Living abroad as a US expat can open you up to new opportunities – particularly when it comes to your career. Depending on your future goals, you may even decide to go into business for yourself. If you do, it’s important to understand how forming your own foreign corporation can impact your taxes, particularly with the addition of GILTI in the US Tax Cuts and Jobs Act (TCJA) of 2017.
GILTI stands for global intangible low-taxed income – and US expats who own a controlled foreign corporation (CFC) are directly impacted. This tax rule provides a distinct way to calculate a CFC’s earnings so that the company pays a certain minimum of US taxes each year.
Whether you’re a US expat who owns a foreign corporation or you’re considering starting one, here’s everything you need to know about GILTI and how it can increase your US tax bill.
What is a CFC?
Before we dive into GILTI, it’s important to understand what a controlled foreign corporation is, so you know if this tax regulation will affect your business. A CFC refers to a corporation registered outside the US, in which more than 50% of the corporation is owned or controlled by US citizens.
In other words, if you, an American expat, decide to form a corporation in Italy, where you’re living, and you’re the sole owner, then it’s classified as a CFC. That’s because you own 100% of the foreign corporation and you are a US citizen.
What’s GILTI tax and how does it impact your US taxes?
Most countries tax based on where you live. But the US taxes you based on your citizenship – meaning even if you live abroad, if you’re a US citizen, you’re on the hook for paying US taxes. GILTI is foreign income your CFC earns on intangible assets, such as patents, copyrights, and trademarks. You’re obligated to pay GILTI if you own at least 10% of a CFC, and if your company is a CFC (majority-owned or controlled by US taxpayers).
How much do you have to pay with GILTI? Well, it depends on your individual tax rate. The individual tax rates range from 0% to 37%.
Before 2017, offshore corporate profits were not taxed by the US. When GILTI was enacted, it significantly changed the US expat foreign business owners’ tax bills.
Does GILTI only apply to US expats?
US expats who own a foreign corporation (or more than 10% of a share of a CFC) and whose foreign business is profitable will most likely need to pay GILTI. But, US citizens who do not live abroad may also need to pay this tax if they participate in a foreign corporation and have a stake that is 10% or greater. GILTI does not only apply to individual taxpayers but also applies to US businesses who have an interest in foreign companies as well.
Why was GILTI passed?
The US passed GILTI as part of the TCJA in 2017, in order to discourage business owners from moving intangible asset profits from US corporations to foreign-controlled corporations. By taxing foreign corporations controlled by US citizens and expats, GILTI makes it more difficult for companies to shift profits to avoid taxation.
How do you calculate and file GILTI?
You’ll determine and report GILTI using IRS tax Form 8992. The calculation is a bit complicated, and we recommend working with a tax specialist, particularly when calculating and paying GILTI for the first time.
To figure out your GILTI tax, you have to first determine how much income your CFC earned in excess of your company’s determined tangible income. Subtracting the total income earned from the tangible income can help you find your intangible income or GILTI.
If your company’s profits are high in intangible income, for instance, you’ll pay more in GILTI. The highest tax rate you could pay for GILTI is 37% – the highest tax bracket currently in the US.
Are there tax breaks to reduce how much GILTI I owe?
While GILTI was an unwelcome surprise for many US expat business owners, there are ways to eliminate this tax altogether – or significantly reduce it.
Reduce your GILTI with a 962 Election
A Section 962 election is a method for reducing your GILTI. This allows US expats who own CFCs and are on the hook for GILTI to treat themselves as a US corporation rather than an individual taxpayer, reducing their corporate tax rate on foreign income by 50%, effectively lowering the GILTI tax to 10.5%.
In addition, they can use Section 962 to take advantage of foreign tax credits for their corporate taxes, which can help lower the amount they have to pay in GILTI. Unfortunately, individual taxpayers are not eligible to offset GILTI tax with foreign corporate tax paid, unless the Section 962 election is made.
Although paying 10.5% in GILTI is much better than paying an individual tax rate of up to 37%, there is a catch with Section 962. In the future, when you receive your foreign corporation’s profits as dividends, you and any other shareholders will have to pay taxes on them again – effectively leading to two layers of taxation. However, US expats who have to pay taxes on dividends can use US foreign tax credits to lower the amount due.
The exact credits and deductions you can use vary depending on your income level and other factors.
Pay Yourself a Salary to Limit GILTI
If you own a foreign corporation, paying yourself a salary can also help reduce the amount you’ll pay in GILTI. If you’re a freelancer, for example, who manages your business through a foreign corporation and you qualify for the FEIE (Foreign Earned Income Exclusion), this approach could work well.
You’ll want to make sure to pay yourself a salary that reduces GILTI to the amount of your standardized deduction, in order to reduce the amount you’ll owe. We recommend talking to a Bright!Tax CPA before attempting this approach. We can help you determine how much of a salary you should pay yourself and make sure you’re eligible for the right tax credits.
In addition, there is a GILTI high tax exemption that you may qualify for. This exemption allows expats who pay GILTI for their CFC at a tax rate that is over 90% of the US corporate rate (which is currently set at 21%). If your country’s corporation tax rate is above 18.9% – and many countries tax rates are – you could qualify.
How New GILTI Rules Affect Past Returns
Although the US passed GILTI in 2017, it wasn’t until mid-2020 that the US posted final regulations on GILTI. If you paid GILTI in 2018, 2019, or 2020 (before the rules were finalized), you can retroactively go back and file amended returns.
Bright!Tax Can Help You Navigate GILTI
US expat taxes are complicated. And if you have foreign business profits to report, filing your tax return can seem even more daunting. Bright!Tax CPAs are well-versed in US expat tax law and can help you navigate the process of paying GILTI.
Our CPAs will work with you to make sure you receive any foreign tax credits you’re eligible for, so that you don’t pay a penny more than you have to. We can also help you catch up on previous tax returns through the Streamlined Procedure and look for opportunities for a refund on past GILTI payments. Reach out to a Bright!Tax CPA today to get started.