Do you know that owning a Controlled Foreign Corporation got affected by New Tax Bill? In a nutshell, Trump’s tax reform now means that all income is Subpart F income. In addition, all currently untaxed retained earnings will be subject to a one-time tax. Read further if you want to find out what it means exactly and how U.S. expats with CFCs are affected.
Let’s take a quick look at a few changes that were introduced in recent tax legislation. Generally, Trump’s tax reform benefits individuals who are struggling with their finances by doubling standard deductions, i.e. from $6,000 to $12,000 for singles, and reducing the rates for five tax brackets of the existing seven.
The Child Tax Credit is increased to $2,000 and taxpayers are allowed to deducts any medicals expenses that are over 7,5% of their adjusted gross income. Additionally, the alternative minimum tax rate (AMT) got raised to $500,000 for individuals and $1 million for couples.
Tax Cuts and Jobs Act 2017 also lowers the corporate tax rate from 35% to 21% and gives 20% reductions for the first $315,000 of joint income for small business such as S corporations and limited liability companies (LLCs).
Good news for US expats is there weren’t any changes to the most important provisions, such as the Foreign Earned Income Exclusion, Foreign Tax Credit or the Foreign Housing Deduction. Yet there are a few modifications that Americans abroad should be aware of.
What Is A Controlled Foreign Corporation (CFC) And Subpart F?
It’s only fair to provide an explanation of what a CFC is as we just mentioned earlier that Trump’s tax reform expanded the CFC ownership rules, which makes more foreign corporations to be treated as CFCs.
A Controlled Foreign Corporation (CFC) is a U.S. corporation which operates abroad with U.S. shareholders who have 50% or more of the control. What does “foreign” mean in the context of business incorporation? The IRS considers only non-U.S. companies and companies which are taxed as corporations (including LLCs that elect to be taxed as a corporation) for the purpose of CFC status.
What Is Subpart F?
CFC status is regulated in a Subpart F and it was created to gather information on the income from foreign corporations owned/controlled by U.S. citizens and to collect tax on that income. As we know already, a foreign corporation is one type of entity which foreign operations may be conducted through. A major tax advantage of conducting foreign operations by using a foreign corporation is income tax deferral: generally, U.S. tax on the income of a foreign corporation is deferred until the income is distributed as a dividend or otherwise repatriated by the foreign corporation to its U.S. shareholders.
The Subpart F provisions eliminate deferral of U.S. tax on some categories of foreign income by taxing certain U.S. persons currently on their pro rata share of such income earned by their controlled foreign corporations (CFCs).
How Does An American Abroad Report An Income From A Controlled Foreign Corporation?
If you own a Controlled Foreign Corporation, then you must file an annual report on IRS Form 5471– Information Return of U.S. Persons With Respect to Certain Foreign Corporations. You will need to submit info regarding U.S. citizens who are shareholders, director, and officers; a listing of all U.S. shareholders and their stocks; CFC’s classes of stock and shares outstanding; a balance sheet and income statement for the tax year.
This is a form filed by the corporation, while each U.S. shareholder, director, or officers who meet the 50% criterion will need to file a separate report. This report will include each U.S. person’s income in dividends, investments and other income from the foreign corporation. This document is called a Summary of Shareholder’s Income from Foreign Corporation.
How Americans Abroad Owning A CFC Got Affected By New Tax Bill
If you are an American abroad, own a business and make more than $100k a year (the FEIE limit), than the tax reform has largely impacted entire tax and legal structure for you and other expat entrepreneurs. There are 2 major changes that you must know:
- One-time Mandatory Repatriation of Funds. Current undistributed retained earnings are taxed at 15.5% if held in liquid assets, and 8% for those held in illiquid assets. Any money you have retained in a foreign company will be subject to this one-time tax but the good news is It can be paid over an 8 year period.
- Everything is Subpart F now thus No More Future Deferral. Before you could defer all retained earning but it’s not available any longer. Any income above $102,100 (or up to ~$204,200 if your spouse or partner works in the business, too) will be now taxed at ordinary rates as Subpart F income. Though you can still use the Foreign Earned Income Exclusion, and conduct operations through a non-U.S. corporation, hence if you make $100,000, you can pay yourself in wages and exclude them so that you wouldn’t have taxable income.
Solutions For CFC Reporting: How Can You Save More Money Now?
Disclaimer: Everything mentioned below is not meant to replace a professional legal tax advice. There are just a few ideas but everyone’s situation is different and you must seek a tax consultation regarding your case. At 1040 Abroad we provide legal and 100% confidential help if you want to find a solution for CFC reporting. You gotta keep more of your money that U.S. government wants to take away thanks to Trump’s tax reform!
So what are your options here?
- You can choose to earn less. If you are earning at the FEIE limit, less or not significantly more than the 100k limit, you won’t need to change your structure and you won’t pay tax (or maybe not much of it). Again, seek a professional advice from US expat tax experts as most of the ordinary accountants do not know nuances of US international tax laws.
- You may change your CFC status. Those who have a non-resident alien spouse or partner may go with an option to remove the status of a “controlled foreign corporation”. Discuss it with a tax professional as you don’t want to end up with worse tax situation than before!
- Renounce US citizenship (given you already have or in process of getting the second passport) in 2018. You will still have to pay the repatriation tax (in course of over 8 years) but you can avoid the Subpart F inclusion on all future profits from the day you are no longer U.S. citizen. The question here is if new CFC reporting is worth giving up your U.S. citizenship.
- Limit tax to 10,5% when you set up a C Corporation. It may be complicated structure and we do not know yet how the non-US banks will react to this. Anyway, you will need a tax attorney help to implement it.
Or you can change nothing and pay taxes at ordinary rates that apply to income over FEIE as if you lived in the US.
Our Thoughts On Owning A Controlled Foreign Corporation After Trump’s Tax Reform
U.S. international tax laws are complicated and nobody saw this new tax reform passing in its current form and having this (negative) impact on US expat businesses. Remember that everyone’s situation is different and there is no one-size-fits-all kind of solution. Though it’s confirmed now that if you were operating offshore and had zero or very little tax, you most likely need a new plan and tax strategy with legal ways to not be left penniless.
As U.S. expat tax experts, we recommend each individual to get some professional help. Especially in cases when you are a U.S. citizen abroad owning a Controlled Foreign Corporation after tax reform and earning much more than the FEIE limit.
Have a question? Contact Olivier Wagner.
Your comments are always welcome!