TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, July 12, 2018

Long-Ignored § 962 Could Let Wealthy Tap 21% Corporate Rate Under New Tax Law

Bloomberg, Tax Loophole From 1960s Could Let Wealthy Tap 21% Corporate Rate:

An obscure tax provision [§ 962] from the 1960s that was left untouched by President Donald Trump’s overhaul could let wealthy individual investors seize for themselves the largest corporate tax cut in U.S. history.

The measure — signed into law by President John F. Kennedy — was designed to prevent Americans from indefinitely shielding themselves from taxes by keeping investments offshore. It forced them to pay taxes annually on these investments, but gave them the option to have that income taxed at the corporate rate instead of at individual rates.

But that all changed in December, when Trump’s tax law slashed the corporate rate to 21 percent — 16 percentage points lower than the top federal individual income tax rate.

“It’s almost never been used until now,” said David S. Miller, a tax attorney with Proskauer Rose LLP in New York. “As far as I can tell, we just forgot about it.”

Since Trump signed the tax legislation, accountants, attorneys and the Internal Revenue Service have spent months attempting to discern its implications. One reason for the struggle is that rather than replace old tax laws with a new regime, Republicans grafted the new law onto decades of old regulations, leading to unintended consequences. Tax professionals say they think the offshore loophole could help wealthy Americans who have investments that yield interest, rent or royalties defer millions of dollars in taxes.

http://taxprof.typepad.com/taxprof_blog/2018/07/long-ignored-962-could-let-wealthy-tap-21-corporate-rate-under-new-tax-law.html

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Comments

Before you jump to plug this "loophole" consider how section 962 plays out for US expat entrepreneurs who have been inadvertently burdened with both section 965 (repatriation) and section 951A (GILTI). Section 962 allows these taxpayers to offset US tax with the tax they have already paid in their home countries on the same income. In the year that the US tax code treats undistributed income of the CFC as taxable to the shareholder, section 962 allows a deemed paid credit for the home country tax paid inside the corporation. While US tax on the subsequent distribution is higher due to the interaction between section 962 and section 959 - there will be home country tax on any dividend distribution which will offset much (if not all) of the US tax due. And, given that GILTI is its own separate FTC basket with no carryovers or carrybacks, the deemed paid FTC from section 962 may be the only way for individual US shareholders to offset US tax on GILTI with tax already paid at home.

Of course, the real solution to this problem is for the US to join the rest of the world and tax based on residence (and source) rather than citizenship. The current system of taxing the residents (and often citizens) of other countries is a 19th century idea that has no place in a globally mobile 21st century economy. Until this is fixed there will continue to be instances where laws which make perfect sense for US resident taxpayers have devastating unintended consequences for tax residents of other countries who happen to be US citizens as well.

Posted by: Karen | Jul 13, 2018 6:53:33 AM

I believe this article is incorrect.

1) For U.S. based residents to take advantage of the recent tax changes for U.S. companies with overseas operations, such investments need to be in a corporate structure. The U.S. applies punitive reporting and taxation for passive structures “foreign” to the U.S.; meaning passive as in just containing investments and no real business operations. The dreaded U.S. treatment for passive foreign companies is called PFIC.

2) The premise of the article does not appear informed about U.S. FATCA requirement to report US person accounts in other countries.

3) The premise of the article presumes that there are no other better structures to hide investments and income from U.S. taxation. I introduce Delaware. Companies for passive or real purposes may be set up in Delaware without disclosure of the beneficiaries of such companies. One may think such structures better to hide international and U.S. based investments with anonymity protected by state law, and free from FATCA and CRS regulations and reporting imposed in other countries. Because of states such as Delaware the U.S. is now recognised internationally among the top three tax haven countries in the world.

While the word “unintended consequences” is used in the article there is no mention of the very consequential consequences for the 6-9 million U.S. persons resident overseas. The tax reform was supposed to also not just be about companies overseas but to include “Territorial Taxation for Individuals,” which would be a version of the Residence Based Taxation as practiced by all other nations in the world except for the U.S. and Eritrea.

The U.S. claim of tax jurisdiction over the residents of other counties completely fails accepted norms around the justification of taxation. Simply, taxation may be justified if services are provided in exchange. In the case of the U.S. claim of tax jurisdiction over residents of other countries there are zero resident services provided in exchange such as for roads, health, unemployment, and for the protection of local property and local rights. These services are provided by the countries in which these individuals live and in exchange for taxes paid to these countries, with an estimated 92.5% of the 6-9 million U.S. persons overseas living in higher taxing countries than the U.S.

A similar comparison: If one lives in California and they move to New York, as a tax resident of New York State they pay state taxes there for the state services they receive there. They then are no longer required to report accounts and pay tax to California with justification that they no longer receive resident services of the State of California. If they move back to California then as California residents then they would be required to pay California state taxes once again. This should be the way for U.S. persons living overseas,

Thus the U.S. double tax claim is not justified. It is one-way in that zero resident services are provided in exchange. An egregious aspect is the punitive treatment of the U.S. tax code for accounts, assets, pensions, and companies that are “foreign” to the U.S., a tax code filled with catch-22 gotchas in the overlay of the U.S. code on top of the code of the country one is resident in; even though these people may have lived for decades in an other countries (think U.K., Canada, Australia), and all their finances are local to them and they may have very tenuous ties to the U.S.

The U.S. double tax claim has been called Tributary Slavery. This term was used by Samuel Adams writing about the imposition of taxation by England on the American Colonies. Actually today the situation is far worse for the reasons stated above, and that in the times of King George III the Colonies were part of England and there were services provided in exchange most notably for local protection of property.

Posted by: JC DoubleTaxed | Jul 14, 2018 8:23:54 PM