INTERNATIONAL PROVISIONS OF THE TCJA: IMPLICATIONS FOR INDIVIDUALS

Transcription

1 INTERNATIONAL PROVISIONS OF THE TCJA: IMPLICATIONS FOR INDIVIDUALS Panelists: Sally Thurston Skadden Arps Slate Meagher & Flom LLP Benjamin Handler Deloitte LLP Melinda Harvey Internal Revenue Service International Tax Institute Luncheon October 9, 2018

2 Agenda Overview of changes created by the Tax Cuts and Jobs Act of 2017 ( TCJA ) and subsequent regulations. Discussion of impact of the the new law for individuals and certain other minority shareholders, specific issues arising under the law and pitfalls for tax planners. 1

3 OVERVIEW OF RELEVANT STATUTORY PROVISIONS

4 Transition Tax Section 965 subjects U.S. Shareholders of CFCs or of entities that are not CFCs but that have at least one domestic corporation as a 10% shareholder (the latter an SFC and together with CFCs, a DFIC ) to a transition tax upon the post-1986 previously untaxed E&P of the DFIC determined as of one of two measurement dates. Section 965(a), (d)(1), (e)(1). Tax applies to partners or owners in U.S. pass-through entities even when the partners/owners own less than 10% of the entity, provided that the entity owns the requisite 10% In determining whether a domestic corporation is a 10% shareholder, attribution under section 958(b) is taken into account (including potential downward attribution) Inclusions under section 965 are taxed as Subpart F income and are generally treated as PTI upon distribution. Sections 965(a) and 959. The amount included in income is offset by a deduction which has the effect of reducing rates for corporate taxpayers to 15.5% for cash and similar assets, and 8% for non-cash assets. Section 965(c). Current year FTCs may be used against the tax but are reduced by a fixed percentage equivalent to the reduction in the effective U.S. tax rate resulting from deductions under section 965(c). Section 965(g). Transition tax liability can be paid in increasing installments over 8 years; certain acceleration events apply. Section 965(h). 3

5 GILTI U.S. Shareholders are now generally taxable upon the global intangible low-taxed income ( GILTI ) of their CFCs. Such shareholders include in income the excess of such shareholder s pro rata share of the net tested income of its CFCs over the net deemed tangible income return of those CFCs for a given taxable year. Section 951A(b). Net tested income is the excess of the CFC s gross income over deductions allocable to such income. Section 951A(c)(2). Gross income does not include Subpart F income, ECI or dividends received from a related person A U.S. Shareholder s net deemed tangible income return equals 10% of the aggregate of the U.S. Shareholder s pro rata share of the qualified business asset investment of each CFC with tested income. Section 951A(b)(2). For U.S. Shareholders that are domestic corporations, the rate of tax on GILTI can be lowered by deduction under section 250 The deduction is currently 50%, and drops to 37.5% for taxable years beginning after December 31, Proposed regulations released in September 2018 did not address section 250 deductions and FTC for GILTI Treasury will address these items in future notices GILTI rules also provide for an indirect FTC with respect to GILTI. Section 960(d) The credit is haircut and may not be carried back or forward The credit is not available to U.S. shareholders who are not domestic C corporations 4

6 Relevant CFC Changes TCJA expanded the definition of U.S. Shareholders and CFCs U.S. Shareholders now include a U.S. person owning 10% or more of a foreign corporation by vote or value (previously only vote considered) The exception from Subpart F inclusions for entities that were CFCs for 30 days or less has been repealed Each of these changes apply to taxable years of foreign corporations beginning after December 31, 2017 and to taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end Section 958(b)(4) has been repealed, so that downward attribution is allowed from related foreign persons to U.S. persons Thus, for example, a domestic subsidiary of a foreign parent may now be treated as owning a foreign subsidiary of such foreign parent Repeal is effectively retroactive, and applies to the last taxable year of foreign corporations beginning before Jan. 1, 2018, and each subsequent taxable year of such foreign corporation and to taxable years of U.S. shareholders in which such taxable years of foreign corporations end 5

7 Section 245A Deduction Section 245A allows a domestic corporation that is a 10% shareholder of a foreign corporation a 100% deduction for the foreign-source portion of dividends received from the foreign corporation. The deduction is only available to domestic corporations and not for individuals. Effective for distributions made after December 31,

