{"id":7611,"date":"2018-11-06T09:00:18","date_gmt":"2018-11-06T17:00:18","guid":{"rendered":"http:\/\/evergreensmallbusiness.com\/?p=7611"},"modified":"2018-11-21T09:48:47","modified_gmt":"2018-11-21T17:48:47","slug":"will-your-small-business-owe-gilti-tax","status":"publish","type":"post","link":"https:\/\/evergreensmallbusiness.com\/will-your-small-business-owe-gilti-tax\/","title":{"rendered":"Will Your Small Business Owe GILTI Tax?"},"content":{"rendered":"

\"Foreign<\/a>A prediction for the coming tax season: GILTI taxes will blindside some small business owners operating internationally.<\/p>\n

Many small business owners with foreign corporations have grown accustomed to not paying tax on the corporation\u2019s earnings until the corporation pays them a dividend. But because of the new tax reform bill, for many small businesses those old rules no longer apply.<\/p>\n

Who Needs to Worry About GILTI<\/h2>\n

GILTI stands for \u201cglobal intangible low-taxed income.\u201d However, the GILTI tax doesn\u2019t just hit taxpayers, investors, and small businesses operating in jurisdictions that lightly tax income.<\/p>\n

Rather, the GILTI tax tags U.S. shareholders who own just about any<\/em> controlled foreign corporation (or \u201cCFC\u201d) that doesn\u2019t have much in the way of fixed assets.<\/p>\n

GILTI forces people who own more than ten percent of a foreign corporation to pay US taxes on their proportional share of the corporation\u2019s profit, even if the corporation doesn\u2019t distribute that profit to the shareholders<\/em>.<\/p>\n

Note:<\/strong> If you or your small business paid (or should have paid) the Section 965 transition tax on a foreign investment, you likely owe GILTI tax starting in 2018.<\/p>\n

How GILTI Works: The $0.10 Explanation<\/h2>\n

For most individual and small business taxpayers, here are the new GILTI rules in a nutshell: U.S. taxpayers need to recognize any income earned inside a foreign corporation that exceeds 10% of the foreign corporation\u2019s fixed assets.<\/p>\n

C corporation taxpayers get a special, lower tax rate on this income. But individual small business owners won\u2019t get a special tax rate. Instead, they\u2019ll just add this income to all the other income they\u2019re paying taxes on, and then calculate income tax on GILTI just like it\u2019s Subpart F income.<\/p>\n

In addition, unlike C corporation taxpayers, individual taxpayers won\u2019t get to claim what\u2019s called an \u201cindirect foreign tax credit\u201d on GILTI. This also applies to individuals who own their foreign corporation through a past-through entity, such as a partnership or S corporation.<\/p>\n

Example:<\/strong> Let\u2019s say an individual small business owner owns 100% of a U.K. corporation with no fixed assets. This corporation earns $100,000 in 2018, none of which is Subpart F income. It pays no dividends to its owners. Before tax reform, the business owner didn\u2019t have to worry about paying U.S. income taxes on the $100,000. But post-tax reform, the business owner will need to include the $100,000 on their 2018 1040 and pay tax on it. And this individual won\u2019t even get to claim a foreign tax credit for any income taxes the corporation paid to the U.K. on this income.<\/p>\n

Avoiding GILTI Tax<\/h2>\n

Some individuals and small businesses do, however, have a way to avoid GILTI. They can elect to treat their foreign business as a partnership or disregarded entity.<\/p>\n

This, of course, means that the taxpayer will recognize taxable income inside the foreign entity as it\u2019s earned. And this may be a disappointment for some. But remember that the GILTI rules mean the IRS now taxes that income currently anyway. However, note that pass-through or disregarded entity status means the foreign income taxes probably work as a foreign tax credit.<\/p>\n

Foreign Partnership Tax Classifications<\/h3>\n

By default, U.S. tax law usually treats foreign entities that limit the liability of their owners as C corporations.<\/p>\n

However, some foreign limited liability entities may elect to be treated as partnerships or disregarded entities. And a taxpayer isn\u2019t stuck with the tax treatment they chose when the foreign entity was formed. A taxpayer subject to the GILTI rules could elect to have their foreign business entity treated as a partnership or a disregarded entity going forward.<\/p>\n

What\u2019s more, revenue procedures often allow taxpayers to make late entity classifications. This means that, even at this late date, some U.S. taxpayers could elect a new tax treatment for their foreign entities for 2018.<\/p>\n

Note:<\/strong> We believe the correct revenue procedure to invoke in order to make a late entity classification is Rev. Proc. 2009-41<\/a>.<\/p>\n

Making Late Partnership Classifications<\/h3>\n

To convert a foreign corporation to a foreign partnership, you would file a late Form 8832<\/a> \u201centity classification\u201d election.<\/p>\n

Note:<\/strong> Some foreign limited liability entities cannot elect to be treated as partnerships. Check Treasury Regulation 301.7701-2<\/a> if you have questions.<\/p>\n

Partnership Reclassification Triggers Gain<\/h3>\n

Note that the change in status from corporation to partnership would mean that you need to report, in essence, foreign corporation stock being \u201csold\u201d for a foreign partnership interest. So, a taxable transaction.<\/p>\n

But that might be a very low-tax transaction. Your \u201cbasis\u201d in your foreign corporation\u2019s stock doesn\u2019t just include the money you originally invested. It also includes your share of the \u201cSection 965 income\u201d dealt with on the 2017 return. (This was the Section 965 transition tax you paid, started paying, or elected to pay sometime in the future.)<\/p>\n

Further, keep in mind that many small businesses have very modest valuations. A multiple of two or three or four times earnings is common.<\/p>\n

The upshot for some individuals and small businesses invested in foreign corporations? A change in entity classification may be the cleanest way to avoid GILTI.<\/p>\n

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\"Cover<\/a>If you\u2019re a tax accountant who needs to learn the Section 965 transition tax stuff in detail, you may be interested in looking at our Preparing International Tax Returns of U.S. Taxpayers<\/a><\/cite> monograph.<\/p>\n

Like our other monographs for CPAs and attorneys, it provides practitioners with a way to get up to speed in few hours\u2014rather than spend days or longer reading the statutes, regulations, and case law.<\/p>\n

Interested in More International Tax Information?<\/h2>\n

We regularly blog about issues related to small business taxation, including international taxes. You may want to consider subscribing to our free monthly-ish newsletter. You can subscribe anytime.
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