Proposed Regulations Offer Deductions to Individuals with GILTI Inclusions

On March 4, 2019, the Treasury Department issued proposed regulations under Section 250 that provide an opportunity for certain individual taxpayers to potentially reduce or eliminate their tax liabilities for global intangible low-taxed income (GILTI) inclusions under Section 951A.

The Section 250 deduction is available to individuals if the individual makes an election under Section 962. There are a number of considerations for these individual taxpayers to weigh.

Extended to Individuals

By statute, the Section 250 deduction and the indirect foreign tax credit are only available to domestic C corporations. Accordingly, individuals with GILTI inclusions under Section 951A must generally pay tax on the full amount of the inclusion at ordinary tax rates.

However, in a somewhat unexpected provision, the newly-released Section 250 proposed regulations extend the deduction to individuals if they elect to be taxed as corporations under Section 962.

Individual Elections

Section 962(a)(1) allows an individual who’s a US shareholder to elect to be taxed on amounts included in the individual’s gross income under Section 951(a) as if the individual were a Subchapter C corporation. The election applies to both GILTI and other Subpart F income, resulting in a tax liability in “an amount equal to the tax that would be imposed under Section 11 if such amounts were received by a domestic corporation.” The current corporate federal tax rate of 21% compares favorably to the individual tax rate of up to 37%.

A Section 962 election can be made by an individual US shareholder who owns stock directly in a foreign corporation or indirectly through a partnership or S corporation.

It was previously broadly understood that an individual making a Section 962 election was allowed to use the indirect foreign tax credit mechanism of Section 960 to potentially reduce the tax liability created by GILTI. The proposed Section 250 regulations clarify that the GILTI income of an electing individual is also reduced by the portion of the Section 250 deduction that would be allowed to a domestic C corporation with respect to the individual’s GILTI and the Section 78 gross-up attributable to the shareholder’s GILTI.

In other words, individuals making Section 962 elections could benefit from both the Section 250 deduction and the indirect foreign tax credit under Section 960. What this means, in practice, is that many individuals making Section 962 election may not have a residual US federal tax liability from GILTI inclusions, provided the foreign corporation of which the individual is a US shareholder pays foreign tax at a rate of at least 13.125%.

Additional Considerations

The Section 962 election may be made by individuals with direct investments in controlled foreign corporations as well as indirect investments through a partnership or an S corporation.

Here are some considerations when making Section 962 elections.

  • There’s a substantial compliance requirement involved in making the election, including additional forms and statements that taxpayers must file.
  • The impact of the election to other tax attributes on a tax basis should be evaluated prior to making the election.
  • The Section 962 election defers the GILTI tax at the individual level but doesn’t permanently eliminate the individual tax on the CFC earnings; future CFC distributions may be taxed as dividends to the individual.

About GILTI

The 2017 tax reform reconciliation act, also known as the Tax Cuts and Jobs Act, requires 10% US shareholders of controlled foreign corporations (CFCs) to include taxable income amounts earned by the CFCs and determined to be GILTI under IRC Section 951A. 

Effectively, the GILTI rule requires US shareholders of CFCs to include in taxable income much of the foreign income earned by the CFCs they own.

To help mitigate the effect of the GILTI inclusions, tax reform also added Section 250 to the Internal Revenue Code which provides domestic C corporations with a deduction of up to 50% of their total GILTI combined with the related foreign taxes grossed up under Section 78. In addition, domestic C corporations are allowed to receive a foreign tax credit for up to 80% of their ratable share of the foreign taxes paid by the CFC. 

The combination of Section 250 and the indirect foreign tax credit rules could potentially prevent taxpayers from owing additional federal tax on GILTI inclusions, provided the CFC has paid foreign tax at a rate of at least 13.125%.

We’re Here to Help

Taxpayers should consider modeling the results to forecast the outcome of making the Section 962 election and carefully consider various alternatives. To learn more about how these proposed regulations could affect your tax liability, contact your Moss Adams professional. You can also visit our dedicated tax reform page to learn more about GILTI.