Owners of non-US Businesses and the New Tax Law
Article Highlights:
- Largest Tax Change in 30 Years
- Rules of Thumb
- 2017 One Time Repatriation Tax
- 2018 Tax Rules for Foreign Corporations
Note: The is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.
Largest Tax Change in 30 Years
In 1986, the tax bill called the “Regan Tax Cuts” was passed. I was a young accountant. In December, a similarly transformative tax bill called The Tax Cuts & Jobs Act was passed. Now I am an experienced and “seasoned” CPA.
Both “Tax Cut” bills were hailed as simplifying the tax code. It took about a decade for the IRS and tax courts to fully define the terms of the 1986 tax bill. It will take years to fully understand the current tax bill. Congress will pass “Technical Corrections,” the IRS will issue interpretations of Congress’ intent and the tax courts will arbitrate between the two.
Americans owning a business outside the US will see the most change under the TCJA tax bill.
Over the next several years, Americans will learn what congress intended and what the impact the new tax law will have on the international business community. If your business is profitable and you want to learn what steps you can take now to minimize your 2018 US taxes schedule a Business Tax Planning consultation here: https://app.acuityscheduling.com/schedule.php?owner=13921549
Rules of Thumb
- If you own a foreign corporation that has lost money for several years or you have paid any earnings out as dividends, then the “Retained Earnings” of the company is likely negative at December 31, 2017. If the foreign corporation has negative retained earnings, you will not be subject to the one-time Repatriation Tax reported on your 2017 1040.
- If your foreign corporation will lose money over the next several years and you will not be paying US income tax on your foreign entity; there is no need to change the ownership or business structure of your foreign corporation at this time.
- As a part of your 2017 tax return we will prepare a tax projection for 2018 under the new tax law.
Out with The Old: 2016 and Prior
citizens are taxed on their world-wide earnings. Historically, US shareholders owning a foreign corporation paid tax in the US when cash was taken out of the business either as a wage or dividend. As long as the cash stayed in the business, the owner (or US Shareholder) was not subject to US income tax. According to the politicians, this resulted in fortune 500 companies holding “too much” cash outside the U.S. As a result, we have the new tax law.
2017 Transition Year; Repatriations Tax
The Repatriation Tax is a one-time tax that can be paid over eight years. Generally, the tax is based on the previously untaxed foreign earnings of the company. The Repatriation Tax is based on the foreign entities retained earnings as of December 31, 2017. Retained earnings represent the corporations gains and losses since inception less depreciation. The transition tax is calculated for cash and cash equivalents. The business press has generally reported the tax rate at 8% and 15.5% rat. This is ONLY true of corporate shareholders. The good news for individual shareholders is that the “Repatriation Tax” is actually additional income that can be reduced by the standard deduction and would be taxed at your individual marginal tax rate. The resulting income could be reduced by exemptions, standard deductions as well as education and child tax credits. If the “Repatriation Income” results in additional tax for 2017, only 8% of the additional tax is owed now and the remaining tax will be paid with the shareholder’s tax return (1040, 1120 or 1065 returns) over eight years.
In with the New: 2018 and Beyond; The Taxation of Foreign Corporations
The Repatriation Tax is a transitional tax to get to the next or new way the IRS will tax US shareholders of specified foreign corporations. This new tax regime was designed with fortune 500 companies in mind but also applies to our clients who are individuals just trying to make a living in a foreign country. Because of this the new tax law is very complicated.
Starting in 2018, US shareholders that own a “specified foreign corporation” will report or include their share of the income every year on the shareholder’s tax return. “Specified foreign corporation” means a US person owns more than 50% of a foreign entity or a US company owns 10% of a foreign entity This is similar to how shareholders of S-corporations report their share of the corporation’s income every year on their individual tax return even if no dividend or wages were paid to the American Shareholder.
Shareholders of specified foreign corporations will pay tax on GILTI (Global Intangible Low-Taxed Income). The GILTI inclusion is included on the shareholder’s tax return and taxed at their respective tax rate. Again this “GILTI Inclusion” can be offset or reduced by the standard deduction, and educational and child tax credits on a form 1040 if the shareholder is an individual.
The taxation of any dividends from a Controlled Foreign Corporation to an individual is reduced for any “GILTI Inclusion” as “Previously Taxed Income.” Congress just wants to tax the income twice.
There are several tax benefits that were given to C-corporations that own a foreign entity. These include a 50% deductions to the “GILITI Inclusion,” Dividend Received Deduction and as well as a special deduction for sales to foreign customers.
Tax Planning Note: The new tax regime may provide an incentive for profitable foreign businesses controlled by an American, to be owned by a US C-corporation but only if your foreign business is generating sufficient profits. We are happy to discuss these with you and evaluate your foreign business in light of your personal tax situation.
Congress’ Intent
The need to change corporate tax law has been discussed for several years. The legislative summaries only addressed US corporate shareholders of foreign subsidiary corporations. The Repatriation Tax is an incentive to encourage US corporations to bring the earnings of their foreign subsidiaries back to the US and invest that money here in the US. The law that passed clearly applies to all US shareholders of specified foreign corporations, even individual American citizens living in their host country. Tax courts have previously overturned tax laws as written and passed if it was not consistent with Congress’ intent. The IRS has received a significant public pressure that the law as passed did not reflect Congress’ intent and that the tax is an undue burden on small business owners who are US citizens. It is difficult to determine if there will be a technical correction to this part of the tax bill. Did congress intend to assess additional taxes on American small business owners who own foreign businesses? We will learn the answer in the years to come. Today we need to prepare your return the best we can with the information available today.
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