As a US expat living in Canada, you may find yourself navigating the complex landscape of international taxation. One of the key areas of concern is the Global Intangible Low-Taxed Income (GILTI) tax on Canadian-Controlled Private Corporations (CCPCs). This article aims to provide an in-depth understanding of GILTI tax, its implications, and strategies to avoid it effectively.
What are CCPCs and GILTI Tax?
A CCPC that is eligible for the small business deduction and has active business income may enjoy a low rate of corporate tax. The small business rate provides a significant tax deferral opportunity by leaving retained earnings inside the corporation and then using the $500,000 exemption, a cornerstone of private company tax strategy in Canada. This would leave the shareholder only having to pay corporate income tax of 11.5%, a substantial saving compared to the marginal tax rate for individuals of 54% (using Nova Scotia data).
However, the GILTI regime aims to delay U.S. tax on foreign-earned earnings, and taxpayers must actively seek to lessen the effects of GILTI. This is particularly true since GILTI punishes this exact behavior: earnings that remain inside the corporation are taxed to the shareholder as individual income, called GILTI income.
Strategies to Avoid GILTI Tax
There are several strategies that can be employed to mitigate the risk of double taxation posed by GILTI.
1. Bonuses
Some business owners choose to give themselves a bonus up to the GILTI amount, but this plan does not provide any tax deferral because bonuses are subject to current taxation. Many incorporated professionals may find it more advantageous to operate as sole proprietorships to avoid the onerous CFC reporting requirements. At this point, a check-the-box election to make it a disregarded entity (and therefore deal with form 8858, which is not nearly as complicated as form 5471 can also be considered)
2. Election under Section §962
Under Section §962, an individual taxpayer has the option to choose to be taxed as a U.S. corporation.
The advantages of this choice include:
- Lowering the U.S. tax on GILTI from the maximum individual tax rate of 37% to the U.S. corporate tax rate of 21%;
- Enabling the taxpayer to claim an 80 percent foreign tax credit for Canadian corporation taxes paid on GILTI profits; and
- Enabling the taxpayer to use the section 250-authorized deduction for 50% of the GILTI.
The combined benefits of section 962 result in an effective tax rate of 13.125%. This means that if a Controlled Foreign Corporation’s Canadian corporate tax rate is 13.125% or higher, no United States tax should be owed on the Global Intangible Low-Taxed Income (GILTI).
3. High Tax Exclusion
Taxpayers have the option to exclude GILTI income if the Canadian corporate tax rate on GILTI revenue exceeds 90% of the U.S. corporate tax rate. The Canadian company tax rate must be higher than 18.9% (in comparison to the current U.S. corporate tax rate of 21%) in order to meet the criteria for this exception. Canadian CFC owners who make over $800,000 may find this option to be a viable alternative, depending on factors such as the taxing province and the availability of the small company rate of tax.
4. Unlimited Liability Companies (ULCs)
Unlimited liability companies are present in certain provinces in Canada, such as Nova Scotia, Alberta, and British Columbia. For U.S. tax purposes, these ULCs are considered disregarded entities. As such, the income received by the ULC being taxed as the owner’s income. Consequently, a ULC’s income is exempt from GILTI. However, since all corporate income is viewed as individual owner income in the U.S., it will be taxable income; the upside is that the individual can now claim a foreign tax credit at the personal level for taxes paid by the company.
Not only do you have to give up some Canadian tax deferral to avoid double taxation, but converting a limited liability company to a ULC is seen as a liquidation transaction in Canada, making the ULC solution impractical for established businesses.
While unlimited liability companies may not always be the perfect fit due to the burden they place on shareholders, by making a check-the-box election, businesses can enjoy the best of both worlds – limited liability and the perks of being treated as disregarded entities.
5. Avoid CFC Status
One clever way to navigate the complexities of U.S. shareholder regulations for Controlled Foreign Corporations (CFCs) is by getting a non-resident alien spouse to own 50% of the corporation. By doing so, you can sidestep CFC status and potentially benefit from GILTI provisions. It’s a nifty tactic worth considering!
6. Renunciation
For many Americans, tax reform was the tipping point. A lot of people have opted to merely renounce their citizenship. Reviewing the IRC section 877 and 877A in detail with their a tax advisor is advised.
In general, we anticipate that planning methods will follow one of two paths:
- Smaller CFC owners seeking simplicity will choose section 962 planning or, if practical, move to a non-CFC structure.
- The high-tax exception will be used by owners of large CFCs.
Navigating the complexities of GILTI tax on CCPCs can be challenging, but with the right knowledge and guidance, you can effectively manage your tax obligations. As experts in US international taxation, we are here to help you understand your tax obligations and plan strategically.
Remember, every individual’s tax situation is unique, and this article provides general information. For personalized advice, please consult with a tax professional.
At 1040 Abroad, we are dedicated to providing expert tax advice to those who need it. We understand that navigating international taxation can be complex, and we’re here to help. If you have any questions or need further clarification on any tax-related matters, please don’t hesitate to reach out to us. You can email us at info@1040abroad.com, and we’ll get back to you as soon as possible. We offer free tax advice to all who seek help because we believe in empowering you with the knowledge to manage your tax obligations effectively.