8 Section 962 Election Section 962 is a little-known provision that allows an individual U.S. Shareholder to elect to be treated as a domestic corporation with respect to certain provisions of Subpart F. If an individual U.S. shareholder makes a section 962 election: However: Corporate tax rates apply to inclusions under section 951, and FTCs are available under section 960(d) Income will be treated as PTI upon a future distribution only to the extent U.S. taxes are actually paid Basis adjustments under section 961 are only made to the extent U.S. taxes are actually paid Intention is to place an electing individual that owns a CFC directly on par with one who owns through a domestic corporation. See H.R. Rep. No , at 620 (2017); S. Rep. No , at 264 (1962). Section 962 elections are only available to individuals who are U.S. Shareholders within the meaning of section 951(b). 7

9 Section 1411 Net Investment Income Tax Section 1411 imposes a 3.8% tax on net investment income ( NII ), which includes dividends and certain other passive income Under Treas. Reg. Section , section 951 inclusions are generally treated as NII only if they are associated with a business that is a passive activity of the taxpayer or a trade or business of trading in financial instruments or commodities Otherwise, earnings of CFCs are generally included in NII when distributed, even if they are treated as PTI for Chapter 1 (regular tax) purposes An individual may make an election under Treas. Reg. Section (g) to treat section 951 inclusions as NII (in which case, distributions of PTI will not be treated as NII) The election is made on a CFC-by-CFC basis The election generally must be made no later than the first taxable year in which the individual has a section 951 inclusion with respect to that CFC and is subject to the Section 1411 NII tax The election can be made on an amended tax return as long as the year (and all subsequent years that would be affected) is open The election is irrevocable The election is often made to avoid the complexities of separately tracking the basis of a CFC for Chapter 1 and Section 1411 purposes 8

10 SECTION 965 TRANSITION TAX ISSUES PECULIAR TO INDIVIDUALS

11 General Effective transition tax rates are higher for individuals than for corporations 17.54% for cash assets and 9.04% for non-cash assets. Higher rates result because section 965(c) deductions are derived from corporate tax rates. Legislative history indicates individuals can achieve equivalent rates to corporations by making a section 962 election. H.R. Rep. No , at 620 (2017). Credits for withholding taxes imposed on subsequent PTI distributions from section 965 inclusions are haircut by the same applicable percentage as with credits under section 960. Prop. Reg. Section (b). As with corporations, individuals can elect to pay tax in installments under section 965(h). S-corp shareholders can indefinitely defer payment of the transition tax until the occurrence of a triggering event (e.g., termination of S-corp status). Section 965(i). An individual s death or cessation of U.S. residency triggers acceleration. Prop. Reg. Section (b)(3)(ii)(B). Installment-payment election available at investor level for pass-through entity owners, even those that are not themselves U.S. Shareholders. Prop. Reg. Section (b)(1). 10

12 Net Investment Income Tax The 3.8% NII tax imposed on individuals under section 1411 and the excise tax imposed on foundations under section 4940 apply to amounts included in income under section 965(a). A section 965(c) deduction is not treated as a deduction properly allocable to the section 965(a) inclusion for purposes of the NII tax or as an ordinary and necessary expense for purposes of the excise tax. Prop. Reg. Section (f)(3) & (4). In the Preamble to the Proposed Regulations, the Treasury and the IRS also clarify that subpart F income (including section 965(a) inclusions) are not subject to the NII tax unless a Treas. Reg. section (g) election is made. If an election is made, NII tax on the section 965(a) amount is due in full on the original due date of the 2017 income tax return. Thus, there is no installment payment option akin to the section 965(h) election with respect to the NII tax due on section 965(a) inclusions. The -10g election is irrevocable; so if made in prior years, the amount is due in full on the 2017 return Absent the election, the NII tax can be deferred on a section 965(a) inclusion until receipt of the related PTI 11

13 AMT and Miscellaneous Itemized Deductions Prop. Reg. section (f) clarifies that the section 965(c) deduction: Is NOT a miscellaneous itemized deduction subject to the 2% floor in Will NOT be disallowed for AMT purposes. Is NOT subject to the deduction disallowance under section 67, as modified by the TCJA, in the case of taxable years beginning after December 31,

