In 2017, if a client owned an interest in a foreign entity (directly or indirectly through a tiered entity structure), then an evaluation should have been done to determine whether the client owed a repatriation tax under the Tax Cuts and Jobs Act (TCJA). Many clients, and their tax advisors, are unaware of this obligation and have failed to pay this tax. The repatriation tax was meant to tax accumulated earnings of a controlled foreign corporation. For clients that own an interest in multiple foreign entities, the accumulated earnings may offset one another from each entity. Two tax rates potentially apply, 15.5% and 8%.
The rules are complex, but in simple terms, if a U.S. person owns an interest in a controlled foreign corporation or owns any interest in a foreign corporation through a domestic corporation, they likely should have paid the repatriation tax beginning in 2017. A special election may be made to pay this tax in 8 installments. Additionally, an election under IRC Section 962 would treat an individual, trust or estate shareholder as a corporation to potentially receive more favorable tax treatment. This analysis and election must be done each year. A controlled foreign corporation is a foreign corporation (some entities may be a corporation for U.S. tax purposes even if called something else) where U.S. persons who own more than 10% also collectively own more than 50% of the entity (but note that the repatriation tax applies to any domestic corporation that owns a foreign entity). Constructive ownership rules apply and generally attribute stock ownership from family, entities, trusts and estates.
Now that we are in 2019, tax professionals are starting to understand the new tax rules for foreign entity reporting and disclosure, including the 2017 repatriation tax under IRC Section 965 (such as those described above). The IRS continues to provide new guidance in this area to help tax advisors apply these new rules.
Additionally, new rules related to what is called Subpart F Income related to controlled foreign corporations just became even more complicated, and in many situations, more severe. Prior to enactment of TCJA, some shareholders of foreign entities were able to defer the tax on income created in a foreign country. Now this benefit has been greatly reduced and most foreign source income will be taxed currently in the U.S. regardless of whether this income is distributed to the U.S. shareholder. In other words, the IRS’ power to essentially disregard the foreign corporate structure for U.S. income tax purposes continues to broaden. It is important to calculate and report this income each year to avoid interest and penalties.
Although not changed by TCJA, many U.S. clients that own 10% in a foreign entity, acquire 10% or more, or reduce their interest below 10%, fail to report this to the IRS. The IRS imposes a $10,000 penalty for failure to report. JMBM can provide solutions to bring clients back into compliance with respect to these disclosure rules (which are separate and apart from tax requirements).
JMBM’s International Tax Group is helping clients, and their tax advisors, to understand the client’s U.S. tax obligations in relation to their foreign entity ownership and the new rules under TCJA including the repatriation tax under IRC Section 965 and the new Subpart F Income rules referred to as Global Intangible Low-Taxed Income, or GILTI. Don’t let the name fool you, the tax applies to most income, not just income from intangible assets. Failure to pay the tax could result in an audit with assessment of tax, interest and penalties. We work with clients and their tax advisors to mitigate these consequences. Additionally, if you failed to pay this tax, there may be other compliance issues that have not been addressed.
Please contact us if we can advise on foreign entity compliance and these new complex rules.
About JMBM’s International Tax Group
JMBM’s International Tax Group advises foreign and domestic businesses and their owners on all aspects of ownership structure, operations, foreign tax credits, cross border transactions, and coordination of tax systems and treaties in various jurisdictions to achieve solutions that are globally tax-efficient. Our tax expertise puts the Firm in a unique position to advise clients on substantially all aspects of international transactions.
This update is provided to our clients, business associates and friends for informational purposes only. Legal advice should be based on your specific situation and provided by a qualified attorney.