Foreign Disregarded Entity Election
One strategy available to owners of a Controlled Foreign Corporations for mitigating tax due to the Global Intangible Low Taxed Income (GILTI) regime, is to make a “check the box” election to treat the corporation as “disregarded”. This means that all income earned by the corporation is deemed to be earned by the shareholders directly. It is therefore reported at the point the income is earned by the corporation, rather than when it is distributed to shareholders. In the case of a sole owner this would require a “disregarded entity” election, whereas for multiple owners an election would instead be made to treat the foreign corporation as a partnership.
Since the complexity of the Form(s) 5471, used to report information pertaining to foreign corporations, seems to be increasing on a yearly basis (and therefore also the potential compliance costs), a Foreign Disregarded Entity (FDE) election is becoming a more attractive option to many US persons when compared to alternative methods of mitigating GILTI, such as making a Section 962 election.
Making the FDE election also has the advantage of giving a much greater degree of flexibility when it comes to the application of foreign tax credits. Whereas usually when making the s.962 election all foreign taxes used must be paid in the calendar year period for which the election is made in order to be allowable, when making an FDE election a separate basket of foreign tax credits is used. This Foreign Branch Income (FBI) basket functions in much the same way as the other foreign tax credit baskets, in that credits can be carried back one year and carried forward up to ten years. This can be particularly useful in years where no foreign corporation taxes are due because of losses carried forward from previous years.
There are however some important factors which need to be carefully considered before opting to make an FDE election. Firstly, in the case of a company with substantial retained earnings; generally these earnings would be considered as distributed to shareholders on the day the election is made. If a sufficient quantity of the right type of foreign tax credits are not available there is potential for a sizeable one-off US tax liability.
Secondly, in the case of a foreign corporation which is not making sufficient distributions on a yearly basis and is instead continuing to retain earnings within the company, there is potential for double taxation in that earnings will be taxed in the US when income is earned by the company (if the taxpayers US average tax rate exceeds the foreign rate of corporation tax), and then again in the foreign jurisdiction when this income is eventually distributed. Therefore the FDE election is generally only recommended when income is being regularly distributed from a foreign corporation at a level such that the foreign corporation taxes, plus the personal taxes due on dividends, exceeds the US tax due on the earnings of the foreign corporation. In all cases you should contact your tax advisor in the first instance when considering making such an election.
Since the complexity of the Form(s) 5471, used to report information pertaining to foreign corporations, seems to be increasing on a yearly basis (and therefore also the potential compliance costs), a Foreign Disregarded Entity (FDE) election is becoming a more attractive option to many US persons when compared to alternative methods of mitigating GILTI, such as making a Section 962 election.
Making the FDE election also has the advantage of giving a much greater degree of flexibility when it comes to the application of foreign tax credits. Whereas usually when making the s.962 election all foreign taxes used must be paid in the calendar year period for which the election is made in order to be allowable, when making an FDE election a separate basket of foreign tax credits is used. This Foreign Branch Income (FBI) basket functions in much the same way as the other foreign tax credit baskets, in that credits can be carried back one year and carried forward up to ten years. This can be particularly useful in years where no foreign corporation taxes are due because of losses carried forward from previous years.
There are however some important factors which need to be carefully considered before opting to make an FDE election. Firstly, in the case of a company with substantial retained earnings; generally these earnings would be considered as distributed to shareholders on the day the election is made. If a sufficient quantity of the right type of foreign tax credits are not available there is potential for a sizeable one-off US tax liability.
Secondly, in the case of a foreign corporation which is not making sufficient distributions on a yearly basis and is instead continuing to retain earnings within the company, there is potential for double taxation in that earnings will be taxed in the US when income is earned by the company (if the taxpayers US average tax rate exceeds the foreign rate of corporation tax), and then again in the foreign jurisdiction when this income is eventually distributed. Therefore the FDE election is generally only recommended when income is being regularly distributed from a foreign corporation at a level such that the foreign corporation taxes, plus the personal taxes due on dividends, exceeds the US tax due on the earnings of the foreign corporation. In all cases you should contact your tax advisor in the first instance when considering making such an election.
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