Due to global intangible low-taxed income (GILTI) tax laws, many companies are no longer able to avoid paying US corporate taxes by moving overseas. GILTI laws were meant to encourage more businesses to return to the United States, but instead, it has just become another obstacle to creating a tax-free structure and has created more questions.
How do GILTI tax laws affect foreign businesses? Do I have to pay GILTI tax? What is the GILTI tax rate?
The GILTI tax law can seem complex and confusing. With all the different parts of it and the use of legal jargon, it’s understandable if you don’t quite get it.
Today, we’re going to answer all of these questions and more. We are going to break down the GILTI tax into smaller parts and explain what you need to do to lower your tax rate.
In this article, we’ll discuss
- What is GILTI?
- What is Net Controlled Foreign Corporation (CFC) Tested Income?
- Do you have to pay GILTI tax?
- How can you reduce your GILTI tax rate by going overseas?
- Foreign Tax Credits
- How can US shareholders reduce your GILTI tax?
- More Ways to Reduce Your GILTI Tax Rate
- Subpart F Income
- Qualified Business Asset Investments
- Renouncing Your US Citizenship
WHAT IS GILTI?
The Tax Cuts and Jobs Act passed in 2017 made it so anyone doing business offshore is subject to the Global Intangible Low Tax Income (GILTI) tax law. GILTI is the category of income that is earned abroad by US-owned Controlled Foreign Corporations.
GILTI tax was created to discourage companies from using intellectual property to move their profits out of the US. Before GILTI tax some US companies could defer the tax on their foreign corporation’s business earnings.
The Tax Cuts and Jobs Acts exempted active US business earnings of foreign subsidiaries even when the US business repatriates (meaning they come back to the United States). This is one way the new laws encouraged foreign companies to come back onshore.
The US also added a 10.5% to 13.125% tax for all global income that comes from intangible assets if not subject to a high tax rate in their source country. Intangible assets include patents, copyrights, and trademarks that a US person holds offshore. GILTI taxes earnings over 10% in returns from a company’s foreign assets.
GILTI is equal to your Net CFC Tested Income minus 10 percent of your qualified business asset investments minus your interest expense.
WHAT IS NET CFC TESTED INCOME?
Net CFC Tested Income is the gross income of a Controlled Foreign Company and excludes Subpart F Income, income connected to a US business or trade, dividends that are received from a related person, and foreign gas and oil incomes.
DO YOU HAVE TO PAY GILTI TAX?
You have to pay GILTI tax if you are a US shareholder who owns at least 10% of a foreign company’s value or vote. If this is the case, the GILTI tax will be applied to you at the individual level.
Before GILTI, a US person only had to pay tax on the income they earned through a foreign corporation when the income was received as a dividend. Now US shareholders have to include their portion of the foreign income on their personal tax return even if they didn’t receive it as a distribution. This tax could be as high as 37%.
Any foreign corporation that has more than 50% of its vote or value owned by a US shareholder is also subject to GILTI tax laws. A foreign company that is at least half-owned by US persons is considered a Controlled Foreign Corporation and is subject to GILTI tax.
GILTI is supposed to only tax companies that have a tax liability under 13.125%. This means if your company is in a jurisdiction where you have to pay 14% in tax, GILTI shouldn’t apply to you.
However, just because that’s how it’s supposed to work doesn’t mean that’s how it always works. As a glaring example, a company that is operated in both the US and Mexico was subject to GILTI tax, even though it was already paying 30% tax to Mexico.
HOW CAN YOU REDUCE YOUR GILTI TAX RATE BY GOING OVERSEAS?
The first step to reducing your GILTI tax rate is by having a foreign corporation. Under GILTI, domestic companies pay a 21% rate while offshore companies pay 10.5% to 13.125%.
The 10.5% tax rate only applies to international businesses that don’t engage in US business or trade. Having any type of operation within the United States will disqualify you from the 10.5% GILTI tax rate. This includes having a dependent agent, office, or warehouse within the US.
FOREIGN TAX CREDITS
You can lower your GILTI tax even more by claiming foreign tax credits. These can cover up to 80% of the foreign taxes you paid or accrued on this income.
What are foreign tax credits?
A foreign tax credit in the US allows you to match up the tax that you paid in another jurisdiction with your tax obligations in the United States. If you are paying less in tax in your offshore jurisdiction than you owe in the United States, you can take what you paid in your offshore jurisdiction as a dollar-for-dollar credit and then pay the excess in the United States.
