Larry is a UK resident US citizen and is a sole director and shareholder of a small business. The business was set up as a UK limited company, which completed financial accounts and Form CT600, paying UK Corporation Tax at a rate of 19%. He had heard about the complications that US citizens can face when they are owners of foreign corporations, and so came to Buzzacott for specialist advice.
In the US, the limited company is treated as a corporate entity, much like the UK, and in general you are only personally taxed on the dividend distributions from the company, assuming you don’t take a salary. However, since 2018 there has also been a potential GILTI tax to consider too. GILTI tax is an additional tax on US owners of foreign companies (see below for more information on GILTI). There is scope in the US to make a ‘check the box’ election on Form 8832, which allows you to change the classification of the business from that of a corporation to a disregarded entity. The change in classification would result in the net income from the business being subject to US taxation on Schedule C of your personal tax return and taxed at your ordinary rate of income tax, as if you were self-employed.
Should Larry ‘check the box’?
In order for Larry to make an informed decision as to whether or not it would be beneficial for him to ‘check the box’, we provided him with projective and comparative calculations based on his expected future revenue income, as well as cash extraction needs. We also took into consideration the US and UK tax implications on the exit strategy of the company and analysed his personal tax position, specifically his use of foreign tax credits, and provided Larry with a detailed report of our findings. Practical guidance, such as making the company year-end on 31 December to tie it up with the US tax year end, was also given.
Our tailored report enabled Larry to make an informed decision regarding the most suitable method of reporting the UK limited company in the US. For Larry, this meant that the ‘check the box’ election was the most appropriate course of action.
As well as the potential tax savings, Larry’s decision also took into consideration the burden of additional compliance costs when reporting the UK limited company. We recommended the one off filing of Form 8832 entity classification form (‘check the box’) , and the yearly reporting of Form 8858 ‘information return of US person with respect to foreign disregarded entities’, which is essentially a simplified version of Form 5471.
The change in classification of the entity also removed the need to worry about any complex Passive foreign investment company (PFIC), Subpart F Income Tax and GILTI tax rules (*see below for more information on these).
The exit strategy from the company was a key element in the decision making as the client wanted to retain the benefit of the Entrepreneurs’ Relief for capital gains purposes in the UK. This is the reduced Capital Gains Tax rate of 10%, which would normally be irrelevant given the US long-term Capital Gains Tax rate of 20% and the additional 3.8% Net Investment Income Tax (NIIT) potentially due. The 'check-the box' strategy could potentially result in no US Capital Gains tax due, therefore retaining the benefit of a 10% tax rate on the disposal of the business.
Our straightforward report took on a holistic approach, taking into consideration the tax consequences for the life of the company, and gave a well-rounded and simplified account of the potential results by comparing the various routes our client could take. This format helped eliminate any unnecessary stress and ultimately made the decision making process simpler and more efficient.
No matter what our clients come to us with, we take the time to fully understand their current position and goals and therefore tailor our advice specifically to their needs.