Final GILTI regulations change reporting for U.S. partnerships and s corporations

On June 21, 2019, final Global Intangible Low-Taxed Income (GILTI) regulations (final regulations) were published, drastically changing reporting requirements for controlled foreign corporations (CFCs) held by U.S. partnerships and S corporations.

Following is an overview of major changes introduced by the final regulations and key insight to help partnerships and shareholders remain compliant.

Background

GILTI is intended to deter U.S.-based multinational corporations from directing profits offshore into lower-tax jurisdictions. It was introduced through the 2017 tax reform reconciliation act, commonly referred to as the Tax Cuts and Jobs Act (TCJA).

The provision requires that a U.S. shareholder of a controlled foreign corporation (CFC) include GILTI income on its return similar to Subpart F. Corporations and individuals making a Section 962 election, subject to certain limitations, could potentially lower the effective tax rate on this income to 10.5%.

GILTI is defined as income of the CFC — certain income, such as Subpart F, is excluded — that exceeds 10% of the foreign subsidiary’s qualified business asset investment (QBAI). Certain losses from one CFC could offset the income of another CFC in the GILTI inclusion computation for the U.S. shareholder.

Proposed GILTI regulations (proposed regulations), introduced in September 2018, stated the GILTI inclusions were to be calculated at the entity level and reported on each owner’s Schedule K-1.

Regulation changes

Although final GILTI regulations uphold many elements of those proposed, there are a few significant modifications that will likely impact how shareholders and partnerships report GILTI.

Shareholder-level calculation

Under proposed regulations, a U.S. partnership could be considered a U.S. shareholder of a CFC. Accordingly, the GILTI inclusions were to be calculated at the partnership level and reported on each shareholder’s Schedule K-1. That meant any U.S. partner who was part of a partnership that was a U.S. shareholder in a CFC had to include GILTI on their U.S. tax return, even if they individually owned less than 10% interest in the CFC.

For GILTI purposes, the final regulations treat the partners as owning proportionately the stock of the CFC that the partnership owns. Now, GILTI is calculated at the partner or shareholder level, rather than the partnership level. This means that any partner or S corporation shareholder who individually owns less than 10% interest in a CFC, but who is part of a partnership that owns 10% of interest or greater in the CFC, no longer needs to include GILTI.

Reporting revisions

While this GILTI calculation change may provide significant savings for many individual shareholders, it also increases individual shareholder reporting responsibilities. GILTI was previously calculated and included in the overall partnership’s Schedule K-1 footnotes, however, partners must now individually calculate their CFC interest ownership and report it in their Schedule K-1 footnotes if they own 10% interest or greater in a CFC. The good news is that any partner who doesn’t meet the definition of U.S. shareholder isn’t required to report any of their ownership in the CFC.

Entity attribution rules

Defining a U.S. shareholder can be complicated if a CFC has a tiered-entity structure. That’s because the attribution rules can change the results of how much interest a partner actually owns.

For example, let’s say a partner owns 10% of a first-tiered partnership that owns 90% of another partnership, and that second partnership then owns 100% of a CFC. To determine shareholder status, the partner would multiply their ownership in each entity, making the calculation 10 x 90 x 100, which equates to 9% interest ownership.

However, the attribution rules would dictate that the top-tier partnership controls the entity in which it owns a 90% interest. That means the calculation should actually be 10 x 100 x 100, which equates to 10% effective interest in a CFC at the individual level. In this case, the partner qualifies as a U.S. shareholder, and must report their ownership interest on their return.

Notice 2019-46

On Aug. 22, 2019, the IRS issued Notice 2019-46 (notice) to address the filing of pass-through entity returns with the change in the final regulations. The notice states that the IRS and the U.S. Treasury Department intend to issue regulations that will allow a U.S. partnership or S corporation to apply a portion of the proposed regulations for tax years ending before June 22, 2019.

The notice lays out notification requirements if a taxpayer were to elect to apply the proposed regulations, and the notification needs to occur before the extended due date of the return.

Effective dates

The final GILTI regulations were published within the 18-month window of the TCJA, which means they will retroactively apply to December 2017, when the TCJA was passed.

Any calendar-year 2018 taxpayer that has already filed may need to amend their return or follow the procedures in the notice for electing to apply the proposed regulations. Calendar-year 2018 filers that haven’t yet filed need to either file a return consistent with the final regulations or follow the procedures laid out in the notice.

Key takeaway

Changes introduced in the final regulations may lead to potential tax savings for shareholders that own less than 10% of a pass-through entity. However, for partners to receive potential tax savings, any already-filed 2018 U.S. partnership or S corporation return that calculates GILTI at the entity level should be reviewed and amended to comply with final GILTI regulation changes.

Individual owners of CFCs are also now obligated to calculate and report their pro rata share of GILTI. They must also report all information that would ordinarily be reported on the Form 8992, as well as the relevant foreign tax credit information, on the Schedule K-1 footnotes.