Subpart F Income vs. GILTI vs. PFIC – Framework of Anti-Deferrals
Subpart F Income vs. GILTI vs. PFIC: When it comes to U.S. tax liability, the IRS wants to tax you on all of your income, all of the time. You, on the other hand probably want to pay the least amount of tax possible.
Subpart F Income vs. GILTI vs. PFIC
That is why the U.S. government developed various anti-deferral regimes. Anti-deferral is used to avoid the “deferral” of income and corresponding tax liability. Three common (and sometimes overlapping) regimes include Subpart F Income, GILTI (Global Intangible Low-Taxed Income) and PFIC (Passive Foreign Investment Companies). While all of the these regimes have the same goal (aka to limit tax deferred income), they do not all work the same.
Let’s review the basics of each type of income:
Subpart F Basics
Subpart F income has been around for a long time. The regime came into effect as offshore investments became more regular.
Here is a common example of what used to happen more frequently: David is a U.S. person. He owns 55% of a foreign company. Tony is a foreign person who owns 45% of the company.
Since David is the majority owner, he can dictate how the operations work. Oftentimes, David would take a loan from the company. The company had consistent excess in earnings aka Earnings & Profit, which the company did not distribute.
As a result, David would take an annual loan of $300,000. And, every few years, the company would forgive and cancel the loan. Result:
- David has no income to report (subject to constructive dividend rules)
- The company can deduct the loss (vs. dividend distribution).
- David paid not tax on the money
Result: The U.S. developed the Subpart F Income regime. A detailed summary can be found here.
Unlike Subpart F, which is primarily dividends and related passive income, GILTI is more encompassing. As part of TCJA, the government introduced GILTI. Unfortunately, in practice, the income is not limited to intangible or low-taxed income.
Common example: Michelle is a doctor. She has a foreign service corporation which generates significant amounts of income. The income is then retained, and considered as “retained earnings.” Michelle does not have many assets associated with the business, so her deductions are limited.
Michelle may be subject to an annual tax on the retained portion of the income, which was not previously taxed. While Michelle may consider removing the corporate structure, the problem is that then she does not receive the tax benefit of the entity structure in her home country. Moreover, if she is a sole proprietor, all of her income is subject to tax, and she may lose some of the protection of being classified as an entity.
Learn more about GILTI.
PFIC is a Passive Foreign Income Company. These rules involve investment income that is being generated in a foreign country. Since most foreign institutions do not issue 1099 or comparable income summary forms, the IRS is in the dark as to the gains and profitability of many of these foreign investments.
In addition, the IRS is concerned that the investors are accruing income within the fund, and not reporting it. Subject to pension and treaty laws, the general proposition is that foreign investment income is reportable and taxable during the growth phase – even if the shareholder plans on keeping the investment overseas until retirement.
PFIC issues are very common. We have authored numerous articles on the topic. Here are links to a basic PFIC summary and/or how the excess distribution calculation works.
Foreign Income Reporting Amnesty – Golding & Golding (Board-Certified)
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