State and federal taxes are things that many business owners feel like they have a good grasp of, but foreign source income is much more complex. All countries tax the income that multinational companies earn inside of their borders. The United States also has a minimum tax applied to the income that multinational companies earn in low-tax countries and a credit for 80% of the foreign income taxes paid. What should your business know about the three types of foreign source income and how it is taxed?
Income That is a Normal Return on Physical Assets
Any income that represents a normal return on physical assets (10% per year applied to the depreciated value) is fully exempt from US corporate income tax.
Income Above a 10% Return
Once you pass a 10% return, you will be subject to Global Intangible Low Tax Income (GILTI) annually. This tax is applied at half the corporate rate of 21% for domestic income, and there is a credit for 80% of the foreign income taxes paid. As a result, the credit can virtually eliminate the GILTI foreign source income tax for corporations except for any income that was earned in countries that tax less than 13.125%.
Income from Passive Assets
If you have bonds or specific categories of easily shiftable assets, they are considered taxable at the full 21% corporate rate. There is a 100% credit for foreign income taxes paid on these forms of foreign source income.
What Does This Look Like in Practice?
While US companies can claim credits for their foreign source income taxes paid to other governments, it can only be credited up to their United States tax liability. You can pool your credits within different income categories, so your excess foreign credits could be used to lower your tax obligation for the GILTI taxes on foreign source income from low-tax countries.
Let’s get a better understanding with an example of how foreign source income is taxed through looking at a United States company operating in Qatar. Qatar has a 10% tax rate.
The multinational company invests $1,000 in their Irish operations and earns $250 over the course of the year. The company would pay Qatar $25 on their profits on their $250 income. Because they invested $1,000, they would not owe taxes to the US on the first $100 of profits due to the 10% of invested capital rule. Using half the corporate tax rate, the tax obligation would be $15.75. The tax before credits owed to the US would be $15.75. Because they paid $25 to Qatar, they could receive an 80% credit, or $20. Since their tax obligation for the US was $15.75, they would have no tax liability.
Prepare Your Foreign Source Income Taxes with Help from MKS&H
MKS&H provides tax and accounting services to businesses of every size and in every industry. We can work with you to explore the many tax benefits of investment properties and assess your real estate portfolio. Contact us today for a consultation.