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Deductions for Foreign-Derived Intangible Income and GILTI: Final Regulations

Deductions for Foreign-Derived Intangible Income and GILTI: Final Regulations
Ines Zemelman, EA
15 December 2021

Individuals with ownership in foreign corporations are now able to benefit from tax exemptions intended for large, multinational corporations

The goal of GILTI tax created in the TCJA was to prevent U.S. corporations from abusively shifting profits from the US to low tax countries. To accomplish this, GILTI imposed tax on the US parent company for annual profits of its foreign subsidiaries.

Unfortunately, individual US owners of foreign small businesses were caught in the same net.  Until the final regulation was issued, only US companies with foreign subsidiaries could take 50% GILTI income deduction. A US individual owner of foreign company could not take the deduction - even after taking Sec 962 election to be treated as a U.S. corporation.

On July 15 2020, the Treasury issued Final Regulations that leveled the playing field. 

These regulations are effective on September 14, 2020.
Applicability date: tax year 2021.

Starting from tax year 2021, individual owners of foreign corporations taking Sec 962 election can deduct 50% of GILTI income before applying 80% foreign tax credit for tax paid by the corporation.

Jul 15, 2020: U.S. Treasury issued Final Regulations

Starting from tax year 2021, individual owners of foreign corporations taking Sec 962 election can deduct 50% of GILTI income before applying 80% foreign tax credit for tax paid by the corporation.

The final regulations are applicable for taxable years beginning on or after January 1, 2021.

Taxpayers may choose to apply the new rules to the earlier periods. To do so, they would have burdensome “substantiation requirements” for “establishing” facts necessary to secure the deduction.

However, the “substantiation requirements” have an exception for small businesses. The final regulations provide that substantiation requirements do not apply if the taxpayer and all related parties of the taxpayer, in the aggregate, receive less than $25,000,000 in gross receipts during the prior taxable year. 

How the tax on the GILTI form works

The tax on GILTI is not targeted directly at the income from specific intangible assets; rather, it operates as a form of minimum tax on the profits of some Controlled Foreign Corporations (CFCs). It requires a complex calculation that determines the portion of a CFC’s income that constitutes GILTI. GILTI generally equals the amount of the CFC’s total income in excess of a CFC’s net deemed tangible income return, which equals 10% of the CFC's investment in depreciable, tangible business assets minus certain interest expense.

This calculation effectively creates an exemption from U.S. corporate tax for a 10% return on the tangible investments of CFCs. CFC profits in excess of the exemption amount are presumed to be income from investments in intangible assets—i.e., more mobile assets—and are taxed as GILTI. As a result, the tax on GILTI is particularly significant for CFCs whose profits are high in relation to their investment in tangible, or fixed, assets, such as providing services, logistics, procurement, distribution, and technology and software. Special reduced foreign tax credit rules also apply with respect to GILTI.

General Implications

  • Final rules on the Section 250 deduction affect US CFC owners who make a Section 962 election.
  • The Section 250 deduction for GILTI is currently 50% of a taxpayer’s GILTI plus the related Section 78 gross-up. 
  • Taxpayers who made a Section 962 election on their 2018 and 2019 tax returns may apply the final regulations to those tax years.
  • US Shareholders making Section 962 elections must include Form 8993 (GILTI Form), “Section 250 Deduction for Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI),” with their returns on or before the due date for the individual income tax return (including extensions) for the year to which the Section 962 election IRS relates. The main purpose of 8993 form is to figure the amount of the eligible deduction for FDII and GILTI under section 250.

Prior year amendment possible to reduce or eliminate GILTI tax

Prior year returns for tax years starting in 2018 can be amended to take Sec 962 election with Sec 250 deduction. 

High-tax (over 18.9%) country residents can benefit greatly by filing amendments for prior years to exempt GILTI tax entirely through the use of Section 954(b)(4).

Ines Zemelman, EA
Founder of TFX