, you can pay up to an additional 33% in Israel and 3.8% in the US.

This adds up to a total tax of 79.83%, leaving you with approximately $20,170 take home!

US corporations originally did better under GILTI than individuals. The reason for this is that there are two big offsets that individuals didn’t get.

The first is that the new law allows corporations a 50% reduction of the income subject to the GILTI tax.

The second offset is foreign tax credits. According to the new law, US C corporations can use 80% of foreign taxes paid by the foreign subsidiary, meaning that as long as the foreign subsidiary has a tax of 13.125%, the GILTI tax will, in effect, be zero. This is because the highest corporate tax rate in the US is now 21%. If you reduce that by 50% and take 80% of foreign taxes, you get to 13.125% (21%*50%/80%).

Unfortunately, individuals don’t get the 50% reduction. They also don’t get any kind of foreign tax credit, since the GILTI tax is on the individual level, and the corporation pays taxes at the corporate level.

Recently, the IRS has tried to make it easier for US individuals in two ways:

• Section 962 election

The IRS released proposed regulations for the US Internal Revenue Code Section 250, allowing the individual to be taxed at lower US corporate tax rates and enjoy both the 50% deduction and the 80% tax credit for the foreign taxes paid by the CFC (controlled foreign corporation).

As a quick example, assume you owned 100% of an Israeli corporation that earned $100 of profit for 2018 and paid 23% Israeli corporate taxes. As the US shareholder, you would have to report the $100 on your US personal tax return and pay taxes up to 37%.

If you elect Section 962, however, the net result would be that you get half off on the $100, taxed at the US corporate rate of 21%, and get an 18.4% foreign tax credit (23%*80%). This would end with a zero tax due result ($100/2=$50; $50*21%=$10.5; $10.5 – $18.4=no tax due).

However, Section 962 does have its limitations. If you are paying foreign taxes of less than 13.125%, you will be subject to GILTI tax. The three most common times this happens is if the company has past losses, you use an Israeli “family company,” or you use an offshore company in a low tax jurisdiction.

While the Section 250 regulations are still only proposed, the IRS has stated that they can be relied upon until final regulations are issued.

There are other repercussions of takng a 962 election, so it should be discussed in detail with your CPA to make sure it is the best option for you.
• High Tax Exception (HTE)

On June 14, the IRS released additional new proposed regulations.

They propose that if your company has foreign corporate tax of 90% or higher of the US corporate tax rate (currently 21%), then the income can be exempt from “tested income” and thereby exempt from GILTI. Simply put, if you pay foreign corporate tax of 18.9% or more, you can elect out of GILTI tax.

The IRS has stated that taxpayers cannot rely on these proposed regulations until they are finalized. Therefore, the HTE cannot be used until final regulations are issued by the IRS. I would not hold off on your 2018 tax return hoping that final regulations will allow it. Additionally, the HTE has a waiting period of 60 months if revoked. Additionally, in many situations Section 962 will still give you better or more benefits than the HTE will.

The writer is the manager of the individual & partnership department at Philip Stein & Associates.

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