A nasty attribute of the US tax system is that continuous reform efforts tend to build new regimes on top of old ones without worrying about abolishing the old ones. It seems that maintaining the old regime provides a sense of security no matter how old or flawed they are. Familiarity brings comfort.
Familiarity aside, this tax hierarchy can overlap. This complicates the tax laws of both taxpayers and the IRS staff responsible for managing the system. It can also create gaming opportunities.
This week’s column indulges in heretics by questioning the continued relevance of our elders, specifically the anti-postponement rules of almost 60 years ago. Has Subpart F been reduced to tax mess or has a lasting benefit? My default position is that running a single tax source erosion prevention regime is preferable to running multiple regimes if you haven’t achieved different things.
To that end, I will convey the minimalist teachings of Marie Kondo. Kondo is a leader in the Japanese lifestyle that keeps homes clean and, by extension, enhances quality of life. It’s better to have less. (Who thought there was good luck to be made by telling people to throw away their junk?)
Kondo’s method relies on some sort of critical self-assessment.We ask if each of our physical possessions provides a sense Tokimek, This roughly means “spark of joy” or “speed of your heart”. If this is not the case, you will need to destroy the item, but only after you are truly grateful that it has served its purpose once. There is an emotional closure in the expression of gratitude, even when directed at inanimate objects.
So reader: Does Subpart F still provide a spark of joy?
If the postponement itself is abolished as a result of tax cuts and employment legislation, is there a legitimate purpose to have a postponement prevention system (nominally just a timing rule)? More importantly, do we need Subpart F even if we have a global intangible low taxable income system?
Given that the Biden administration and parliamentarians are considering major changes to the GILTI rules, how to answer this question can change quickly. Throughout Washington, policymakers are asking themselves which of these rival proposals offers the best approach.
Please come up with the following suggestions. The optimal version of GILTI is a version that completely eliminates subpart F. This allows us to appreciate the service to the country and to discontinue it immediately. The urge to keep things tidy needs more.
For the past four years, I have answered the above questions positively. Yes, subpart F is still required in the post-TCJA environment. The sparks of joy may not be so abundant, but they are still there.
Income inclusion for the current year at the statutory tax rate (even at 21%) is significantly different from the results that could be obtained under GILTI with a 50% deduction of eligible income. This will continue even after the GILTI deduction for tax years beginning after 2025 drops to 37.5% as planned. Subpart F is partially needed to monitor the rate difference.
I don’t think many would be convinced that this is a compelling interest. fair enough.
Of course, that’s not all. As an income inclusion rule, GILTI and Subpart F may be kinship spirits, but they cover different grounds. Consider their structure. Subpart F is defined by the income categories that make it up, while GILTI is defined by exclusions — other income categories.
Also, while Subpart F is primarily related to passive income, GILTI does not suffer from the difference between passive and active income. Under GILTI, the fact that active income is a fair game is arguably a good model to prevent a shift in profits.
Preventing GILTI’s reach is the exclusion of qualified business asset investments. With QBAI allowances, there are segments of foreign income that completely avoid income inclusion and remain eligible for tax exemption under dividend income deductions. When you think about it, it’s a significant departure from the way US tax law operates over the last 100 years, and taxpayers are taxed on income “from any source.”
QBAI is a statutory class of foreign income that can avoid domestic taxation and there is no backstop mechanism, so if the host country is a tax haven, the taxation of the source country may not be very high.
On the one hand, QBAI is what territoriality looks like, and TCJA’s marketing promised territorial results. On the other hand, no one said there was no guardrail on the territory. Having a foreign enterprise structure managed as one of those backstops achieves some positive profits by protecting against the profit shifts allowed by GILTI.
In this regard, the current purpose of Subpart F is not to control whether CFC’s income is taxed early rather than later, but to exempt those foreign income and distribute it to the United States. Sometimes it is to monitor if you are eligible for Section 245A Exemption. group. This is an important feature, but taxpayers can plan subpart F through checkbox regulation.
One way to understand the importance of subpart F is to explain what can happen if it does not cover a subset of CFC revenue. Consider the high tax exception in Section 954 (b) (4). Generally speaking, the GILTI scheme taxes US groups based on CFC income that is not taxed in Subpart F. This prevents the same dollar from being taxed twice.
As an exception, to determine the inclusion of GILTI, CFC income ignores the amount excluded in the subpart F high tax exception. As a result, the group can avoid US taxation on such income in both Subpart F and GILTI. Distribution to groups is tax exempt under participation tax exemption.
If the CFC pays a truly high tax rate in the country of origin, the result (no tax in the country of residence) may be appropriate. This is the underlying logic of Section 954 (b) (4) and is consistent with the concept of territorial consciousness. However, we have seen how the high tax exceptions in Subpart F are manipulated by taxpayers.
So, yes, subpart F remains important, at least for now, in the post-GILTI world. Its direction is set to evolve in the light of the various changes being discussed. Readers will now notice a discussion draft published in late August by a trio of Democrats on the Senate Finance Committee: Chairman Ron Weiden, D-Ore. , Mark Warner, D-Va. , And Sherrod Brown, D-Ohio. Also, courtesy of the House Ways and Means Committee, there are rival suggestions from the other side of Capitol Hill.
These proposals are quite different and it is not yet known which details will go to the final bill. Details that have been overlooked will change in the future …