The 2018 tax reform brought significant changes, including a reduction in corporate tax rates, a lower maximum marginal tax rate, and tax exemptions on foreign company dividend distributions. However, despite these benefits, the reform also introduced new tax obligations—one of which is the GILTI provision. In this article, we will examine the key aspects of the GILTI provision, its rationale, whom it applies to, and how it impacts different entities.
The 2018 Tax Reform: Tax Relief and New Obligations
In 2018, President Trump’s tax reform took effect through the Tax Cuts and Jobs Act. This reform lowered tax rates and restructured the international tax system. However, it also introduced new tax obligations, eliminated certain deductions and credits, and imposed limits on expense deductions. For example:
- The corporate tax rate and maximum marginal tax rate were reduced.
- A tax exemption was granted on dividend distributions by foreign companies.
- Tax benefits were introduced for LLCs.
At the same time, the reform also:
- Eliminated standard tax deductions.
- Imposed a one-time mandatory repatriation tax on foreign earnings of American-controlled companies.
- Introduced the GILTI tax.
These are just a few of the major changes brought by the reform.
The Rationale Behind the GILTI Tax
The GILTI (Global Intangible Low-Taxed Income) tax was designed to prevent U.S. corporations and individuals from shifting profits to foreign-controlled companies to avoid taxation. These companies—incorporated under foreign law but effectively controlled by American stakeholders—often operate outside the U.S., making their income non-taxable under previous laws.
This practice is particularly common among businesses with intangible assets such as intellectual property and patents. To counteract this, the U.S. government introduced the GILTI tax, ensuring that profits from American-controlled foreign companies are taxed—even if they are not distributed as dividends.
Key Principles of the GILTI Provisions
The GILTI provision applies to American entities that hold more than 10% of a Controlled Foreign Corporation (CFC). The taxable income is calculated by deducting expenses and 10% of the value of the company’s tangible assets from its total income.
Who Is Affected by GILTI?
American Entities
The provision applies to:
- U.S. citizens
- Green card holders (permanent residents)
- U.S.-incorporated businesses, including C-Corporations and LLCs
Controlled Foreign Corporation (CFC)
A CFC is a corporation incorporated under foreign law but controlled by American entities. For a company to qualify as a CFC:
- At least 50% of its shares must be held by U.S. citizens or U.S.-incorporated companies.
- Each U.S. entity must hold at least 10% of the shares.
If some shareholders hold less than 10%, but a U.S.-incorporated subsidiary is fully owned by the foreign company, the foreign company will still be classified as a CFC. Additionally, all subsidiaries fully controlled by the CFC will also be designated as CFCs.
Tax Liability on Company Income
The GILTI tax applies to undistributed company earnings after deducting:
- Expenses
- 10% of the company’s tangible asset value
This ensures that the tax primarily affects intangible income, discouraging the offshoring of intellectual property to low-tax jurisdictions.
GILTI Tax Rates: Impact on C-Corporations
The GILTI tax is calculated based on adjusted income (revenues after deducting expenses and 10% of the value of tangible assets). For C-Corporations, the corporate tax rate is 21%. However:
- The GILTI provisions grant a 50% deduction, reducing the effective tax rate to 10.5%.
- A foreign tax credit of up to 80% is available for foreign taxes paid on the income.
In practice, this means that the effective tax rate for U.S. C-Corporations under GILTI is about 13.1%. This can be advantageous compared to other scenarios where income distribution as dividends would have resulted in higher taxes.
GILTI Tax Rates: Impact on Individuals and Partnerships
For individuals, LLCs, and partnerships, the situation is more challenging:
- Instead of benefiting from a lower corporate tax rate, they are taxed at their marginal individual tax rate, which ranges from 10% to 37%.
- They do not qualify for the 50% deduction or the foreign tax credit that C-Corporations receive.
As a result, individual taxpayers under GILTI could face an effective tax rate of up to 70% when accounting for foreign taxes paid on company income.
A Potential Solution for Individuals
Individuals may elect to be taxed as a C-Corporation under Section 962 of the U.S. tax code, which would allow them to benefit from the corporate tax rate and deductions. Consulting a US tax expert in Israel is recommended to determine the best strategy.
Conclusion
The 2018 tax reform introduced both tax relief and new tax obligations, requiring businesses and individuals to reassess their tax strategies. The GILTI provisions are just one of the complexities introduced by the reform, impacting U.S. entities with foreign holdings.
The MasAmerica team, US tax advisors in Israel, specializes in U.S. and Israeli tax law and can help you navigate these changes to optimize your tax situation.
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Disclaimer: This article does not constitute legal advice. We recommend consulting MasAmerica’s team before making any financial decisions. Our team includes bilingual (English & Hebrew) attorneys and accountants licensed in the U.S.
