2018 was the year for Guilty tax, a tax that hits U.S. owners of foreign corporations. In order to understand what GILTI tax is, let’s begin by looking the history behind it so that we can then understand its purpose. This will help us figure out situations in which we should expect to see GILTI liabilities pop up.
In 1962, Subpart F was passed to treat passive income overseas harshly. Later it was thought that Subpart F income could be an impediment to offshore tax planning, so the need to create some sort of taxing regime to active income earned overseas came about. The purpose of GILTI is to tax active income of foreign businesses that are controlled by US shareholders. GILTI can hit them so hard, that for some people, having their income taxed as Subpart F could even be better than GILTI!
The Tax Reform also expanded the definition of what it means for a shareholder to be subject to not just controlled foreign corporation rules, that is CFC rules in addition to GILTI regime. GILTI does not just affect huge corporations overseas, but small and medium-sized businesses, and it can even affect someone who is self-employed. For larger clients, the cost may not be all that noticeable, but I can tell you that for our clients who are working hard to create something for themselves, this amount of research is pushing many beyond their breaking point, forcing them to make a decision they wish they didn’t have to.
Characterize GILTI as Subpart F
First, you can elect to covert GILTI to subpart F income. GILTI can be so bad, that it can make Subpart F seem good!
You can increase something call QBAI. QBAI stands for Qualified Business Asset Investments. There are a few ways to do this. For instance, you can purchase equipment that has been previously leased.
The downside is that just because someone is a shareholder in a Controlled Foreign Corporation (CFC) it does not mean that they can actually control the corporation enough in order to implement this strategy. Management might not be fond of this idea, especially if they aren’t US persons. Secondly, this is a business decision that could have negative effects on cash flow. You might solve a GILTI problem but you could end up with a business problem.
Combine Controlled Foreign Corporations into one.
GILTI is NOT calculated on a company basis. It is done on a shareholder basis. And what’s worse is that losses in one CFC may not get full credit against gains of another CFC. The way to make sure you don’t miss out on any of your losses is by combining CFCs.
Avoid CFC or US shareholder status.
This can be the easiest solution simply avoid either CFC status or US shareholder status. The problem with this is tax reform expanded the definition of what it means to have a CFC status. However, by adjusting ownership levels with non-US owners, you may be able to find a great solution that avoids this entire mess. The downside is this is not feasible for many people and second, you need to watch those attribution rules which also have changed for the worse. When you have related parties, you might be considered to have CFC even though you would otherwise not if the parties were not related.
Create a US holding company to own all CFC shares
The fifth way, and this is proving to be the winner of all, is to funnel all shares in foreign corporations into a domestic US holding company. This was an overriding theme of the 2017 Tax Cuts & Jobs Act — bring capital back to the US. The reason it works is that US “C” corporations are allowed to do something US individuals are not. Take what is known as a Section 250 deduction of 50% of GILTI. The downsides are that this does require extra hurdles of having a US domestic corporation which you must honor the corporate formalities of and an additional tax filing requirement of the domestic corporation. However, if your GILTI liabilities are even as low as say $20,000 or even $10,000, it still could be worth the hassle to create this structure.
What about putting CFC shares into a Private Placement Life Insurance Policy?
PPLIs are used by the most sophisticated investors for what I consider to be the ultimate tax structure. Essentially how it works is that your assets go into a life insurance policy and you borrow from the death benefit while you are alive. Since death benefits are tax-free, you’ve essential avoided all income taxes, both federal and state. This is an even better move to make if you happen to be in a high tax jurisdiction like California or New York.
The downside is that life insurance turns most people off, and these are complicated structures and require flexibility and relinquishing so some control that so many business owners and investors are unwilling to do. Typically, it only starts making sense when you have about $10 million in assets, although we’ve been hearing of ways to reduce the amount needed to get into such a powerful platform.
There are diverse requirements of a PPLI’s portfolio that could force you to sell your stock so much so that you could no longer have that CFC or US shareholder status. Also, you must be very committed to following the structure. People get into trouble with PPLIs when they don’t take the rules seriously. But when you do, it is truly magical.
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Stephanie LaGatta was born in Lima, Peru and grew up in different places, between the U.S., Peru, and Argentina. She graduated from the University of Central Florida with a Bachelor’s of Science in Accounting and later she pursued her Master’s of Science in Accounting with an emphasis in Taxation. After moving back to her hometown, she decided to pursue a career in what she knew best and serve the American Community in doing so. So, she started LaGatta And Company Tax Advisors, where she and her partners provide many types of Tax counsel for U.S. citizens.