US Tax Reform 2018 – GILTI and “deemed transition tax” for US taxpayer individuals and pass-through LLCs

Beginning 1 January 2018, two new U.S. taxes affecting these shareholders are the “deemed transition tax” and the Global Intangible Low Tax Income (“GILTI”) tax. The “deemed transition tax” applies to retained earnings from 1 January 1986 through 31 December 2017 in Specified Foreign Corporations that have not been previously subject to U.S. taxation.

These Corporations include CFCs and 10-50 foreign corporations. Earnings arising from cash and liquid assets, such as net Accounts Receivable, are subject to tax at 15.5{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}, and from other assets at 8{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}. For U.S. shareholders in a CFC, the GILTI tax applies the maximum marginal tax rate of the shareholder to CFC earnings in excess of a certain threshold.

 Consider a simple example in which a U.S. individual owns 100{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the shares in a CFC.

The CFC trades actively in an offshore country and has accumulated retained earnings of $2m from 1 January 1986 to 31 December 2017. The CFC is expected to earn profits of $1m in 2018 from active trading. The company owns virtually no tangible assets (e.g. factories, plant and equipment etc.).

Assume the split between cash and non-cash assets produces a tax rate of 15.5{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} for the deemed transition tax.

Effective for tax year 2017, the deemed transition tax for the retained profits of $2m in the CFC is $310,000. This once-off tax on the $2m retained earnings can be paid over an 8-year period, without interest, as follows:

• 8{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the amount for the first 5 years;
• 15{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the amount in year 6;
• 20{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the amount in year 7, and
• 25{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the amount in year 8.

The GILTI tax kicks in on 1 January 2018 on the CFC’s $1m profit from active trading.  As mentioned above, the GILTI tax applies to CFCs only. Do not be fooled by the word “intangible” as the GILTI tax potentially affects all active trading profits generated in the CFC. Because the shareholder in the example is a U.S. individual shareholder, the full profit LESS 10{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the value of the CFC’s assets is subject to GILTI tax in the US at the individual’s maximum applicable marginal tax rate (up to 37{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}). Let’s assume the CFC’s assets (plant, equipment, factories etc.) is minimal – a few computers and office desks. The CFC has virtually no deduction to offset the GILTI tax. For tax year 2018, the individual will include as taxable regular income $1m arising from the GILTI tax. This GILTI tax has resulted in a $370,000 U.S. tax liabilityTax liability represents the total amount of tax owed by an individual or business to a tax authority, whether local, national, or international. This obligation arises through various forms of income, profits, or transactions subject to taxation laws and regulations. Understanding tax liability is essential for compliance and efficient financial management for corporations and individuals. It influences how businesses structure... for the U.S. shareholder because the GILTI (income) is subject to the maximum marginal tax rate for the shareholder (i.e. 37{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of $1m is $370,000). Note that the GILTI (income) may also be subject to the Net Investment Income TaxIncome Tax is a direct levy imposed by governments on the income generated by individuals, corporations, and other entities within a specific jurisdiction. It serves as a major source of revenue for governments and funds various public expenditures, such as infrastructure projects, healthcare, education, national security, and welfare programs. The tax is generally calculated as a percentage of the taxable... (NIIT) of 3.8{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}.

U.S. corporate shareholders are also subject to the GILTI tax. Assume in our example the shareholder is a U.S. C-corporation rather than a U.S. individual. The C-corporation shareholder will pay the GILTI tax at its flat tax rate of 21{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}. However, as a C-corporation, the shareholder gets a 50{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} deduction credited against the GILTI tax liabilityTax liability represents the total amount of tax owed by an individual or business to a tax authority, whether local, national, or international. This obligation arises through various forms of income, profits, or transactions subject to taxation laws and regulations. Understanding tax liability is essential for compliance and efficient financial management for corporations and individuals. It influences how businesses structure.... The C-corporation will get a $500,000 deduction, so that only the remaining $500,000 is subject to the GILTI tax at the new corporate rate of 21{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}.  The C-corporation shareholder will be subject to a GILTI tax of $105,000. Furthermore, C-Corporations get a deemed paid Foreign Tax Credit (FTC) at 80{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} of the deemed paid foreign tax. (Note that the IRC §78 gross up stays at 100{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}). As a result, a U.S. C-corporation shareholder will have no GILTI tax liabilityTax liability represents the total amount of tax owed by an individual or business to a tax authority, whether local, national, or international. This obligation arises through various forms of income, profits, or transactions subject to taxation laws and regulations. Understanding tax liability is essential for compliance and efficient financial management for corporations and individuals. It influences how businesses structure... if the foreign corporate taxCorporate Tax refers to the tax imposed by governments on the income or capital of corporations. Corporations, considered separate legal entities, are taxed on their profits, meaning the income generated from their operational activities, investments, and other financial undertakings. This tax is generally a key revenue source for governments, helping to fund public services, infrastructure, and other essential functions. The... rate is at least 13.125{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} (i.e., 13.125{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} x 80{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} = 10.5{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e}). There are various articles online explaining this complex amendment, and section 14202 and 14203 of the Bill amending the IRC for corporations, but not for individuals and pass-through LLCs:

• https://ftalphaville.ft.com/2017/12/05/2196254/gilti-or-not-gilti/
• http://iitfconnect.com/?p=610

To summarize, for tax year 2018 the U.S. individual taxpayer in this example will pay tax in the US of:

• His or her usual US tax on US income;
• $24,000 the first installment on the “deemed transition tax”;
• $370,000 tax on the CFC earnings under the GILTI tax.

This individual’s U.S. tax bill for tax year 2018 just increased by $394,000 plus potentially 3.8{780f53c297e2c008074d23b865a0ce0b35a4f08852d8e1e49466a5a902c4e44e} more for the NIIT. And, do not forget the individual’s tax year 2017 tax liabilityTax liability represents the total amount of tax owed by an individual or business to a tax authority, whether local, national, or international. This obligation arises through various forms of income, profits, or transactions subject to taxation laws and regulations. Understanding tax liability is essential for compliance and efficient financial management for corporations and individuals. It influences how businesses structure... increased by $24,000 for the first “deemed transition tax” installment as well.

As mentioned above, the impact of the new U.S. tax lawTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public... on U.S. individual shareholders in foreign corporations can be severe. If you have any questions or would like to discuss potential impacts on your U.S. clients, please do not hesitate to contact me.