Strategies To Repatriate Untaxed Foreign Earnings
When a US person has foreign income, one of the most difficult aspects may be just bringing the foreign earnings back into the United States. This is referred to as repatriation, which is when a taxpayer seeks to repatriate foreign earnings back into the United States. Oftentimes, income that the taxpayer may have earned overseas may not have yet been taxable in the foreign country or may not even be taxable in the foreign country, but once the income is distributed, there may be a taxable event (subject to the worldwide income taxation rules). In addition, there are also ancillary issues to consider such as the repatriation act (section 965). A common question we receive is how can taxpayers repatriate untaxed foreign earnings.
Does it Qualify for DRD Under 245A?
One of the first ways to repatriate untaxed foreign earnings is through Section 245 DRD (Dividend Received Deduction from certain foreign corporations distributions). Under this code section, if dividends are distributed from one corporation to another qualifying corporation under the code section, then there is a 100% deduction of the dividend. Of course, there are very specific requirements that must be met in order to accomplish this goal — but if possible then it can result in a 100% deduction.
Are There Foreign Tax Credits Available?
An alternative route to untaxed foreign earnings is a situation in which foreign income may not have been distributed yet in the United States, but it is foreign income that was already taxed abroad. In this type of situation, once the income is distributed in the United States then the person can apply for foreign tax credits in order to reduce or if not eliminate US tax on foreign earnings. Noted, there are various rules, regulations, and limitations depending on whether it is a Form 1116 vs Form 1118 issue and whether or not the income is distributed to an individual or to a US corporation — the latter which then distributes the income out as earnings.
US Person vs Non-US Person
Sometimes, the path can be easier. For example, let’s say a person is only a US person because they met the Substantial Presence Test. If there is a large amount of foreign income that may be due to the US person, they can attempt to seek to avoid US person status and thus avoid US tax on that income unless it otherwise falls into a category of taxable income by the US government. If the person already met the Substantial Presence Test they may consider qualifying for the Closer Connection Exception.
If the person is a US person with foreign income but resides in a treaty country — they may seek to qualify under the treaty for an exemption or exclusion of tax under a tax treaty. This may be impacted by the saving clause and the specific US person status of the taxpayer, but something that should be considered. If the person is a US Citizen or Green Card Holder they should also consider whether this may ignite unintentional expatriation.
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