US Tax on Retained Earnings of Foreign Corporations
Friday, February 16th, 2018
Shortly before Christmas, the US congress passed a massive tax reform bill. The reduction in personal and corporate tax rates has received significant attention.
One of the lesser known aspects of the bill, is the US tax on accumulated retained earnings of foreign corporations. This tax applies to US taxpayers owning Controlled Foreign Corporations.
For foreign subsidiaries of US corporations, or US residents with offshore businesses, this tax effectively accelerates the dividend tax that would otherwise have been deferred until the profits were repatriated to the US.
However, for US citizens living abroad, this creates double tax – US tax in 2017 or 2018 (depending on the fiscal year of the foreign corporation), and foreign tax when the profits are actually distributed to the shareholder and subjected to personal tax in the home country.
The calculation of the tax is rather complex, as it depends on the “liquid assets” of the foreign corporation, at several testing dates. First, the “Earnings and Profits” (adjusted retained earnings under US tax principles) at December 31, 2017 (or November 2, 2017 if higher) are treated as ordinary income to the shareholder. Then deductions are allowed depending on liquid working capital and other assets. The deduction for non-liquid assets is higher than for liquid assets (since presumably it would be more difficult to fund the tax payment if the retained earnings are invested in plant and equipment). The effective rate of tax is between 8% and 18% of the retained earnings for US individuals owning foreign corporations directly (the higher the available liquid assets, the higher the effective tax rate).
The deductions are based on the working capital balance at the fiscal year end (December 31, 2017 or 2018 fiscal year), or the average of the 2 years ending prior to November 2, 2017, whichever is highest. Clearly, detailed calculations and projections are required to accurately estimate the impact.
S+C Partners can assist with estimating the tax liability, and also in implementing planning steps to potentially mitigate the double tax impact. However, the implementation of any planning may be time sensitive, depending on the fiscal year end of the foreign corporation.