The IRS recently 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.
The Internal Revenue Service issued an FAQ and guidance on the new Section 965 transition tax in March and April. 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: 5% tax rate for cash and 8% tax rate for non-cash
- Individual shareholders: 5% tax rate for cash and 9% 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 statementsigned 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.
- 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.
- On April 13, 2018, the IRS issued further guidance related to overpayment for the 2017 tax year where a taxpayer will elect to pay out the transition tax over installments. It indicated that if a taxpayer’s 2017 tax payments exceed the 2017 net income tax liability and the first annual installment (due in 2018) pursuant to an election under Section 965, the excess will be applied to the next successive annual installment (due in 2019). Further, the IRS indicated that it will apply any overpayments related to the regular income tax liability against the deferred transition tax. A taxpayer may not receive a refund or credit of any portion of properly applied 2017 tax payments unless and until the amount of payments exceeds the entire unpaid 2017 income tax liability, including all amounts to be paid in installments under Section 965 in subsequent years.
- Other elections (i.e., election to pay the Section 965 tax over eight years, S corporation election to defer the section 965 tax indefinitely, election not to apply NOLS, etc.) require separate PDF attachments. See question #7 of the FAQ to download these PDF documents.
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.
Carlos Somoza, J.D., LL.M., is an international tax principal in Kaufman Rossin’s Miami office. Kaufman Rossin, one of the top CPA firms in the U.S., offers international tax services for individuals and businesses. Carlos can be reached at firstname.lastname@example.org.