3 Pitfalls to Avoid When Restructuring for GILTI Tax Reduction

Published: Jun 22, 2018
Topics: Tax
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The new tax law’s global intangible low-taxed income (“GILTI”) provision is triggering uncertainty among individual shareholders and non-C corporations that invest in controlled foreign corporations (or “CFCs”). Neither can leverage the same tax relief as C corporations as they navigate this extension of the Subpart F regime.

The disadvantages for non-C corporations include the fact that they can’t deduct 50% of their GILTI income, under IRC Section 250. They’re also taxed at 37%, compared with the 21% corporate tax rate, and while 80% of foreign tax is available to C corporations as a credit against GILTI income, individuals and pass-through entities can only claim credits for direct taxes they pay such as withholding taxes.
With these drawbacks, the question isn’t whether individuals and S corporations should restructure but how to do it. Here are potential pitfalls to consider in any restructuring effort.

1. Leveraging Untested Law for a Section 250 Deduction

If you don’t qualify for Section 250, you may be considering a Section 962 election, which attempts to allow individuals to have their GILTI taxed at corporate rates. In essence, it is like putting a phantom C corporation between the individual and the CFC in an effort to minimize GILTI liability. But creating an artificial C corporation between the individual and the CFC, based on an old and largely untested law, is like dusting off a lawnmower that’s been in the back of your garage for 20 years. How well does it still work, if at all?

Introduced in 1962, when Subpart F came into effect, Section 962 was originally intended to put individuals who could not directly invest in CFCs in the same position as C corporations. In the decades since, however, 962 has rarely been used to create an artificial entity in the middle.

There’s an ensuing lack of authority on many issues associated with the section. Section 962’s original intent covers a foreign tax credit. But is 962 broad enough to cover Section 250’s 50% deduction of the amount outlined under Section 951A? The IRS has yet to make a determination.

2. Relying on 962 for a Qualified Dividend Rate

Non-C corporations may also be eying Section 962 to offset another issue: If a CFC is not incorporated in a treaty country, dividends are taxed at regular rates. A treaty-qualified entity enjoys a lower rate of roughly 20%, plus a potential Medicare tax of 3.8%.

Does inserting an artificial U.S. corporation mean the dividend you ultimately get results from a treaty-qualified dividend? That issue is now in litigation and isn’t likely to be resolved until year’s end, if then. Once again, until consensus is reached, proceed cautiously with this strategy.

3. Assessing Domestic C Corporation Status in Isolation

Instead of creating an artificial entity, is it better to create a regular domestic C corporation?
We know this entity structure works—like a new lawnmower, it includes a current instruction manual. Domestic C corporations can also benefit from the much-discussed foreign-derived intangible income, which allows corporations to claim an additional deduction and reduce their overall tax burden.

But switching entity structures to minimize GILTI liability should be just one part of the restructuring analysis. The same holds true when factoring in the 21% corporate tax rate over the individual 37% rate. Plus, keep in mind GILTI’s other moving parts, such as state-by-state variations in provision interpretation yet to come.

Still, waiting until year’s end to assess restructuring options may only increase your overall GILTI liability. That’s why it’s important to carve out the time now—and speak to a tax professional—so you wisely avoid potential pitfalls later.

Business Tax Quarterly - Summer 2018