Tax reform’s aim to protect the US tax base and prevent domestic companies from shifting jobs, manufacturing and profits to lower tax jurisdictions overseas resulted in a significant benefit to export businesses. Not only does the new law preserve the preferential tax treatment of Interest Charge-Domestic International Sales Corporation (IC-DISC), it also introduces a new tax incentive for C corporations that sell American-made goods or services to foreign customers for consumption outside of the U.S.
Interest Charge-Domestic International Sales Corporation (IC-DISC)
U.S. businesses that sell, lease or distribute goods made in the US to customers in foreign countries may realize significant tax benefits when they create an IC-DISC to act as their foreign sales agent to which they pay commission as high as 4 percent of gross receipts or 50 percent of taxable income from the sale of export property.
Essentially, a qualifying business forms the IC-DISC as a separate US-based “paper” company, typically with no offices, employees or tangible assets, to receive tax-free commissions that the business can claim as deductions that ultimately reduce its taxable income. The amount of the tax savings the business may reap for the commission it pays to the IC-DISC can be as high as 37 percent, depending on its structure (21 percent for C corporations beginning in 2018) and its source of income. Only when the IC-DISC distributes earnings to shareholders will there be a taxable event. At that time, the shareholders will be liable for paying taxes on the IC-DISC earnings at lower qualified dividend rates not to exceed 23.8 percent.
While businesses that make IC-DISC elections are most commonly exporters and distributors of U.S.-manufactured products or their components, software companies, architects, engineers and other contractors who provide certain limited types of services overseas may also qualify to take advantage of this permanent tax benefit.
Foreign Derived Intangible Income (FDII)
To encourage U.S. corporations to keep their exporting operations and profits in the country, the TCJA introduces a new tax-savings opportunity in the form of a deduction of as much as 37.5 percent on profits earned from Foreign Derived Intangible Income (FDII).
This new concept of FDII is defined as income C corporations earn from (1) sales or other dispositions of property to a foreign person for a foreign use; (2) an IP license granted to foreign person for a foreign use; and (3) services provided to a person located outside of the U.S. The types of services that qualify for FDII are not severely restricted, like they are for IC-DISC applications.
Under the law, FDII earned after Dec. 31, 2017, is subject to an effective tax rate of 13.125 percent until 2025, when the rate is scheduled to increase to 16.046 percent for a total FDII deduction of 21.87 percent. That’s quite an incentive for domestic businesses to use the U.S. as its export hub and distribute products made in the country to foreign parties located outside the country!
It is important to note that like most provisions of the tax code, the FDII deduction is subject to a number of restrictions and calculation challenges. For example, it applies only to domestic C corporations, which under the TCJA are subject to a permanent 21 percent income tax rate beginning in 2018, down from 35 percent before tax reform. In addition, the amount of the deduction is reduced annually by 10 percent of the corporation’s adjusted basis of depreciable tangible assets used to produce FDII.
Planning Opportunities
Corporate taxpayers that combine the benefits of an IC-DISC and the new FDII deduction may receive enhanced tax savings. However, every business entity is unique and not all businesses will qualify to apply the benefits of both export tax incentives. However, with proper planning under the guidance of experienced tax professionals, businesses can maximize the benefits that are available to them.
For example, an S corporation or LLC with an IC-DISC may not realize the added tax savings of the FDII deduction, which is only available to C corporations. While an S corporation may consider changing its entity structure to a C corporation to take advantage of the lower tax rate, it must first consider its unique business goals and weigh them in context against all of the new provisions of the new tax code, which will affect the tax liabilities of both the business and its shareholders.
Companies doing business across borders can successful plan around the new provisions of tax law with the strategic counsel and guidance of knowledgeable advisors and accountants with deep experience in these matters.
About the Author: James W. Spencer, CPA, is a director of International Tax Services with Berkowitz Pollack Brant, where he focuses on a wide range of pre-immigration, IC-DISC, transfer pricing and international tax consulting issues for individuals and businesses. He can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at info@bpbcpa.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service
The U.S. Supreme Court’s June 2018 decision in South Dakota v. Wayfair has far-reaching impact on the state and local sales tax (SALT) obligations and previous competitive advantages of online and foreign businesses that sell products into the U.S.
The court’s ruling eliminates the prevailing physical presence test, which requires sellers to collect sales tax from customers who live in states where they own property or employ workers.
Instead, the court, under Wayfair, introduces an economic nexus test based on the sellers’ sales volume into each state. More specifically, U.S. states may now impose sales tax collection obligations on sellers, foreign or domestic, that conduct more than $100,000 in sales or more than 200 transactions in their jurisdictions in a given year regardless of whether the sellers has a physical presence in that locale. This economic nexus standard varies by state.
