'GILTI' Reprieve: Electing Individuals Owning CFCs Eligible for Deduction

U.S. individual shareholders of a controlled foreign corporation (CFC) are eligible to make a Section 962 election to be taxed as if they held the CFC through a U.S. corporation.  On March 4, 2019, the IRS and Treasury issued proposed regulations providing that the hypothetical U.S. corporation may be eligible for a 50 percent deduction on its global intangible low-taxed income (GILTI) as if were an actual U.S. corporation.

The original intent of the Section 962 election, which predates the introduction of the GILTI regime, was to ensure that the tax burden of U.S. individuals owning CFCs with respect to “subpart F income” would be no higher than if the U.S. individuals had invested in a U.S. corporation that owned the same CFCs.  The downside to making the Section 962 election is two layers of taxation: first, the hypothetical U.S. corporation is subject to U.S. corporate tax; and second, U.S. individuals are subject to tax on the receipt of any actual distributions from the CFC as determined under the Section 962 regime.  The upside to making the Section 962 election is the potential to reduce the U.S. corporate tax by indirect foreign tax credits and the deferral of the individual-level tax until the CFC makes an actual distribution.

After the enactment of the Tax Cuts and Jobs Act (TCJA), U.S. individual and corporate shareholders are currently taxed on a CFC’s GILTI amount, which is generally the CFC’s income that exceeds an implied 10% rate of return on its tangible business assets.  Similar to subpart F income, the CFC’s GILTI amount is taxable to the U.S. individual or corporate shareholder even if no earnings are distributed from the CFC.  In connection with the TCJA, under Section 250, U.S. corporate taxpayers of a CFC may be entitled to a 50 percent deduction, potentially reducing its effective GILTI tax rate to 10.5 percent (50 percent of the 21 percent corporate tax rate).  However, the statutory language under Section 250 does not provide for a hypothetical U.S. corporation in the context of a Section 962 election to be eligible for the 50 percent deduction. 

The proposed regulations provide that a U.S. individual shareholder that makes a Section 962 election would be eligible to apply the 50 percent deduction with respect to the GILTI income deemed earned by the hypothetical U.S. corporation.  This change may make Section 962 elections more attractive for U.S. individual shareholders owning CFCs.  U.S. individual shareholders should consult their advisors as to whether the Section 962 election may be advisable with respect to their CFC investments given these new proposed regulations.

 

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