IRS Proposed Regulations Include High-Tax Exclusion for GILTI and Eliminate the Hybrid Approach for Domestic Partnerships

The Internal Revenue Service (IRS) released final and proposed regulations on June 14, 2019, that provide for an expanded high-tax exclusion for global intangible low taxed income (GILTI) and provide relief from GILTI tax for some partners in a domestic partnership that is a shareholder of a controlled foreign corporation (CFC).

Background

The IRS issued initial proposed regulations in September 2018 effective for tax years beginning after December 31, 2017. Under Section 951A and the proposed regulations, U.S. shareholders of a CFC have to include “intangible” income earned by the CFC in excess of a deemed return on depreciable assets in their U.S. taxable income. The tax on GILTI is intended to impose a minimum tax on U.S. shareholders of CFC’s to result in a tax rate of no less than 10.5 percent after the application of foreign tax credits and the Section 250 deduction.

High-Tax Exclusion (Expanded)

The proposed regulations issued last week expand the high-tax exclusion by providing for an election to exclude from tested gross income any amounts that have been subject to foreign tax at a rate that exceeds 90 percent of the U.S. rate. Testing and election for high-taxed status would require examining the effective tax rate on items of income at the qualified business unit level. Therefore, while the expansion of the high-tax exclusion would provide some welcome relief, the testing will require precise and meticulous calculations. The expanded exclusion also does not apply to tax returns from the 2018 calendar year.

Aggregate Approach to Partnerships

The proposed regulations also change the approach to domestic partnerships for the purposes of calculating GILTI inclusion. In previously proposed regulations, domestic partnerships calculated the GILTI inclusion amount for a US partner that was not a U.S. shareholder with respect to the CFC under the entity theory, whereas U.S. shareholder partners reported their share of net CFC tested income under the aggregate approach. Under the new proposed regulations, the aggregate approach is applied to domestic partnerships so that they are not treated as independent entities with capacity to own stock in a foreign corporation. As such, only U.S. shareholder partners will be subject to the GILTI inclusion. The IRS has stated that the aggregate approach is essential for consistent treatment of foreign and domestic partnerships under the GILTI regime.

If you have questions about your potential impact as a result of these proposed regulations, please contact your tax advisor.