14 PITFALLS FOR INDIVIDUALS UNDER INTERNATIONAL REFORM

15 TRANSITION TAX

16 Transition Tax Liability Inclusions under section 965(a) were to be reported on and paid with the taxpayer s 2017 return for calendar year taxpayers. Individual shareholders may not have had the information necessary to determine a DFIC s post E&P or cash position for purposes of calculating their section 965(a) inclusion, particularly if they are minority investors in pass-through entities Investors typically receive K-1s after April Moreover, the Proposed Regulations did not adopt commenters requests that shareholders be allowed to use alternative methods to determine E&P and cash positions, noting that similar challenges exist for shareholders making E&P determinations with respect to QEF elections or subpart F inclusions. See Notice of Proposed Rulemaking, Fed. Reg. Vol. 83, No. 154 p The expanded definition of a U.S. Shareholder under the TCJA (resulting in particular from the repeal of section 958(b)(4)) created CFCs of many foreign corporations that were previously not CFCs with a retroactive effective date. This change resulted in a transition tax liability for these new U.S. Shareholders, who likely would not have been receiving relevant information previously. Well-advised individuals contributed CFC stock into S corporations prior to 2018 to be able to defer their transition tax liability under favorable deferral rules for S corporations. It is possible that these CFC stock contributions might be invalidated under section 269 or under the regulatory authority granted under section 965(o) or might lack business purpose for purposes of section

17 Overpayment of Estimated Taxes -- Basic Example Colleen made a total of $310,000 in estimated and extension tax payments for the 2017 tax year. Her 2017 net income tax liability determined without regard to section 965 is $250,000, her total tax liability under section 965 is $75,000, and she made a section 965(h) election to pay this tax liability in installments. How much of her 2017 tax payments may she apply to the 2018 tax year? A. $60,000 provided she made a separate payment of the first section 965 installment (8% of $75,000 = $6,000). B. $54,000, assuming no separate payment of the first section 965 installment. C. Either A or B could be true. D. $-0-. $60,000 would go towards her section 965 liability, notwithstanding her section 965(h) election. If a taxpayer overpays with respect to its 2017 net income tax liability (without regard to transition tax liability) and the first annual installment payment of its transition tax payments pursuant to section 965(h) is due in 2018, it may not receive a refund of such overpayment or credit such amounts to its 2018 estimated tax payments until its full transition tax liability has been paid. See IRS, Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns, at Q&A14 (June 2018). See also section 6403 (no refund for taxes paid in installments for amounts paid in excess of installments until full amount of installment payments are made). However, the IRS will not assess a penalty on a taxpayer who previously elected to credit a 2017 overpayment to its 2018 estimated tax payment amounts. See IRS, Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns, at Q&A15 (June 2018). 16

18 Relief Provisions Individuals who failed to pay the first 2017 installment of their transition tax liability are not subject to additions to tax or accelerations of their transition tax liability under section 965(h)(3), provided that: Such individual s net tax liability under section 965 in the 2017 taxable year is less than $1 million; Such individual made a timely election under section 965(h); and Such individual pays the full amount of the first installment (and its second installment) by the due date for its 2018 return (determined without regard to extensions). See IRS, Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns, at Q&A16 (June 2018). Individuals who underpaid on their first installment payment are also granted relief. Section 965(h)(4) provides that any underpayment will be prorated among future installment payments. There is no acceleration of future payments as a result of an underpayment. See Prop. Reg. section (b)(1)(ii). No penalties are assessed for underpayments. See Prop. Reg. section (b)(1)(ii). Relief inapplicable to underpayments due to negligence, intentional disregard of the rules and regulations or fraud. See Prop. Reg. section (b)(1)(ii). 17

