GILTI Year-End Restructuring Considerations for U.S. CFC Shareholders

Thoughtware Article Published: Nov 27, 2018
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By the end of 2018, noncorporate U.S. shareholders of controlled foreign corporations (CFC) may want to consider restructuring their CFC holdings to a U.S. limited liability company (LLC) that would be eligible to make a C corporation election, which would help reduce the U.S. tax effect of the new global intangible low-taxed income (GILTI) rules.

The Tax Cuts and Jobs Act (TCJA) has significantly changed the U.S. tax landscape for U.S. shareholders of CFCs through its move from a deferral system of taxation to a modified territorial system for C corps with certain base erosion provisions that apply to all U.S. shareholders of CFCs.

One such base erosion provision of U.S. tax reform is the new GILTI rules of Internal Revenue Code Section 951A, which apply to all U.S. shareholders of CFCs—both corporate and noncorporate shareholders—for taxable years of CFCs that begin after December 31, 2017. The GILTI rules require U.S. shareholders of CFCs to include their pro rata share of CFC-deemed intangible income in their U.S. taxable income.

CFC-deemed intangible income that must be included in U.S. shareholders’ taxable income is all CFC current-year net income except for the following exclusions:

  1. Nontested income:
    1. CFC net income that is subject to Form 1120-F U.S. corporate income tax at the CFC level as effectively connected to a U.S. trade or business
    2. CFC net income that is already included in U.S. shareholders’ taxable income under existing subpart F rules
    3. CFC net income that would be subpart F if not for a high-taxed exception election
    4. Foreign oil and gas extraction income
    5. Related-party dividend income
  2. CFC net deemed tangible income:
    1. Ten percent of a CFC’s depreciable fixed assets that generate CFC tested income, less
    2. Net interest expense of a CFC except to the extent taken into account in nontested income

The GILTI rules include two favorable provisions:

  1. A deduction equal to 50 percent (37.5 percent beginning in 2026) of the GILTI inclusion plus the gross-up for foreign income taxes
  2. A deemed paid foreign tax credit equal to 80 percent of the CFC’s foreign income tax liability attributable to the GILTI inclusion

However, there are significant limitations regarding these two favorable GILTI provisions:

  1. Both the 50 percent GILTI deduction and the 80 percent foreign tax credit are only available to U.S. C corps.
  2. The 50 percent GILTI deduction can only be claimed to the extent of a U.S. corporation’s taxable income after net operating loss (NOL) deduction. In other words, a corporation will permanently lose the benefit of the 50 percent GILTI deduction to the extent a deduction would otherwise create an NOL.
  3. The 80 percent foreign tax credit is in its own separate foreign tax credit category with no carryback or carryover for the disallowed credit that exceeds the foreign tax credit limit of the U.S. income tax liability on foreign-source taxable income. Thus, if a U.S. corporation has no U.S. income tax liability due to being in a loss position, the corporation will permanently lose the benefit of the foreign tax credit with no ability to carry over the disallowed credit.

C Corp Shareholder Year-End Restructuring Planning

U.S. C corps that are in loss or NOL carryover position may want to consider deconsolidation strategies before year-end to isolate the GILTI inclusion in a separately filed subsidiary to avoid the permanent loss of the 50 percent GILTI deduction and 80 percent foreign tax credit. Deconsolidation strategies could include setting up a partnership “blocker” within the corporate structure to own a U.S. holding company subsidiary that owns CFC shares.

Noncorporate Shareholder Year-End Restructuring Planning

Individuals and certain trusts that own at least 10 percent of a CFC directly or indirectly through a partnership or S corp generally have the ability to make a §962 election with respect to their pro rata share of CFC GILTI and subpart F income. A §962 election causes the GILTI to be taxed at the 21 percent U.S. corporate tax rate and allows for the 80 percent foreign tax credit as though the CFC stock was held through a phantom U.S. C corp. The §962 election extends the fiction to treat the ultimate distribution of previously taxed CFC income as though the distribution goes through the phantom C corp, resulting in a taxable dividend of the net after-tax CFC income when the noncorporate U.S. shareholder eventually receives a distribution from the CFC.

A noncorporate U.S. shareholder is not likely to owe any incremental U.S. tax liability on the GILTI inclusion if the §962 election allows for the 50 percent GILTI deduction and if the CFCs are subject to foreign income tax at a rate of more than 13.125 percent. A zero incremental U.S. tax liability under a §962 election would effectively place the U.S. shareholder in a tax position comparable to what is under the pre-tax reform deferral system, whereby U.S. shareholders generally would not be taxable in the U.S. on CFC income until the CFC pays an actual dividend distribution.

However, it is unknown whether a noncorporate U.S. shareholder will be permitted to claim the 50 percent GILTI deduction in connection with a §962 election until the IRS issues regulations.

Because of this uncertainty regarding the ability or inability to claim a 50 percent GILTI deduction in connection with a §962 election, noncorporate U.S. shareholders of CFCs—including partnerships and S corps—may want to consider transferring their CFC shares to a wholly owned U.S. LLC before year-end.

Noncorporate U.S. shareholders who transfer their CFC shares to a single-member U.S. LLC before year-end can make a retroactive “check-the-box” election on Form 8832 to treat the LLC as a U.S. C corp for U.S. income tax purposes if IRS regulations do not allow the 50 percent GILTI deduction in connection with a §962 election. If IRS regulations ultimately allow noncorporate U.S. shareholders to claim a 50 percent GILTI deduction in connection with a §962 election, the single-member U.S. LLC can remain as a disregarded entity for U.S. income tax purposes.

S corp shareholders who made a §965(i) election with their 2017 U.S. tax return to indefinitely defer payment of the §965 transition tax liability will generally want the U.S. corporation to maintain its S corp status to avoid a triggering event. Therefore, S corp shareholders will generally want the S corp to transfer its CFC shares to a wholly owned LLC subsidiary that could elect C corp status rather than converting the S corp itself to a C corp.

Contact Chris or your trusted BKD advisor to discuss these issues further.

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