Author: Fuad S. Saba
Congress introduced the GILTI tax with the TCJA at the end of 2017. The tax applies to tax years beginning after December 31, 2017. GILTI is defined as the income of a “Controlled Foreign Corporation” (CFC) that exceeds the CFC’s “net deemed tangible income return.” The latter is defined as a 10% return on the tax basis of the tangible assets of the CFC that are used in the CFC’s business, adjusted for the CFC’s interest expense. Thus, the term GILTI is a misnomer because any CFC that earns a relatively high return on its business assets can have GILTI, even if intangible assets are not directly a factor in the production of its income. Note that the GILTI tax applies with respect to the annual income of a CFC regardless of any distributions of that income by the CFC.
The tax on GILTI is applied at the level of the “U.S. Shareholder” of a CFC. A U.S. Shareholder is one who owns 10% or more, by vote or value, of a CFC, and a CFC is a foreign corporation that is more than 50% owned by one or more U.S. Shareholders. For U.S. Shareholders that are C-Corporations, the GILTI tax is ameliorated by two factors: first — and until 2025 — 50% of the GILTI income is deductible before tax is imposed, so that a C-Corporation pays no more than 10.5% in federal income tax (half the federal corporate income tax rate of 21%). Second, if the GILTI of the CFC is subject to income tax in a foreign country, a “deemed paid” foreign tax credit is available to the extent of 80% of that foreign tax, not to exceed the GILTI tax itself. Thus, if GILTI is subject to a foreign income tax of 13.125% or more, the U.S. Shareholder’s GILTI tax is eliminated. Finally, any GILTI that is distributed to the C-Corporation at a later point is not taxed again in the U.S. because it is considered “previously taxed.”
On the other hand, individual taxpayers who are U.S. Shareholders, whether directly or through a pass-through entity such as a partnership or an S-Corporation, are ineligible for both the 50% GILTI deduction and the deemed paid foreign tax credit. This means that without tax planning, such individuals will pay federal income tax on GILTI at a rate up to 37% plus state income tax, if applicable, regardless of the amount of income tax paid by the CFC on its GILTI income. The individual now must fund a significant tax liability, although the CFC might not have distributed any profits to the individual. Although the individual can receive the income taxed as GILTI without further tax — because it was “previously taxed” — by that time the tax damage has been done. By way of example, an individual U.S. Shareholder of a CFC with GILTI income that is subject to a 25% foreign income tax would incur tax in excess of 55% after considering federal, state, and Net Investment Income taxation.
