Tax Reform Brings Immediate Impact to U.S. Taxpayers Doing Business Overseas by Andre Benayoun, JD
Posted on March 08, 2018 by Andrè Benayoun, JD
While many provisions of the Tax Cuts and Jobs Act (TCJA) will not be reportable by U.S. taxpayers until they file their 2018 tax returns in 2019, individuals and businesses with overseas operations must prepare now and, in some instances, apply provisions of the new law to their 2017 tax returns. Following are two important and timely provisions of the law that require immediate attention and planning.
Deemed Repatriation Tax
The TCJA introduces an immediate, one-time “deemed repatriation tax” on income that U.S. businesses earned and were previously allowed to hold overseas as untaxed profits since 1987. More specifically, the law requires businesses to presume they brought foreign earnings back to the U.S. in 2017 and pay taxes on that amount. The tax on these deemed repatriated earnings tax is 15.5 percent on liquid assets (or 17.5 percent on those liquid assets held by individuals) and 8 percent on investments in illiquid assets, such as plants and equipment (9.05 percent when the tangible assets are held by U.S. individuals).
Because the deemed repatriation tax is effective immediately, it requires taxpayers to quickly assess their tax liability on as much as 30 years-worth of foreign earnings through 2017, and convert those foreign earnings from local accounting and tax standards to U.S. tax standards and, ultimately, also into U.S. dollars.
While the law does allow U.S. taxpayers to elect to pay this obligation over an eight-year period, the first installment is due on the same day as the taxpayer’s federal income tax filing deadline without regard to extension. For example, an individual with foreign, untaxed earnings subject to this rule would need to make the first installment payment on April 16, 2018, even if the taxpayer receives a six-month filing extension. Should the taxpayer miss the initial installment due-date, he or she may lose the option to pay the deemed repatriation tax over the next eight-year period and instead be compelled to pay the entire tax liability up-front in one lump-sum payment.
This leaves U.S. multinationals with a very limited window of time to determine not only the amount of earnings they hold offshore under U.S. tax principles but also the tax rates that should apply to that income based on the liquidity of their foreign-entity balance sheets. Making this determination and deciding whether to allocate overseas earnings to liquid or illiquid assets for purposes of calculating the tax will be a time-consuming, burdensome process. For example, according to the law, stock held in a publicly traded company is a liquid asset because taxpayers may easily sell their shares for cash. Conversely, shares in a private company are considered illiquid assets, which would be subject to the lower repatriation tax rate of 8 percent or 9.05 percent.
Accuracy is key when calculating the deemed repatriation tax, and businesses should be prepared to substantiate their calculations with supportable facts in the event the IRS challenges their estimates. A good starting point for many businesses to comply with this law would be an earnings and profits (E&P) study on their untaxed accumulated offshore earnings and profits. An E&P study looks at the historical foreign earnings reported under local tax principles and recalculates those amounts under U.S. tax principles with the support necessary to pass IRS audit procedures.
Once an E&P study is complete, taxpayers should consider what other benefits may be available to lower their deemed repatriation tax liabilities. As an example, the law permits taxpayers to apply E&P deficits from one foreign company against the earnings of another. In addition, the law allows for taxes paid by the foreign corporation to partially reduce the deemed repatriation tax if the U.S. taxpayer is a C corporation. Generally, U.S. individual shareholders who in invest in foreign corporations are not allowed to take credit for foreign taxes paid at the foreign-entity level, but they may be able to do so by making certain elections. As such, it behooves businesses to engage professionals to appropriately and accurately calculate and support the required repatriation tax.
Looking beyond the deemed repatriation tax, the new tax law provides a participation exemption for C corporations to effectively exclude from future income those dividends they receive from certain foreign corporations. For example, distributions of earnings to a C corporation by its long-held foreign subsidiary may not be subject to a second level of tax upon repatriation of those earnings to the U.S. Yet, U.S. corporations will not be able to deduct or claim a credit on their federal U.S. income tax returns for any withholding tax that they pay abroad on those future dividends. With this in mind, U.S. individual taxpayers with an interest in a foreign corporation may consider establishing or converting an existing LLC to a C corporation to bring dividends from abroad to a U.S. corporation free of U.S. taxation. It is also worth noting that imposing a C corporation between a U.S. individual and a foreign corporation may result in a lower rate of tax upon ultimate distribution to the U.S. individual if the foreign entity is organized in a country that does not have an income tax treaty with the U.S.
Global Intangible Low-Taxed Income (GILTI)
One provision of the new tax law that will not go into effect until 2018 is the new anti-deferral regime known as Global Intangible Low-Taxed Income (GILTI). In an effort to prevent U.S. businesses from shifting profits offshore to low-tax countries, the TCJA 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. The law excludes from this calculation some items of income, most notably income that is subject to a local tax rate above 18.9 percent that would otherwise be treated as Subpart F income (Subpart F income is a currently existing anti-deferral regime). The effective GILTI tax rate through 2025 is 10.5 percent for C corporations and as high as 37 percent for individuals and S corporations. Beginning in 2026, the rate is scheduled to increase to 13.125 percent for C corporations and remain at 37 percent for individuals.
Again, due to this preferential treatment afforded to C corporations, partnerships and other pass-through entities might consider converting to a C corporation in 2018 to avoid a potentially higher tax liability come 2019.
The provisions of the tax law that relate to outbound international matters are complex and will require further guidance from the IRS in the coming months. It is critical that U.S. taxpayers with overseas interest meet with qualified tax professionals to assess the entirety of their domestic and foreign operations and develop strategies to improve global tax efficiency going forward.
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 firstname.lastname@example.org.