The Tax Cuts and Jobs Act of 2017 made significant changes to the taxation of businesses. The new tax law brought not only an end of tax deferral for foreign companies. It also introduced a new tax on any new foreign income that international companies earn, the GILTI tax (pronounced “guilty” – no pun intended?). (For more on the impact of the tax reform on offshore businesses, please download our free whitepaper.)
GILTI stands for Global Intangible Low-Taxed Income, which represents a new category of income.
Reduced GILTI tax rate for C corporations
Generally, GILTI is taxed at the corporate tax rate of 21%.
Under the GILTI rules though, certain C corporation US shareholders can deduct 50% of their GILTI, which halves the effective corporate tax rate to 10.5%. In addition, they can claim foreign tax credits, lowering the US federal income tax due even further.
This is a significant reduction over the previous 35% corporate tax rate and still substantially lower than the new 21% corporate tax rate.
How to qualify for the reduced 10.5% GILTI tax rate
Of course there are requirements to qualify for the low 10.5% tax rate. Just as for the previous tax deferral, the lower GILTI tax rate only applies to international businesses that do not engage in US trade or business.
If you have operations, an office or warehouse in the US, or a “dependent agent” that works for you exclusively, you have a US presence and cannot take advantage of the 10.5% GILTI tax rate. Typically, Amazon resellers using direct shipping or businesses with only an online presence such as a membership website, would qualify for the low GILTI tax rate.
When earnings are distributed to shareholders as dividends, shareholders will pay tax on those dividends. The qualified dividend tax rates remained unchanged at 0%, 15% and 20%, depending on your personal income tax bracket.
Higher GILTI tax for non C corporations
The GILTI rules apply a higher tax rate to GILTI attributed to individuals and trusts who own CFC stock (either directly or through LLCs or S corporations) than to C corporation shareholders.
Previously, a US person generally only had to pay tax on income earned through a foreign corporation when he received that income as a dividend.
Now under the new rules, if a US person (not a C corp) is a 10% shareholder of a Controlled Foreign Corporation (CFC), he or she must include their portion of the foreign income on their personal tax return, regardless of whether or not it was received as a distribution to shareholders. This income would be taxed at a whopping 37%.
How to reduce GILTI tax as non C corp
Owning shares in a CFC either directly or through a LLC or S corp exposes you to a higher tax rate than owning the same shares through a C corp.
As a non-C corporation US shareholder of a foreign company you can take steps to reduce your tax rate:
Electing section 962 treatment
Section 962 election allows individual to be taxed as a corporation. This would lower your tax rate to 21%. The reduced 10.5% rate however is not available for individuals.
Owning CFCs through a C corporation
Putting a C corp in place that owns the foreign company allows you to take advantage of the lower corporate tax rates.
Even if you don’t take advantage of the lower C corp tax rates, there is a silver lining. While you would pay more as an individual owner than as a C corp with GILTI, you won’t need to worry about dividend taxation.
The bottom line on GILTI tax
You cannot defer taxes on foreign earnings anymore. However, you gain the flexibility to move the money as you see fit. You can now decide if you want to keep your taxed earnings overseas or bring it to the US, with no additional tax impact.
To make the best of the new tax situation, you should review your company structure with your advisor and make the necessary elections or adjustments as soon as possible as they affect the 2018 tax year.
If you’d like to review your situation and next steps with an expert, please schedule a consultation.