Section 962 Elections, GILTI, and "As If" in the Internal Revenue Code

Yet Another "As If"

And the preparation for next Friday's Section 962 workshop dragged my attention across a sleepy backwater of the Internal Code: Section 951A(f)(1)(A).Well, not so sleepy, actually. Section 951A is the gnarled source of that gratuitously complex eruption of overly excessive legislative overkill dubbed GILTI by its authors.¹There we find a newly-minted (circa December, 2017) instance of "as if", this time disguised by using the magic words "in the same manner".Everything works out in the end. We can figure out what the law is (more or less). Still, I wish the writers (let's be fair to writers, like Sparky Anderson)² had not introduced yet another fiction into the Code.Let's go exploring.

What's a Section 962 election?

Section 962 is an election for a U.S. shareholder human being to be taxed as a corporation on Subpart F income. Rufus likes to refer to this as a "phantom corporation."³The human, for tax purposes and only for the purposes of this income, will be treated as a phantom corporation.Why on earth would a human want to be taxed as a corporation? Answer: lower tax rates and foreign tax credits.

Tax Rate

The election applies only to income received by a U.S. shareholder under Section 951(a). Subpart F income. As to that income, a human shareholder in a foreign corporation can elect to have Subpart F income taxed at corporate rates.Now that corporate income tax rates are 21%, this is . . . interesting. Human income tax rates are usually higher than that.

Tax Credit

Additionally, making the Section 962 election allows the individual shareholder to use the indirect foreign tax credit rules of Section 960.This means that if the foreign corporation paid income tax on the Subpart F income, the individual shareholder would be allowed to claim a foreign tax credit.Ordinarily, Section 960 only allows U.S. corporations to take a foreign tax credit for taxes paid by their subsidiaries. Humans can only get a foreign tax credit if they, themselves, actually pay the foreign income tax.When an individual makes the Section 962 election, you can think of the individual taxpayer as a "phantom corporation" -- taxed as if a human is a corporation -- and therefore entitled to use the indirect foreign tax credit.

Section 962 Election vs. GILTI

I won't even explain what GILTI is. Nor will I parse the acronym.⁴ For our purposes, it doesn't matter. Let's just focus on what it does, and why.

Why GILTI exists

Congress reworked international tax laws dramatically last December. You know that. You're an international tax groupie.To prevent American multinationals from overly-aggressive income shifting to foreign subsidiaries,⁵ Congress installed a kind of minimum tax on shareholders in foreign corporations.A certain amount of the foreign corporation's operating income is treated as if it is received by the U.S. shareholder. The calculations are complicated. But the primary purpose is to force immediate taxation of most of a foreign subsidiary's operating income. ("Most" means whatever amount the complicated formula tells you).GILTI dovetails neatly with Subpart F:

• GILTI forces a U.S. shareholder to pay tax on a computed amount of a foreign corporation's operating income.
• Subpart F forces a U.S. shareholder to pay tax on the foreign corporation's passive income.

GILTI vs. Section 962

GILTI (a type of income) is included in the gross income of a U.S. shareholder because Section 951A(a) says so:

Each person who is a United States shareholder of any controlled foreign corporation for any taxable year of such United States shareholder shall include in gross income such shareholder’s global intangible low-taxed income for such taxable year.

Section 962 says the election for a human to be taxed like a corporation applies only to Subpart F income, included because Section 951(a) says so.⁶GILTI is not Subpart F income. So at first blush a Section 962 election should not apply to GILTI.But . . .Here's where fiction saves us. "As if". "In the same manner as". "Let's pretend".For certain limited purposes (including Section 962 elections), we are allowed to pretend that GILTI is Subpart F income.

[G]lobal intangible low-taxed income included in gross income under subsection (a) shall be treated in the same manner as an amount included under section 951(a)(1)(A) for purposes of applying sections 168(h)(2)(B), 535(b)(10), 851(b), 904(h)(1), 959, 961, 962, 993(a)(1)(E), 996(f)(1), 1248(b)(1), 1248(d)(1), 6501(e)(1)(C), 6654(d)(2)(D), and 6655(e)(4).⁷

So. This is as close to a simple declarative statement as you will find in the Code. You can use a Section 962 election to be taxed on GILTI as if you are a corporation.The result will be:

• You are taxed on GILTI at a 21% tax rate; and
• You can get indirect foreign tax credit.

"As if" you're a corporation for everything GILTI-related?

Interesting question.Brand new Section 250 says that you get a deduction of 50% of GILTI included in gross income. But this is true only if you are a "domestic corporation".So. If you make a Section 962 election to be taxed as a corporation, are you a "domestic corporation" for Section 250 purposes? If so, this will cut your tax in half, because your GILTI included in gross income will be cut in half.The law is silent.Some commentators says "yes", a Section 250 deduction will be permitted against GILTI.Other commentators say no--Section 250 is limited to domestic corporations, not "as if" or "phantom" corporations.All I can tell you is . . . attend the May 4, 2018 workshop, where Rufus and I will play dueling banjos on this topic--and others.