The GILTI laws apply to far more taxpayers than expected, require long detailed calculations, and after all that work could likely result in no tax. However, the cost of ignoring the application, even if no tax is due, could come with very high penalties.
On the surface, the new GILTI (Global Intangible Low-Taxed Income) laws seem to make sense. As is detailed in the beginning of the regulations, the GILTI rules seek to make it tax neutral whether intangible income is earned within the U.S. or offshore. This is done by potentially taxing the intangible income that is earned offshore. Theoretically, if it is truly intangible income, the taxpayer could be earning that money from the U.S. as it is not a physical asset that needs to be present in the foreign country. Despite conceptually making sense, the application is where the problems are hidden, and if you choose to ignore the application it is more than a slap on the wrist.
Wasting our Money
At first glance, many taxpayers may assume the GILTI laws do not apply to them because they do not have intangible income. However, this is the first problem of the application. Instead of taxing the actual intangible income, the GILTI rules determine how much tangible income a foreign business should be earning and deem everything above and beyond that amount “intangible income.” This means even if your business is purely manufacturing you may not be off the hook. The calculation of what should be tangible income is represented by 10% of the Qualified Business Asset Investment (QBAI). This allowable return is then compared against the “tested income” of the company. Any tested income in excess of the allowable return is deemed GILTI. From this simplified overview the problem is obvious that GILTI is going to encompass businesses that have nothing to do with intangible income. For example, a manufacturing business with fully depreciated assets, a sales entity with very few assets, or just a successful company that is able to generate more than a 10% return on its assets, could all potentially be at risk. For these reasons, the GILTI rules may be wasting taxpayer money by making some taxpayers pay taxes on “intangible income” when in fact they have zero “intangible income.”
Wasting our Time
The actual GILTI calculation is onerous, and as discussed below, may result in simply proving GILTI does not apply. First, is the determination of “tested income.” This is a calculation that involves netting of companies with losses and gains, and weeding out of certain types of income that may already face U.S. tax. Next, the QBAI mentioned above, is a loaded term which represents the fixed assets of the company depreciated using the ADS depreciation method, which is rarely used so everyone gets to recreate depreciation tables from scratch. Also, the assets of any company with a tested loss are not considered. For good measure, this also must be done on a quarterly basis because the actual QBAI is the average of the four quarters’ net basis. Lastly, there are certain adjustments that must be made related to interest income and expense. Once all of these calculations are complete the final GILTI number is obtained, unless you are a corporation or an individual making a Section 962 election. For these taxpayers, the next step is to take a 50% deduction of the entire GILTI amount, leaving half of the calculated amount. Then, a foreign tax credit is allowed for up to 80% of the indirect credits paid in the home country of the business. Therefore, the end result is that if the business is paying tax of 13.125% in the foreign country, corporate taxpayers, including individuals with a Section 962 election, will end up paying NOTHING. (If you want to see the math – the corporate rate is 21% – half of that is 10.5% (half because these taxpayers only pay tax on half of GILTI). Therefore, you would only need to pay taxes at 10.5% except that the foreign tax credit is limited to 80%, which means at 13.125% of taxes the 80% limitation leaves you enough credits to cover the 10.5% effective rate.)
This is where the GILTI is wasting our time, and again the money in terms of the fees taxpayers must pay a professional to go through this onerous calculation. After all of that, the fees and the time, unless you are an individual that doesn’t make the Section 962 election for other reasons, or are in a very low tax jurisdiction, it probably won’t mean anything.
In the end, some taxpayers may prefer to ignore the entire process. However, if you decide not to report your GILTI, or lack thereof, the penalty is up to $10,000 and the statute of limitations never begins to run on your ENTIRE tax return. Also, there are new forms required, such as Form 5471 Schedule I-1, Form 8992, and Form 8993, which make it very easy for the IRS to see who is and isn’t accounting for GILTI. Therefore, unfortunately, regardless of whether the law is unfair, onerous, or just a waste of time, it is clear that it cannot be ignored.