Many small enterprise house owners with overseas companies have grown accustomed to not paying tax on the company’s earnings till the company pays them a dividend. But due to the brand new tax reform invoice, for a lot of small companies these outdated guidelines not apply.
Who Needs to Worry About GILTI
GILTI stands for “global intangible low-taxed income.” However, the GILTI tax doesn’t simply hit taxpayers, traders, and small companies working in jurisdictions that calmly tax earnings.
Rather, the GILTI tax tags U.S. shareholders who personal nearly any managed overseas company (or “CFC”) that doesn’t have a lot in the way in which of fastened property.
GILTI forces individuals who personal greater than ten % of a overseas company to pay US taxes on their proportional share of the company’s revenue, even when the company doesn’t distribute that revenue to the shareholders.
Note: If you or your small enterprise paid (or ought to have paid) the Section 965 transition tax on a overseas funding, you probably owe GILTI tax beginning in 2018.
How GILTI Works: The $zero.10 Explanation
For most particular person and small enterprise taxpayers, listed here are the brand new GILTI guidelines in a nutshell: U.S. taxpayers want to acknowledge any earnings earned inside a overseas company that exceeds 10% of the overseas company’s fastened property.
C company taxpayers get a particular, decrease tax charge on this earnings. But particular person small enterprise house owners gained’t get a particular tax charge. Instead, they’ll simply add this earnings to all the opposite earnings they’re paying taxes on, after which calculate earnings tax on GILTI identical to it’s Subpart F earnings.
In addition, not like C company taxpayers, particular person taxpayers gained’t get to assert what’s known as an “indirect foreign tax credit” on GILTI. This additionally applies to people who personal their overseas company via a past-through entity, resembling a partnership or S company.
Example: Let’s say a person small enterprise proprietor owns 100% of a U.Ok. company with no fastened property. This company earns $100,000 in 2018, none of which is Subpart F earnings. It pays no dividends to its house owners. Before tax reform, the enterprise proprietor didn’t have to fret about paying U.S. earnings taxes on the $100,000. But post-tax reform, the enterprise proprietor might want to embody the $100,000 on their 2018 1040 and pay tax on it. And this particular person gained’t even get to assert a overseas tax credit score for any earnings taxes the company paid to the U.Ok. on this earnings.
Avoiding GILTI Tax
Some people and small companies do, nevertheless, have a strategy to keep away from GILTI. They can elect to deal with their overseas enterprise as a partnership or disregarded entity.
This, after all, signifies that the taxpayer will acknowledge taxable earnings contained in the overseas entity because it’s earned. And this can be a disappointment for some. But keep in mind that the GILTI guidelines imply the IRS now taxes that earnings at present anyway. However, notice that pass-through or disregarded entity standing means the overseas earnings taxes most likely work as a overseas tax credit score.
Foreign Partnership Tax Classifications
By default, U.S. tax legislation often treats overseas entities that restrict the legal responsibility of their house owners as C companies.
However, some overseas restricted legal responsibility entities might elect to be handled as partnerships or disregarded entities. And a taxpayer isn’t caught with the tax remedy they selected when the overseas entity was fashioned. A taxpayer topic to the GILTI guidelines may elect to have their overseas enterprise entity handled as a partnership or a disregarded entity going ahead.
What’s extra, income procedures typically permit taxpayers to make late entity classifications. This signifies that, even at this late date, some U.S. taxpayers may elect a brand new tax remedy for his or her overseas entities for 2018.
Note: We consider the proper income process to invoke in an effort to make a late entity classification is Rev. Proc. 2009-41.
Making Late Partnership Classifications
To convert a overseas company to a overseas partnership, you’ll file a late Form 8832 “entity classification” election.
Note: Some overseas restricted legal responsibility entities can not elect to be handled as partnerships. Check Treasury Regulation 301.7701-2 when you have questions.
Partnership Reclassification Triggers Gain
Note that the change in standing from company to partnership would imply that it’s essential report, in essence, overseas company inventory being “sold” for a overseas partnership curiosity. So, a taxable transaction.
But that could be a really low-tax transaction. Your “basis” in your overseas company’s inventory doesn’t simply embody the cash you initially invested. It additionally consists of your share of the “Section 965 income” handled on the 2017 return. (This was the Section 965 transition tax you paid, began paying, or elected to pay someday sooner or later.)
Further, needless to say many small companies have very modest valuations. A a number of of two or three or 4 occasions earnings is frequent.
The upshot for some people and small companies invested in overseas companies? A change in entity classification would be the cleanest strategy to keep away from GILTI.
If you’re a tax accountant who must be taught the Section 965 transition tax stuff intimately, you might be occupied with our Preparing International Tax Returns of U.S. Taxpayers monograph.
Like our different monographs for CPAs and attorneys, it offers practitioners with a strategy to rise up to hurry in few hours—reasonably than spend days or longer studying the statutes, rules, and case legislation.