Why Are Tax Inversions Suddenly So Popular?

The United States is one of the few large countries that taxes citizens, permanent residents and corporations on income earned anywhere in the world.

U.S. corporations have a nifty way to avoid tax on their foreign income and reduce their U.S. tax without really leaving home. It’s called tax inversion, and due to some recent high profile deals it’s becoming all the rage.

In the past year alone, at least 14 U.S. companies have announced inversion deals with foreign (mostly Irish and British) companies. Left unchecked, these deals will continue to erode the corporate tax base, leaving others like you and me to pick up the slack.

What is tax inversion?

A U.S. company reincorporates overseas by getting acquired by a smaller company in a country where the corporate tax rate is much lower than the top U.S. rate of 35%. Generally, the U.S. firm’s management and operations remain in the United States, but it is no longer taxed on income earned outside the United States. The firm will still pay taxes on income earned inside the U.S., but it gets easier to minimize that tax. For example, the U.S. subsidiary can borrow money from its foreign parent, then deduct the interest it pays on that debt, which reduces its U.S. income and taxes.

An inversion also gives companies ways to avoid U.S. tax on profits that have been piling up overseas, largely in tax havens such as Bermuda. It is estimated that U.S. companies have about $1 trillion sitting in foreign subsidiaries. They would love to bring it home and use it to pay dividends or buy back shares, which would increase their stock price. But they would have to pay U.S. tax on it.

However, if the U.S. company gets acquired by an Irish company, for example, the Irish company can borrow that cash from the Bermuda company. The Irish company can use it to buy back shares or pay dividends without paying U.S. tax. The shareholders of the former U.S. company benefit because they own most of the Irish company.

If the big corporations can do this to avoid U.S. taxes, could you or your little corporation do the same thing?

As an individual you would have to not only leave the country but also renounce your U.S. citizenship – meaning that you now must be a citizen of some other foreign country and you will never be able to attain U.S. citizenship again. You will also need to pay an “exit tax” 15% of the value of all your assets.

For your little corporation, you will not be able to accomplish the tax inversion due to special rules that the IRS has in place. These rules would classify the new foreign corporation as a Controlled Foreign Corporation (“CFC”) because you individually as a U.S. person for tax purposes would be the sole shareholder for the foreign corporation. These rules provide that regardless of whether any distributions are made by the CFC to you, you are required to report on your individual income tax return the income that the CFC earned. Big corporations would not be classified as a CFC because their stock is widely held and not concentrated to one or a few shareholders.

Does it make any sense for the taxes to be based on where the corporate “hub” is anyway? Shouldn’t it be based on WHERE they made the money?

Actually the big corporations still have to pay U.S. taxes despite accomplishing a tax inversion. Profits earned in the U.S. would still be subject to U.S. taxes; however, the U.S. federal income tax bill on repatriated profits is reduced by the amount of income taxes paid to foreign governments on the same U.S. profit reported to IRS. So, profits earned outside the U.S. would not be subject to U.S. income taxes until those profits are repatriated back to the U.S. at which time they are subject to the full U.S. statutory corporate income tax rate of 35% upon repatriation.

So as an individual or little corporation, how do you fight back?

You would be surprised of the many tax saving opportunities that are available to U.S. persons and U.S. businesses without the need to go offshore. The tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Los Angeles, San Diego, San Francisco and elsewhere in California are highly skilled in making sure that you are getting all the tax saving benefits that are legally possible.

Description: Let the tax attorneys of the Law Offices Of Jeffrey B. Kahn, P.C. evaluate your tax exposure and legally minimize the amount you need to pay.