Proposal by @JoeBiden to increase the GILTI tax has particularly vicious implications for #Americansabroad

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Introduction

Taxation is what America is about and America is about taxation.

Perhaps it’s better to say that:

Politics is about taxation and taxation is about politics.

Once Upon A Time In America

The primary legislative achievement of President Trump’s first term was the 2017 TCJA. It’s important to note that the TCJA had it’s genesis in the work of Michigan Congressman Dave Camp and was the result of a long term project of reworking the US tax system. It is absolutely incorrect to suggest that the TCJA was developed by the Trump Administration. It should not be referred to as “Trump Tax Reform”. That said, because of the “politics” involved in enacting the TCJA, the Trump Administration and Republican Controlled Ways and Means Committee, did impact the legislation at the margins. (Rate of repatriation tax, etc.)

Like all tax legislation the TJCA had clear winners and clear losers.

The TCJA Winner(s)

At first blush it would appear that a reduction in the corporate tax rate from 35% to 21% made US corporations the clear winners. In addition, (at least initially) it appeared that the United States was moving to a territorial tax system for corporations. In simple terms, this means that US corporations would not pay US tax on profits earned by their foreign subsidiaries. In other words, a company could be the owner of a foreign corporation and no longer pay US tax on that company’s earnings, when those earnings were distributed back to the US owner as a dividend. This legislative change moved US corporations into a world where they were taxed in the same way as most of their competitors. But, Congress Giveth and Congress Taketh. In order to ensure that the foreign subsidiaries of US corporations were subject to a minimum tax, Congress enacted the Section 951A GILTI rules, which would impose an immediate US tax on the earnings of foreign subsidiaries. In order to understand how (in a general way) the GILTI rules work, see this analysis from Dr. Karen Alpert. In reality I suspect that history will record that the GILTI exception, may have “eaten the general rule of territorial taxation”, leaving the US with territorial taxation for corporations, only in theory. Or to describe the legislative sleight of hand more accurately:

When the United States moved to “Territorial Taxation”, what really happened was the United States expanded the territory over which it claimed tax jurisdiction.

In any event, it appears that on balance, US corporations were the winners in the 2017 TCJA.

The TCJA Losers

The clear losers of the 2017 Tax Reform were Americans abroad. Although, Ways And Means Chair Representative Brady acknowledged the possibility of mitigating citizenship-based taxation for Americans abroad, the result was a nightmare that has forced Americans Entrepreneurs abroad to renounce US citizenship. (The transition tax and GILTI provisions are expansions of the Subpart F regime (developed by the Kennedy administration), which was introduced in 1962. Interestingly, in 1964, Sir John Templeton, the pioneer of investing in foreign stocks, renounced his US citizenship. Although correlation is not proof of causation, it’s hard to believe that there was no connection between these two events.)

The 2017 TCJA established extraordinarily punishing provisions for Americans abroad who are the owners of small business corporations. The punishment resulted from (1) punishing “entrepreneur” Americans abroad for their past and (2) ensuring that their futures as business owners would be destroyed. (These provisions obviously do not apply to Homeland Americans with local small businesses.) Was this the legislative intention? Clearly not. But the accounting and legal professions interpret the rules. The accounting and legal professions are not (in general) comfortable with the idea of interpreting rules in accordance with legislative intent. Accountants and most lawyers interpreted these destructive provisions to apply to Americans abroad with small businesses in their country of residence.

To be specific the TCJA as applied to entrepreneur Americans abroad was about:

(1) Punishing Americans Abroad For Their Past: This is the Section 965 Transition Tax which imposed a 17.54% retroactive taxation on the earnings of the business from 1986 to 2017. Note that this tax was imposed without any distribution to the shareholders and virtually guaranteed double taxation for most Americans abroad with small businesses.

(2) Destroying The Future Prospects of Americans Abroad: This is the Section 951A GILTI Tax which basically ensures that profits earned inside the small business corporation are subject to immediate taxation to the individual shareholder without actual distribution.

The horror of the GILTI rules gradually became known to Americans abroad and their advisors. Surprisingly partial relief, for Americans abroad, came from US Treasury.

Significantly, Democratic Senators and the Biden campaign appear to be taking steps to roll back the relief given by Treasury.

The Two Decisions Made By Treasury That Protected Americans Abroad From The Brutal Horror Of GILTI

March 2019: The decision to make the Section 250 Deduction Available to Americans Abroad In The Context Of A Section 962 Election

Section 250 (more on this later) allows for corporations and only corporations to deduct 50% of income that qualifies as GILTI income from the calculation for determining the GILTI tax. The greater the income subject to taxation the greater the tax paid. Individual shareholders (think Americans abroad) were NOT given the benefit of the 50% deduction. This in combination with higher individual tax rates (37% vs. 21%) significantly exacerbated the GILTI nightmare.

How Treasury provided relief: Treasury interpreted the rules to mean that individual shareholders were entitled, in the context of a Section 962 election, to the same 50% deduction from income that corporations received. A full discussion of how this works is available here.

Biden’s tax plan could easily be interpreted to eliminate the 50% income deduction for corporations. This would effectively end the deduction for individuals too. Ending the 50% deduction would effectively end the March 2019 relief that Treasury made available to individuals.

June 2019: The decision to deem foreign income taxed by a foreign country at higher than 18.9% to NOT be GILTI income

This is just common sense. Obviously if the US corporate tax rate is 21% and the goal is to ensure that US CFCs (“Controlled Foreign Corporations”) pay a minimum tax, then they should not be required to pay a total tax (foreign and US) greater than 21%. This is particularly helpful to Americans abroad because it means that if the corporate tax rate in their country of residence exceeds 18.9%, then the earnings in their corporations would NOT be GILTI income. A full discussion of how this works is available here.

Significantly, Senators Wyden and Brown introduced a bill to repeal this Treasury interpretation of the law.

Joe Biden’s Plan To Raise The GILTI Tax To 21%: What Does It Mean For Americans Abroad?

Joe Biden’s proposals (as reported by Tax Foundation) include:

1. Raising the US corporate tax rate to 28%

2. Raising the GILTI tax rate to 21%

Individual American entrepreneurs with CFCs have born the brunt of the GILTI Tax. It’s clear that the United States never considers the effects of its tax policy on Americans abroad. Any worsening of the GILTI regime will make an intolerable tax regime even worse.

It’s difficult to know precisely what the Biden campaign means when it decrees that the GILTI rate should rise to 21% (the top rate of US taxation). Absent the companion proposal to raise corporate rates to 28%, the GILTI rate could move from 10.% percent to 21% (doubling) by simply removing the Section 250 50 percent discount. This would effectively reverse the March 2019 Treasury relief that ensured that Americans abroad (in the context of a Section 962 election) would not be treated worse than corporations.

In any case, regardless of the mechanics, the Biden proposal to make GILTI more punitive, will have a disproportionate impact on individual Americans abroad who run small businesses.

That’s the simple “FATCA Of The Matter!”

John Richardson – Follow me on Twitter @ExpatriationLaw

Appendix – For those and only those who wish to understand more about the Section 951A GILTI tax

What follows is a video series made between December 2018 and March 2019. It’s probably best to watch these in order. Please note that the understanding of the GILTI rules has been a gradual thing. It has been informed by time, experience and evolving IRS regulations. Therefore, although the videos will help you understand the general theory of the GILTI rules, they should NOT be used as a substitute for good professional advice!

Discussion 1 – 3: December 2018

Discussion 4 – 5: March 2019

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