New Regulations — 962 Election Section 250 Deduction
The U.S. Department of Treasury issued much awaited proposed regulations (REG-104464-18) under Internal Revenue Code (the “Code”) section 250 to provide further guidance to determine the amount of the deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI).
One of the new provisions added to international tax provision by the Tax Cut and Jobs Act of 2017 (the “Act”) is the section 951A, the Global Intangible Low Taxed Income (GILTI). Under this section, U.S. shareholders of a Controlled Foreign Corporation (CFC) are taxed on the CFCs GILTI. Many international tax professionals have seen that the new international tax provisions somewhat favor corporate U.S. shareholders over non-corporate shareholders of a CFC. The Congress enacted IRC section 250 that provided corporate U.S. shareholders a deduction of 50 percent on their GILTI. However, the Act did not allow this 50 percent deduction for individual or partnership U.S. shareholders with GILTI. Another example of this favoritism is GILTI provisions of a corporate U.S. shareholder is taxed at the U.S. corporate tax rate (21%) and non-corporate U.S. shareholder is taxed at ordinary income rate (highest been 37%). This can cause a significant disadvantage for non-corporate U.S. shareholders of Control Foreign Corporations (CFCs). The Act provided some relief to the individual and partnership U.S. shareholder’s GILTI inclusion under the IRC section 962. Under the section 962, a non-corporate U.S. shareholder of a CFC can elect their GILTI inclusion to be taxed as such amounts were to be received by a domestic corporation (taxed at 21% corporate rate). Even though the GILTI inclusion amount is treated as if it was received by a corporate U.S. shareholder, the Code and previous regulations were silent on whether such U.S. shareholder can obtain 50% deduction available under the section 250.
The Act also introduced section 962 where a non-corporate U.S. shareholder can elect their GILTI inclusion amount to be taxed at corporate tax rate. This is not a one-time election. Therefore, taxpayers have to make this election every year. Even though section 962 taxes the GILTI inclusion of a non-corporate U.S. as it was earned by a U.S. corporate, it did not allow the 50% deduction.
Proposed by the Regulation
Proposed regulation issued on March 5, 2019, the IRS and the Treasury recognize that congressional purpose for providing section 962 election was “to ensure that individuals’ tax burden with respect to undistributed foreign earnings of their CFCs will no longer be heavier than they would have been had they invested in an American corporation doing business abroad”. Therefore, section 250 proposed regulation advocates extending section 250 deduction to an individual U.S. shareholder of a CFC’s GILTI amount elected to be taxed at the corporate rate and section 78 gross-up attributable to the shareholder’s GILTI. When section 250(a) stated that only a domestic corporate U.S. shareholder can obtain the 50% deduction (will reduce to 37.5% after December 31, 2025) on GILTI inclusion created disparity with the individual U.S. shareholder with GILTI. Many hoped the Treasury would address this issue when they issued GILTI proposed regulations. However, Treasury finally spoke about this disparity between non-corporate and corporate U.S. shareholders when they proposed allowing section 250 deduction to individual U.S. shareholders, which would somewhat reduce their GILTI burden.
The GILTI rules can cause a significant tax surprise and a burden for U.S. shareholders of a CFC. Initial rules and regulations indicated different tax treatments and benefits between corporate and non-corporate U.S. shareholders’ GILTI inclusions. It is important for U.S. individuals who own shares of foreign corporations to understand whether new international tax rules would have an effect on their tax. Without proper planning they could face adverse tax treatment. Navigating through new CFCs, Passive Income, Foreign Tax Credit rules and proposed rules can be complicated and complex. U.S. shareholders of a CFC should seek tax advice from their tax counsel to determine if these rules have an impact on their taxes.