Changes coming in GILTI rules

The Internal Revenue Service and the Treasury Department issued a notice Thursday saying they intend to issue regulations that will permit a domestic partnership or an S corporation that is a U.S. shareholder of a controlled foreign corporation to apply some proposed rules for determining the amount of the global intangible low-taxed income, or GILTI, inclusion, for taxable years ending before June 22, 2019.

Notice 2019-46 also addresses the applicability of penalties for a domestic partnership or an S corporation that acted consistently with the proposed rules in Section 1.951A-5 on or before June 21, 2019, but files a tax return consistent with the final regulations under Section 1.951A-1(e).

To apply the rules in the proposed Section 1.951A-5, or to avoid tax penalties under the notice, a domestic partnership or an S corporation will need to satisfy certain notification and reporting requirements, which are described in the new notice. Until the regulations described in the notice are issued, the IRS said domestic partnerships and S corporations can rely on the notice, provided they satisfy the requirements that are described there.

Internal Revenue Code books sit during a House Ways and Means Committee markup hearing in Washington, D.C.
Internal Revenue Code books on a table during a House Ways and Means Committee markup hearing on the Tax Cuts and Jobs Act.

The Tax Cuts and Jobs Act of 2017 introduced the GILTI provisions as a way to discourage U.S-based multinational companies from shifting profits from their intellectual property out of the U.S., but the provisions have proven to be difficult and complicated to implement, prompting the IRS and the Treasury to issue more guidance to spell out the requirements of the hastily drafted tax law.

Some states have also been trying to get involved in balancing the new federal tax law with their own state’s tax rules, but have been facing legal challenges. Earlier this week, New Jersey’s Division of Taxation withdrew Technical Bulletin-85, which provided a special apportionment regime for GILTI and the income used to compute the foreign-derived intangible income (FDII) deduction — another feature of the Tax Cuts and Jobs Act, after some taxpayers complained about the state’s guidance.

A pair of tax attorneys with the law firm McDermott Will & Emery, Stephen P. Kranz & Kathleen M. Quinn, wrote an alert for clients Tuesday about the withdrawal of New Jersey’s rules. “Under Technical Bulletin-85, GILTI and income used to compute the FDII deduction were apportioned to New Jersey separately from other business income based on the New Jersey Gross Domestic Product (GDP) relative to the GDP in all states where the taxpayer had nexus,” they explained. “This regime was unfair and likely unconstitutional as applied to many taxpayers because the apportionment formula was in no way related to where GILTI and income used to compute the FDII deduction were earned.”

After withdrawing the technical bulletin, the state tax department instead said that GILTI and income used to compute the FDII deduction should be apportioned to New Jersey with the rest of the taxpayer’s business income, with GILTI (net of the federal deduction for GILTI) included in the denominator of the apportionment formula and income used to compute the FDII deduction (net of the FDII deduction) included in the denominator of the apportionment formula and the numerator to the extent such income is sourced to New Jersey, according to the attorneys.

The state quickly issued Technical Bulletin 92 to replace the withdrawn Technical Bulletin 85.

The original bulletin was issued late last year, but it’s likely that other states will be discouraged after seeing how New Jersey was forced to withdraw its rules. “New Jersey has been the only major corporate headquarter state that has attempted to tax GILTI in any significant manner,” Kranz explained. “New Jersey adopted a formula to determine ‘its share’ of GILTI that simply allocated an arbitrary 3.1 percent of GILTI to the state. That approach was repealed by the state’s withdrawal of TB-85. The action signals an understanding by the state that arbitrary taxation is unconstitutional and we are hopeful that the state will now reconsider its decision to tax GILTI at all. Even New York backed away from taxing GILTI after understanding the constitutional and economic ramifications of doing so.”

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