With the ratification of the Tax Cuts and Jobs Act (TCJA), many U.S. taxpayers are reconsidering their business structures. The reason for this is that the tax provisions of the TCJA contain greater benefits for domestic corporations than other business entities and individuals. One of these benefits is a 100% dividends received deduction for domestic corporations that receive dividends from their foreign subsidiaries. Another is the decrease of the U.S. top corporate tax rate to 21% from 35%. Because of the clear advantages corporations have with the new tax provisions of the TCJA, it makes sense for other taxpayers to consider becoming a corporation. In the case of individual taxpayers, electing to be taxed as a corporation under IRC Section 962 might be beneficial.

IRC Section 962 allows U.S. individuals who are shareholders of controlled foreign corporations to elect to have gross income received under IRC Section 951(a) taxed as if it were received by a domestic corporation. IRC Section 951(a) income includes subpart F income and income from the investment of earnings in U.S. property under IRC Section 956. IRC Section 962 also allows U.S. shareholders who are individuals to apply the deemed paid credit for subpart F inclusion provisions under IRC Section 960 as if they were domestic corporations. The IRC Section 962 election must be made annually and cannot be revoked during the year without permission from the IRS. The election is made with a U.S. individual’s timely filed income tax return (including extensions) by attaching a statement to the tax return for the tax year the election is in effect. Treas. Reg. Section 1.962-2(b) lists the information that must be included on the IRC Section 962 election statement. With respect to the new international tax provisions of the TCJA, U.S. individuals who are shareholders of controlled foreign corporations might benefit from making an IRC Section 962 election for the 2017 tax year for the mandatory repatriation tax they owe under new IRC Section 965.

IRC Section 965 imposes a one-time mandatory tax on a U.S. shareholder’s share of the post-1986 accumulated earnings and profits of a deferred foreign income corporation (DFIC). Without going into a detailed explanation of the mechanics of IRC Section 965, it is important to note that only domestic corporations are allowed to apply IRC Section 960 deemed paid foreign tax credits against the mandatory IRC Section 965 tax. Whether an individual can make an IRC Section 962 election for IRC Section 965 tax purposes is not clear per IRC Section 962. However, according to IRS Notice 2018-26,   

“The Treasury Department and the IRS have determined that in the case of a taxpayer making an election under section 962, Congress intended for the section 965(c) deduction (which is generally available to United States shareholders of DFICs, including individuals) to be allowed with respect to the tax imposed under section 11 rather than under section 1.”

Based on that, it appears that the benefits of an IRC Section 962 election are allowed for IRC Section 965 purposes, and it follows that an individual U.S. shareholder making an election under IRC Section 962 can apply deemed paid foreign tax credits to the mandatory IRC Section 965 tax. This can be greatly beneficial to U.S. individual shareholders of deferred foreign income corporations. Let’s take a look at two basic examples illustrating this.

Example 1:

John’s IRC Section 965 income inclusion from his stock ownership of J Corp in the U.K. = $1,000,000. Assuming he’s in the highest income tax bracket for 2017, and he does not make an IRC Section 962 election, his tax on the $1,000,000 IRC Section 965 income inclusion is calculated as follows:

Example 2:

Same facts as example 1 above, except that John has made an IRC Section 962 election and has an allowed IRC Section 960 deemed paid foreign tax credit of $100,000. Assuming the IRC Section 965 income inclusion is taxed at the highest 2017 corporate tax rate of 35%, the calculation is as follows:

As displayed in the two examples above, a U.S. individual can have a significant amount of tax savings by making the IRC Section 962 election with regard to the IRC Section 965 income inclusion. Keep in mind that the election is not exclusive to the IRC Section 965 income inclusion. The IRC Section 962 election can be beneficial for U.S. individuals in other income tax situations especially with respect to new tax rules under the TCJA. An example of another income tax situation is a U.S. individual subject to the new Global Intangible Low-Taxed Income (GILTI) provisions. Therefore, it’s crucial for U.S. individuals to consider making an IRC Section 962 election if they are shareholders of controlled foreign corporations, and if it enables them to reduce their U.S. tax liabilities.

Charles Ladas, CPA, is a tax supervisor at Citrin Cooperman & Company, LLP.  He is involved with a wide array of tax services for domestic and international clients. The services include tax compliance for businesses and high-net-worth individuals, tax provisions for corporations, and tax research, with an emphasis on international tax issues.  Mr. Ladas is licensed in New York State and is a member of the NYSSCPA and AICPA.  He is also a member of the NYSSCPA’s International Taxation Committee. He can be reached at cladas@citrincooperman.com.