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Old Tax Loophole Could Benefit the Wealthy


Posted in on September 28, 2018

A Virginia tax lawyer can provide insight into how the Tax Cuts and Jobs Act could affect your tax liability. The Tax Cuts and Jobs Act has made fundamental changes to many aspects of the way that businesses and corporations are taxed. Recently, Bloomberg reported that some taxpayers may be able to take advantage of some of the changes in the tax code by using an obscure tax provision that remains in place from the 1960s.

Wealthy Taxpayers Could Benefit From This Obscure Tax Provision

In the 1960s, President John F. Kennedy signed a law that was intended to prevent American taxpayers from keeping their investments offshore indefinitely in order to avoid having to pay taxes on the money in the United States.

Under the measure signed into law, taxpayers with offshore investments had to pay annual taxes to the IRS on the money kept offshore. However, the law permitted taxpayers to choose whether they wanted to have their investment income taxed at the individual income tax rate or the corporate income tax rate.

The corporate income tax rate since that time has been close to the top personal tax rate, so there wasn't a reason for taxpayers to decide to file their taxes using the corporate rate. However, the Tax Cuts and Jobs Act dramatically lowered the corporate income tax rate. The corporate tax rate was reduced to just 21 percent, which is 16 percentage points lower than the top tax rate the federal government charges to individuals.

Essentially, for taxpayers to be able to take advantage of this loophole, they would need to have a company overseas called a controlled foreign corporation and would need to put investments under the control of that corporation that generate passive income. The taxpayer can choose to pay the corporate tax rate on the investments for as long as the money is kept abroad. Additional provisions in the tax code also allow individual taxpayers to act as if a “phantom” domestic corporation exists and stands between the taxpayer and his or her foreign company.

Bloomberg indicates it is unclear what rate taxpayers would pay when they live in the U.S. and collect their money from foreign corporations. The IRS and taxpayers are currently involved in litigation to determine if the money that the U.S. taxpayers receive from their foreign corporations should be treated as a qualified dividend, which would mean the income is subject to a 20% tax rate because it would be considered a long-term capital gain.  The IRS, however, argues that the money these foreign corporations pay to U.S. taxpayers should be treated as ordinary income, so it could be taxed at a rate as high as 37%.

The rules will remain unclear until a decision is reached, so taxpayers should be certain to monitor changing rules and regulations. A Virginia tax lawyer like Kevin Thorn can provide help to taxpayers in understanding complex issues including those related to offshore investments. To find out more about how an attorney can provide guidance, give us a call today. Contact attorney Kevin Thorn as soon as possible by calling 703-752-3752.

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