Section 965 Transition Tax (What You Should Know)

Section 965 Transition Tax (What You Should Know)

Section 965 Transition Tax 

Section 965 of the Internal Revenue Code deals with the treatment of deferred foreign income for certain foreign corporations. The Section 965 transition tax is a very complex aspect of international tax law because it interweaves already highly complicated tax issues involving Controlled Foreign Corporations (CFC), Subpart F Income, and GILTI. From a baseline perspective, taxpayers who have previously untaxed foreign income generated in certain foreign corporations may have to pay a one-time tax on the income that was not previously taxed. This is true, even if that income is not actually repatriated to the United States. For taxpayers who are unable to make a lump sum payment, some payment options are available —  but unfortunately, those options are not available under the Streamlined Procedures – which is a popular amnesty program used by many taxpayers who have undisclosed foreign assets, investments, as well as income from deferred foreign corporations. Let’s take a look at five important aspects of the 965 transition tax.

Specified Foreign Corporations

Foreign Corporations deemed ‘Specified Foreign Corporations’ may be responsible for making an IRC Section 965 transition tax payment. Specified Foreign Corporations can be broken down into two main categories. The first category is for Controlled Foreign Corporations — which typically includes foreign corporations that are owned more than 50% by US shareholders who each have at least a 10% ownership interest attribution and indirect ownership rules apply). The second category is for foreign corporations that have a domestic corporation shareholder.

Taxes Due in 2017

In general, taxpayers were required to make an IRC Section 965 tax payment as part of their 2017 tax return. But, depending on what type of tax year the foreign corporation utilizes — in addition to whether there is a domestic corporation shareholder can impact whether the applicable tax year was 2017 or 2018. While the payment is due when the tax return is filed, taxpayers can (usually) pay it over an eight-year period.

The 965 Computation is Complicated

While the Internal Revenue Service provides a detailed analysis on how to prepare the Section 965 computation, the computation is still complicated nonetheless — especially depending on the extent of other variables, such as how many foreign countries the company operates in, foreign tax credits, and individuals who made treaty elections to be treated as foreign persons. For taxpayers who do not properly comply with this code section, the Internal Revenue Service may issue fines and penalties – and the penalties can be substantial.

LB&I Compliance Initiative

In order to promote enforcement of the 965 transition tax, the IRS developed a compliance campaign that is still active.

As provided by the IRS:

    • Pursuant to the changes to IRC §965 under the Tax Cuts and Jobs Act, U.S. shareholders, including individuals, that directly or indirectly own at least 10% of the stock of a specified foreign corporation (SFC) are required to include in gross income their share of the SFC’s accumulated post-1986 deferred foreign income for the last taxable year of the SFC beginning before January 1, 2018, and report this amount on their returns for the taxable year in which or with which their SFC’s taxable year ends (generally, 2017 and/or 2018). The Internal Revenue Service will address noncompliance through soft letters and examinations.

Streamlined Procedures & Section 965

The IRS recently updated the Streamlined Procedures on matters involving the Section 965 transition tax. Essentially, the IRS takes the position that even if the 965 transition tax is not part of the three-year tax return compliance period, Taxpayers are still required to include the Section 965 calculation as part of the submission, but cannot use the 8-year payment installment.

As provided by the IRS:

      • Note: The election to pay net tax liability in installments under section 965(h)(1) is not available for taxpayers submitting delinquent returns under the Streamlined Filing Compliance Procedures.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure

Contact our firm today for assistance.