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FDII Export Incentive | Foreign Business Income Tax Lawyer & Attorney

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The 2017 Tax Cuts and Jobs Act (the “2017 tax reform” or “TCJA”) enacted a highly-lucrative incentive for US corporations to export directly from the United States – the Foreign-Derived Intangible Income (“FDII”) regime. In this article, I would like to introduce the readers in a general manner to the FDII export incentive contained in the TCJA.

FDII Export Incentive: TCJA

The creation of the participation exemption system posed a problem for the drafters of the TCJA – how does one stop US corporations from running all of their foreign business through a foreign corporation since foreign corporate profits may actually be transferred to the United States tax-free? Among other provisions of this complex law, the drafters utilized two powerful incentives for US corporations to export directly overseas.

The first one was a “stick” – the Global Intangible Low-Taxed Income or GILTI. The GILTI regime established what can be best described as a global minimum tax on the earnings of foreign subsidiaries of a US business entity.

The second approach was a “carrot” – the FDII export incentive. The FDII regime creates a powerful incentive for US corporations to export goods and services from the United States by creating a deemed deduction of a large percentage of corporate export income. In other words, the effective corporate tax rate is reduced through the FDII regime because a portion of a corporation’s export income is being deducted and never subject to US taxation.

FDII Export Incentive: General Description of the Deemed Deduction

The deemed deduction applies only to a US corporation’s FDII. FDII is basically a certain portion of corporate income from foreign sources determined by a formula established by Congress.

The formula requires a multi-step process. The first steps involve the determination of the Deduction-Eligible Income (DEI), Qualified Business Asset Investment (“QBAI”), Foreign-Derived Deduction-Eligible Income (“FDDEI”). Once all of these items are calculated, then the Deemed Intangible Income (“DII”) is figured out.

FDII is calculated last. The basic formula for FDII is: DII times the ratio of FDDEI over DEI.

The last step is to calculate the tax liability which involves the reduction of FDII by 37.5%. Thus, the effective tax rate for a corporate taxpayer (assuming the current 21% corporate tax rate stays the same) with respect to its FDII is only 13.125%.

It should be mentioned that the current deemed deduction will stay at 37.5% only through December 31, 2025. For the years after December 31, 2025, the deemed deduction will go down to 21.875%. This means that the effective tax rate on FDII will be 16.406%. Unless the law changes (which is possible), non-FDII corporate income will continue to be taxed at 21%.

FDII Export Incentive: Net Impact of the Deemed Deduction

Based on even just this general analysis of FDII, we can understand why the FDII export incentive is such an important part of the US corporate tax law. First, in most cases, the FDII deduction is a disincentive to shift foreign-source income from a US corporation to a controlled foreign corporation (“CFC”). A CFC may be subject to taxation under two different anti-deferral regimes, Subpart F or GILTI tax. Subpart F income will just force the recognition of foreign income by the CFC right away without any deemed deduction (i.e. this would be the worst-case scenario).

If the Subpart F rules do not apply, then the corporation may be subject to the GILTI tax. It is true that the effective corporate tax rate for GILTI, after its current 50% deemed reduction is only 10.5%. Nevertheless, FDII”s effective tax rate of 13.125% significantly reduces the difference from that what it would have been otherwise (i.e. between 10.5% and 21%). Moreover, when one factors in the additional administrative, US tax compliance and local tax compliance expenses, this difference may become nonexistent.

Second, the FDII deemed deduction makes US corporations more competitive worldwide, because they may now realize a higher profit margin even if they lower the prices for their products and services sold overseas.

Contact Sherayzen Law Office for Professional Help With FDII Calculations and International Business Tax Planning

If your business engages in selling products or services overseas, there are opportunities for international business tax planning from US perspective. Contact Sherayzen Law Office to take advantage of these opportunities through professional, creative and ethical tax help.

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Employment Income Sourcing | International Tax Lawyer & Attorney

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Employment income sourcing is a very important tax issue for employees of US corporations sent overseas, employees of foreign corporations stationed in the United States and employees who work in different countries during a tax year. For employees who are tax residents of a foreign country, this issue will determine whether their income will be taxed in the United States; whereas for US tax residents, the source of income rules will determine the amount of the allowable foreign tax credit. In this article, I will focus on the employment income sourcing rules concerning monetary compensation of employees.