For example, if a foreign company that sells tangible goods from its headquarters in South America into the U.S. meets the sufficient dollar/transaction threshold in a particular U.S. state, the company would be required to collect sales and/or use tax on all orders received from customers in that state. This would apply even if the company does not have a permanent establishment (PE) in that state. When the company’s sales meet the test for establishing a meaningful and substantial presence in multiple states, it would need to collect and remit sales tax in each of those jurisdictions. With economic nexus laws, states will now be able to enact or enforce sales or transaction threshold and compel more companies outside of their borders to collect tax on sales made to in-state customers.
The Wayfair decision places a significant administrative burden on foreign businesses. International tax treaties generally apply solely to income taxes on the federal level. As a general rule, tax treaties do not apply to U.S. states, and bilateral tax treaties generally do not apply to non-income taxes at the state level. Therefore, foreign companies with U.S. customers may not escape sales and use tax obligations on the state and local levels. Instead, non-U.S. companies have a potential U.S. tax collection and filing responsibility when they meet the sufficient dollar/transaction threshold in a particular state regardless of whether or not they have a permanent establishment (PE) there.
It is important to note that while the U.S. Commerce Clause prohibits states from imposing excessive burdens on interstate commerce without Congressional approval, the Supreme Court has demonstrated its authority to “formulate rules to preserve the free flow of interstate commerce” when Congress fails to enact legislation. In its opinion in Wayfair, the court affirms that the dollar/transaction threshold satisfies South Dakota’s burden to establish economic nexus and impose tax on businesses that are “fairly related to the services provided by the state,” including “the benefits of a trained workforce and the advantages of a civilized society”. This final factor, which demonstrates a fair relationship between the tax imposed and the services provided by a state, can be easily applied to foreign companies that conduct business in U.S. states.
Foreign businesses must consider how the Wayfair decision will affect their sales and profits, and they must take steps to comply with state-level taxation going forward. This may involve assessing the volume of their transactions in each U.S. state, gaining an understanding of and a method for applying the SALT regimes in each U.S. state to their sales orders, and developing communication to let customers know that sales tax will be added onto future purchases.
About the Author: Karen A. Lake, CPA, is state and local tax (SALT) specialist and an associate director of Tax Services with Berkowitz Pollack Brant, where she helps individuals and businesses navigate complex federal, state and local tax laws, and credits and incentives. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.
In an effort to prevent U.S. businesses from shifting profits offshore to low-tax countries, the Tax Cuts and Jobs Act imposes an annual tax on foreign income that exceeds 10 percent of a taxpayer’s return on all foreign depreciable assets, including plants, equipment and real estate. However, under this Global Intangible Low Taxed Income (GILTI) regime, U.S. owners of foreign corporations may exclude from this calculation some items of income, including income that is considered “high-taxed” (i.e., income subject to a local tax rate above 18.9 percent). While this can be a very powerful tool to avoid GILTI, the language used in the current version of the law does not exempt all income subject to high-tax. Rather, the exemption applies only to income subject to high-tax that would have otherwise been picked up on a pre-existing anti-deferral regime known as Subpart F.
As the IRS continues to issue guidance to help taxpayers apply the new law, it is possible that the agency will interpret the language contained in the TCJA to mean that only high-tax income already exempt from Subpart F income should be exempt from GILTI. At this point in time, it appears that this interpretation is very likely to be the correct one. The reason for this exemption is that if the IRS does not allow taxpayers to exempt from GILTI high-taxed income that would have been Subpart F, then the pre-existing exception to Subpart F would be rendered meaningless. This is because taxpayers would simply pick up that same income by the new tax law’s GILTI anti-deferral regime after exempting it under the older Subpart F rules.
Keeping this exception in mind, will more businesses feel GILTI under the new law? Maybe, maybe not.
U.S. C corporation taxpayers receive a credit against GILTI inclusions for foreign taxes they paid at the level of their foreign corporate subsidiaries (albeit a reduced benefit of 80 percent). They also receive a 50 percent deduction on GILTI income that reduces their corporate rate from 21 percent to 10.5 percent. In essence, if a U.S. C corporation has foreign entities that pay taxes locally, in a foreign jurisdiction, at a rate of 13.125 percent (20 percent more than the U.S. rate charged on GILTI of 10.5 percent), then, the foreign tax credits allowed against GILTI should theoretically eliminate the corporation’s U.S. tax liability. However, this is not always the case. For example, if a C corporation has interest expense at the U.S. level, it may allocate and apportion some of that amount in such a way as to reduce the entity’s foreign tax credit, and subsequently leave the entity with some additional U.S. tax liability.
What about U.S. individual taxpayers who may be taxed as high as 37 percent on GILTI income? They neither receive the 10.5 percent tax rate on GILTI inclusions, nor do they benefit from the possibility of getting credit for foreign taxes paid by foreign-owned subsidiaries. However, eligible taxpayers may be able to reduce their GILTI liability by making Section 962 elections to be treated similar to C corporations. When this occurs, a U.S. individual taxpayer may receive a credit for foreign taxes paid at the corporate level to be used against his or her individual GILTI liability.