19 Ownership Through Multiple Funds by Sophisticated Investor What are the possible consequences for this taxpayer? Colleen receives around 75 Schedules K-1, related to her hedge fund and private equity investments. She has received Schedules K-1 from her smaller investments and basic estimates only from the larger funds. She has not received any information related to section 965. Colleen is paid in safe for her federal income tax estimate. She makes one payment at 4/17/18 based on the information received to date regarding her 2017 income tax liability. Because of the uncertainty around the potential for a transition tax liability, her extension payment includes $50,000 of extra cushion. Transition tax (section 965) liability Increase in income tax due to section 958(b) attribution rule (for example, increased subpart F inclusion) Section 6651(a)(2) penalty for failure to pay tax due Statutory interest Section 6654 estimated underpayment penalty related to transition tax liability Section 6654 estimated underpayment penalty related to increased subpart F income inclusion as a result of 2017 Tax Act (for 2017 tax year) Ability to make section 965(h) election to pay transition tax in installments over 8 years Acceleration of section 965(h) installment payments Inability to make section 965(i) election (with respect to Schedule K-1 from S corporation where S corporation is a US shareholder) Inability to make section 962 election 18

20 SECTION 962 ELECTION

21 Section 962 Example without FTC Individual, A, subject to tax at 39.6%, owns 100% of CFC stock. A has an inclusion before foreign taxes and aggregate foreign cash position of $100. CFC has no FTCs available. A is entitled to a section 965(c) deduction in the same amount as a corporate U.S. Shareholder ($55.71), resulting in an income inclusion of $ No Section 962 Election A has $44.29 of income taxed at a 39.6% rate, which results in a U.S. federal income tax liability of $ Entirety of any future distribution is excluded from income as PTI under section 965. Entirety of future distribution is subject to 3.8% NII tax, absent a -10(g) election. Applicable percentage of foreign withholding taxes imposed on such future distributions of the PTI (typically 15% withholding rates under treaties) are an additional cost. Section 962 Election A has $44.29 of income taxed at a 35% rate, which results in a U.S. federal income tax liability of $ Portion of any future distribution included in income because section 965 PTI is excluded from income only to the extent of tax paid. $100 - $15.50 = $84.50 inclusion upon distribution Tax liability of $16.90 on distribution (assuming QDI) or $ (if QDI unavailable) Entirety of future distribution is subject to 3.8% NII tax, absent a -10(g) election. It appears that the applicable percentage of any foreign withholding taxes imposed on any future distributions of the taxable PTI may not be claimed as FTC against this incremental liability. 20

22 Section 962 Example with FTCs Facts are the same as the prior example except that a CFC has FTCs available. $10 of FTCs Available $35 of FTCs Available A has $44.29 of income taxed at a 35% rate, which results in a tentative U.S. federal income tax liability of $ FTC is allowed with haircut total tax liability of $ ($15.50-$4.43). Portion of any future distribution included in income because section 965 PTI is excluded from income only to the extent of tax paid. $100 - $ = $ inclusion upon distribution Tax liability of $17.79 on distribution (assuming QDI) or $ (if QDI unavailable) It appears that the applicable percentage of any foreign withholding taxes imposed on any future distributions of the taxable PTI may not be claimed as FTC against this incremental liability. A has $44.29 of income taxed at a 35% rate, which results in a tentative U.S. federal income tax liability of $ FTC is allowed with haircut total tax liability of $0 ($15.50-$15.50). Portion of any future distribution included in income because section 965 PTI is excluded from income only to the extent of tax paid. $100 - $0 = $100 inclusion upon distribution Tax liability of $20.00 on distribution (assuming QDI) or $39.60 (if QDI unavailable) It appears that the applicable percentage of any foreign withholding taxes imposed on any future distributions of the taxable PTI may not be claimed as FTC against this incremental liability. Examples demonstrate that, absent substantial FTCs, individuals should not elect. With substantial FTCs, electing individuals could potentially benefit from election with substantial deferral of distributions. Although the $44.29 is taxed at a slightly higher rate, with the small differential between corporate and individual rates, not electing under section 962 and treating entirety of future distributions as PTI results in a lower tax liability in the long-term. 21

23 SPECIFIC ISSUES ARISING UNDER THE GILTI PROVISIONS

24 How are Individuals Different under GILTI? Absent a Section 962 election: Individuals aren t entitled to section 960 FTCs Individuals aren t entitled to the Section 250 deduction Individuals aren t entitled to the Section 245A 100% DRD Individuals are subject to the section 1411 NII tax Individuals are subject to tax at ordinary income rates 23

