Finalized Transition Tax Regulations: An Overview
The IRS has issued highly anticipated final regulations under Internal Revenue Code Section 965, the Transition Tax (TT) provision added by the Tax Cuts and Jobs Act (TCJA). Sec. 965 generally requires U.S. shareholders to pay a “transition tax” on the untaxed foreign earnings of certain specified foreign corporations (SFC) as if those earnings had been repatriated to the United States.
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The TCJA provides for a shift from the pre-2018 “worldwide” tax system to a “participation exemption system.” Under the old rules, U.S. taxpayers were generally taxed on all income whether earned in the U.S. or abroad, but foreign income earned by a foreign subsidiary of a U.S. corporation wouldn’t be subject to U.S. tax on that income until it was “repatriated” to the United States via dividend. The transition tax effectively bridges the old rules with the new by taxing certain previously untaxed foreign income. Unfortunately for individual owners of SFC, there is no “transition”; only a deemed repatriation of old retained earnings and then the same tax on future dividends from future earnings!
In a SFC’s last tax year that began before January 1, 2018, the foreign corporation’s subpart F income is increased by any previously untaxed, post-1986 earnings and profits (E&P) of the corporation. This is measured as of one of two measuring dates. U.S. shareholders of one or more SFCs must include in income their pro rata share of the corporation’s pre-2018 accumulated deferred foreign income less their pro rata share of any other SFCs’ E&P deficits. A corporate U.S. shareholder is allowed a deduction from this amount that results in a 15.5% tax rate for earnings held in cash and liquid assets, and an 8% tax rate on other earnings. The rate for an individual US Shareholder is higher: 17.5% and 9%, respectively.
Taxpayers may elect to pay the TT in installments over an eight-year period. Generally, an SFC means either a controlled foreign corporation (CFC) or a foreign corporation (other than a passive foreign investment company) with a U.S. shareholder that’s a US domestic corporation.
Taxpayers may have had to already pay tax resulting from Sec. 965 when filing their 2017 tax returns. For example, Sec. 965 may have given rise to a 2017 tax liability for a calendar-year U.S. shareholder holding an interest in a calendar-year SFC.
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James J. Miesowicz. CPA
Grensey Quintero, CPA
+41 43 433 1040