Introduction On April 14, 2021 Tax Notes published my post “To Punish 100 GILTI Corporations Is To Punish Millions More Individuals“. The purpose of that post was to describe the harm that President Biden’s proposed changes to GILTI would inflict on individual shareholders of CFCS generally and on expat entrepreneurs in particular. I proposed two possible solutions: 1. Exempting individuals from the Subpart F regime; or 2. Exempting individuals who would qualify for the 911 Foreign Earned Income Exclusion from the Subpart F regime. This post, written by Dr. Karen Alpert of SEAT, proposes a third way to both have reform to the GILTI rules and NOT inflict unnecessary harm on individuals. What follows is Dr. Alpert’s post as it appeared on the SEAT site. https://twitter.com/ExpatriationLaw/status/1384502158092128261
How To Fix The Proposed GILTI Changes – Dr. Karen Alpert
At the end of March, the White House released its economic and tax plans – “The American Jobs Plan” outlining extensive spending on infrastructure, to be paid for by increasing corporate taxes, especially on large multinational corporations. This plan revises some of the international provisions of the 2017 Tax Cuts and Jobs Act (TCJA). The TCJA international provisions hit American citizens living and running small businesses outside of the US pretty hard, with both GILTI and a Transition Tax decimating the savings of individual owners of small non-US businesses including expat entrepreneurs around the globe. The current proposals will also be painful to these business owners, but there’s an easy fix that should be considered by Congress.
What is being proposed?
Near the bottom of the White House Fact Sheet released 31 March is “The Made In America Tax Plan.” The first three points of the plan are to:
- Increase the corporate tax rate to 28%
- Strengthen GILTI
- Encourage other countries to enact minimum tax provisions
This plan proposes “to fix the corporate tax code so that it incentivizes job creation and investment here in the United States, stops unfair and wasteful profit shifting to tax havens, and ensures that large corporations are paying their fair share.”
These proposals have yet to be introduced in Congress, so the exact parameters are still under negotiation. The discussion about strengthening GILTI includes provisions that will increase the tax rate on GILTI to 21% (presumably by eliminating the 50% deduction allowed by §250), eliminate the 10% return on foreign assets (QBAI) allowed as a deduction in computing GILTI, and require that GILTI be computed on a country-by-country basis.
While encouraging other countries to enact minimum tax provisions similar to GILTI is mainly a diplomatic exercise, the proposal also “denies deductions to foreign corporations on payments that could allow them to strip profits out of the United States if they are based in a country that does not adopt a strong minimum tax.”
The focus here is on large multinational corporations – the Biden Administration wants to ensure that Fortune 500 companies are not shifting profits to tax havens so that these large multinationals pay “their fair share.” One of the main motivations is a study that showed that 91 of the Fortune 500 paid zero US corporate tax. The Administration, and Congress, are not thinking about small non-US businesses owned and operated by individuals, many of them US citizens residing abroad.
How does this hurt individual entrepreneurs?
Because Congress and the Administration do not understand that these rules aimed at multinationals will also affect small businesses, including expat entrepreneurs, it is likely that these provisions will make a bad situation worse.
While the IRS does not believe that small businesses can be impacted by GILTI (or the Transition Tax), the damage is real. GILTI applies to all Controlled Foreign Corporations (CFCs). Even though a small business owned by a US shareholder may have no cross-border transactions, the fact that it is controlled by a US citizen and incorporated outside the US makes it a CFC. That means that, if the corporation does not pay a minimum level of tax in the country where it is incorporated, the US citizen shareholder must make up the difference by paying additional tax to the IRS. Plus, when computing the amount due to Uncle Sam, the shareholder can offset US taxes by no more than 80% of the tax paid in the corporation’s home country. The computations required are onerous, even when no tax is due. Explaining the details is beyond the scope of this post, but there are plenty of other resources including:
- The US Tax Reform’s GILTI Provision: A Webinar (with John Richardson and Karen Alpert)
- Explaining GILTI (part 2) (part 3)
- Posts tagged with GILTI at Citizenship Solutions
Compliance with GILTI is so complex and onerous that Monte Silver filed a lawsuit challenging the GILTI regulations and seeking an exemption for small businesses.
How can this be fixed?
Small businesses were not on Congress’ radar when they were debating the international provisions of TCJA. They must be on the radar this time around. The target here is large corporations, not dentists, yoga studios, and milk bars run by US citizens living in Canada, Australia, Israel, France, or any other country. The rules and regulations around CFCs are among the most complex in the US tax code. Congress can easily, without compromising the purpose of President Biden’s tax plan, write in a de minimis exception to GILTI – and to all of subpart F (the part of the tax code that contains CFCs and GILTI). These entrepreneurs have not chosen to incorporate their small business outside of the US because they want to avoid US tax. They have incorporated their business in the country where the business operates, and often the country where the shareholder lives. The exception can take one of two forms:
- Size based exception: exempt businesses where the entire economic group (the foreign corporation and its controlling shareholders) meets the US Small Business Administration size standards. These standards vary by industry to better reflect what “small” means for a given business.
- Shareholder location based exception: exempt businesses whose US shareholders meet the residence requirements in §911 (Foreign Earned Income Exclusion) in the same country where the corporation is incorporated.
Either way, such an exception will ensure that the proposed changes to GILTI will hit their intended targets and that individual US shareholders, including expat entrepreneurs, will not be unintended victims as they were after TCJA.
Have a question? Contact John Richardson, Citizenship Solutions.
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