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US Tax Reform 2018 – GILTI and “deemed transition tax” for US taxpayer individuals and pass-through LLCs

US 2018 Tax Reform Bill H.R.1 sections 14201 and 14202 on GILTI

US 2018 Tax Reform us-tax-reform-context-new-tax-concepts-and-impact-on-your-business-models

A US taxpayer, if you own shares in a foreign company of more than 10{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} – major repercussions are in play now after the latest US tax reform amendments

Published on February 1, 2018
Dr Daniel N Erasmus PhD EA USTCP Int'l Tax Attorney
Dr Daniel N Erasmus PhD EA USTCP Int’l Tax Attorney

As an EA, a CPA or other tax advisor in the USA or abroad, you will have U.S. clients that own shares in Foreign Corporations. These clients who have 10{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} or more ownership in a foreign corporation will be impacted severely by the recent U.S. tax reform changes. Note that these clients are not just the clients who are 10{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} or more shareholders in a controlled foreign corporation (CFC). Shareholders in so-called “10-50” foreign corporations will be impacted as well.

Beginning 1 January 2018, two new U.S. taxes affecting these shareholders are the “deemed transition tax” and the Global Intangible Low Tax Income (“GILTI”) tax. The “deemed transition tax” applies to retained earnings from 1 January 1986 through 31 December 2017 in Specified Foreign Corporations that have not been previously subject to U.S. taxation.
These Corporations include CFCs and 10-50 foreign corporations. Earnings arising from cash and liquid assets, such as net Accounts Receivable, are subject to tax at 15.5{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}, and from other assets at 8{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}. For U.S. shareholders in a CFC, the GILTI tax applies the maximum marginal tax rate of the shareholder to CFC earnings in excess of a certain threshold.

 Consider a simple example in which a U.S. individual owns 100{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the shares in a CFC.

The CFC trades actively in an offshore country and has accumulated retained earnings of $2m from 1 January 1986 to 31 December 2017. The CFC is expected to earn profits of $1m in 2018 from active trading. The company owns virtually no tangible assets (e.g. factories, plant and equipment etc.).

Assume the split between cash and non-cash assets produces a tax rate of 15.5{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} for the deemed transition tax.

Effective for tax year 2017, the deemed transition tax for the retained profits of $2m in the CFC is $310,000. This once-off tax on the $2m retained earnings can be paid over an 8-year period, without interest, as follows:

  • 8{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the amount for the first 5 years;
  • 15{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the amount in year 6;
  • 20{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the amount in year 7, and
  • 25{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the amount in year 8.

The GILTI tax kicks in on 1 January 2018 on the CFC’s $1m profit from active trading.  As mentioned above, the GILTI tax applies to CFCs only. Do not be fooled by the word “intangible” as the GILTI tax potentially affects all active trading profits generated in the CFC. Because the shareholder in the example is a U.S. individual shareholder, the full profit LESS 10{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the value of the CFC’s assets is subject to GILTI tax in the US at the individual’s maximum applicable marginal tax rate (up to 37{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}). Let’s assume the CFC’s assets (plant, equipment, factories etc.) is minimal – a few computers and office desks. The CFC has virtually no deduction to offset the GILTI tax. For tax year 2018, the individual will include as taxable regular income $1m arising from the GILTI tax. This GILTI tax has resulted in a $370,000 U.S. tax liability for the U.S. shareholder because the GILTI (income) is subject to the maximum marginal tax rate for the shareholder (i.e. 37{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of $1m is $370,000). Note that the GILTI (income) may also be subject to the Net Investment Income Tax (NIIT) of 3.8{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}.

U.S. corporate shareholders are also subject to the GILTI tax. Assume in our example the shareholder is a U.S. C-corporation rather than a U.S. individual. The C-corporation shareholder will pay the GILTI tax at its flat tax rate of 21{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}. However, as a C-corporation, the shareholder gets a 50{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} deduction credited against the GILTI tax liability. The C-corporation will get a $500,000 deduction, so that only the remaining $500,000 is subject to the GILTI tax at the new corporate rate of 21{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}.  The C-corporation shareholder will be subject to a GILTI tax of $105,000. Furthermore, C-Corporations get a deemed paid Foreign Tax Credit (FTC) at 80{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the deemed paid foreign tax. (Note that the IRC §78 gross up stays at 100{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}). As a result, a U.S. C-corporation shareholder will have no GILTI tax liability if the foreign corporate tax rate is at least 13.125{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} (i.e., 13.125{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} x 80{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} = 10.5{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}). There are various articles online explaining this complex amendment, and section 14202 and 14203 of the Bill amending the IRC for corporations, but not for individuals and pass-through LLCs:

To summarize, for tax year 2018 the U.S. individual taxpayer in this example will pay tax in the US of:

  • His or her usual US tax on US income;
  • $24,000 the first installment on the “deemed transition tax”;
  • $370,000 tax on the CFC earnings under the GILTI tax.

This individual’s U.S. tax bill for tax year 2018 just increased by $394,000 plus potentially 3.8{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} more for the NIIT. And, do not forget the individual’s tax year 2017 tax liability increased by $24,000 for the first “deemed transition tax” installment as well.

As mentioned above, the impact of the new U.S. tax law on U.S. individual shareholders in foreign corporations can be severe. If you have any questions or would like to discuss potential impacts on your U.S. clients, please do not hesitate to contact me.

For a discussion about your client’s potential exposure, please arrange an appointment with Dr. Daniel N. Erasmus through
PLACE IN the subject heading of the email: “DEEMED TAX AND GILTI DISCUSSION REQUEST”
TIME is limited to do something about this new tax exposure. REMEMBER reverse planning is NOT effective. PLAN now.