Wealthy clients who have substantial investments in certain multinational megacorporations might benefit from a new U.S. tax regulation.

The Treasury Department and the IRS have issued final regulations addressing income from certain overseas corporations that are subject to a high tax rate. The new rules allow shareholders to exclude certain income from their Global Intangible Low Taxed Income (GILTI) computation. The regulations become effective Sept. 21.
Generally, GILTI is the income earned by controlled foreign corporations (CFCs). U.S. corporate shareholders have been allowed deductions and credits against tax allocable to GILTI, but that benefit had not been extended to individual shareholders.

“The CFC regime, including GILTI, is far more friendly to larger corporations than to individuals,” said Ryan Dudley, CPA and partner-international tax services at Friedman LLP in New York. “Compliance and administrative burdens from international structures are very substantial.”

Taxpayers now have the option to retroactively apply the exclusion to the taxable years beginning after Dec. 31, 2017, and before July 23, 2020. “An annual election is required to use the exception. There are disadvantages in certain situations and a review is necessary to determine that the election would be beneficial,” said Gerry O’Beirne, New York-based tax partner and leader of EisnerAmper’s international tax group.

Under the new regulations, an individual shareholding taxpayer can elect to exclude from GILTI income that’s taxed at an effective rate of at least 18.9%, O’Beirne said. Tax at a lower rate can’t be excluded.

Dudley added that the "high tax kick-out" (HTKO) exception has for decades been part of the CFC regime, which is designed to deprive U.S. individuals from enjoying substantial tax benefits by moving portable income into offshore corporations. Typically, the kick-out exemption only applied to investment income and business income from related party transactions, referred to as subpart F income. From 2018, the CFC regime was expanded to include GILTI, with a tax applied to almost everything earned by the CFC that was not already being taxed as subpart F income, Dudley said. “While the HTKO exception was available for subpart F income, it seemed that it was not available to shelter GILTI from U.S. tax,” he said. The new regs change that.

The HTKO exception is available where the income is subject to tax at an effective rate of greater than 18.9%, Dudley said. Election can be year by year. “This election process may be helpful if taxpayers have expiring net operating losses or have little taxable income and are in a low tax bracket,” he added. “The HTKO will provide greater flexibility to wealthy U.S. taxpayers.”

The Treasury also recently issued another set of final regulations dealing with Internal Revenue Code Sec. 250 that permit individuals to consider a deduction for GILTI and take a credit for 80% of the foreign taxes, O’Beirne noted.
Taxpayers in high-tax states may also see local tax benefits. “States tend to follow the federal taxable income computation in relation to exclusions of foreign income but don’t generally allow foreign tax credits,” Dudley said. “By changing from a credit relief to an exclusion relief federally, the taxpayer will enjoy a tax saving in many jurisdictions.” 

Interests in multinationals have always involved cumbersome tax-compliance, and changing tax laws worldwide and a global pandemic have only worsened the burden.

“Wealthy clients that have international operations have been well aware of the U.S. anti-tax deferral rules that apply to controlled foreign corporations since they were first written in 1962,” said Brent Lipschultz, partner in the personal wealth advisors group at EisnerAmper. “For the most part it’s not been difficult to educate the clients that have had CFCs in the past. It has been more challenging to educate the investors new to international tax planning.”