How Section 962 Election for GILTI Works

How Section 962 Election for GILTI Works

How Section 962 Election for GILTI Works: Before getting into the mechanics of making an Internal Revenue Code Section 962 election, it is important to understand the basics of why a US Person would want to make an IRC 962 election in the first place. Until recently, Internal Revenue Code section 962 was not used much by Taxpayers, since the US tax rate for individuals has dropped significantly than in years past. An IRC 962 election is an election to be taxed as a Corporation. And, most taxpayers would not want to elect to be treated as a corporation and then become double taxed. Then, came the Tax Cuts and Jobs Act TCJA — and the introduction of GILTI and FDII. FDII is Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI).  The US corporate tax rate in the United States was reduced to 21%. Thus, depending on a specific individual’s facts and circumstances, a Taxpayer may benefit from making an election to be subject to tax at corporate rates for GILTI (and sometimes Subpart F) — and take a 50% deduction along with utilizing up to 80% of Foreign Tax Credits that were paid by a foreign corporation and therefore not generally applicable for a US Person filing their individual tax return. Let’s go to the basics of this section 962 election and how it impacts individual taxpayers for GILTI.

GILTI

GILTI is Global Intangible Low-Taxed Income. Unfortunately, the acronym does not adequately represent the tax implications the name implies. The idea behind GILTI, is that for income that is not classified as Subpart F, and not repatriated or previously taxed income (PTI) it has escaped “immediate” tax consequences in the US.  In order to avoid this outcome, the US government developed GILTI.

Unfortunately, for individual Taxpayers within the United States who have foreign businesses, such as service businesses — without assets sufficient to reduce the tested income — it can have significant tax consequences. For example, if the US Person individual operates an asset-light foreign corporation that is a service business — such as a professional services firm such as a foreign medical practice or consulting firm — they could be subject to a significant amount of GILTI.

As provided by the IRS:

• • • IRC 951A, which contains the global intangible low-taxed income (“GILTI”) rules, was added to the Code by the Tax Cuts and Jobs Act (“TCJA”). A key feature of the TCJA was to provide corporate shareholders a 100% dividends received deduction (“DRD”) on dividends from foreign corporations (assuming certain requirements are met), but the DRD could incentivize taxpayers to shift income offshore to low- or no-tax jurisdictions (e.g., mobile income from intangible property).

    • To neutralize that incentive, in addition to retaining subpart F rules (which are discussed in other Practice Units), the TCJA also enacted the GILTI rules, which require U.S. shareholders of controlled foreign corporations (“CFCs”) to include GILTI in gross income each year (the “GILTI inclusion”). Rather than explicitly identifying intangible income, the GILTI provisions approximate the intangible income of a CFC by assuming a 10% rate of return on the tangible assets of the CFC, and any income in excess of that “normal return” on assets is effectively treated as intangible income.

    • A U.S. shareholder’s GILTI inclusion is the excess of the U.S. shareholder’s pro rata share of net CFC tested income over its net deemed tangible income return (“net DTIR”). A U.S. shareholder’s net CFC tested income is the aggregate pro rata share of tested income from each of its CFCs minus the aggregate pro rata share of tested loss from each of its CFCs (but not less than zero). Net DTIR is defined as 10% of the U.S. shareholders pro rata share of aggregate qualified business asset investment (“QBAI”) of its CFCs less specified interest expense. A CFC’s QBAI is its average quarterly basis in depreciable tangible property used in a trade or business for the production of tested income.

Corporations with GILTI Receive a 50% Deduction

In accordance with the GILTI rules, a US corporate taxpayer receives a 50% deduction under Internal Revenue Code section 250 (37.5% for FDII). Unfortunately, this rule does not apply to individual taxpayers. So, in order to even the playing field, an individual Taxpayer would have to able to make some sort of election to be treated as a corporation for tax purposes — which can be found in relatively obscure IRC Section 962. In accordance with Internal Revenue Code section 962 and the final GILTI regulations, a US individual shareholder is eligible to make the election. So, if the US person individual makes a 962 election regarding income for a foreign corporation that will be classified in the US GILTI — they receive the same benefits as US corporate shareholder.

26 U.S. Code § 962 – Election by Individuals to be Subject to tax at Corporate Rates U.S. Code

(a) General rule

• Under regulations prescribed by the Secretary, in the case of a United States shareholder who is an individual and who elects to have the provisions of this section apply for the taxable year—

• (1) the tax imposed under this chapter on amounts which are included in his gross income under section 951(a) shall (in lieu of the tax determined under sections 1 and 55) be an amount equal to the tax which would be imposed under section 11 if such amounts were received by a domestic corporation, and

• (2) for purposes of applying the provisions of section 960 [1] (relating to foreign tax credit) such amounts shall be treated as if they were received by a domestic corporation.

(b) Election

• • • An election to have the provisions of this section apply for any taxable year shall be made by a United States shareholder at such time and in such manner as the Secretary shall prescribe by regulations. An election made for any taxable year may not be revoked except with the consent of the Secretary.

(c) Pro ration of each section 11 bracket amount

• • • For purposes of applying subsection (a)(1), the amount in each taxable income bracket in the tax table in section 11(b) shall not exceed an amount which bears the same ratio to such bracket amount as the amount included in the gross income of the United States shareholder under section 951(a) for the taxable year bears to such shareholder’s pro rata share of the earnings and profits for the taxable year of all controlled foreign corporations with respect to which such shareholder includes any amount in gross income under section 951(a).

(d) Special rule for actual distributions

• • • The earnings and profits of a foreign corporation attributable to amounts which were included in the gross income of a United States shareholder under section 951(a) and with respect to which an election under this section applied shall, when such earnings and profits are distributed, notwithstanding the provisions of section 959(a)(1), be included in gross income to the extent that such earnings and profits so distributed exceed the amount of tax paid under this chapter on the amounts to which such election applied.

What does this Mean?

It means that for some US Persons subject to GILTI and Subpart F — they may now become subject on income which  escaped US tax in years past. In order to level the playing field, regulations approved individuals to be allowed to make an IRC section 962 election to be treated as a Corporation. Thus, Taxpayers making the 962 election will treat the GILTI Income as if it first passes through a US Domestic Corporation before being distributed to the US Person. By making this election, the Taxpayer can utilize a 50% deduction and 80% of foreign tax credits to essentially reduce, if not eliminate GILTI tax.

962 Election Can Reduce and Eliminate GILTI Tax Liability

After the US shareholder individual makes an Internal Revenue Code section 962 election, they will be entitled to a 50% deduction against GILTI and be eligible to utilize up to 80% of foreign tax credits. Otherwise, the US individual persons could be subject to a much bigger tax bill — although making the election can have other cons that the individual Taxpayer must assess.

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