Structuring Ownership of CFCS to Reduce Tax of US Individual Shareholders
Prior to 2017 U.S. Tax Cuts & Jobs Act (“TCJA” or “Tax Reform”), the active income of controlled foreign corporations (“CFCs”” was generally not taxable to US shareholders until it was distributed as a dividend. Following Tax Reform, the active income of CFCs is generally classified as Global Intangible Low Taxed Income (“GILTI”) and is subject to current tax at the US shareholder level as a deemed dividend whether the income is distributed or not. The rate of US tax on the deemed dividend varies depending on whether the US shareholder is an individual (including a passthrough entity held by individuals) or a corporation.
A foreign corporation is a CFC if it is owned over 50% control by “U.S. Shareholders.” US Shareholders are US individuals or entities that own at least 10% of a foreign corporation.
GILTI = “Global Intangible Low Taxed Income”, which is generally active income of a CFC in excess of a fixed 10% return on tangible, depreciable assets of the foreign corporation. Per 2017 U.S. Tax Reform, a CFC’s GILTI income is immediately includible in U.S. shareholder’s gross income as a deemed dividend.
U.S. Tax Consequences
U.S. corporations are taxed on the GILTI deemed dividend at an effective rate of 10.5% tax after applying a 50% deduction on the deemed dividend. The deemed dividend may also be offset by up to 80% of FTCs.
In general, US individuals who own controlled foreign corporations directly or via U.S. passthrough entities (e.g., LLCs, partnerships or S corps) may be paying rates as high as 40.8% on GILTI deemed dividends.
Outcome and Benefit
Prager Metis has advised numerous individual clients that own CFCs directly or via U.S. passthrough entities on various structuring options for aligning the existing cross border ownership structure with the CFC GILTI regime in order to reduce the effective rate on CFC income from a federal rate as high as 40.8% (i.e., individual rate of 37% plus the 3.8% net investment tax. to 28%.