The 962 Election – Untangling a GILTI Expat Intricacy

If you’re an expat business owner, the 962 election is one of several tax provisions you may need to wrap your head around. This is especially true if you earn GILTI, Global Intangible Low Taxed Income. 

As a reminder, in 2017, the US government introduced the Tax Cuts and Jobs Act (TCJA), which initiated GILTI. The GILTI provision stipulated that if you are a US shareholder of a controlled foreign corporation (CFC), the offshore profits you earn on intangible business assets are now subject to IRS taxation.

(Note: A foreign corporation is defined as one where US shareholders own more than 50% of the vote or value of a foreign company.)

The 962 election is a way in which US taxpayers can significantly reduce the taxes owed on income earned from intangible assets. In some cases, the 962 election may eliminate those taxes entirely.

Here’s what you need to know about the GILTI 962 election.

What is a 962 election? 

If you’re an expat who owns or is affiliated with a corporation registered in a low-tax jurisdiction, you may find the 962 election an appropriate tool to reduce your tax bill. 

In essence, making a 962 election means that a taxpayer’s portion of corporate profits will be taxed at the US corporate tax rate – but with a 50% deduction applied. This results in an effective corporate tax rate of 10.5%.¹

And besides slashing your effective tax rate by 50%, the 962 election also permits CFC shareholders to offset their tax liability with foreign tax credits that without the election they wouldn’t be eligible for.

This means a 962 election comes with two layers of benefits:

1. Reduction in the effective tax rate and 
2. A chance to offset your tax bill with the foreign tax credit.

On the flip side, if you’re an expat shareholder of a CFC and don’t make the 962 election, you will pay tax on the income you earn from intangible assets at your marginal personal federal income tax rate. This rate can be as high as 37%. However, this is exactly the type of tax a US expat tax professional can help you sidestep with ease.

Let’s look at a simple example to understand how taking a 962 election may yield substantial US tax benefits 

Assume Arthur is a US citizen and expat. He is the sole CFC shareholder in a corporation registered in the United Kingdom. 

Assume Arthur’s company earned $100,000 in intangible income (i.e., professional services fees for his digital marketing agency). And, the company paid $20,000 in British income tax.

If Arthur made a 962 election, this is what his US tax position would look like. 

Item	Amount
Intangible income from CFC	$100,000
50% exclusion	($50,000)
Taxable income	$50,000
Corporate tax rate of 21%	$10,500
Foreign tax credit (up to 80%)	($16,000)
Tax due to IRS	$0

Thanks to the 962 election, Arthur will not have to pay a dime to the IRS. 

Unfortunately, neglecting to make the 962 election would cost Arthur. In this case, he would pay tax at his marginal tax rate on his GILTI income of $100,000. Remember, without a 962 election, Arthur loses the 50% exclusion and the ability to take a foreign tax credit. 

Assuming his marginal tax rate is 37%, he will part with a massive $37,000.

Considerations before making a Section 962 election

The Section 962 election may allow certain US taxpayers to reduce their tax bill. However, each US taxpayer’s particular circumstances need to be considered before forging ahead. 

Below are several considerations you’ll need to consider before making a section 962 election. 

Whether the foreign corporation is qualified

A qualified foreign corporation is one that can claim the benefits of an income tax treaty with the United States.

If you receive a distribution in the form of dividends from a qualified corporation, your dividend will be designated as qualified. Because of this designation, you’ll pay a tax of only up to 20% of your dividend income.²

Conversely, dividends from a non-qualified foreign corporation attract a marginal federal income tax rate as high as 37%. 

Did the corporation pay foreign taxes?

In addition to receiving the 50% deduction on the intangible profits of their foreign company, by using the Section 962 election, taxpayers also are eligible to take the foreign tax credit for foreign corporate tax paid on their business profits.

So, bear in mind that if the corporation did not pay any foreign income tax, the benefit derived from a 962 election will either be eliminated or, at best, minimized.

Type of CFC earnings

You’ll need to remember that not all earnings will qualify as GILTI income. It has to be income earned abroad by CFCs and from intangible assets. 

Full spectrum CFC consideration

If you are a shareholder of several CFCs, you can’t make a 962 election on only one CFC. The 962 election applies to all your CFCs.

So, suppose one of your CFCs isn’t a qualified foreign corporation because it’s in a country without a tax treaty with the US. In that case, you’ll lose the preferential tax rates for subsequent dividend distributions.

Is the high tax election better for your circumstances

If your CFC’s intangible earnings are from a high-tax jurisdiction, your taxes can be uncomfortably high.

Although Congress created the GILTI tax with low-tax-income jurisdictions in mind, there is a GILTI high-tax election that may benefit CFCs in high-tax jurisdictions.

The GILTI high tax exemption allows a CFC to exclude its GILTI if that income was already taxed in a high tax locale such that with a foreign tax credit, little, if any, US income tax would be due. 

How to make a Section 962 election

To make a Section 962 election, you must attach a written statement when you file Form 8993 as part of your annual Form 1040. Taking the foreign tax credit as a result of the election will also require filing Form 1118.

There is no specific 962 form to complete beyond the written statement.

References

1. Corporate tax rate applied to GILTI
2. Capital gains tax on qualified dividends
3. How to make a 962 election on a 1040