How do Roth IRAs differ from traditional retirement accounts?
The GILTI high tax exception is not a permanent shield; it’s a timing decision. You’re deferring tax, not eliminating it. If foreign rates drop or rules change, you could lose the protection midstream. It’s a smart move for many companies, but only if the rest of your tax model can handle the consequences.
The GILTI high tax exception (HTE) presents U.S. shareholders of controlled foreign corporations (CFCs) with a potent tool to manage international tax exposure. The short-term benefit is the exclusion of high-taxed foreign income from the Global Intangible Low-Taxed Income (GILTI) provision. However, it’s essential also to consider the longer-term trade-offs that come with this powerful tool.
Let’s start with the mechanics. Under current law, if a CFC’s income is taxed at a foreign rate higher than 90% of the U.S. corporate rate (21%), it qualifies for exclusion from GILTI. That threshold is 18.9%. By electing the GILTI high tax exception, a taxpayer avoids recognizing that income in their U.S. taxable income, thus potentially lowering their GILTI tax rate to near zero for those tested units.
This isn’t a decision to be taken lightly. The election is made annually and must be applied consistently across all eligible CFCs. Any flip-flopping could have ripple effects on your tax strategy, making it a decision that requires careful consideration.
When income is excluded from GILTI under the high-tax exception, the foreign taxes paid on that income are also excluded from the GILTI foreign tax credit basket. If you’ve been relying on excess credits from high-tax jurisdictions to offset U.S. tax on low-taxed GILTI income, this election could potentially backfire. The GILTI tax rate on remaining low-taxed income might be higher without those credits to cushion it.
It also complicates foreign tax credit planning more broadly. By carving out high-taxed income, you could find yourself with stranded credits (i.e., foreign taxes that aren’t usable in any basket).
There’s the issue of QBAI (Qualified Business Asset Investment). Excluded income also means excluded QBAI, which reduces the deemed tangible income return (DTIR) that shelters other GILTI income. So, ironically, using the HTE can sometimes lead to a larger inclusion from other CFCs.
The election also doesn’t create previously taxed earnings and profits (PTEP). That means when the income is eventually repatriated as a dividend, it won’t be automatically exempt from U.S. tax unless the distribution qualifies for the Section 245A deduction, and not all states follow that rule. Many states ignore the GILTI high tax exception entirely, so you may still owe state tax on excluded income.
From a compliance standpoint, the HTE adds complexity. You’ll need to calculate effective foreign tax rates on a tested-unit basis and document them meticulously. That means more coordination across jurisdictions and more work for your tax team every year.
Back to Q&A
Never miss an update. Sign up to receive our monthly newsletter to unlock our experts' insights.
Subscribe Now