Is Transition Tax and GILTI Tax the same?

Tax Saving Tips

How does it affect me when filing my tax return?

We spoke to Leo, who has 30 years of experience helping Americans abroad.

GILTI tax is tax on Global Intangible Low-Taxed Income, that targets US corporations owning Controlled Foreign Companies. This was passed in 2017 as US Congress wanted to discourage the erosion of US tax bases caused by taxpayers moving income outside of the US, and encourage the repatriation of capital to the US. GILTI is especially impactful on foreign companies with high profit relative to the fixed asset base. Under this new tax act, the IRS can tax you year by year.

Section 965 requires US shareholders to pay Transition Tax on untaxed earnings from controlled foreign corporations. The Transition Tax calculated how many profits up until December 31 2017 have not been subject to US tax, and how much tax should apply to this profit. Taxpayers can choose to pay the transition tax in instalments over an eight-year period. Transition Tax is a one-off event for the 2017 tax year, while GILTI is a yearly occurrence beginning in the 2018 tax year.

GILTI tax is applying the rules of the tax act on an ongoing basis. For each year going forward, if a US person has controlling ownership of a non-US corporation, then there is a need to calculate the profits each year and calculate the GILTI tax on these profits.

How does the GILTI tax affect my US tax payments?

In the past, you could be a US person and own controlling interest in the shares of a non-US company and did not necessarily pay tax on the profits until you had a distribution (such as dividends or a salary) from the company. Now, you may not yet have received the funds and therefore not have the cash flow to pay the taxes on these profits that are essentially still sitting in the company.

Of even more concern, you could be subject to tax in the local country where the company is set up on top of GILTI tax. If you cannot ensure the US person does not have a ‘controlling interest’ (owning 50% or over of shares) in the company, it might be in your best interest to consider restructuring the shares of the company to avoid double taxation.

For example, if you owned 100% of the shares, it could be effective to reduce your shares to 50%, and it would not be considered a Controlled Foreign Company (CFC). It would then not be subject to GILTI tax, but would still have IRS reporting requirements for US tax, however this tax would not apply to profits until they are distributed.

Can I give half of my shares away to my spouse to avoid GILTI taxation?

Yes, provided that the spouse is not a US citizen, Green Card Holder or not physically residing in the US, then this non-US person could own 50% of the shares of that non-US company and the company would no longer be defined as a CFC owned by a US person. If your spouse is a US person, then you could consider selling your shares to a trusted non-US person to change the status of the company, so that the profits are not subject to year by year GILTI tax.

Does Section 962 provide GILTI tax relief?

Section 962 is an election (statement) that you can make when filing your information return for a foreign corporation. It is an attachment to Form 5471, which is attached to a 1040 (personal tax return). This election is designed to give an individual taxpayer relief from a higher tax rate on earnings from a foreign corporation.

It is determined on a yearly basis and gives you a corporate tax rate (of 21%) which is lower than a personal tax rate. There can also be a special deduction available through this election, bringing the tax on the foreign company profits down to between 10-13%. This election can therefore be extremely beneficial, when compared to the higher marginal personal tax rate.

If the profits have already been subjected to tax in home country, this can be adeemed foreign tax credit on this return. There are cases where the corporate taxes paid in the home country are higher than 21%, in which case you can end up getting a full offset and not paying any taxes on the profit in that point in time. However, once the election is made and you receive a distribution of the profits at a later point in time, the distribution would be subject to tax. This is a solution to defer taxes and prevent any cash flow problem.

How does the GILTI tax affect small business owners?

Small business owners are assessed on a case by case and year by year basis. If GILTI tax does not apply, it simplifies everything. As mentioned above, you can achieve this by not owning more than 50% of the shareholding of that company.

You should speak to a tax professional and consider planning the time flow of income streams to influence the net income of the company of that year, so you can predict the tax. For example, you could pay bonuses to change the net income and profits.

If you didn’t realise that GILTI tax applied to you, should you amend your tax returns?

What if you have filed a regular Form 5471 not aware of the GILTI tax or knowing that it would apply to you, for example because you are a small business, then you can file an amended tax return to include forms with the correct information. If you do nothing, you risk the IRS sending a notice. If the IRS contacts you first, you would be facing fees and penalties. It is best to anticipate the problem and volunteer the information yourself to the IRS, through an amended return.

How does the GILTI tax affect a US expat living in Dubai?

For US expats in Dubai and most of the Middle East, you do not pay corporation tax. Therefore, your exposure to the GILTI tax is greater than for clients anywhere else, as you would get no foreign tax credit. If you have a CFC with net profit, you should anticipate a minimum of 10-13% tax on that profit, and tax occurring later on when distributions are made. Our off-the-bat advice is to consider changing the ownership of the company structure if it works for you. It is therefore very important that a US owner of a foreign company considers the implications of GILTI tax. We are happy to answer any questions and work through your options going forward.

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