Author: Ray Polantz
Pass-through forms of business such as S Corporations and partnerships offer certain domestic tax benefits — namely, the avoidance of double taxation and the ability to claim the 20% deduction under IRC Code Section 199A. However, the global intangible low-taxed income (GILTI) provisions of the Tax Cuts and Jobs Act (TCJA) can provide significant and unique challenges to pass-through and individual owners of foreign corporations.
The GILTI provisions provide that individuals with investments in profitable foreign corporations, including pass-through entities, will encounter immediate double taxation on foreign earnings. The local country will tax the corporation’s earnings, and then the U.S. will tax those same earnings through the GILTI provisions. U.S. C Corporations often don’t face these harsh consequences. The lower corporate tax rate, the special 50% GILTI deduction and the availability of indirect foreign tax credits often mitigate or eliminate a C Corporation’s U.S. tax on GILTI income.
However, Sec. 962 allows an individual U.S. shareholder to make an annual election to be taxed as a C Corporation on certain specific income earned by its foreign subsidiary (including GILTI). By making this election, the shareholder may claim an indirect foreign tax credit for foreign taxes the corporation paid.
What is the Sec. 962 Election?
Sec. 962 was designed to allow individuals investing in foreign corporations to elect the same treatment had they invested through a domestic corporation doing business abroad.
By making a Sec. 962 election, the individual will generally pay tax on their pro rata share of GILTI as if they were a U.S. C Corporation. Therefore, the lower corporate rate of 21% will apply and the individual may claim an indirect credit for foreign taxes the foreign corporation has paid. In March, Treasury issued proposed regulations allowing the individual to claim the 50% deduction against GILTI, which is otherwise only available to corporations.
When a foreign corporation makes a distribution to a U.S. shareholder who has made a Sec. 962 election, the individual will pay tax on this deemed dividend out of the hypothetical C Corporation, but only to the extent the amount of the distribution exceeds the amount of tax previously paid as a result of the Sec. 962 election.
Tax Planning Using Sec. 962
The Sec. 962 election can be a powerful planning tool in mitigating or deferring the inherent double-taxation of being a U.S. shareholder of a foreign company. There are a number of benefits to making a Sec. 962 election for GILTI. It is a flexible annual election that allows individual taxpayers access to the lower corporate tax rate, the 50% GILTI deduction and indirect foreign tax credits — all of which are typically only available to C Corporations.
However, certain things must be considered, including additional administrative requirements, a possible automatic second layer of tax upon repatriation and the inability to garner other C Corporation benefits. Careful consideration should be given before making this election.
Contact Ray Polantz at rpolantz@cohencpa.com or a member of your service team to discuss this topic further.
