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US “TCJ Act” Tightening of CFC Rules Eliminates Common Approach To Post-Death Avoidance Of US Beneficiary Taxation

February 14, 2018

On December 22, 2017, President Trump signed into law H.R. 1 (Pub. L. No. 115-97), known as the Tax Cuts and Jobs Act (the “Act”). The Act is the first major overhaul of the Internal Revenue Code (the “Code”) in more than 30 years.  

The Act includes as a “revenue raiser” the elimination of an obscure provision of the controlled foreign corporation (“CFC”) regime the effect of which is that priority review is required of the estate plan or trust administration of a living foreign individual who (i) owns, or is the settlor of a trust that owns, a majority interest by vote or value of a foreign entity that is characterized currently as corporation and (ii) anticipates that following the death of the individual the majority of the shares will be owned by or for the benefit of US taxpayers.

The repealed provision is the long-standing exception that the “Subpart F” income of a foreign corporation that is not controlled by U.S. shareholders for at least 30 days during a calendar year is not taxed to the US shareholders. As a result, starting 1st January 2018, an individual treated as a (direct or indirect) U.S. shareholder of a CFC at any time during the taxable year must include Subpart F income arising in the corporation during the shareholding period in which it was a CFC in gross income (even if that period is only for one day in the calendar year).

Since the advent of the “check-the-box” election regime, a common element of estate plans for foreign individuals and for immediate post-death administration of trusts of which a living foreign individual is settlor with US taxpayer heirs or trust beneficiaries has been causing a check-the-box election to be made with respect to each relevant foreign corporation effective soon after the death of the foreign individual. A combination of the CFC 30 day rule and the ability to file a check-the-box election with an effective date of up to 75 days prior to the date the election is filed allowed many foreign individuals and their trustees and anticipated executors to avoid taking steps to minimize potentially adverse taxation of US beneficiaries beginning immediately after the death of the foreign individual during that individual’s lifetime. Where the foreign corporation invests from time to time in assets that are considered situate in the United States for US Federal estate tax purposes, that combination of 30 day CFC rule and retroactive check-the-box election rule was crucial to achieving with relative simplicity both protection from US estate tax on the death of the foreign individual and avoidance of onerous income taxation of the US beneficiaries following the death of the foreign individual.

Most affected entities should first ascertain whether the simple expedient of implementing the anticipated check-the-box election during the lifetime of the foreign individual rather than after death is possible and appropriate in all the circumstances. If not then consideration must be given to the benefits and burdens of a number of alternative steps to minimize or eliminate the risk of adverse income taxation of US beneficiaries under the CFC rules if the entity election is made effective after the death of the foreign individual.

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