After Tax Reform, Don't Always Think Outside the Box: Reevaluate whether existing foreign investment holdings continue to be tax-efficient and consider reorganizing them.

• Author: Ray, Jennifer
• Position: FROM THE FAMILY OFFICE

The tax reform act enacted in December 2017 (commonly referred to as the Tax Cuts and Jobs Act or TCJA) significantly altered the landscape of U.S. taxation of foreign investments. Historically, U.S. individuals preferred to own foreign investments directly or through entities classified as partnerships for U.S. federal income tax purposes. Partnerships are not subject to entity-level U.S. federal income tax and are often an important part of family office investment structuring. However, the TCJA made sweeping changes to the U.S. international tax rules and reduced the U.S. corporate tax rate to twenty-one percent.

As a result, family offices should reevaluate whether their existing foreign investment holdings continue to be tax-efficient and consider reorganizing those holdings. In certain circumstances, it may be more efficient to structure foreign investment through a U.S. corporation (rather than as a direct investment or through a pass-through entity), notwithstanding the added exposure to a second layer of U.S. taxation. Using a U.S. corporate holding company could reduce the net U.S. tax rate (that the U.S. individual ultimately pays or bears) on the foreign company's earnings by over twenty percent depending on circumstances, some of which this article discusses. That said, U.S. corporate holding company structures may trigger certain rules against tax avoidance.

Choice of Entity: Form of Ownership

Many of the U.S. international tax changes enacted by the TCJA aim to transition the United States from a worldwide tax system toward a modified territorial tax system. Among these changes, the implementation of a "participation exemption" for U.S. corporations and a new tax on certain high-return foreign assets (the "global intangible low-taxed income" or "GILTI" tax) significantly alters the calculus for U.S. investors in determining the ownership structure of their foreign investments. These changes generally disadvantage direct individual investment in foreign corporations when compared to U.S. corporate investments in foreign corporations.

The chart below (Figure 1) provides an overview of certain key considerations for the ownership of an investment in a foreign corporation. For simplicity's sake, this article assumes that the investment target is a controlled foreign corporation that generates only foreign-source income that is not Subpart F income (generally referred to as a "foreign corporation"). The term "U.S. individual" refers to a U.S. individual shareholder (direct or through a pass-through entity) of a foreign corporation, and the term "U.S. corporation" refers to a U.S. corporate shareholder of a foreign corporation. In each case, this article also assumes that more than ten percent of the foreign corporation's stock is owned by the relevant U.S. investor.

Foreign Taxes

As with U.S. corporations, a foreign corporation's earnings may be subject to multiple layers of...