Employment Income Sourcing: General Rules

The source of income rules concerning employees are very similar to the rules that apply to self-employment income, but there are some differences. The main rule is that the location where the services are rendered determines whether this is US-source income or foreign-source income. If an employee works in the United States, then his salary would be considered US-source income; if he works in a foreign country, his salary would be sourced to that country. See §§861(a)(3) and 862(a)(3).

If the employer pays for work partly performed in the United States and partly outside of the United States, then the salary needs to be allocated between the countries. Treas. Reg. §1.861-4(b)(2)(ii)(A). The key issue arises here – how does an employee allocate this income between the countries?

Employment Income Sourcing: Time Basis Allocation

The first methodology for allocation of income between the countries is stated directly within the regulations – time basis. Id. Here, the IRS offers two choices to the employees: allocation based on specific number of days working in the United States versus separate time periods.

Under the “number of days” variation, the employee adds together the number of days worked in the United States and the number of days worked in a foreign country, figures out the percentages for each country and sources the income according to the percentage allocation. Treas. Reg. §1.861-4(b)(2)(ii)(F).

Under the “time periods” variation, a tax year is split into distinct time periods: one where employee spends all of his time in the United States and one where employee spends all of his time in a foreign country. The compensation paid in the first period is allocated entirely to the United States, whereas the salary paid in the second time period is considered to be foreign-source income. Id.

Employment Income Sourcing: Multi-Year Compensation

An interesting situation occurs with respect to employees with multi-year compensation contracts. A multi-year contract in this context means a situation where the “compensation that is included in the income of an individual in one taxable year but that is attributable to a period that includes two or more taxable years.” Reg. §1.861-4(b)(2)(ii)(F).

Generally, the employment income sourcing in this case occurs in the following manner: (1) employee first aggregates his total contract compensation for the entire year; (2) then, the employee sums up all of the days worked in the United States and all of the days worked in a foreign country for the period covered by the multi-year contract; and (3) the employee sources the income to the United States based on the number of days worked in the United States vis-a-vis the total number of days worked under the contract; the rest of the income is considered foreign-source income. Id. While this approach is specifically described in the regulations, the regulations also generally refer to the “time basis” allocation. Hence, it appears that an employee may have a choice between the “number of days” approach that was just described and the “time periods” variation.

Employment Income Sourcing: Alternative Basis Sourcing

Employees have the right to disregard completely the time basis approach to employment income sourcing and adopt an alternative basis approach. Treas. Reg. §1.861-4(b)(2)(ii)(C)(1)(i).  An employee can do so as long as he is able to establish that “under the facts and circumstances of the particular case, the alternative basis more properly determines the source of the compensation than a basis described in paragraph (b)(2)(ii)(A) or (B), whichever is applicable, of this section.” Id.

An employee is not the only person who has this right; the IRS also has the right to utilize an alternative basis for employment income sourcing “if such compensation either is not for a specific time period or constitutes in substance a fringe benefit.” Treas. Reg. §1.861-4(b)(2)(ii)(C)(1)(ii). The IRS can do so as long as the “alternative basis determines the source of compensation in a more reasonable manner than the basis used by the individual pursuant to paragraph (b)(2)(ii)(A) or (B) of this section.” Id.

A taxpayer does not need to obtain the IRS consent in order to use the alternative basis for employment income sourcing. He should, however, keep the records in order to be able to show how his method is better than the time basis approach. TD 9212, 70 FR 40663, 40665 (07/14/2005).

Special requirements apply to employees who received $250,000 or more in compensation and use the alternative basis for employment income sourcing. Not only must such employees answer the relevant questions on Form 1040, but they should also attach a detailed statement to their tax returns. Id. The statement must contain the following information: “(1) The specific compensation income, or the specific fringe benefit, for which an alternative method is used; (2) for each such item, the alternative method of allocation of source used; (3) for each such item, a computation showing how the alternative allocation was computed; and (4) a comparison of the dollar amount of the compensation sourced within and without the United States under both the individual’s alternative basis and the basis for determining source of compensation described in § 1.861-4(b)(2)(ii)(A) or (B).” Id.

