The Tax Cuts and Jobs Act of 2017 (TCJA) made many changes to how the U.S. taxes earnings or dividends from overseas. One of the areas impacted was foreign tax credits, which changes how taxpayers in the U.S. calculate and pay taxes on certain foreign income. Like many other parts of tax law, this can be complicated, so we’ve broken things down to explain what these changes could mean to you, whether you’re a U.S. expatriate, a corporation, or you receive income from overseas.
There are five main areas that the IRS changes as a result of the TCJA, and we’ll cover each one below.
As always, everyone has unique tax circumstances, so if you have any questions please contact us.
Foreign Tax Credits and Dividends Received by a Domestic Corporation
This section of foreign tax credits applies to U.S. domestic corporations that own ten percent or more of the voting stock in an overseas corporation.
Before the TCJA, domestic corporations would get a credit for income tax paid on dividends received from overseas corporations. Following the TCJA the U.S. domestic corporation gets:
A 100-percent deduction for the foreign-source portion of the dividends received from the foreign corporation.
This is subject to a one year holding period.
There is no foreign tax credit or deduction for any overseas taxes paid or accrued on the qualifying dividend.
Limitations on Foreign Tax Credits by Income Categories
Prior to the TCJA, overseas income was classified as “passive” or “general” and taxed accordingly. The TCJA made several changes to this area.
The IRS now allows for separate income categories for non-passive Global Intangible Low Tax Income (GILTI), and foreign branch income. The IRS says that foreign branch income is, “the business profits of a U.S. person attributable to qualified business units (QBUs) in foreign countries.”
The new law also means you can’t carryover or carryback any foreign tax credits to or from your GILTI income category.
Unused Domestic Losses and Foreign Tax Credits
Before the TCJA, domestic losses had to be shown by creating or increasing a balance in a domestic loss account, and part of the U.S.-sourced taxable income needed to be recharacterized in the following years as foreign-sourced taxable income. The IRS had various rules about how to calculate foreign-sourced taxable income for foriegn tax credit purposes.
Since the TCJA, you can elect to recapture up to all of any pre-2018 unused overall domestic loss amounts from a prior year. You can elect to apply this to any taxable year beginning after December 31, 2017, and before January 1, 2028.
Changes to “Deemed-Paid” Credit on Foreign-Sourced Income and Distributions
The TCJA made several changes to part of the tax law known as “Subpart F.” Before the new law came into effect, overseas income earned by a foreign subsidiary of a U.S. corporation typically isn’t taxed until the subsidiary pays the income as a dividend to the U.S. parent corporation.
Under Subpart F, certain income was taxed to U.S. shareholders. This was calculated under something called “pooling concepts.” The TCJA removed pooling concepts and replaced them with a “properly attributable to” standard.
This standard is now used to calculate:
“Deemed paid” taxes with Subpart F inclusions.
Foreign taxes on the distribution of previously taxed income.
Revised Sourcing Rules for Inventory
Previously, you had to divide your gross income from sales between production activity and sales activity. You needed to do this using one of the methods described in the IRS regulations. Following TCJA changes:
The source of income from inventory sales is based on where the inventory was produced
Sales income from inventory property produced in the U.S. and sold overseas is considered to be 100 percent U.S.-sourced.
Income from inventory property produced partly within and partly outside the United States is considered to be partly U.S.-sourced and partly foreign-sourced.