INTRODUCTION

"Get thee a good husband, and use him as he uses thee."

- All's Well That Ends Well, Act 1, Scene 1

"Marriage is a matter of more worth Than to be dealt in by attorneyship."

- Henry VI, Part I, Act 5, Scene 5

Today's cross border tax planners are expected to know all there is about various provisions of Subchapter N of the Internal Revenue Code. That is home to several provisions of U.S. tax law that affect taxpayers with foreign income. Examples include (i) the source of income, (ii) the imposition of U.S. tax on nonresident, non-citizen individuals, (iii) the taxation of foreign corporations, (iv) the foreign tax credit, (v) the foreign earned income exclusion, (vi) Subpart F income, (vii) G.I.L.T.I., (viii) the transition tax, (ix) currency transactions, and (x) international boycott income. Cross border tax planners are not expected to know more mundane provisions of tax law such as the rules that apply to married persons filing a joint tax return, with the possible exception of elections that apply when one of the spouses is neither a citizen nor a resident of the U.S.

Yet, as the I.R.S. rolls out regulations on all the provisions in Subchapter N that have been affected by the Tax Cuts & Jobs Act of 2017, strangely enough the highly sophisticated provisions of Subchapter N can be affected by the highly mundane provisions regarding married individuals electing to file joint tax returns with a U.S. spouse.

This article addresses a recent hiccup in the tax law that is brought about under the G.I.L.T.I. provisions of U.S. tax law that focus computations in a top-down way. What happens when one spouse separately owns C.F.C.'s with losses and the other spouse separately owns C.F.C.'s with positive earnings in a fact pattern where none of the C.F.C.'s generates Subpart F income? If a joint tax return is filed, are the tested losses of companies owned by one spouse available to offset tested income of companies owned by the other spouse? The answer should be simple, but is it?

JOINT TAX RETURNS

In a report to Congress prepared by the U.S. Treasury Department in 19981 incident to adoption of Section 401 of the Taxpayer Bill of Rights,2 requiring the Treasury Department to conduct a study of issues relating to joint income tax returns, the Treasury Department focused on the history of the joint tax return filed by married couples.

In 1918, married taxpayers were allowed to file joint returns. This earliest form of joint filing permitted spouses to offset deductions and losses against each other's income. There was only one tax rate schedule for taxpayers, however, regardless of whether they filed jointly or separately. If both spouses earned income and did not have offsetting deductions or losses, the result of filing jointly would have been an increase in total tax because of the single tax rate schedule and that schedule's progressivity. * * *

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In 1938, Congress enacted the predecessor of I.R.C. § 6013(d), which introduced explicit statutory joint and several liability for joint returns. As explained in the legislative history, the provision was enacted to preserve the administrative ease of joint filing for taxpayers and the Government * * *

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In Poe v. Seaborn, 282 U.S. 101 (1930), the Supreme Court held that a husband and wife in a community property state were entitled to file separate returns, each treating one-half of the couple's community income as his or her respective income for Federal income tax purposes. Because of progressive rate structures, the immediate effect of Poe v. Seaborn was that many married couples with only one income earner who resided in community property states could pay significantly less tax than their counterparts in common law states by choosing to report their income on separate returns. * * *

The current provision, Code §6013, was added by the Revenue Act of 1948, with the objective of allowing married taxpayers in States without community property laws to obtain similar treatment as those in States that do, i.e., split income equally between two individuals, frequently offering a tax rate benefit.3 By virtue of checking "married filing jointly" two taxpayers report all their income and deductions together to determine taxable income and pay tax due.

APPLICATION TO G.I.L.T.I.

The question posed is whether the system adopted to split income of a married couple works well in connection with the computation of G.I.L.T.I. where one spouse owns C.F.C.'s with positive tested income and the other spouse owns C.F.C.'s with tested losses.

The irony is that uncertainty arises here due to Congress's largesse in two, perhaps competing respects - on the one hand, the policy vis-à-vis married taxpayers to allow pluses of one to offset minuses of the other; and the architectural feature of the G.I.L.T.I. system on the other hand, allowing U.S. Shareholders in multiple C.F.C.'s, to use negative results of one C.F.C. to offset positive results of another. As noted by one senator in an April 2000 Senate floor discussion of a Republican-backed bill to eliminate certain marriage penalties in the Code, "the ironic thing about the marriage penalty is that it was actually borne out of fairness."4

Example

Assume Wife ("W") and Husband ("H"), each a U.S. citizen, are newlyweds and each owns a European business.5 The property regime applicable to H and W is one of separate property. W incorporated her business several years ago as a société anonyme ("S.A") under the laws of France. H formed his business as a German Gesellschaft mit beschränkter Haftung ("GmbH") prior to 2017. For illustration, assume that S.A.'s business in 2019 has been profitable, netting $100, while GmbH's business has netted losses of $100.

Under Code §951A global intangible low-taxed income provisions ("G.I.L.T.I."), S.A.'s earnings gives rise to $100 tested income for W, and $100 of G.I.L.T.I. each year, assuming no allocable deductions. G.I.L.T.I. applies to tax years beginning after 2017 to a U.S. shareholder owning at least 10% of controlled foreign corporations, by vote or value ("U.S. Shareholder"), in which U.S. Shareholders collectively own more than 50% by vote or value, thereby making the foreign corporation a controlled foreign corporation ("C.F.C."). In 2019 W, as U.S. Shareholder of S.A., a C.F.C., reports $100 of net tested income which results in $100 of G.I.L.T.I. taxable at the highest marginal rate.6 At the same time, the GmbH owned by H is a C.F.C. In 2019, it generates a net tested loss of $100, and zero G.I.L.T.I. income to H. The tested loss cannot be carried forward to any future year of H. The tested loss is not a recognized loss for H in that it does not reduce other income. That being the case, will the filing of a joint income tax return produce a benefit for the couple?

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Footnotes

1. Report to the Congress on Joint Liability and Innocent Spouse Issues, pp. 6-7.

2. 2, Pub. L. No. 104-168, 110 Stat. 1453 (July 30, 1996).

3. In consequence of Poe v. Seaborn, 282 U.S. 101, supra, taxpayers in community property states who do not file joint returns are generally liable for the tax on half of community income regardless of which spouse generated the income.

4. In Senate floor discussion of Republican marriage tax penalty relief in 2000 referred to as the Marriage Tax Penalty Relief Reconciliation Act of 2000, ultimately passed by a slim Republican majority in both houses - who lost control of the Senate that year - but vetoed by President Clinton before leaving office, Arkansas Senator Blanche Lincoln (D) explained that the Republican plan, in her view, addressed only 3 out of 65 marriage penalties in the Code.

5. Consistent with Treas. Reg. §301.7701-18 wherein the I.R.S. reflected the Supreme Court's decisions in Obergefell v. Hodges, 135 S. Ct. 2584 (2015) and U.S. v. Windsor, 570 U.S. 12 (2013), the terms spouse, husband, and wife since 2016 refer to lawfully married individuals with a gender neutral signification.

6. If W lives in New York State, 5% of the total G.I.L.T.I. (or in the example above, $5) may also be taxable at the State level at maximal rates for married couples filing jointly of up to 8.82% (declining to 6.57% over a few years). N.Y.C.'s highest tax bracket applicable to married filing jointly returns is 3.876%. Confusingly, N.Y.C. has not updated its rules post 2018, and follows prior N.Y.S. rules which included 100% of G.I.L.T.I. in taxpayer income after any Code §250 deduction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.