Contact Sherayzen Law Office for Professional Help With US International Tax Law

If you are a US taxpayer who receives foreign-source income and/or has foreign assets, contact Sherayzen Law Office for professional help. Our professional tax team, headed by international tax attorney, Mr. Eugene Sherayzen, has helped hundreds of US taxpayers around the world with their US international tax issues. We can help You!

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Happy New Year 2019 from Sherayzen Law Office!

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The legal tax team of Sherayzen Law Office, Ltd. wishes a very Happy New Year 2019 to our clients, blog readers and all US taxpayers around the world! May this new year bring you good health, prosperity and happiness! And, of course, full and proper compliance with all US international tax laws.

2019 Will Be a Highly Challenging Year from US Tax Compliance Perspective Due to the 2017 Tax Reform

The coming year is going to be a challenging one for all US taxpayers due to the enormous changes made to the Internal Revenue Code as a result of the 2017 tax reform. Already in 2018, some US taxpayers (especially owners of foreign corporations) had to work through the tax year 2017 transition rules.

The 2017 tax reform will be felt on an even grander scale in 2019 as millions of US taxpayers will struggle with the new rules in order to correctly file their 2018 tax returns. While many of these rules are meant to benefit these taxpayers, the tax compliance associated with them is likely to be complex.

Happy New Year 2019 to Individual US Taxpayers!

After the pain of learning how to comply with the new rules subsides, tens of millions of Americans are likely to call this a Happy New Year 2019 due to lower 2018 individual tax rates, the doubling of the child tax credit and higher standard deduction.

Millions of other, especially the upper middle-class Americans, however, are likely to be greatly hurt by the itemized deductions limitations with respect to state taxes and property taxes. The elimination of personal exemptions will further aggravate this problem. It will not be a Happy New Year 2019 for these taxpayers.

Happy New Year 2019 to Small-Business Owners!

It should still be a Happy New Year 2019 for the majority of the small business owners, including owners of S-corporations, due to the 20% reduction of pass-through income mandated by the tax reform. New depreciation rules are likely to have an overall beneficial impact, even if, in some cases, they may not be very helpful.

Happy New Year 2019 to C-Corporations and Their US & Foreign Owners!

It will be a very Happy New Year 2019 for one class of taxpayers in particular – regular C-corporations. These taxpayers arguably benefitted from the 2017 tax reform more than any type of taxpayers. The reduction in the tax rate from 35% to 21%, introduction of Foreign-Derived Intangible Income (“FDII”) and a whole series of small changes to corporate tax code have already led to the surge to corporate profits; this corporate tax boom is likely to continue to play out this year.

On the other hand, the introduction of the GILTI (Global Intangible Low-Taxed Income) tax, new attribution rules concerning the inclusion of non-US corporations and a myriad of other rules will greatly complicate the tax year 2018 corporate tax compliance. In fact, some corporations that never paid any taxes on their foreign income may now be forced to pay the GILTI tax in the United States.

Happy New Year 2019 to US Taxpayers Who Are Trying to Remedy Past Tax Noncompliance Through an Offshore Voluntary Disclosure!

The taxpayers with undisclosed foreign bank accounts and other assets will face increasing challenges in the year 2019 due to two unwelcome trends that came into existence after FATCA was fully implemented but became apparent to most professionals only in 2018. First, the IRS is narrowing the voluntary disclosure options, especially for willful taxpayers. As I just mentioned, this trend began already in 2017, but it could be clearly observed in the closure of the flagship 2014 OVDP on September 28, 2018. While it does not appear that the Streamlined Compliance Procedures will be targeted by the IRS any time soon, there is always a danger that the IRS may modify the terms of this voluntary disclosure option.

The November 20, 2018 modification of the Traditional Voluntary Disclosure (which greatly narrowed the utility of this option) is another manifestation of this trend. In fact, this modification poses a direct danger of forcing taxpayers into either Streamlined Compliance Procedures or the Traditional Voluntary Disclosure Program at the expense of Reasonable Cause disclosures.

