Update: On August 1, 2018, the IRS and the Treasury issued proposed regulations on Section 965. Learn more at irs.gov.
The IRS provided guidance on the Section 965 transition tax impacting international businesses. Here’s what you need to know about the new transition tax – from tax rates to return deadlines.
The Tax Cuts and Jobs Act contains a number of international tax provisions affecting U.S. businesses with outbound operations. Although most provisions are effective on or after January 1, 2018, some provisions are applicable to the 2017 tax year. One of the most significant of these provisions is the one-time transition tax under IRC Section 965.
The one-time transition tax imposes an income tax on certain U.S. taxpayers that own a specified interest in a foreign corporation and where such foreign corporation has positive post-1986 earnings.
On March 13, 2018, the Internal Revenue Service issued an FAQ providing guidance on the new Section 965 transition tax. Here are the highlights:
Who does the one-time transition tax affect?
The transition tax applies to a specified foreign corporation (SFC) defined as:
- Any U.S. person that owns a controlled foreign corporation (CFC): Any foreign corporation where more than 50% is owned by U.S. shareholders (i.e., a U.S. person that owns 10% or more of the foreign corporation). Accordingly, the transition tax can apply to an individual, subchapter C corporation, shareholder of a subchapter S corporation, partner of a partnership, trust or estate.
- Any subchapter C corporation that owns 10% or more of a foreign corporation: The pro-rata share of the shareholder’s accumulated post-1986 deferred income of a SFC is included as subpart F income for the SFC’s last tax year beginning before January 1, 2018. The amount taken into account is the larger of the foreign corporation’s earnings and profits as of November 2, 2017 or December 31, 2017.
What are the one-time transition tax rates?
The tax rate applied to the deferred earnings depends on the aggregate foreign cash position on the SFC’s balance sheet. The rates are:
- Subchapter C corporation: 15.5% tax rate for cash and 8% tax rate for non-cash
- Individual shareholders: 17.5% tax rate for cash and 9.05% for non-cash
When is the tax due?
The tax is due on the due date of the taxpayer’s 2017 tax return (i.e., April 17, 2018). An election is available to defer the tax for eight years; however, the first installment requires a payment of 8% of the liability and is due on April 17, 2018.
Interestingly, an S corporation is eligible to defer the tax indefinitely altogether. The tax becomes due when a “triggering event” occurs, which includes a situation where the S corporation is liquidated, ceases to be an S corporation, etc.
What else do I need to know about the one-time transition tax?
Here are additional guidance details provided by the IRS:
The IRS is advising that individual taxpayers (with a Section 965 liability) that electronically file Form 1040 wait at least until April 2, 2018 to file their return. Taxpayers with a Section 965 amount or inclusion that have already filed a tax return should file an amended return.
- A taxpayer (i.e., individual, corporation, trust or estate) that recognizes income under Section 965 must include a Section 965 transition tax statement signed under penalties of perjury. In the case of an electronically filed return, it must be attached in PDF format with a filename of “965 Tax.” The International Tax Department will prepare a template in this respect.
- Other elections (i.e., election to pay the Section 965 tax over 8 years, S corporation election to defer the section 965 tax indefinitely, election not to apply NOLS, etc.) require separate PDF attachments. See Q7 of the FAQ to download these PDF documents.
- The IRS will issue future guidance (expected before April 2, 2018) regarding the election to pay the Section 965 tax over 8 years.
- The IRS has confirmed that the first installment of the 965 transition tax must be paid by April 17, 2018.
- The Section 965 transition tax must be paid and designated separately. It cannot be combined with the regular income tax liability.
U.S. taxpayers operating outside the U.S. through foreign corporations should consult their tax advisors regarding the one-time transition tax. Please reach out to me or another Kaufman Rossin professional with questions on how the new transition tax might impact you.