The US Citizen Foreign Business Income Tax Reporting Requirements
The United States follows a worldwide income tax model. That means that when a person is a US Citizen or a Lawful Permanent Resident or otherwise meets the Substantial Presence Test — they are required to report their worldwide income. As a result, if a US citizen has a foreign business — there is a high likelihood that they will have United States income tax and international reporting requirements. This is especially true in any situation in which they own a controlled foreign corporation — which means that the US persons own more than 50% of the business and each shareholder owns at least 10% with certain attribution and constructive ownership rules designed to make it infinitely more complicated for taxpayers. The international taxation and reporting requirements for foreign businesses are very complicated. Let’s take a look at six (6) important facts about the basics of US citizens with foreign businesses and what their income tax reporting requirements consist of.
CFC (Controlled Foreign Corporation)
What a foreign corporation qualifies as a controlled foreign corporation, from a baseline perspective means that more than 50% of the company is owned by a US person – and attribution/constructive ownership rules apply. When a company is considered a controlled foreign corporation it may become subject to a whole host of different types of taxes that non-CFC companies can avoid. This will typically include items such as Subpart F and GILTI.
Tax on Distributed Income
Even though the companies are located overseas –and all of the income generated from the foreign business may have originated from foreign sources, the hitch in the giddyup is that the US citizen owner is still the owner of the company. Therefore, as a US citizen who has ownership of a foreign business, the IRS has authority over the US Citizen. If the business generates income, the income may be taxable. If it is distributed then it is almost always taxable; if it is not distributed and it qualifies as CFC Subpart F or GILTI, then there are still potential tax implications.
Subpart F (Even if Income is Not Distributed)
When income is considered Subpart F income, it means that it can be taxed to the US person even though it has not been distributed. While there are various tax implications of having Subpart F income, there are also various exceptions, exclusions, and limitations to be aware of — noting that there must be some E&P in the current year,, and if there is a crossover with PFIC — then certain tax consequences may be avoided, at least in the short term.
GILTI refers to Global Intangible Low-Taxed Income. Unfortunately, the name is misleading because it is not limited to low-taxed income or intangible income. The best way to think about it is that unless income is excluded from GILTI, it will presumably be considered GILTI. But, in order to minimize the tax implications to individuals, they can elect under Section 962 to be treated as a domestic corporation for purposes of GILTI, and therefore receive the 50% deduction. In addition, certain foreign tax credits can apply.
Foreign Tax Credit Conundrum
One of the biggest issues with foreign tax credits and foreign corporations is the following: if a foreign corporation pays tax on foreign income that that corporation owned, then technically the US person individual did not pay the income taxes out of their own pocket. This in turn will impact the ability of the US individual to claim a foreign tax credit against taxes paid by the foreign business. Depending on whether certain elections are made and whether the company qualifies under GILTI, it will impact the ability to claim certain foreign tax credits.
Form 5471 and Schedules
One of the biggest headaches about having a foreign corporation is that depending on the type of ownership, the taxpayer may become subject to filing Form 5471 — which is a monster of an international tax reporting form. Sometimes, the taxpayer may only have to file it in the year certain events occur such as acquiring more than 10% ownership, but for other taxpayers — especially if they are shareholders of a controlled foreign corporation — they may have to file the form each year.
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