The second trend complements the first trend: the loss of interest in offshore voluntary disclosures directly coincided with an increasingly aggressive IRS tax enforcement. The IRS audits, especially international tax audits, are on the rise as the IRS is taking advantage of the huge pile of information it has accumulated as a result of the previous voluntary disclosure programs, Swiss bank program and FATCA compliance.

The taxpayers will need professional help from an international tax attorney to successfully navigate around the legal challenges posed by these two negative trends in US international tax enforcement.

Taxpayers Will Need the Professional Help of Sherayzen Law Office For Proper Tax Compliance and Offshore Voluntary Disclosures of Foreign Assets in 2019

Overall, the new year 2019 promises to be a very interesting but highly complex year from the perspective of US international tax compliance. US taxpayers without adequate legal help are likely to either fail to take full benefit of the 2017 tax reform, suffer excessively from the negative aspects of the reform and/or even face the dreaded IRS penalties for international tax noncompliance.

At the same time, the narrower post-OVDP offshore voluntary disclosure options and the rising intensity of IRS audits will also present additional challenges to the already difficult situation of many taxpayers who wish to voluntarily resolve their past US international tax noncompliance issues.

Sherayzen Law Office can help you meet all of your 2019 tax challenges, including annual 2018 tax compliance, 2019 offshore voluntary disclosures of foreign assets and foreign income and IRS audit defense. We have helped hundreds of US taxpayers like you, and We can help you!

Contact Us Today to Schedule Your Confidential Consultation!

Sherayzen Law Office Successfully Completes October 2018 Tax Season

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Sherayzen Law Office, Ltd., successfully ended yet another tax season. The October 2018 tax season presented formidable challenges not only due to the diversity of the issues involved, but also the sheer volume of deadlines that needed to be completed between September 16 and October 15, 2018.

Let’s analyze the October 2018 tax season in more detail.

October 2018 Tax Season: Diversity of Tax Forms

During this October 2018 tax season, the tax team of Sherayzen Law Office had to deal with highly diverse tax issues – as usual. Our team is very well-versed in foreign income reporting and US international information returns such as: FBAR and FATCA Form 8938, business tax forms (926, 5471, 8858 and 8865), foreign trust forms (3520 and 3520-A), foreign gifts & inheritance reporting (Form 3520 and other relevant forms), PFICs and others. All of these forms needed to be completed for the October 2018 tax season.

However, there was something very new this time – Section 965 Transition Tax. As a result of the 2017 tax reform, US owners of certain foreign corporations were forced to recognize as income the accumulated E&P of their foreign corporations at their ownership percentage. The Section 965 tax compliance added a significant burden to the October 2018 tax season.

October 2018 Tax Season: High Volume of Deadlines & High Diversity of Assets

Between September 16 and October 15, 2018, Sherayzen Law Office completed over 70 deadlines for its clients. As part of these deadlines, we filed about 50 FBARs and a similar number of Forms 8938, about two dozens of Forms 5471/5472 and a smaller number of Forms 8865, about a dozen of Forms 3520 and over 200 Forms 8621.

Numerous forms were filed to report foreign rental income as well as foreign dividend and interest income. The vast majority of the filed tax returns included Foreign Tax Credit calculations.

October 2018 Tax Season: Diversity of Countries

The reported assets belonged to a wide variety of countries. During the October 2018 Tax Season, Sherayzen Law Office reported assets from virtually all main areas of the world. The majority of assets were reported from the European (particularly: France, Germany, Italy and the United Kingdom) and Asian countries (especially, China, India and Thailand); a smaller number of assets reported for Canada and Latin America. The deadlines for most of our New Zealand and all of our Australian clients were completed prior to September 15.

Lebanon and Egypt stood out among the Middle Eastern clients.

Sherayzen Law Office is a Leader in US International Tax Compliance

Sherayzen Law Office is committed to helping our clients to properly comply with their US international tax requirements. Our highly knowledge and higher experienced tax team has successfully helped hundreds of clients around the world with their US tax compliance issues, including offshore voluntary disclosures of foreign assets and foreign income. Our successful October 2018 tax season is just another proof of our commitment to our clients!

Contact Us Today to Schedule Your Confidential Consultation!