25 GILTI Example CFC has $100 in profits before taxes, $80 of tested income, $10 of NDTIR and $20 in foreign taxes. U.S. Corp Owns CFC U.S. Corp has: $70 GILTI inclusion amount $20 Section 78 inclusion $45 Section 250 deduction $16 of FTCs Assuming no section 904 limitation on FTC utilization, U.S. Corp has: $45 of income taxed at a 21% rate $9.45 tentative tax with respect to GILTI basket $0 total tax with respect to GILTI basket When CFC later distributes $80: $70 is treated as a tax-free distribution of PTI $10 is eligible for a 100% DRD under Section 245A Effective tax rate of CFC income is 20%, which is consistent with legislative history that at foreign tax rates greater than or equal to %, there is no residual U.S. tax owed on GILTI Individual Owns CFC U.S. Individual has: $70 GILTI inclusion amount taxed at a 37% rate As a result, U.S. individual has: $25.9 total tax with respect to GILTI basket When CFC later distributes $80: $70 is treated as a tax-free distribution of PTI $10 is a dividend taxable at either 20% (if QDI) or 37% All $80 is treated as net investment income taxable at 3.8%, assuming no election under Treas. Reg. Section (g) Effective tax rate of CFC income is 50.94% (if QDI) or 52.64% 24

26 Section 962 and GILTI As noted above, an individual can make a Section 962 election to be taxed for certain purposes as a corporation with respect to Section 951 inclusions. GILTI inclusions are treated as Section 951 inclusions for these purposes and, accordingly, electing Section 962 shareholders: Are taxed on GILTI income at the 21% corporate rate Are entitled to FTCs under Section 960, as if they were corporations Section 951A(f)(1)(A) contains a list of provisions under which a GILTI inclusions will be treated in the same manner as a Section 951 inclusion However, considerable uncertainty remains with respect to the effect of a Section 962 election on other aspects of the GILTI regime Is an electing Section 962 shareholder entitled to a Section 250 deduction? How does an electing Section 962 shareholder calculate its Section 904 limitation? What rate applies to the taxable portion of a distribution under Section 962(d)? Does a Section 962 election have any effect of taxation under AMT? Does a Section 962 election have any effect of taxation under the Section 1411 net investment income tax? Recently released proposed GILTI regulations do not address the application of Section 250 and Section 960 to GILTI inclusions 25

27 Section 962 and Section 250 Should electing Section 962 shareholders be permitted to claim a deduction under Section 250? Under the Section 962 regulations, an electing U.S. shareholder s section 11 taxable income may not be reduced by any deductions of the U.S. shareholder However, the section 250 deduction is a corporate deduction rather than a deduction of the electing individual Section 962(a) provides that the tax imposed on Section 951 and GILTI inclusion shall be an amount equal to the tax which would be imposed under section 11 if such amounts were received by a domestic corporation Is this amount of tax 21% of the inclusion? Or 10.5% of the inclusion? Allowing electing Section 962 shareholders to claim a deduction under Section 250 appears consistent with the legislative policies The legislative history to section 962 supports that the election was intended to provide individuals with an equivalent tax burden as if such individual had invested in an American corporation doing business abroad Although section 960 is only available to domestic corporations, section 962 explicitly clarifies that an electing individual may apply section 960 as if the amounts were received by a domestic corporation similar logic should apply in the case of the section 250 deduction Congress envisioned the GILTI regime as imposing a 10.5% effective rate of tax on GILTI income that is subject to an overall rate of foreign tax of %; this is achieved through the use of both the deemed-paid foreign tax credits and the section 250 deduction Allowing electing Section 962 shareholders to claim a Section 250 deduction is consistent with the approach taken with respect to Section 965(c) deductions under transition tax in both cases, Congress chose to use a deduction as a mechanism to reach a targeted effective tax rate 26

28 Section 962 and Section 904 Regulations under Section 962 make clear that the Section 904 limitation is separately calculated with respect to income subject to corporate rates and applied to associated Section 960 FTCs, and calculated with respect to all other income and applied to all other FTCs 27

