For American business owners expanding overseas, foreign corporations offer massive growth potential. However, navigating U.S. international tax law is critical to keeping profits from being eroded. The most significant hurdle for cross-border businesses is the Global Intangible Low-Taxed Income (GILTI) tax.
Understanding GILTI is essential for protecting your foreign profits from double taxation.
What is GILTI?
The GILTI tax regime was enacted under the 2017 Tax Cuts and Jobs Act (TCJA). Despite its name, GILTI does not just apply to intangible assets like patents or trademarks. It applies to active business operations conducted through foreign corporations.
GILTI targets U.S. shareholders who own a significant stake in a Controlled Foreign Corporation (CFC). A CFC is any foreign corporation where U.S. shareholders own more than 50% of the total vote or value. If you are a U.S. citizen, resident, or domestic entity owning 10% or more of a CFC, GILTI applies to you.
The tax ensures that foreign earnings are taxed by the U.S. annually, rather than being deferred indefinitely.
How GILTI is Calculated
The IRS calculates GILTI by looking at your foreign corporation’s net income and subtracting a routine return on tangible assets. The remaining “excess” profit is deemed GILTI and taxed in the United States.
The Calculation Formula
- Net CFC Tested Income: The gross income of the foreign corporation minus its operating expenses and taxes.
- Qualified Business Asset Investment (QBAI): The average quarterly adjusted basis of depreciable tangible assets (like machinery, buildings, and equipment) used in the business.
- Net Deemed Tangible Income Return: The law allows a standard 10% tax-free return on your QBAI, minus certain interest expenses.
- GILTI: Net CFC Tested Income minus the 10% Net Deemed Tangible Income Return.
Hypothetical Example
Imagine you own 100% of a foreign software consultancy structured as a CFC.
- Net CFC Income: $500,000
- Tangible Assets (QBAI): $200,000 (computers, office furniture, server hardware)
- Deemed Return: $20,000 (10% of the $200,000 QBAI)
In this scenario, $480,000 of your foreign profits will be treated as GILTI and must be reported on your U.S. tax return.
Potentially Mitigating and Avoiding GILTI Taxes
Business owners can utilize several legal strategies to reduce or eliminate the financial impact of GILTI. This area is complex due to attribution rules and potential PFIC risks or other consequences.
1. The Section 962 Election
Individual owners can make a Section 962 election on their personal tax returns. This election tells the IRS to tax your foreign income as if you were a C-Corporation. Doing this unlocks the 50% Section 250 deduction and allows you to claim the 80% foreign tax credit. This is the most common way individual expatriates and business owners slash their GILTI liability without restructuring. Individuals without it face ordinary rates up to 37%.
2. Utilize the High-Tax Exception
If your foreign corporation operates in a country with a high corporate tax rate, you may qualify for the GILTI High-Tax Exclusion. If the effective foreign tax rate paid by the CFC is at least 90% of the maximum 21% U.S. corporate tax rate (currently meaning a foreign rate of 18.9% or higher), you can elect to exclude that income from GILTI entirely. Election is annual and can be made on a tested-unit/country basis
3. Restructure via a Domestic Holding Company
Instead of owning the foreign corporation directly, you can form a U.S. C-Corporation to act as a holding company for the CFC. The C-Corporation will inherently qualify for the 50% deduction and foreign tax credits, shielding your personal tax return from ordinary income rates on foreign profits.
4. Increase Local Tangible Investments (QBAI)
Because GILTI only taxes profits above a 10% return on tangible assets, increasing your QBAI reduces your GILTI exposure. Buying real estate, upgrading manufacturing equipment, or purchasing physical office infrastructure in the foreign country increases your QBAI and lowers your taxable excess return.
5. Adjust Ownership Percentages
You can completely avoid GILTI if the foreign entity is no longer classified as a CFC. If you dilute U.S. ownership so that total U.S. shareholders own 50% or less of the company—or if you reduce your personal stake below 10%—the GILTI rules will no longer apply to your shares.
Post-2025 Updates
- GILTI is being revamped/renamed to Net CFC Tested Income (NCTI) for tax years beginning after Dec 31, 2025.
- QBAI (the 10% tangible asset return) is eliminated. This broadens the tax base significantly for asset-light businesses (tech, consulting, services).
- Section 250 deduction drops from 50% to a permanent 40% (effective corporate rate rises from ~10.5% to ~12.6% before FTCs).
- Foreign Tax Credit (FTC) haircut improves from 80% to 90% of foreign taxes (better offset potential).
Final Thoughts
Expanding your business globally is a major milestone, but international tax compliance requires proactive planning. GILTI can penalize profitable, low-asset companies like tech startups, consultants, and service providers. By analyzing your entity structure early and leveraging elections like Section 962, you can protect your global revenue from burdensome double taxation.
FAQs
1. What is GILTI and who does it affect? GILTI requires certain U.S. shareholders of Controlled Foreign Corporations (CFCs) to include a portion of the CFC’s earnings in their U.S. taxable income currently, even if not distributed. It primarily affects U.S. persons (citizens, residents, domestic entities) owning ≥10% of a foreign corporation that qualifies as a CFC (>50% U.S. ownership by vote or value).
2. How is GILTI calculated (pre-2026)? Start with the CFC’s net tested income, subtract a deemed 10% return on qualified tangible assets (QBAI). The excess is GILTI. Corporations (and individuals via §962) then apply a 50% §250 deduction and limited foreign tax credits. Post-2025 (NCTI), QBAI is eliminated, changing the base significantly.
3. Can I avoid or reduce GILTI tax? Yes, common strategies include the §962 election (for individuals), high-tax exception (if foreign rate ≥18.9%), increasing tangible assets (pre-2026), using a U.S. C-Corp holding company, or careful ownership structuring. Each has trade-offs and compliance costs.
4. What is the High-Tax Exception? If your CFC pays foreign taxes at an effective rate of at least 18.9%, you can elect to exclude that income from GILTI/NCTI. This is useful in high-tax countries and is elected annually.
5. Should I make a Section 962 election? It often benefits higher-income individuals by taxing GILTI at corporate rates (~10.5–12.6% effective) with deductions and credits unavailable otherwise. However, it can trigger other corporate-level rules and requires careful analysis with your tax advisor, especially around distributions and state taxes.
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The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.
