In addition to annual tax reports and reports of global income, US citizens are obligated to file informative and declarative reports concerning their holdings of foreign entities according to preset criteria.
Offshore company
An offshore company’s owner or chief executives must disclose according to five categories. Each category requires disclosure and a statement regarding more details, in ascending order. Filing is done annually or sporadically via form 5471, depending on the category defining the US citizen. The form is not filed separately, and should be filed along with the 1040.
1
For offshore companies defined as CFCs – an offshore company of which 50% is controlled by US citizens. US companies with ownership of over 10% of offshore companies are also included in this category.
2
For high-ranking or board members of in an offshore company. Said US citizen must report and other American whose share has risen to 10% in the tax year, or in increments of 10%. Reporting is required once this event has occurred.
3
US citizen holding an offshore company and whose share during the tax year has increased by 10% or added up to 10%. The difference between this category and category two is self filing. In category 2, reporting is for others, whereas reporting in category 3 is for oneself. Reporting is required once this event has occurred.
4
US citizen owning 50% or more of an offshore company. This category includes Israeli citizens married to US citizens who have chosen to be considered as citizens for tax purposes. Annual reporting is required.
5
US citizen holding over 10% of an offshore company defined as a CFC, a company controlled by Americans. Annual reporting is required.
As these are informative reports, lack of reporting, partial reporting or late reporting may result in heavy penalties. It is imperative that you report properly and on time.
GILTI, SUBCHAPTER F, TRANSION TAX
During the Trump administration we have seen a significant reform in taxation of offshore companies controlled by Americans. Up until then, the general income of an offshore company were out of reach for the IRS, unless the shareholder took dividends. Wishing to battle globalization and corporation tax shelters, in addition to wanting to generate more funds, Trump forced these companies to perform deemed distribution of their accumulated profits and taxes. In 2017, Trump instituted the transition tax for these companies, requiring them to pay taxes for their public income starting in 1987, according to a specific formula. In 2018 he introduced the GILTI system, taxing companies regularly on an annual basis. GILTI is also calculated according to a special formula.
Trump wanted to battle mega-corporations, but the unique US tax system also included and subjected small businesses and citizens residing offshore. Therefore, according to the new GILTI regulations, offshore companies residing in a country with a tax rate of at least 90% of the US tax rate are eligible for benefits. Since the federal tax rate in the US is 21% and the tax rate in Israel is 23%, Israeli companies meet the requirements for these breaks. Note that this refers to the effective tax rate, so companies with tax breaks in Israel or transferred losses may find themselves outside the high-tax exemption.
Section 962
A possibility that separates the shareholder from the offshore company, in the form of a US “ghost” company. The shareholder chooses to be taxed as though they were a US company, that is, according to the 21% tax rate rather than 37%. Additionally, one may receive a deduction of 50% according to section 250, and can be reimbursed on the taxes paid by the offshore company. Choosing this tax policy requires careful planning and does not fit every scenario.
Subchapter F
A taxation policy that משקיפה passive income for the shareholder and prevents them from utilizing a tax deferral mechanism by using an offshore company.
Indeed, category 4 will often join category 5, but there are several instances in which a 50% holding does not qualify as an LLC. For example, an American husband and a non-American wife own 20% and 80%, respectively. According to the laws of family affiliation, the husband owns more than 50% since his wife also has a hold of the company, and so he is considered category 4; this affiliation does not constitute category 5 because the wife is non-American.
GILTI obligates the shareholder to acknowledge, in every instance, the ongoing profits of the company on an annual basis. Once a dividend has been distributed, it is no longer significant because it was already taxed via GILTI. It is important to understand that acknowledging foreign taxes according to שיטת הסלים, meaning that the foreign tax owed at the time of withdrawing the dividend is not identical to the GILTI tax.
Foreign partnership
US citizens are also required to provide a comprehensive report of their holding in offshore partnerships, outside the US. This too is done according to categories, with the span of information about the offshore partnership being in descending order – category 1 transmits plenty of information, whereas category 4 transmits partial, negligible information. Reporting is done via form 8865 and is added to the US citizens tax report.
Category 1 – A partner holding over 50% of the partnerships’ units.
Category 2 – A partner holding over 10% of a partnership controlled by Americans. Irrelevant if one partner is a Category 1 partner.
Category 3 – A US citizen who transferred an asset in exchange for a percentage of the partnership.
Category 4 – A partner who acquired, sold or made some change in their percentage of holding.
Filing is relevant for US citizens residing in Israel and partners in limited partnerships, general partnerships, VCs, hedge funds, etc.
