When U.S. companies do business abroad, they often create foreign subsidiary corporations to conduct their affairs in foreign countries. Under pre 2017 tax law, a significant tax advantage of using a foreign corporation to conduct foreign operations was income tax deferral. Under prior tax law, U.S. tax on the income of a foreign corporation was generally deferred until the income was distributed as a dividend or otherwise repatriated by the foreign corporation to its U.S. shareholders. This is known as tax deferral. Currently however, under changes made by the Trump Administration, tax deferral is ordinarily overridden by provisions accelerating the imposition of U.S. tax on U.S. shareholders of foreign corporations. As a result, income is often taxed before a dividend is distributed. Our experienced International Tax Attorneys and CPAs at the Tax Law Offices of David W. Klasing understand the two major anti-deferral regimes in the U.S. and can help advise our clients about whether their cumulative prior tax deferrals related to their foreign holdings was overridden by Trump’s changes and what deferred profits therefore need to be repatriated, and what to do if they failed to do so back in 2018 if you were required to do so.
Subpart F Provisions
The “Subpart F” provisions of the U.S Tax Code serve to prevent deferral of taxation on some categories of foreign income. They do this primarily by taxing certain U.S. persons on their pro-rata share of such income earned by a qualifying controlled foreign corporation (CFC). In order to qualify as a CFC, stock representing more than 50% of either the total combined voting power or the total value of shares of the foreign corporation must be owned, directly, indirectly, or by attribution, by “U.S. shareholders” on any day during the foreign corporation’s taxable year. A “U.S. shareholder” is, in turn, defined as any person, corporation, partnership, estate, or trust holding stock representing 10% or more of the total voting power of all classes of the foreign corporation’s stock that is entitled to vote.
Broadly speaking, any “Subpart F income” earned by a CFC that is not distributed or otherwise taxed for the tax year in which it was earned is considered constructively repatriated. As such, U.S. persons must report the pro-rata share of any such income as part of their gross income on their yearly returns, meaning it will be subject to U.S. taxes. “Subpart F income” is generally movable income with little or no economic relation to the CFC’s country of incorporation. However, the definition of what does and does not count as “Subpart F income” is very complicated and contains many narrow exceptions and other confusing issues. If you have investments in foreign companies, you should always speak with a skilled tax lawyer and CPA like those at the Law Offices of David W. Klasing before filing your returns so we can take a close look and help you understand what does and does not qualify as Subpart F income that needs to be included in your gross income total.
Passive Foreign Investment Companies
In addition to CFCs, passive foreign investment companies (PFICs) are also subject to a sort of anti-tax deferral scheme. Unlike the rules in Subpart F, these rules apply to all U.S. investors in a PFIC, not just those with a certain amount of ownership stake. Again speaking in the broadest sense, a PFIC is a foreign corporation that has, during the tax year, at least 75% passive income, meeting what is known as the “income test,” or an average percentage of assets that produce passive income of at least 50%, meeting what is known as the “asset test.” If a foreign company meets the standards of either of these tests, its U.S. shareholders become subject to the anti-deferral rules of the PFIC regime.
Like with CFCs and Subpart F income, what does and does not qualify as “passive income” for the purposes of this section is a very fact and situation-intensive calculation that should not be done without the help of an experienced tax attorney and CPA like those at the Tax Law Offices of David W. Klasing. For example, while most foreign investment companies will qualify, only certain personal services firms will. In some cases, the tax and interest imposed under these rules may exceed the amount of the distribution. In such an instance, we may encourage you to forego deferral voluntarily and to include the income as if the PFIC were tax transparent.
Transition Repatriation Tax
Under the 2017 Tax Cuts and Job’s Act, (TCJA) the U.S. now generally exempts earnings from active business carried out through foreign subsidiaries even if the profits are repatriated via a new 100% dividends received deduction. To prevent a windfall profit to U.S Corporations with foreign subsidiaries any accumulated but unrepatriated offshore earnings are taxed as if the offshore earnings were repatriated but at preferred tax rates. Generally starting in 2018, foreign unrepatriated earnings held in cash and cash equivalents were taxed at 15.5% and those not held in cash or cash equivalents were taxed at 8%. The TCJA permitted this tax to be paid in installments over eight tax years.
Global Intangible Low Taxed Income (GILTI) regime
Starting in 2018, the GILTI tax regime now applies to income earned by foreign affiliates of U.S. companies from intangible assets like patents, trademarks and copyrights. To prevent the shifting of profits from these types of assets to foreign subsidiaries in low tax offshore jurisdictions because of the new 100% dividends received deduction, a 10.5% minimum tax on GILTI assets was added under the TCJA. U.S. businesses are required to include GILTI minimum tax in income annually. GILTI is calculated as the total active income earned by a U.S. companies foreign affiliates that exceeds 10% of the firm’s depreciable property. A U.S. Corporations can generally deduct 50% of the GILTI and claim a foreign tax credit for 80% of the foreign taxes paid on GILTI assets. If the foreign tax rate is zero, the effective tax rate on GILTI will be 10.5% or ½ of the 21% corporate rate because of the 50% deduction. If the foreign tax rate is 13.125% or higher there will be no U.S. tax after the 80% credit for foreign taxes.
