Following on from Excess Profits and GILTI, we will now look into the Section 250 deduction. Section 250 applies to tax years beginning on or after January 1, 2018. Until 31 December 2025, the deduction is equal to 50% of a corporation’s GILTI. From 1 January 2026 the deduction is reduced to 37.5%.
To recap, for U.S. tax purposes, income from a foreign corporation may subject a U.S. shareholder to U.S. tax under Subpart F provisions or GILTI provision in the Code.
These anti-deferral provisions ensure that income captured within a corporation, that was formed outside the United States by U.S. persons, does not escape U.S. tax by not being paid out to U.S. shareholders.
This is referred to as unattributed income of a foreign corporation.
Assuming GILTI applies, it is possible to reduce GILTI income by taking a Section 250 deduction.
This requires that the shareholder make an election to tax GILTI income at the corporate domestic rate of 21% (Section 962 election).
This works as follows.
A, a U.S. citizen, has lived in NZ since 1985. A owns 100% of Foreign Corporation (CFC), a NZ limited liability company.
A and FC have a 31 December year end and use the U.S. dollar as functional currency.
For the 2023 taxable year, CFC has $6m of pre-foreign tax earnings with respect to which it accrues and pays $1m of foreign income tax, leaving $5m of post-tax income.
In the above example, the effective tax rate is 16.67%, falling short of the high-tax exception tax rate of 18.9%. Therefore, the high tax exception to GILTI doesn’t apply.
Of the $5m, $3m is general limitation income, and $2m is passive Subpart F income in a single subpart F income group.
Of the $1m of foreign income tax paid or accrued by CFC,
*$600,000 is allocable to the general category tested income group,
*$400,00 is allocable to the passive category subpart F income group.
A’s provisional income includes:
*$3m as GILTI income, and
*$2m as Subpart F income.
For the 2023 taxable year, of the $2m passive income, $1m is foreign source with $100,000 of foreign withholding tax deductions.
A’s total US source income is $3m.
A elects to have the CFC income taxed at the U.S. corporate tax rate of 21% under Section 962.
By making a Section 962 election, income includible as GILTI is treated as though it were received by a U.S. domestic corporation.
The electing individual is also allowed a credit against the U.S. tax imposed on the income for foreign taxes paid or accrued.
The ability to claim foreign tax credits arises under Section 960(a) of the Code.
Section 960(a) deems a domestic corporation that is a U.S. shareholder of a controlled foreign corporation to pay the foreign income tax paid or accrued by the foreign corporation that are properly attributable to the foreign corporation’s items of income included.
Under section 78 A a domestic corporation is required to include in its gross income the foreign income taxes that it is deemed to pay/have paid.
A is required to include tax allocable to general limitation income and therefore grosses up GILTI from $3m to $3.6m.
50% of $3.6m is then available as a section 250 deduction, $1.8m.
$5m is also grossed up to $6m by the amount of foreign taxes paid.
In this example we are referring to the $1m foreign taxes paid by CFC, and which is referred to as a Section 78 inclusion.
The result, $6m, is the number from which the section 250 deduction is then made, arriving at taxable income under Section 962.
So, $6m minus $1.8m equals $4.2m.
Tax at 21% equals $882,000: pre-credit US tax.
This amount may then be offset either partially or fully by foreign tax credits.