29 Section 962 and QDI In general, a distribution to an individual is QDI, and thus subject to 20% capital gains rates if it is paid by: a domestic corporation, a corporation formed in a US possession, a foreign corporation that is eligible for the benefits of a tax treaty with the US (and that meets certain other requirements) or a foreign corporation whose stock is traded on a US securities market What rate should apply to a distribution of taxable section 962 E&P or taxable section 959(c)(3) E&P? As noted above, the legislative history to section 962 indicates that the election was intended to provide individuals with an equivalent tax burden as if such individual had invested in an American corporation doing business abroad. If an individual actually held stock of a CFC through a domestic corporation, dividends up the chain would always be QDI regardless of the residency of the CFC Barry M. Smith v. Comm r, 151 T.C. No. 5, concludes that a Section 962 election does not cause a distribution from an otherwise non-qualifying corporation to be QDI The court notes that Section 962 does not create hypothetical corporations or change realworld facts and that there is nothing in the statutory text to suggest that Congress intended this counterfactual hypothesis to apply for any other purpose under the Code other than determining the applicable rate and availability of foreign tax credits. 28

30 Section 962 and AMT Assume an electing Section 962 shareholder generated the following amounts in 2016: $10 of Subpart F income $90 of other income $40 of Section 57 AMT preference items FSA and FSA (Aug. 16, 2002) conclude that: The shareholder pays the sum of (i) the greater of the regular corporate income tax and the corporate AMT on the Subpart F income, plus (ii) the greater of the regular individual income tax on the individual AMT on the other income increased by the AMT preference items The shareholder does not pay the greater of (i) the sum of the regular corporate income tax on the Subpart F income and the regular individual income tax on the other income increased by the AMT preference items, and (ii) the sum of the corporate AMT on the Subpart F income and the individual AMT on the other income increased by the AMT preference items The shareholder is entitled to a credit in future years for any corporate AMT paid as a result of Section 962 Under this approach, electing Section 962 shareholders should not be subject to AMT on Section 951 (or GILTI) inclusions post-tax reform 29

31 Section 962 and Section 1411 Under the recently released proposed GILTI regulations a GILTI inclusion amount is treated in the same manner as a Section 951 inclusion for purposes of applying section As a result: An individual US shareholder would generally be taxed under Section 1411 on foreign earnings when distributed An individual US shareholder that has made an election pursuant to Treas. Reg. Section (g) would be taxed under Section 1411 on foreign earnings when included in income under Section 951 or GILTI) and would be entitled to make corresponding Section 961 adjustments to the basis of the stock of the CFC Section 962 only applies to the tax imposed under Chapter 1 of the Code (i.e., Sections 1 and 55) and not to Section 1411, which is contained in Chapter 2A Accordingly, a Section 962 election should have no effect on an individual s Section 1411 tax liability if it doesn t make a Treas. Reg. Section (g) election How is taxable section 962 E&P distributed to an electing Section 962 shareholder that make a Treas. Reg. Section (g) election treated? 30

32 GILTI Example (Revisited) Section 962 Election CFC has $100 in profits before taxes, $80 of tested income, $10 of NDTIR and $20 in foreign taxes. Individual Owns CFC Individual Elects Section 962 U.S. Individual has: $70 GILTI inclusion amount taxed at a 37% rate As a result, U.S. individual has: $25.9 total tax with respect to GILTI basket When CFC later distributes $80: $70 is treated as a tax-free distribution of PTI $10 is a dividend taxable at either 20% (if QDI) or 37% All $80 is treated as net investment income taxable at 3.8%, assuming no election under Treas. Reg. Section (g) U.S. Individual has: $70 GILTI inclusion amount $20 Section 78 inclusion $45 Section 250 deduction? $16 of FTCs Assuming no Section 904 limitation on FTC utilization and no Section 250 deduction, U.S. Corp has: $90 of income taxed at a 21% rate $18.90 tentative tax with respect to GILTI basket $2.90 total tax with respect to GILTI basket When CFC later distributes $80: $2.9 is treated as a tax-free distribution of excludable section 962 E&P $67.1 is treated as a distribution of taxable Section 962 E&P $10 is treated as a distribution of taxable Section 959(c)(3) E&P All $80 is treated as net investment income taxable at 3.8%, assuming no election under Treas. Reg. Section (g) Effective tax rate of CFC income is 50.94% (if QDI) or 52.64% Effective tax rate of CFC income is 41.36% (if QDI) or % 31

