updated 2:57 PM CEST, Sep 21, 2023

U.S. Treasury finally cuts expat small-biz owners some GILTI slack

Campaigners for fairer treatment for American citizens abroad are claiming a victory this morning, as news emerged that the U.S. Treasury had finally cut owners of small businesses located abroad some slack yesterday, by enabling such individuals to choose to be treated like a corporation for tax purposes, and thus reduce their tax burden.

By opting to be treated for tax purposes as a corporation, individual American taxpayers with businesses abroad may receive a deduction on their intangible income worth up to 50%, the new regulations say.

As reported, a number of campaigners against the global intangible low-taxed income (GILTI) tax, which had been introduced in President Trump's 2017 Tax Cuts and Jobs Act (TCJA), had come to believe the Treasury would act soon on the matter, as time was running out, with tax-reporting season under way.

Those opting to take advantage of the corporate option to access the benefits that the Tax Cuts and Jobs Act provides for businesses will, however, face significantly more paperwork when they prepare their tax returns, experts noted.

Monte Silver low resThe changes came as part of a package of  IRS/Treasury regulatory changes aimed at fixing elements of the TCJA that had been criticized for unintended consequences some said were likely due to the speed with which the Trump tax overhaul package was rushed into law towards the end of 2017.

Among the campaigners who were celebrating today was Monte Silver, the  U.S. tax attorney resident in Israel who, in February, filed a lawsuit in U.S. District Court against the IRS and U.S. Treasury, in which he challenged key elements of the TCJA, including the way it treated owners of small non-U.S. businesses owned by Americans. 

"In addition to getting two temporary forms of relief in 2018, we just won our first permanent form of relief since we started the movement less than one year ago!" Silver, pictured, who is a partner and founder of the Tel Aviv-headquartered U.S. tax law firm, Silver & Co., said today.

"Its official.  People will be able avoid GILTI taxes if they make the 962 election [in their tax filing].

"There are certain ifs, ands and buts to the election, which we can discuss later. 

"But for now, we can all sit back and relish a victory.  I am unaware of any other expat tax advocacy campaign that has ever won relief previously, either permanent, or even temporarily.

"So together, we have accomplished something very special."

That said, Silver added, he is continuing with his lawsuit, which asks for additional breaks for expat business owners affected by the TCJA that the changes unveiled yesterday don't address.

Also welcoming the news of the changes in the tax treatment of Americans' overseas small businesses was John Richardson, a Toronto-based lawyer at CtizenshipSolutions.ca, who specializes in assisting Americans abroad with their tax and citizenship issues. The Treasury, Richardson said, should be congratulated for taking a "purposive" approach "when interpreting how Sec. 951A interacts with Sec. 962" of the relevant regulations.

In layman's terms, Richardson noted, the new regulation means that "American expats may now deduct 50% of the active business income defined as GILTI, thus reducing the amount of GILTI they would be expected to have to pay tax on."

However, the new regulations don't affect the so-called Section 965 "transition tax," he noted.

"It appears that Treasury heard and understood the problems faced by individual shareholders of CFCs  [Controlled Foreign Corporations].

"I suspect that organisations representing S Corps [a type of closely-held corporation, as defined by the U.S. Internal Revenue Service]  also made submissions to Treasury and had an influence on this decision.

"All Americans abroad should be encouraged by this. Instead of interpreting the law in the most literal and punitive way, it appears that Treasury has recognized the problems that individuals, whether living inside or outside America, faced.

"The bottom line is that small business owners abroad will now, for the most part, be able to defer U.S. taxation on the active business income of their corporations by using the Sec. 962 election, provided that their corporations are paying sufficient local tax. They will of course have to pay U.S. tax when the income is distributed to them.

"But [even here], the distributions will be subject to local tax which can then be used, via the FTC rules, to offset U.S. tax owing – for active business income. 

"In other words, this is excellent news for Americans abroad."

Transition Tax  'reduces competitiveness'

In January,   American expatriates and other American citizens who own small businesses located outside of the U.S. were stunned to learn that despite their pleas for some relief,  the U.S. government had gone ahead and published its final draft of the so-called Transition Tax element of the TCJA without acknowledging their concerns.

The Transition Tax, also sometimes referred to as the Repatriation Tax, is said to hit individual owners of small businesses and partnerships located outside of the U.S. particularly hard, because many of them had been counting on their set-aside corporate profits to either expand their businesses in the short term, or to rely on later in life to fund their retirements.

Designed to go after large multi-national companies owned by Americans that had been seen to have held corporate profits overseas for decades to avoid paying U.S. tax on them, the new regulations impose a one-off tax on previously-untaxed foreign earnings dating all the way back to 1987.

Given that non-American-owned small businesses won't be expected to pay this tax, many of those facing these new charges have said it could make it difficult for any American expat owners of small businesses outside of the U.S. to compete with their non-American rivals – or even simply to remain in business.

Silver's lawsuit relies on a claim that the final version of the regulations failed to contain a "regulatory flexibility analysis" that is required by the Regulatory Flexibility Act, a U.S. law that requires federal agencies to review regulations for their impact on small businesses.

He also maintains that the final draft of the TCJA imposes "many unreasonably complicated burdens” on small businesses, and that the defendants had "made no effort to examine the helpless situation of small business, and did not attempt to address alternatives which would allow small business to comply with the law without undue burden."

For such American small business owners, the Transition Tax rate they are being expected to pay varies, but for some, who would be taxed at an individual top rate of 39% in 2017, it is said to run as high as 17.54% on liquid/cash assets, and approximately 9% for fixed assets. American-owned overseas corporations – including large companies of the kind the the legislation was designed to target – are taxed at a slightly lower rate, at 15.5% on liquid/cash type assets and 8% for fixed assets.

The regulatory changes unveiled yesterday are due to be published tomorrow in the Federal Register. For now, they can be viewed here, with the relevant sections found on pages 49 and 50, according to Silver.  

Silver and Richardson will address the Transition and GILTI taxes, and their implications for Americans abroad, tomorrow (March 6) at 9am, at http://www.ThatChannel.com.

 Below is an excerpt from page 50 of the document:  

"Congress enacted section 962 to ensure that individuals’ tax burdens with respect to undistributed foreign earnings of their CFCs “will be no heavier than they would have been had they invested in an American corporation doing business abroad.”

S. Rept. 1881, 1962-3 C.B. 784, at 798. Existing §1.962-1(b)(1)(i) provides that a deduction of a U.S. shareholder does not reduce the amount included in gross income under section 951(a) for purposes of computing the amount of tax that would be imposed under section 11.

However, allowing a section 250 deduction with respect to GILTI of an individual (including an individual that is a shareholder of an S corporation or a partner in a partnership) that makes an election under section 962 is consistent with the purpose of that provision of ensuring that such individual’s tax burden with respect to its CFC’s undistributed foreign earnings is no greater than if the individual owned such CFC through a domestic corporation.

Accordingly, the proposed regulations provide that, for purposes of section 962, “taxable income” as used in section 11 of an electing individual is reduced by the portion of the section 250 deduction that would be allowed to a domestic corporation with respect to the individual’s GILTI and the section 78 gross-up attributable to the shareholder’s GILTI. See proposed §1.962-1(b)(1)(i)(B)(3)."