Should you opt out of GILTI?
The IRS released two sets of rules on July 20, 2020. These rules allow taxpayers to opt out of the global intangible low-taxed income tax (GILTI) known as the high-tax exclusion election.
The tax is relevant to U.S. companies that own more than 50% of a foreign corporation, known as controlled foreign companies (CFCs), and individual shareholders who own more than 10% of any stock in that corporation.
GILTI is focused on income earned from “intangible assets” such as copyrights, patents, licenses, trademarks and other intellectual property (IP).
The type of income to be excluded from GILTI is the specific income of the CFC in which the foreign tax paid or accrued is greater than 90% of the U.S. corporate rate, currently at 21%, which comes to 18.9%.
The determination of high-taxed income is made on an effective tax rate basis. This determination does not consider foreign net operating losses (NOLs) or the country’s statutory corporate tax rate. It is, however, strongly recommended to obtain the relevant local country tax returns to document the tax liability and income reported.
The election is made on a yearly basis and, if made, is in effect for all CFCs of the taxpayer. If the CFC qualifies, per the above calculation, then the election applies. In other words, the taxpayer can’t pick and choose which CFC the election applies to.
The election is made by the U.S. shareholder on their U.S. income tax return on an annual basis and on a tested-unit basis, a new concept introduced by the regulations pertinent to the GILTI high-tax exclusion. A tested unit is defined as a CFC, a hybrid entity owned by the CFC or a foreign branch of the CFC by country or foreign jurisdiction.
Further, the election is made by the controlling domestic shareholder of the CFC. The controlling domestic shareholders of a CFC generally are the U.S. shareholders who, in the aggregate, directly or indirectly (but not constructively) own more than 50% of the CFC’s total combined voting power.
Notice requirements
The final regulations also clarify that the controlling domestic shareholders must provide notice of elections (or revocations) as required by Regulation Section 1.964-1(c)(3)(iii) to each U.S. shareholder who is not a controlling domestic shareholder. For pass-through entities, this notification is done via Schedule K-3.
The election is not mandatory and can be made on an amended tax return. For the election to be made on an amended return, there are additional requirements related to the U.S. shareholders and the need to amend their returns and pay any related tax, if applicable.
The election itself is made by attaching a statement to a timely filed income tax return, including extensions.
High-tax election considerations
Some items to consider with regard to the high-tax election include:
- The high-tax election typically results in undistributed earnings and profits at the CFC level. If tax rates increase in the future, when the foreign earnings are repatriated, the tax cost could be higher than if not making the election.
- Have other tax attributes been considered? U.S. net operating losses, CFC stock basis, foreign tax credits and foreign source income allocations are some examples of attributes that could be impacted by the election.
- Has the impact of the election been modeled out? As an example, there may be substantial qualified business asset investment (QBAI) that reduces the required GILTI inclusion absent the election or domestic NOLs that are expiring may be able to be applied under one scenario but not the other.
- Have future distributions been considered? For instance, if there are planned distributions, is it better to distribute the earnings from previously taxed earnings and profits (PTEP) accounts first? PTEP would be available in the absence of the high-tax exclusion election before a distribution dipping into the untaxed earnings, which requires section 245A analysis.
How Wipfli can help
Wipfli specialists can help you analyze your tax liability and risk — and are ready to help you with the decision-making over opting out of GILTI. We understand the complex tax implications for multinational taxpayers operating in the US and around the globe — and our deep experience and knowledge can help support your plans for growth.