33 GILTI Example (Revisited) Interposing a U.S. Corporation CFC has $100 in profits before taxes, $80 of tested income, $10 of NDTIR and $20 in foreign taxes. Individual Owns CFC U.S. Individual has: $70 GILTI inclusion amount taxed at a 37% rate As a result, U.S. individual has: $25.9 total tax with respect to GILTI basket When CFC later distributes $80: $70 is treated as a tax-free distribution of PTI $10 is a dividend taxable at either 20% (if QDI) or 37% All $80 is treated as net investment income taxable at 3.8%, assuming no election under Treas. Reg. Section (g) Effective tax rate of CFC income is 50.94% (if QDI) or 52.64% Interposing a U.S. Corporation U.S. Corp has: $70 GILTI inclusion amount $20 Section 78 inclusion $45 Section 250 deduction $16 of FTCs Assuming no section 904 limitation on FTC utilization, U.S. Corp has: $45 of income taxed at a 21% rate $9.45 tentative tax with respect to GILTI basket $0 total tax with respect to GILTI basket When CFC later distributes $80 to U.S. Corp: $70 is treated as a tax-free distribution of PTI $10 is eligible for a 100% DRD under Section 245A When U.S. Corp later distributes $80 to U.S. Individual: $80 is a dividend taxable at 20% All $80 is treated as net investment income taxable at 3.8% Effective tax rate of CFC income is 39.04% 32

34 Interposing a U.S. Corporation Considerations Section 269 Section 351 business purpose Section 951A(d)(4) anti-abuse provisions Personal holding company rules Accumulated earnings tax Risk of change of law / tax rates 33

35 Converting U.S. Tax Classification of CFC Considerations Although pass-through form may provide a lower tax rate (and more certainty) for U.S. individual shareholders, it may result in a higher tax rate for other U.S. corporate shareholders Converting an existing CFC into a pass-through entity will generally result in both corporate-level and shareholder-level gain 34

36 ISSUES RELATING TO ATTRIBUTION, PASS- THROUGH ENTITIES AND CFCS

37 GILTI and Pass-Through Entities Under its most harmonious approach, the proposed GILTI regulations treats a U.S. partnership as an entity with respect to partners that are not U.S. shareholders of any CFC owned by the partnership, but treats the partnership as an aggregate for purposes of partners that are themselves U.S. shareholders with respect to one or more CFCs owned by the partnership. As noted above, a partner are ineligible to make a section 962 election if it is not itself a U.S. Shareholder of the CFC 15% USI 5% USP1 USP2 CFC A CFC B CFC C CFC D Tested income (loss) $100 ($100) $200 ($100) USI has a $85 net tested loss ($15 of tested income from CFC A, reduced by $100 of tested loss from CFC B Separately, USP2 has $100 of GILTI income, of which $5 is allocated to USI USI cannot use the excess tested loss from CFC B to offset the net tested income from USP2 If USI makes a section 962 election, it will apply with respect to CFC A&B, but not CFC C&D 36

38 Transition Tax: Attribution, Pass-Through Entities and CFCs If a taxpayer is a partner or owner in a partnership or other pass-through entity that is a 10% shareholder of a CFC: Required income inclusion is net of the section 965(c) deduction. Partner ineligible for section 962 election if it is not itself a U.S. Shareholder of the CFC. No downward attribution of partner-owned stock to the partnership if partner owns less than 5% of the partnership. Prop. Reg. section (f)(45)(ii). Transition tax is not imposed on persons that are U.S. Shareholders with respect to a DFIC if such DFIC is only considered to be a DFIC because of constructive ownership of stock under section 318(a)(3). Notice , IRB 341, section Section 965 DOES NOT APPLY Section 965 DOES APPLY 50% USP < 5% cap/profits interest 50% USP 5% cap/profits interest US Corp US Pship >10% US Corp US Pship >10% ForCo ForCo 37