Yet, the law does not yet make clear whether a Section 962 election would also allow an individual taxpayer to take advantage of all of the tax benefits afforded to C corporations. For example, it is yet to be seen if the IRS will permit an individual to apply the 50 percent deduction against GILTI inclusions that a C corporation may use to reduce its effective tax rate to 10.5 percent, rather than the 21 percent rate that a corporation would otherwise have on GILTI inclusions. Even without this deduction, a 21 percent tax rate would still be better than the maximum 37 percent that could apply to U.S. individuals. Currently, it appears that an individual making a Section 962 election will only be entitled to the 21 percent rate and will not receive the 50 percent deduction afforded to corporate taxpayers.
Are there any other options that a U.S. individual could employ to reduce or eliminate the GILTI inclusion? Since many foreign jurisdictions effectively tax income at a rate greater than 18.9 percent, U.S. individual taxpayers may be able to use the new tax law’s high-tax exception to avoid the GILTI inclusion. However, the language used in the new tax law relevant to the GILTI provision allows this exception only for income that would otherwise have been picked up as Subpart F income.
As an example, consider that a U.S. individual owns a foreign distribution business carried out by two foreign subsidiaries, CFC1 and CFC2. Both subsidiaries are located in different jurisdictions and subject to effective tax rates that are greater than 18.9 percent in their local countries. If CFC1 and CFC2 buy widgets from suppliers and then sell each widget in their local markets, the income on these transactions would not be considered Subpart F, regardless of the high local taxes the subsidiaries paid. Therefore, neither CFC1 nor CFC2 would be eligible for the GILTI exception to include income that would have been treated as Subpart F income, but for the high-tax exception. What if the operations change and, instead, CFC1 and CFC2 can treat their foreign income as Subpart F income (but for the high tax)? Presumably, this type of a change in operation would allow for an exemption from the GILTI inclusion.
No matter what the circumstances, taxpayers with offshore earnings should engage in careful advanced planning under the guidance of experienced international tax advisors to maximize their exemptions from GILTI. Under some circumstances, it may behoove taxpayers to restructure their international operations to avoid or minimize feeling GILTI in the future.
About the Author: Andre Benayoun, JD, is an associate director of International Tax Services with Berkowitz Pollack Brant, where he works with inbound and outbound multinational businesses and nonresident aliens on a variety of matters, including structuring for mergers, acquisitions and liquidations; planning for repatriation of profits; treaty analysis; tax-efficient debt financing; and pre-immigration tax planning. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
The Tax Cuts and Jobs Act introduces a one-time “deemed repatriation tax” on the previously untaxed profits that U.S. individuals, businesses and foreign corporations owned by U.. shareholders earned and left overseas. Under the law, foreign earnings held overseas in the form of cash and cash equivalents are taxed at a rate of 15.5 percent rate, whereas foreign earnings invested in illiquid, fixed assets, such as plants and equipment, are subject to an 8 percent tax rate.
While the law allows taxpayers to make a timely election to pay the transition tax over an eight-year period, the IRS has clarified some of the initial questions that arose following the enactment of the hastily drafted new law. Following are three key points that taxpayers should plan for under the guidance of experienced tax advisors and accountants:
- Individuals who already filed a 2017 return without electing to pay the transition tax in eight annual installments can still make the election by filing an amended tax return by the extended filing deadline of Oct. 15, 2018.
- In some instances, the IRS will waive an estimated tax penalty for taxpayers subject to the transition tax who improperly attempted to apply a 2017 calculated overpayment to their 2018 estimated tax as long as they make all required estimated tax payments by June 15, 2018.
- Individuals with a transition tax liability of less than $1 million who missed the April 18, 2018, deadline for making the first of the eight annual installment payments may receive a waiver of the late-payment penalty if they pay the installment in full by April 15, 2019. A later deadlines applies to certain individuals who live and work outside the U.S. The language of the law previously led taxpayers to believe that if they missed the April 18, 2018, initial installment payment deadline, they would be required to pay the entire transition tax liability immediately, rather than over an eight-year period.
About the Author: Andre Benayoun, JD, is an associate director of International Tax Services with Berkowitz Pollack Brant, where he works with inbound and outbound multinational businesses and nonresident aliens on a variety of matters, including structuring for mergers, acquisitions and liquidations; planning for profit repatriation; treaty analysis; tax-efficient debt financing; and pre-immigration tax planning. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or via email at info@bpbcpa.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
A common planning challenge faced by multinational families is the U.S. taxation of gifts from foreign, non-U.S. family members to their relatives who are U.S. citizens and U.S. tax residents. For example, if a husband is a non-U.S. citizen who lives and works in foreign country X, what is the best way for him to transfer money to his wife and family living in the U.S.? What does U.S. tax law require the wife to report to the IRS on an annual basis to prevent those cash gifts from becoming subject to U.S. income tax and/or penalties? What are the reporting requirements and how can a U.S. family member avoid penalties when he or she receives a large inheritance from a relative who was a non-U.S. person at the time of passing?
