Foreign Income Impact on State Income Tax, Flow-Through Entities and Small Businesses

This is the PKF Texas Entrepreneur’s Playbook. I’m Jen Lemanski, and I’m back again with
Frank Landreneau, one of our International Tax Directors. Frank, welcome back to the Playbook. Well, thank you. It’s great to be back. So, we’ve done a series – we talked about
GILTI, we’ve talked about FDII, we’ve talked about how it’s impacted federally
– but what about state income taxes? Right. I’m glad you asked me that, because a lot
of the focus on the provisions, because they are rather complicated, has been on the federal
tax liability. In other words, how does that affect my 1040,
my Form 1120 if I’m doing business as a corporation, but very little has been talked
about as to how does that impact state taxes. In Texas, the questions would be things like:
will the state include that income in taxable income? Will it exclude it? There’re certain cases where foreign income
is excluded. For Texas, probably the more straightforward,
if the income is sourced outside of Texas, as what you would typically find with foreign
income, it would be included in the tax base but not in the apportionment factor. So, that would have the effect of effectively
excluding it. For other states, I think the regime might
be a little bit more complicated in they may use it as, you know, if you get tax relief
for some of these provisions, they may add them back, because they don’t want to give
state tax relief alongside of federal tax relief. Most states begin their tax base coupled with
the federal tax base, and so you’ll see some decoupling from the federal provisions
in that states will add back some of these deductions of federal tax. In a previous episode you also talked about
flow-through entities. How does the flow-through tax planning work
with the international businesses? That’s not gotten a lot of attention. One of the things to keep in mind is that
when we talk about flow-through entities, keep in mind we’re talking about S corporations,
entities that do business as partnerships, or they may be owned by a trust or something
like that. Those types of entities don’t pay tax, per
se, but the owners do, such as they’re high net-worth individuals, or business owners,
and that’s where the tax is paid, so that’s the first thing to kind of keep in mind. The tax law came out with a provision trying
to get similar results under tax reform that the regular corporations got. So, for example, if you recall, tax reform
gave regular corporations a 21% tax break. Individuals doing business as a flow-through
entity said, “Hey, what about me? Where’s my tax break?” Like, “Hi, I’m here.” Exactly. And so, they came up with a deduction called
a Qualified Business Deduction under a provision called Section 199A. That provides a 20% deduction that flows through
to individuals. The thing to keep in mind if those flow-through
entities are doing business internationally, let’s say, through the extension of their
U.S. entity, such as in the form of a branch or something like that, that income is not
subject to a special tax rate. It would be taxed at 37% tax rate, as individuals
are all taxed at that rate. There are some implications that that income
would not get favorable treatment any different—in other words, the 20% deduction that I talked
about would not apply to that foreign income. Okay, so you’ve really got to pay attention
to that. Now, we’ve talked about how this impacts
middle market businesses, but what about small businesses and the tax reform and that kind
of thing? That’s a good question, because a lot of
times people think the tax reform affected just big business, and only big business has
to worry about the changes in tax reform. One of the things is that because small businesses
kind of segue on the last question you asked me, and the last discussion we talked about,
is that small businesses typically do business as a flow-through entity. The things to keep in mind is the special
20% deduction to mirror the tax break that corporations got does not apply to foreign
income. So, the question becomes, “Should I restructure
for doing business internationally that’s a different structure than what I have for
doing business domestically, or within the United States?” The answer we found is that it all depends
on where you want that foreign income to end up. Where do you want the cash? And that’s the fundamental questions small
business owners need to be asking. Not to automatically be saying, “We need
to restructure,” but where is the cash going to end up at the end of the day? And what are your ultimate business goals
and how do you want to grow and that kind of thing. That’s right, because you want to optimize
that. Perfect. Well, we’ll get you back to talk some more
about that. That’d be great. Thank you. Thank you. To learn more about other international topics,
visit This has been another Thought Leader Production
brought to you by PKF Texas The Entrepreneur’s Playbook. Tune in next week for another chapter.

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