When Congress passed the Tax Cuts and Jobs Act (TCJA) in 2017, a new tax was added on income earned by foreign affiliates of U.S. taxpayers from intangible assets, known as global intangible low-taxed income (GILTI). Under the TCJA, GILTI is calculated as the total active income earned by a U.S. taxpayer’s foreign affiliates, that exceeds 10 percent of the basis in the foreign affiliate’s depreciable tangible property. Under the current tax rules, an eligible U.S. C corporation that is a shareholder of a controlled foreign corporation may claim a deduction of 50% of GILTI inclusion to reduce the effective tax rate on GILTI from 21% down to 10.5%. After tax year 2025, the 50% deduction will be reduced to 37.5%, which will raise the effective tax rate to 13.125%, up from 10.5%. A U.S. individual taxpayer of a controlled foreign corporation is not eligible to take any GILTI inclusion deductions.
For example, company A is a U.S. C corporation, which is the 100% shareholder of a foreign company B. For tax year 2019, company B’s basis in depreciable tangible assets is $500, and the foreign net income is $100. Company A should report total GILTI of $50 (total foreign net income $100 minus 10 percent of $500 of depreciable tangible assets) and claim a deduction of $25 (50% of GILTI). If a U.S. taxpayer has GILTI from several foreign affiliates, total GILTI is calculated on a combined basis. In other words, net losses from a controlled foreign corporation can be used to offset other controlled foreign corporations’ net income. For instance, company A is a U.S. C corporation, which is the 100% shareholder of foreign companies B and C. For tax year 2019, company B has net income of $100, and company C has a net loss of $200, resulting in a net GILTI loss of -$100. In this case, company A does not need to include any GILTI in its gross income.
President-elect Biden proposed several key changes to the current tax laws related to GILTI. First, the proposals will increase the minimum tax on GILTI to 21% up from 10.5%, by eliminating the 50% deduction of GILTI inclusion. Secondly, the proposals will eliminate the 10% exemption for return on the depreciable tangible assets. For example, company A is a U.S. C corporation, which is the 100% shareholder of a foreign company B. For tax year 2021, company B’s basis in depreciable tangible assets is $500, and the foreign net income is $100. Under the TCJA, company A’s net GILTI inclusion is $25, while the amount would be increased to $100 under the Biden tax proposals. Furthermore, U.S. taxpayers are required to calculate GILTI on a country-by-country basis under Biden tax proposals instead of a worldwide basis under the TCJA. For instance, company A is a U.S. C corporation, which is the 100% shareholder of foreign companies B and C, which are located in two different countries. For tax year 2021, company B has net income of $100, and company C has a net loss of $200. Under the TCJA, net income from company B can be offset by the net loss from company C. Under the Biden tax proposals, company A needs to include GILTI of $100 from company B.
Even though Biden’s tax proposals call for higher taxes and unfavorable tax treatments for GILTI, there are significant incentives for proactive tax planning. The key tax planning area under the Biden tax proposals is the allocation of income among foreign affiliates in different countries. Within the scope of the applicable laws, U.S. taxpayers could shift net losses from foreign affiliates in one country to other foreign affiliates’ that have profits in different countries to minimize GILTI inclusion.
Another tax planning opportunity is to take the tax incentive for investing in the U.S.
In the last few decades, a large number of U.S. multinationals expanded their business internationally mainly because of cost saving purposes. Biden’s tax proposals for GILTI will significantly increase U.S. taxpayers’ cost of doing business overseas. On the other hand, if U.S. multinationals can bring production or service jobs back to the U.S. and create more domestic jobs, they may be eligible to take a proposed 10% “Made in America” tax credit under Biden’s proposals.