Cures for a Cosmopolitan Hangover: What We’re Doing for International Clients Following Tax Reform
January 20, 2020
By Brent Lipschultz
Presented by Scott Bowman, McDermott Will & Emery LLP; Lucy Lee, Greenberg Traurig LLP; and Aaron Schumacher, Withers Worldwide
The panel presented recent changes in the international private client landscape and planning opportunities following Tax Reform. The panel focused on the changes to the controlled foreign corporations (“CFC”) regime, the repeal of Grecian Magnesite case, planning for inbound real estate investment and changes in the electing small business trust (“ESBT”) rules allowing non-residents of the United States to become S corporation shareholders.
Tax reform brought in sweeping changes in how cross-border activities are taxed with the primary aim of preventing multi-national companies accumulating retained earnings offshore and a move to a “territorial system of taxation.” Many private client businesses were inadvertently swept into these new regimes.
Definition of U.S. Shareholder: The primary changes in the CFC regime included the change to the definition of the U.S. shareholder, the tax on global intangible low taxed income (“GILTI”), elimination of the 30-day rule for when an entity is considered a CFC, and the downward attribution causing havoc for many foreign holding company structures having U.S. subsidiaries.
A CFC is any non-U.S. corporation if more than 50% of the vote or value of the company is owned (directly or indirectly) by U.S. shareholders, defined as any U.S. person who owns (directly, indirectly, or constructively) 10% or more of the corporation by vote or value. The “or value” was added by the Tax Cuts and Jobs Act (“TCJA”). This became an issue where U.S. family members did not hold the vote, but had the value based on how the enterprise was capitalized. This has thrown more individuals into the realm of having to file Forms 5471 than ever before.
The panel recommended restructuring the enterprise especially where there are U.S. and non-U.S. family members to push the equity interests to the non-U.S. family members. Foreign grantor trusts could be set up in certain circumstances where the U.S. family members would have a beneficial interest in the trust. Alternatively, U.S. family members could own the shares of the U.S. operations while the non-family members own the foreign business.
GILTI: The panel discussed GILTI which is defined as including most business income reduced by 10% of the adjusted basis of the CFC’s depreciable tangible personal property. GILTI applies to most foreign businesses that do not have significant tangible property such as non-U.S. IP structures, administrative structures and treasury centers. U.S. persons holding interests in foreign companies do not benefit from the relief provisions only applicable to C corporations. Most of the planning in this area involved having U.S. individuals, trusts or estate electing under IRC Sec. 962 to be treated as corporations or inserting U.S. C corporations in the structure, all with the intent of obtaining the benefits of reducing the GILTI tax exposure.
30-Day Rule: Prior to Tax Reform, a foreign corporation needed to be a CFC for 30 days in order to cause a deemed inclusion of subpart F income. In the case of a non-U.S. client’s death, the 30-day rule was important in order to allow for a check-the-box election to create a step-up of inside basis without causing U.S. income tax consequences to the U.S. beneficiary. With the elimination of the 30-day rule, a post mortem check-the-box election may cause subpart F income to the U.S. shareholders.
The presenters considered either buying and selling the company’s portfolio to eliminate any appreciation prior to death; adopting a two-tiered partnership structure, or utilizing an asset protection trust with a single blocker. The panel agreed that using the trust structure would be optimal and not really change the planning that had been recommended prior to the tax law change.
Downward Attribution: This was the most controversial provision; it forced tax practitioners to review the foreign holding company structures to determine whether there were U.S. subsidiaries in the mix, which essentially created CFCs of entities that had no U.S. owners. Planners used spin-offs as a mechanism to remove the U.S. companies from the holding company structure but had to take into account foreign tax laws. The panelists indicated that the IRS relaxed its reporting for those entities impacted by the downward attribution rules in Revenue Procedure 2019-40.
U.S. Partnerships/ECI: The panelists focused on the Tax Reform provisions repealing the Grecian Magnesite case where the Tax Court held that the sale of a partnership interest did not result in U.S.-sourced effectively connected income (“ECI”). Under TCJA, gain or loss from the sale of a partnership interest is treated as U.S.-sourced ECI to the extent that the seller would have ECI on the sale of the partnership assets. The key focus on the discussion was the withholding mechanism adopted by the proposed regulations and whether buyers of partnership interests were complying.
Inbound Real Estate Investment: The panel concluded that the two-tiered corporate structure for acquiring U.S. real estate would be used more often given the reduced corporate income tax rates; however, political risk should be considered if the rates were to go up in the future. Utilization of domestic irrevocable trusts continue to be very attractive in the right circumstances especially where the property is to be held for the long-term and the property may be used by family members other than the grantor. Related party borrowing can be used to finance the acquisition and still qualify as portfolio interest without any withholding tax assessed to the lender.
Non-U.S. Persons Can Be Shareholders of S Corporations if They Are Beneficiaries of an ESBT: This opens the door to have multi-national families owning interest in an S corporation as well as non-domiciled green card holders to make gifts of S corporation stock into trusts for non-U.S. beneficiaries. It also allows the S corporation strategy to be preserved due to changes in U.S. day counting, surrendering of the green card/ treaty tie breaker or expatriation from the U.S.
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