Reporting Requirements
The IRS requires U.S. taxpayers to file Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, to report receipts of large gifts and inheritances that meet the following thresholds:
Gifts or bequests valued at more than $100,000 received from non-US individuals or foreign estates, including non-US persons related to the non-US individual or foreign estate,
- Gifts valued at more than $16,111 in 2018 from foreign corporations or foreign partnerships, including foreign persons related to those foreign entities,
- Gifts in the form of distributions of loans from a foreign trust, regardless of the amount.
The $100,000 threshold is based on the aggregate value of all gifts a U.S. taxpayer receives in a given year from a foreign estate or from a non-U.S. person and his or her family members. Therefore, if a U.S. citizen receives $50,000 from her non-U.S. mother and $60,000 from her non-U.S. father, she will have a requirement to file Form 3520 and report to the IRS the aggregate value ($110,000) of both gifts.
Form 3520 is due by April 15th following the year of the gift and can be extended to October 15th if additional time is needed. Failure to timely file and report a gift or inheritance from a foreign person will result in a penalty as high as 25 percent of the amount of the foreign gift or bequest. This penalty may also apply when the information contained on a taxpayer’s Form 3520 is inaccurate or incomplete. The IRS will waive penalties for late filing if there is reasonable cause.
Avoiding Penalties and Tax Traps
U.S. citizens who expect to receive gifts from foreign sources have an opportunity to minimize their U.S. tax liabilities when they take the time to plan under the guidance of experienced tax accountants and advisors. With some advance planning preparation, it is possible for U.S. persons to receive gifts or inheritance free of U.S. taxes.
For example, foreign family members should not make “gifts” to their U.S. family members from a foreign corporation, since the IRS will consider such transfers to be taxable corporate dividends that cannot qualify as tax-free gifts. There is a similar concern with distributions received from foreign partnerships, which the IRS would also presume to be taxable distributions.
Another potential tax trap can occur when U.S. persons receive as “gifts” shares in a foreign corporation that owns assets that produce passive income. This may include an offshore company that owns a portfolio of stocks and bonds or passively managed rental real estate. The primary tax concern is that these gifts of corporate shares could ultimately trigger a U.S. tax liability to the new U.S. owner, even if no actual cash was distributed. U.S. persons are also susceptible to taxation in connection with distributions or loans they receive from certain foreign trusts. For example, a U.S. beneficiary who receives a distribution from a foreign non-grantor trust could be subject to U.S. income tax and an interest charge on the distribution amount. While beneficiaries of foreign trust distributions and loans cannot avoid the IRS’s reporting requirement (also on Form 3520) they may be able to minimize their income tax exposure on these transfers when they plan ahead and properly structure the trust and the distributions.
In each of these situations, multinational families have the opportunity, with advance planning, to restructure their holdings and/or develop appropriate gifting strategies to maximize tax efficiency for U.S. family members.
Similarly, U.S. persons should be careful of their susceptible to taxation in connection with distributions or loans they receive from certain foreign trusts. For example, a U.S. beneficiary of a foreign non-grantor trust who receives a distribution or loan from the trust could be subject to income tax and an interest charge on the distributed amount. While the U.S. beneficiary cannot avoid his or her IRS reporting requirement on Form 3520, he or she may minimize his or her income tax exposure on these transfers when the trust and distributions are properly structured far in advance.
Some Tax Relief for Married Couples
Under U.S. tax laws, special rules apply to gifts between U.S. citizens and their non-U.S. spouses. In general, married couples who are both U.S. citizens may make unlimited tax-free gifts to each other during life and at death. This is known as the marital deduction. Similarly, a U.S. citizen may receive from a non-U.S. spouse an unlimited amount of tax-free gifts.
However, the unlimited marital deduction does not apply when the spouse receiving a gift is not a U.S. citizen. Under these circumstances, a U.S. tax citizen spouse must report to the IRS any gift exceed $152,000 in 2018 that he or she makes to a nonresident alien spouse.
The advisors and accountants with Berkowitz Pollack Brant work with multinational families to comply with complex international tax laws and maximize tax efficiency across borders.
About the Author: Lewis Kevelson, CPA, is a director with Berkowitz Pollack Brant’s International Tax practice, where he assists cross-border families and their advisors with personal financial planning and wealth management decisions. He can be reached at the firm’s West Palm Beach, Fla., office at (561) 361-2050 or via email at info@bpbcpa.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
