International Tax Planning for Accessing Cash and Reducing US Tax in 2020

International Services | Fernando R. Lopez | Aug 10, 2020

Accessing Cash from CFC or non-CFC Foreign Subsidiary

If you have liquidity needs and own one or more foreign subsidiaries, it may be possible to access cash held by the CFC in a tax-efficient manner. The following are just three of the available methods:

  1. Distribute earnings that were previously taxed in the US as deemed dividends. These deemed dividends from foreign subsidiaries would have occurred under the following three provisions:
  • Section 965 deemed dividends (i.e. the 2017 “Transition Tax”)
  • Section 951A GILTI deemed dividends (applicable to tax years 2018 and forward)
  • Section 951 Subpart F Income
  1. Making a distribution that is treated as a tax-free return of capital. This is available for foreign corporations that are CFCs or non-CFCs.
  2. Direct or indirect loans to the US shareholders. This requires careful planning and documentation.

Prager Metis can assist you in determining if any methods are available to you and can assist with planning and implementation, including any required analysis or documentation.

  1. Accessing Cash Refund from a Prior Year or Reducing Taxable Income in the Current Year Using Worthless Stock Deduction

If you own distressed domestic or foreign companies, you may want to consider whether it makes sense to terminate the entity and benefit from the US worthless stock deduction, which permits a loss deduction of worthless stock equal to a shareholder’s basis in such stock. Worthlessness may be easier to establish in 2020 given the indefinite economic and business fallout caused by COVID-19.

In order to obtain a worthless stock deduction, shareholders (individuals or corporations) have to prove the following:

  1. They had basis in the stock. The amount of the deductible loss is limited to the taxpayer’s basis in the stock. The burden is on the shareholder to establish the basis.
  2. The stock became worthless in the same year the worthless stock deduction is being taken. If the stock became worthless in a prior year, the deduction should be taken by filing an amended return. Worthlessness is established by showing that liabilities exceed the fair market value of assets in the year of worthlessness. The applicable regulations require that worthlessness be evidenced by a closed and completed transaction, fixed by an identifiable event, and actually sustained during the taxable year. Examples of this include bankruptcy, liquidation of an insolvent corporation (actual or by check-the-box election) or termination of business activities. However, such events are not necessarily required if the business is completely insolvent (i.e., the fair market value of assets exceed liabilities). Although the determination of worthlessness can be subjective, it is generally upheld when there is no reasonable possibility that the investors will receive anything of value.
  3. The security was worthless in the year claimed. Since it may often be difficult to identify the appropriate year the deduction should be claimed, the regulations provided a seven-year limitation period (from the date the stock became worthless) for reporting a loss from worthless securities. Even if some of your companies became worthless up to seven years ago, you still have time to amend applicable tax returns to claim the loss. The Second Circuit has noted that the only safe practice is to claim a loss for the earliest year when it may possibly be allowed and to renew the claim in subsequent years if there is any reasonable chance of its being applicable to the income for those years.

Given the difficulties for businesses caused by the current pandemic, it is likely that the IRS will be more lenient than ever regarding worthless stock deductions.

III. NOL Carryback Impact on Foreign Tax Credits, Section 965 Transition Tax and GILTI

The CARES Act NOL carryback provision provides potential cash flow assistance for businesses as well as passthrough entities that incur NOLS in 2018, 2019, and 2020. Specifically, Congress made the following three relevant changes:

  1. Provided a five-year carryback for losses earned in 2018, 2019, or 2020, which allows firms to modify tax returns up to five years prior in order to offset taxable income from those tax years.
  2. Suspended the NOL limit of 80 percent of taxable income. This means that firms may deduct their NOLs to eliminate all of their taxable income in a given year, instead of having to carry forward any NOL beyond 80 percent of taxable income.
  3. Pass-through business owners may use NOLs to offset their non-business income above the previous limit of $25,000 (single) or $500,000 (married filing jointly) for 2018, 2019, and 2020.

Carrying Back to Pre-2017 Years

If NOLs are carried back to pre-2017 years, it will permit NOLs generated in 21% tax years to be carried back and used against income taxed at 35%. In addition, an NOL deduction claimed in a pre-2017 carryback year could increase FTC carryover from that year, which may be available in the Section 965 transition tax year (whether 2017 or 2018 for fiscal year clients), thus reducing your transition tax liability.

Carrying Back to 2017 Transition Tax Year

If you do carry back NOLs to 2017, the CARES Act provides that taxpayers are deemed to make the election under Section 965(n) with respect to the NOL carryback. The Section 965(n) election excludes NOLs from the determination of the transition tax liability. However, the carryback of an NOL to 2017 will create NOL which might have an indirect impact on other tax attributes in subsequent years to which the NOL is carried, such as freeing up foreign tax credits to be carried forward or creating an overall domestic loss carryforward.

It should be noted that if you made the election under Section 965(h) to pay the tax over eight years, any overpayment caused by a change in these tax attributes or by a reduction in regular tax liability as a result of the NOL carrybacks will be applied against any deferred transition tax liability and will not result in a refund under current IRS procedures.

Carrying Back to GILTI Years (2018 and forward)

Due to the way the Section 250(a)(2) limitation for GILTI and FDII income operates, a carry back to 2018 years and forward could potentially result in utilizing a 21% tax attribute (the NOL deduction) against GILTI and FDII income that may be subject to a lower rate of tax.

For taxpayers who did not make a section 962 election on GILTI, the NOL carryback is highly useful.

If you have questions on the above planning options, or any other cross border tax planning, or reporting issues, please contact Fernando Lopez, International Tax Director for Prager Metis CPAs at flopez@pragermetis.com.

2020-08-18T15:22:22-04:00