For example, if you owed $1,000 in taxes to the United States but already paid $600 in tax to your offshore jurisdiction, you can take that $600 in credit and then will only have to pay $400 for your US tax.
If your offshore jurisdiction tax obligation is the same as or more than the US tax obligation, you won’t have to pay the US tax.
If your business is in a high-tax country, you may be able to use a foreign tax credit to cancel out your GILTI tax completely as long as the tax rate where you are incorporating is 13.125% or more.
HOW CAN US SHAREHOLDERS REDUCE THEIR GILTI TAX?
There are two main options that individual shareholders may use to reduce their GILTI tax obligation.
One option is to elect to be treated under section 962. This section allows individuals to be taxed as a corporation. This only works if you are a US shareholder living in the United States and would mean that your allocation of the profits would be taxed at the US corporation tax rate but with a 50% deduction applied.
Another option would be to own your Controlled Foreign Corporation through a C corporation. This will allow you to take advantage of lower corporate taxes.
MORE WAYS TO REDUCE YOUR GILTI TAX RATE
There are more ways you can reduce your GILTI tax obligation or avoid having to pay GILTI tax.
One option is pretty basic: if you don’t want to pay GILTI tax, make sure you don’t qualify to pay. This means avoid owning a CFC or holding the role of shareholder. Remember you have to pay GILTI tax if you own 10% of a foreign company. You can avoid paying GILTI by owning less than 10% of the companies shares.
Other options include using Subpart F Income rather than GILTI or you could increase your qualified business asset investments (more on this below).
SUBPART F INCOME
Another option for lowering your GILTI tax rate is to convert GILTI to Subpart F Income. While this will depend on your individual situation and tax plan, often the tax you’ll have to pay on your Subpart F Income is going to be lower than your GILTI tax rate.
What is Subpart F Income?
Subpart F Income is another complicated set of tax laws, and while not the same, the categories are similar to those covered by GILTI. Subpart F allows the US to collect tax on income earned by a CFC.
Subpart F Income includes foreign personal holding company income such as passive income including dividends, interest, net foreign currency gains, rent and royalties, net gains from the sale of a property, and income from personal contracts.
QUALIFIED BUSINESS ASSET INVESTMENTS
As mentioned above, one way to lower your GILTI tax rate is to raise your qualified business asset investments.
What are qualified business asset investments?
Qualified business asset investments (QBAI) are the average of a corporation’s aggregated adjusted bases at the close of each quarter in a taxable year in specified tangible property.
If you remember, earlier we said that your GILTI is calculated by subtracting 10% of your qualified business assets investments and interest expense from your net CFC Tested Income. If you raise your QBAI, a greater value is going to be subtracted from your net CFC Tested Income and you will have less GILTI.
QBAI applies to all your assets used in your trade or business as part of your corporation and assets that qualify for deductions under Section 167.
One way that you can increase your QBAI is by purchasing equipment that was previously leased. If you are only a partial shareholder in a company, it may be a bit harder to convince the rest of the shareholders of the company to agree to do this. While this strategy will help you to reduce your tax obligations, it may not be the best decision for your business.
RENOUNCING YOUR US CITIZENSHIP
The only way to get rid of your GILTI tax obligation is to leave the United States and renounce your US citizenship. This doesn’t mean you can’t reduce your GILTI tax as a US citizen, it just means that this is the only way to get rid of it completely.
Renouncing your citizenship is a huge step and the process may take a while. The first step toward renouncing is to get a second citizenship in another country. Depending on how you go about this, getting second citizenship can take months to years to even decades. If you are serious about reducing your tax rate to zero, you might want to look into second citizenship now so that you can renounce in the future and free yourself of the US tax net forever.
GILTI is another attempt to draw individuals and businesses back into the US tax net. The United States is going to continue to create new laws and expand its ability to take more money from US persons.
At the same time, if GILTI tax laws have hurt your tax structure, it’s not the end of the world. You just need to do some restructuring. Determine how you can take advantage of existing exclusions and laws to lower your tax rate.
Your GILTI tax rate can be lowered legally. To get the best advice, work with an attorney or tax expert who works with offshore corporations and structures. An expert in the field is going to know a lot more than anyone who only works domestically.