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The IRS Clarifies the Regulations for the High-Tax Exception to GILTI

The IRS Clarifies the Regulations for the High-Tax Exception to GILTI

By Anthony Diosdi

Global intangible low-taxed income (“GILTI”) is the excess of a U.S. shareholder’s net controlled foreign corporation (“CFC”) tested income for such taxable year over its net deemed tangible income return. Net CFC tested income is any excess of the U.S. shareholder’s pro rata share of the tested income of each CFC for which it is a U.S. shareholder over its pro rata share of each CFC’s tested loss. A U.S. shareholder’s net deemed tangible income return is 10 percent of the shareholder’s pro rata share of the CFC’s tax basis in tangible personal property used by its CFCs in the production of tested income (reduced by certain interest expense).

Congress presumably intended that GILTI apply only to income that is subject to a low tax rate of tax in the source country. Unfortunately, this is not the case. The mechanisms that were created to ensure this result are only applicable to U.S. shareholders that are domestic corporations. A domestic C corporation foreign source income is only taxed at a maximum marginal tax rate of 21 percent on GILTI inclusions. Domestic corporations are also eligible to make a Section 250 deduction equal to 50 percent of the GILTI inclusion. This deduction effectively reduces the current 21 percent federal corporate rate to 10.5 percent on a GILTI inclusion. Second, a domestic corporation may elect to use a foreign tax credit equal to 80 percent of the foreign taxes paid on GILTI income.

On the other hand, individuals that hold CFCs directly are taxed on GILTI inclusions at rates as high as 37 percent, plus Medicare tax of 3.8 percent may apply. The Section 250 deduction is also not available to individual U.S. shareholders of a CFC. Fortunately, in some cases, there are GILTI planning options for individuals that hold CFC shares directly. Recent proposed regulations (which have been finalized by the IRS and Department of Treasury) allows a CFC shareholder to make a high tax exception to GILTI inclusions. (This option is also available to corporate CFC shareholders).This exception applies to the extent that the net tested income from a CFC exceeds 90 percent of the U.S. federal corporate income tax rate. This means, if the CFC’s effective foreign tax rate exceeds 18.9 percent, a CFC shareholder can elect to make a high tax exception and defer the recognition of foreign income for purposes of GILTI. If the CFC is incorporated in a country that has entered into a bilateral tax treaty with the United States, the deferred foreign could qualify for reduced dividend rates. 

Any CFC shareholder wishing to claim a high tax exception for purposes of GILTI must properly make an election on its applicable U.S. tax return. Failure to timely make a high tax election could result in a denial of the election.


Determining if a CFC shareholder may qualify for a high tax exception is complicated.
If you are a CFC shareholder, chances are that you will have a GILTI income. CFC shareholders should consult with an attorney or tax professional well versed in international tax planning and compliance to determine if they may qualify for the high tax exception or other tax planning opportunities. We provide international compliance assistance and international tax planning services to domestic corporations. We also assist other tax professionals who need guidance regarding international tax compliance matters.

Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.