Background on the credit
Both the United States and foreign countries may tax the foreign source income of U.S. taxpayers. To ease this double taxation burden, the Internal Revenue Code permits most U.S. taxpayers who pay income taxes to a foreign country to either deduct the taxes from gross income for U.S. purposes or credit them dollar for dollar against their U.S. income tax liability on foreign source income. The FTC is calculated separately for certain categories (also referred to as “baskets”) of income.
The TCJA significantly revised the FTC rules in many ways, including:
- Repealing Internal Revenue Code section 902,
- Adding two FTC limitation categories in section 904(d) to the previous two categories of general and passive income,
- Adding section 951A, which requires a U.S. shareholder of a controlled foreign corporation (“CFC”) to include certain amounts in income (referred to as “The Global Intangible Low Taxed Income Inclusion”), and
- Providing a new dividends-received deduction for dividends from foreign subsidiaries.
In December 2018, the Internal Revenue Service (“IRS”) issued proposed regulations providing guidance on the FTC for businesses and individuals. The proposed FTC regulations reflected changes made by the TCJA, including the expansion of the number of separate income categories for the FTC limitation, as well as other statutory amendments. In June 2019, the IRS finalized discrete parts of the proposed FTC regulations. On December 2, 2019, the remaining FTC regulations were finalized and additional proposed regulations released.
Highlights of the final regulations
The finalized key remaining provisions retain the basic structure and approach of the proposed FTC regulations but make some revisions to address various issues. Highlighted areas include:
Allocation of expenses to section 951A category income. The IRS notes that the final FTC regulations do not alter the statutory requirement for deductions to be allocated and apportioned to the section 951A category. However, simultaneously issued 2019 FTC proposed regulations do include certain additional rules that may effectively preclude the allocation and apportionment of certain research and experimentation expenses to the section 951A category.
Exempt income and asset definitions and the section 250 deduction. The final FTC regulations adopt the proposed FTC regulations’ treatment of the section 250 deduction for purposes of the exempt income and asset provisions. Certain related modifications have been made addressing issues pertaining to identification of assets that produce income included in foreign-derived intangible income for these purposes, and changes regarding foreign-derived deduction eligible income (“FDDEI”) and gross FDDEI.
Interest expense allocation and apportionment; special rules for specified partnership loans and anti-abuse. The final FTC regulations clarify some language in these rules, modifying the regulatory language that the rules for specified partnership loans apply solely to match existing income and expense related to the loan. Therefore, the rules do not create additional gross income. Also, expanded rules relating to specified partnership loans are provided in the 2019 proposed regs.
FTC limitation under section 904; transition rules for new separate categories; safe harbor and “reconstruction option.” The IRS notes that the proposed FTC regulations provide transition rules for assigning carryforwards of unused foreign taxes paid or accrued, or deemed paid or accrued, in pre-2018 tax years to post-2017 separate categories. These include the new foreign branch category income.
The final FTC regulations provide a simplified safe harbor option with respect to the “reconstruction option.” In light of the addition of a safe harbor option, no changes are made to the requirements for reconstruction if the safe harbor option isn’t chosen. Thus, taxpayers that do not choose the safe harbor must determine the unused foreign taxes with respect to foreign branch category income as if that separate category had applied in the year the taxes were paid or accrued.
Look-through rules and interest expense. The final FTC regulations provide that the allocation and apportionment rule is applied in the year the interest income is taken into account — even if the interest expense isn’t deductible by the CFC in that year.
The final FTC regulations generally retain the proposed FTC regulations’ applicability date, providing that the portions of the regulations that relate to TCJA statutory amendments apply to tax years beginning after December 31, 2017. Portions of the regulations that don’t relate to such statutory amendments apply to tax years ending on or after December 4, 2018.
For those regulations containing rules encompassing both situations, they generally apply to tax years that satisfy both of the following two conditions:
- The tax year begins after December 31, 2017, and
- The tax year ends on or after December 4, 2018.
We can help
Please contact your Elliott Davis advisor for additional guidance and planning under the final regulations.