The impact of US tax reforms on owner managed UK limited companies
Many US residents of the UK who have been self-employed, have taken the decision to create a limited company to then employ themselves. While this has a number of UK tax advantages, there are conversely a number of US Federal tax issues to be considered and understood, both from a reporting standpoint and potential additional tax cost.
For US owners of foreign companies there has always been a significant amount of additional reporting for US Federal tax purposes and individuals owning 10% or more in a foreign company are required to report income and expenditure from that investment annually. Although purely informational the completion of IRS Form 5471 is a requirement to accompany the filing of the personal tax return. But in late 2017 the situation became more complex and potentially costly, with the passing of the 2017 Tax Cuts and Jobs Act.
Amongst the many changes to the US tax code, was a legislation that addressed many US corporations’ practice of structuring their global operations to shield income from what was a comparatively high corporate tax rate. US President, Donald Trump, determined to make the US a more attractive location for business, cut the corporate tax rate, but it came with a sting in the tail. Where corporations declared income for tax purposes outside the US, the funds became subject to a tax at a punitive rate.
This so-called repatriation tax, taxed income that previously and legally had not been subject to US tax. And, in 2018 this repatriation tax was replaced by the aptly titled GILTI tax that is levied on unrecognized income not taxed in the US. The result has been that many US companies have changed their accounting structures and are now actively repatriating income back to the US in order to avoid both the punitive rate of tax, and the associated reporting.
So, how does this affect the small business owner here in the UK, who also happens to have a US filing requirement? Like most legislation aimed at major corporations the impact has no bounds. US taxpayers who have a foreign limited company are now required to account for the potential GILTI tax on income that may be left on their company balance sheet, but not yet recognized for tax purposes. While UK tax legislation enables the limited company to leave money in the business for either the proverbial “rainy day” expenditure, or as a savings fund, the Internal Revenue Service looks directly through and assesses tax on that income.
Naturally this can be an unpleasant surprise for the US taxpayer, who will have set up their structures specifically for legitimate UK tax purposes. They may now be paying tax to Uncle Sam on income that in some cases, would never have been cash to spend, but may for example have been used for inward company investment. Therefore, all US taxpayers with such limited companies, urgently need to review their status and their strategy to address this tax.
It is not going away and US taxpayers need to determine how to manage their liability and recognise that there are solutions to this challenge. We would strongly recommend a consultation with advisors that are able to examine both the UK and US implications of their reporting and income stream management, to ensure that the tax exposure is managed effectively.