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Do Individuals Invested in Foreign Business Wish to be Taxed as Corporations?

Owning a profitable business? Everyone would agree that sounds nice. Owning a profitable foreign business?  Still nice, just a tad more complicated.

With a few compliance seasons in our rear view mirror after the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA or “Tax Reform”), there is no better time for individuals to explore their options to create tax efficiencies.

Leaving the complex tax code definitions aside, a pressure point arose after Tax Reform with GILTI.  This new income inclusion arose for both individuals and US Corporations, yet US Corporations are afforded direct relief from the income inclusion through a 50% GILTI deduction and Foreign Tax Credits (FTC).  Not to mention the corporate tax rate of 21% compared to the highest individual tax rate of 37%.

What are individual taxpayers to do? 

When an individual makes a Section 962 election they are electing to be taxed as a corporation for purposes of Subpart F and GILTI inclusions. The benefit of this election is that it affords individuals the same 50% GILTI deduction and FTC that C corporations are allowed, as well as the corporate tax rate of 21% versus the 37% for individuals. Understandably, this election has become popular due to GILTI and Tax Reform.

A word of caution, however, is necessary as actual distributions that relate to a Section 962 election are taxed differently, and potentially double, as compared to similar earnings where a Section 962 election was not made. Consequently with a section 962 election it is imperative to consider the impact of the election over the life of the investment.

What steps can be taken as part of 2020 year-end planning?

  1. The facts drive the outcome, this includes an understanding of the foreign business operations, timing for potential distributions, and the overall client needs.
  2. Consider other relief such as the high tax exception
  3. Confirm prior year compliance
  4. Keep an eye out for the next article in this series, how do I get cash out of my foreign business in a tax effective manner?

Author: Saira Fida, CPA, sfida@withum.com

For more information or questions, please contact a member of the International Tax Team.

International Services Tax

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