Is Unrealized Foreign Corporate Income Taxable in the U.S.?

Is Unrealized Foreign Income from a Corporation Taxable in the U.S.?

Unrealized Income from a Foreign Corporation and U.S. Taxes

Currently, there is a very important international tax case before the Supreme Court, Moore v. U.S., which (rightfully so) challenges the U.S. government’s ability to implement the ‘mandatory’ repatriation tax act. The Repatriation Tax Act requires U.S. taxpayers who have certain previously untaxed foreign income overseas to pay a one-time repatriation tax on either their 2017 or 2018 tax return. While some Taxpayers may get eight years to pay the amount due to the IRS, without any interest — the real question is whether this type of tax on unrealized income is even legal in the first place. It is important to note, that the Repatriation Tax Act is not the first time that the US government has implemented a tax regime allowing the US government to tax unrealized foreign corporate income. Let’s look at a few other common examples of unrealized foreign income that may be taxable to a US person.

Subpart F Income

One of the most common types of foreign income that gets taxed even before it is realized is ‘Subpart F income’ Subpart F income was introduced in 1962, when the tax rate could reach close to 90%. The concept behind this was that many years ago when the US tax rates were much higher, taxpayers got the idea of stashing money overseas and then instead of issuing distributions to the owners — they would issue loans, and then these loans would be forgiven and then nobody paid any tax and the international tax gap expanded further. To offset this issue, Subpart F income was developed in order to prevent taxpayers from moving money into lower tax jurisdictions offshore and then avoiding paying taxes altogether. While subpart F income can include many different types of income, for the most part, it includes passive income. Noting, there are exceptions to Subpart F income, such as the high tax exception.

PFIC MTM Election

PFIC refers to passive foreign investment companies. PFICs come in all different flavors, but for US taxpayers, oftentimes this will include foreign pooled funds such as mutual funds and ETFs. Taxpayers who want to avoid the typically harsh tax regime referred to as excess distributions may try to make certain elections such as a Qualified Electing Fund or a Mark-to-Market (MTM). With the MTM election, taxpayers pay tax on the increase in value of certain growth within these funds even though technically the funds have not distributed the income and thus there are no unrealized gains. This concept can get very complicated because most people do not consider their foreign mutual funds for example to be a company of which they are an investor. In other words, when a taxpayer goes on to the Vanguard equivalent overseas and invests in some mutual funds abroad, they don’t consider themselves an owner of the company per se. Nevertheless, this unrealized foreign income can be taxable since each mutual fund is generally its own corporate entity for structural purposes.

GILTI

GILTI refers to the Global Intangible Low Taxed Income. Quite frankly, these are just a bunch of weasel words combined together because oftentimes GILTI does not involve income that is necessarily intangible or low-taxed. From a baseline perspective, taxpayers who earn foreign income each year may have to include GILTI as part of their U.S. income. Noting, that there are some exceptions and limitations — and the high tax exception does apply. Still, it does not always work and some taxpayers are subject to income tax on this unrealized gain.

Section 965 as Written Should be Eliminated

The problem with IRC Section 965 and the repatriation tax is the simple fact that taxpayers want to be able to rely on the law. Thus, Taxpayers who have previously untaxed income overseas which is not a traditional type of Subpart F income (such as general earnings) are not normally taxed on this income until it is distributed out of the foreign company –  at which time foreign tax credits may apply. Instead, some Taxpayers who have kept a significant amount of previously untaxed income in these foreign companies were being blindsided with a 6 or 7-figure tax they were not prepared for.

Hopefully, the Supreme Court rules on the side of the taxpayers so that they can catch a break from what has really turned out to be a very unfair tax regime for taxpayers who operate on the right side of the law but just happen to have a global reach.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.