39 Impact on Ability to Make Section 962 Election USP US 1 DFIC 100% 10% interest US Pship is a US Shareholder of DFIC US 1 is a US Shareholder of DFIC as it directly owns 100% of the DFIC stock (which is a CFC in this example) USP is also a US Shareholder of DFIC as it constructively owns 10% or greater of the DFIC The Proposed Regs clarify that USP is permitted to make a section 962 election with respect to the section 965 inclusion (i.e., can calculate the liability using section 11 (corporate) tax rates). Proposed Regs also confirm that the section 965(c) deduction is available to reduce section 965(a) inclusion in calculating the section 11 tax USP 10% interest US 1 is a US Shareholder of DFIC as it directly owns 100% of the DFIC stock (which is a CFC this example) US 1 100% US Pship is a US Shareholder of DFIC USP is NOT a US Shareholder of DFIC as it constructively owns less than 10% of the DFIC USP is NOT permitted to make a section 962 election with respect to the section 965 inclusion DFIC 38

40 Ownership Through Trusts and Tiered Partnerships Beneficiary USP US Trust DFIC Distribution - $60 Net inclusion - $100 Beneficiary treated as a domestic pass-through entity (DPE) owner USP is to be treated as a US Shareholder of the DFIC; as such is entitled to benefits of specified elections Election to pay transition tax in installments is available to USP Proposed Regulations clarify that: US Trust (a regarded complex trust) pays transition tax on $40; Beneficiary pays on $60 USP US 2 US 1 DFIC USP is not a US Shareholder of DFIC 10% interest US Pship is a US Shareholder of DFIC US 1 is a US Shareholder of DFIC and thus determines the section 965(a) and (c) amounts US 2 is not treated as a DPE owner and thus merely passes through relevant amounts to USP USP is a DPE owner and takes into account his/her share of the section 965(a) and (c ) amounts even though not a US Shareholder of DFIC and can elect to defer payment of the transition tax 39

41 Ownership Through S Corporations USP S Corp US 1 DFIC USP is not a US Shareholder of SFC 10% interest US Pship is a US Shareholder of SFC S Corp is a US Shareholder with respect to SFC As such, shareholders of S Corp (USP) can make a section 965(i) election to defer transition tax payment until there is a triggering event Proposed Regs provide that USP will be treated as a US Shareholder for purposes of determining the section 965 tax liability USP S Corp US 1 USP is not a US Shareholder of SFC 10% interest US Pship is a US Shareholder of SFC S Corp is NOT a US Shareholder with respect to SFC because it owns less than 10% of SFC constructively As such, shareholders of S Corp (USP) can NOT make a section 965(i) election to defer transition tax payment Notice 3.05(c) provides that USP will be treated as a US Shareholder for purposes of determining the section 965 tax liability DFIC 40

42 Ownership Through S Corporations (cont.) >50% USP S Corp Direct DFIC 10% interest US 1 Indirect DFIC S Corp is a US Shareholder with respect to Direct DFIC S Corp is NOT a US shareholder with respect to Indirect DFIC only US 1 is As such, shareholders of S Corp (USP): Can make a section 965(i) election with respect to the section 965 inclusion from Direct DFIC, but The section 965(i) election to defer transition tax payment does not cover the inclusion from Indirect DFIC (the amounts of which flow through US 1 partnership). USP can consider making a section 965(h) election with respect to Indirect DFIC s section 965 inclusion 41

43 COMPLIANCE CONSIDERATIONS

44 Compliance Considerations IRS will be creating or revising approximately 450 forms, instructions and publications in response to the TCJA, including: IRC 965 Transition Tax Statement and related instruction updates to Forms 1040, 1120s, 1065, 1041 and 990T. Updated instructions to Form Updated instructions to Forms 2210 and 2220 related to underpayment of estimated taxes. 43

45 M&A CONSIDERATIONS

46 M&A Considerations Due diligence S Corp acquisitions Information covenants Demands by shareholders to restructure U.S. or foreign operations to minimize problems resulting from downward attribution 45

47 This presentation and related panel discussion contains general information only and the respective speakers and their firms are not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. The respective speakers and their firms shall not be responsible for any loss sustained by any person who relies on this presentation.