By Linda Pelczarski, CPA – Moore Stephens Doeren Mayhew

The Internal Revenue Service (IRS) has released a new Form 1118, “Foreign Tax Credit — Corporations,” and new instructions along with it. However, with the Tax Cuts and Jobs Act (TCJA), it might also impact individuals who own foreign corporations.

Credit Overview

The United States and foreign countries may tax the foreign-source income of U.S. taxpayers. The amount of taxes imposed by foreign countries is allowed as a credit against U.S. taxes (but then a deduction cannot be taken).

The foreign tax credit is limited to the U.S. tax on foreign-source income. This ensures that the credit only mitigates double taxation of foreign-source income without offsetting U.S. tax on U.S.-source income.

The foreign tax credit limitation is calculated separately for certain categories, or “baskets,” of income. Under pre-TCJA law, there were two such baskets:

  • passive income, and
  • general income (defined as income other than passive income).

On Dec. 22, 2017, President Trump signed into law the TCJA. It made far-reaching changes to the treatment of foreign taxes and the foreign tax credit (FTC). There are now at least four baskets of income to consider for FTC purposes and certain subgroups within these baskets that need to be reported.

Impact of Tax Reform

The TCJA makes the following changes to the calculation of FTC:

Two new foreign tax credit limitation categories.
Section 904(d) was amended to add two new baskets for determining the allowable foreign tax credit:

1.  GILTI Shareholders of controlled foreign corporations (CFCs) must include in gross income their global intangible low-taxed income (GILTI) for the tax year in a similar manner to Subpart F income (certain income earned by CFCs, which certain U.S. shareholders generally must currently recognize). Any amount includible in gross income as GILTI, other than passive basket income, is included as a separate foreign tax credit basket.

2. Foreign branch incomeForeign branch income must be allocated to a specific foreign tax credit basket. Foreign branch income is defined as the business profits of a U.S. person attributable to one or more qualified business units in one or more foreign countries.

Repeal of Sec. 902 indirect credits with respect to dividends from foreign corporations.
No foreign tax credit or deduction is allowed for any taxes (including withholding taxes) paid or accrued with respect to any dividend to which the deduction for a foreign-source portion of dividends applies. This change applies to tax years of foreign corporations that begin after Dec. 31, 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.

Modification of indirect credits under Sec. 960 for inclusions under Sec. 951(a)(1) and Sec. 951A.
Under Sec. 960, a foreign tax credit is allowed for any Subpart F income that’s included in the income of the U.S. shareholder on a current-year basis. Under Sec. 951(a)(1), 10 percent U.S. shareholders of a CFC are required to include in income their pro rata share of the CFC’s Subpart F income, whether or not this income is distributed to them.

If a domestic corporation takes into income a Subpart F inclusion as to a CFC in which it’s a U.S. shareholder, the domestic corporation is deemed to have paid as much of the foreign corporation’s foreign income taxes as is properly attributable to that income. For purposes of the CFC provisions, if any amount is includible in the gross income of a domestic corporation as GILTI, that domestic corporation is deemed to have paid foreign income taxes equal to 80 percent of the foreign income taxes paid or accrued by CFCs.

Modification of Sec. 78 gross-up with respect to Subpart F and GILTI income inclusions.
If a domestic corporation chooses to take a foreign tax credit for any tax year, an amount equal to the taxes deemed to be paid by that foreign corporation is treated for income tax purposes as a dividend received by that domestic corporation from the foreign corporation.

New adjustments for purposes of Sec. 904 with respect to expenses allocable to certain stock or dividends for which a dividends-received deduction is allowed under Sec. 245A.
Under the TCJA, if a domestic corporation that’s a U.S. shareholder of a 10-percent owned specified foreign corporation receives a dividend from that foreign corporation, a deduction is allowed for the foreign-source portion of the dividend.

For purposes of determining the foreign tax credit limitation, in the case of a domestic corporation that’s a U.S. shareholder, the shareholder’s taxable income from sources outside the United States (and entire taxable income) is determined without regard to the foreign-source portion of any dividend received from that foreign corporation. This determination is also made without regard for any deductions properly allocable or apportioned to:

  • Income other than amounts includible as Subpart F or GILTI income, or
  • Such stock to the extent income with respect to the stock is other than amounts includible in Subpart F or GILTI.

Thus, for deductions for tax years ending after Dec. 31, 2017, dividends allowed as a Sec. 245A dividends-received deduction aren’t treated as foreign-source income for purposes of the foreign tax credit limitation.

Limited FTC with respect to inclusions under Sec. 965 (the “Transition Tax”).
For the year (calendar year 2017 for many), a U.S. shareholder that was a domestic corporation included its Sec. 965 net income in taxable income and was subject to the transition tax, the specified foreign corporation (e.g., a CFC) increased the amount of its Subpart F income that could be distributed tax free in the future.  However, the foreign tax credit is limited, but in calculating the transition tax and in future years when this income is distributed. The new form requires reporting related to these taxes and how they are treated.

Individual U.S. Shareholders Taxed Under the Transition Tax Provisions.
The new Form 1118 may be a form required for individual U.S. shareholders, not just for domestic corporations that are U.S. shareholders. This is because under the transition tax provisions, an individual U.S. shareholder could elect (Sec. 962) to be taxed in a manner like a corporation U.S. shareholder. This election is potentially even more attractive under the new GILTI deemed income inclusion provisions that start for 2018 calendar year CFC U.S. shareholders. This will require these individuals to understand the requirement in completing the Form 1118 because it will need to be included with their Form 1040.

Our international tax advisors at Moore Stephens Doeren Mayhew have been analyzing the TCJA provisions and the new Form 1118 and are prepared to discuss how this might impact your corporate or individual income tax return. This includes an analysis as to whether the Sec. 962 election might be beneficial in reducing the U.S. taxes you need to pay currently because of the new GILTI deemed income inclusion rules. Contact us today for assistance.

*This article is a reprint from Moore Stephens Doeren Mayhew’s GlobalVIEW.