If You Are Concerned Your 2018 & 2019 Tax Returns May be Misstated Because of a Misunderstanding of the new Federal Anti-Deferral Rules, Contact Our Experienced International Tax Attorneys and CPAs Today
Many of the tax deferral benefits of creating foreign subsidiary corporations to do business have been reduced or eliminated under the TCJA if the company and its shareholders are subject to one of the above anti-deferral tax regimes. Whenever you are thinking of investing in or creating a foreign subsidiary company, you should first consult with an experienced dual licensed International Tax Attorney and CPA like those at the Tax Law Offices of David W. Klasing. We can help you understand whether the anti-deferral rules are likely to apply to your situation and whether this may mean the investment is not worth it.
More Questions and Answers About International Tax
- What are the Mixed Sourcing rules?
- A Citizenship Renunciation FAQ
- What Actions of Foreign Persons Affect U.S. Tax Attributes?
- Foreign corporations taxed on their U.S. source income
- Possible for a Domestic Trust to Become a Foreign Trust?
- What is The Stop Tax Haven Abuse Act?
- Are there any exceptions to the mark-to-market regime?
- Can an expatriate elect to defer tax?
- Taxes on gifts and bequests to Americans from expatriates
- Generally, what are the tax consequences of expatriation?
- How foreign tax credit affects domestic or foreign losses
- Social security/Medicare taxes for self-employed abroad
- Taxes for business income earned by nonresidents
- How is Dividend Income Sourced?
- Nationality and Residency for Federal Tax Purposes
- Taxes on non-business income earned by nonresidents
- Is there a limit on availability of foreign tax credit?
- Make dual contributions for social security taxes?
- When are taxpayers obligated to taxes on foreign income
- Foreign Income and Information Reporting Filing Requirement
- Basic Rules for Sourcing Income
- What are the Basics of the Foreign Tax Credit?
- What are the basics of U.S. International Taxation?
- What are the Basic Sourcing Rules for Interest Income?
- Nexus Over Foreign Persons and Activities for U.S. Tax
- What is a controlled foreign corporation (CFC)?
- What is expatriation and how is this accomplished?
- What is the Branch Profits Tax?
- What is the exit tax?
- Nonresident filing, withholding, and reporting requirements
- What other Source Rules Focus on the Payee’s Residence?
- Tax treaties role between the U.S. and its trade partners
- Common income issues in international tax treaties
- What Sourcing Rules Turn on an Asset’s Location?
- Tax incentives for U.S. citizens living abroad
- International Tax Q and A
- The main purpose and effect of the foreign tax credit
- Is the Foreign Tax Credit a Refundable credit?
- Difference between a foreign tax credit and a deduction
- How to claim foreign tax credit on property income taxes
- Must an individual claim the foreign tax credit?
- Why is foreign tax credit allowed?
- Statute of limitations longer when tax paid and tax accrued
- IRS re-determination of tax liability
- Difference between a Foreign and Domestic Trust?
- Foreign Trusts Subject to Outbound U.S. Taxation Rules?
- Benefit to a deferral of tax for an outbound transaction?
- What is Deferral in the Context of Outbound Transactions?
- What is involved in planning for an outbound transaction?
- What Are the Primary Concerns of Outbound U.S. Taxation?
- Basics of U.S. international taxation of a business
- Are U.S. Partners in a Foreign Partnership Taxed?
- Are U.S. Corporations Taxed on Foreign Sourced Income?
- Can Government Tax Shareholders of a Foreign Corporation?
- What is a Controlled Foreign Corporation (CFC)?
- Constructive Ownership Rules for Foreign Corporation
- US Shareholders Taxed on Distributive Share of CFC Income
- What are the Two Main Categories of Subpart F Income?
- Investing in Controlled Foreign Corporation
- Subpart F Income Requires Separate Computations
- What is the Foreign Tax Credit (FTC)?
- What is the “Deemed Paid” Foreign Tax Credit?
- Basic Tax Rules for Passive Foreign Investment Companies
We Are Here for You
Regardless of your business or estate needs, the professionals at the Tax Law Offices of David W. Klasing are here for you. We are open for business and our team will help ensure that your business is too. Contact the Law Offices of David W. Klasing today to discuss your business with one of our professionals.
In addition to our main office in Irvine, the Tax Law Offices of David W. Klasing has unstaffed (conference room only) satellite offices in Los Angeles, San Bernardino, Santa Barbara, Panorama City, Oxnard, San Diego, Bakersfield, San Jose, San Francisco, Oakland, Carlsbad and Sacramento. During the COVID-19 pandemic, our staff are working from home, but have full virtual meeting capability.
Our office technology allows clients to meet virtually via GoToMeeting. With end-to-end encryption, strong passwords and top-rated reliability, no one is messing with your meeting. To schedule a reduced rate initial consultation via GoToMeeting follow this link. Call our office at (800) 681-1295 and request a GoToMeeting if you are an existing client.
