What is Section 965 Transition Tax? What is Deferred Income?

What is the Repatriation Tax (IRC 965)

Repatriation Tax (IRC 965)

What is the Repatriation Tax (IRC 965): With the introduction of the Tax Cuts and JOBS Act back in 2017/2018 – came the introduction of the repatriation act under Internal Revenue Code Section 965. The idea behind the repatriation act, was that the US government would tax all of the previously untaxed income of a foreign corporation from 1986 through 2017 — which was then submitted by Taxpayers to IRS with their 2017 or 2018 tax return. The repatriation act tax would apply even if the money was not repatriated to the United States (which is where much of the confusion lies). A main catalyst for the repatriation act where is the increasing of DRD two 100% — which essentially created a territorial system for corporate tax (aside from GILTI and Subpart F). In the past year or so, the Internal Revenue Service has developed enforcement procedures for people who have not complied with the repatriation act; likewise, the Internal Revenue Service also published a reminder that it would now be a permanent fixture for streamlined submissions.  With the ever-increasing enforcement of Internal Revenue Code section 965 repatriation tax, it is important to understand IRC 965 Repatriation Tax Act basics.

IRC 965(a)

The analysis and calculation of the repatriation tax can be very complicated — depending on how many years the corporation was in existence and how many different Controlled Foreign Corporations the Taxpayer has. The baseline requirement is contained in Internal Revenue Code section 965 subsection a as follows:

(a) Treatment of deferred foreign income as subpart F income

• • • • • In the case of the last taxable year of a deferred foreign income corporation which begins before January 1, 2018, the subpart F income of such foreign corporation (as otherwise determined for such taxable year under section 952) shall be increased by the greater of—

          • (1) the accumulated post-1986 deferred foreign income of such corporation determined as of November 2, 2017, or

          • (2) the accumulated post-1986 deferred foreign income of such corporation determined as of December 31, 2017.

What does this Mean?

It means that with the Repatriation Tax Act, when there is a Deferred Foreign Income Corporation, the US owners of the company have to look back from 1987 to 2017 to determine how much accumulated deferred foreign income the company has — which had not been previously taxed.

*This is different than subpart F income, which is also taxed even if it has not been repatriated —

IRS Summary of IRC 965 Repatriation Tax Act

• • • • • Section 965 requires United States shareholders (as defined under section 951(b)) to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States.

        • Very generally, a specified foreign corporation means either a controlled foreign corporation, as defined under section 957 (“CFC”), or a foreign corporation (other than a passive foreign investment company, as defined under section 1297, that is not also a CFC) that has a United States shareholder that is a domestic corporation. Section 965 allows U.S. shareholders to reduce the amount of the income inclusion based on deficits in earnings and profits with respect to other specified foreign corporations.

        • The effective tax rates applicable to income inclusions are adjusted by way of a participation deduction set out in section 965(c). A reduced foreign tax credit applies to the inclusion under section 965(g). Taxpayers may elect to pay the transition tax in installments over an eight-year period.

        • Taxpayers may have to pay a section 965 transition tax when filing their 2017 tax returns. The tax is payable as of the due date of the return (without extensions).

        • The IRS recently issued guidance on the calculation of the tax and filing for 2017 in the form of answers to frequently asked questions (FAQs) which can be found, along with additional IRS news releases on section 965, and other topics relating to tax reform and the Tax Cuts and Jobs Act.

What Taxpayers are Impacted?

• • • • • It is important that all potentially impacted taxpayers are aware of the requirements under section 965. U.S. shareholders of specified foreign corporations need to be aware that an income inclusion may be required for 2017 and certain elections, which may have a significant impact on a taxpayer’s 2017 payment and filing obligations, must be made no later than the due date for a taxpayer’s 2017 tax return. U.S. shareholders include domestic corporations, but could also include other U.S. persons, such as individuals, S corporations, partnerships, estate, trusts, cooperatives, REITS, RICs and tax-exempt organizations.

        • Notably, all U.S. shareholders of a CFC previously filing a Form 5471 should determine if there is an obligation to file and pay the tax under section 965 for 2017. Note, however, that even if a United States shareholder has not previously filed Form 5471, the United States shareholder may be subject to tax under section 965.

IRC 965 (h)(2)

Is it Due All at Once?

Another important aspect of the repatriation tax is knowing when the payments are due. In accordance with subsection H, a Shareholder can pay in eight installments without any interest accruing on the unpaid portion. The size of the installment increases overtime from 8% to 25% of the total balance due per year.

• • • • • (h)Election to pay liability in installments

        • (1)In general In the case of a United States shareholder of a deferred foreign income corporation, such United States shareholder may elect to pay the net tax liability under this section in 8 installments of the following amounts:

        • (A) 8 percent of the net tax liability in the case of each of the first 5 of such installments,

        • (B) 15 percent of the net tax liability in the case of the 6th such installment,

        • (C) 20 percent of the net tax liability in the case of the 7th such installment, and

        • (D) 25 percent of the net tax liability in the case of the 8th such installment.

Streamlined Offshore Submissions and the Repatriation Tax Act

Recently, the Streamlined Program confirmed that not only is IRC 965 repatriation tax required, BUT the requirement has been grandfathered into the requirement — even when 2017 is not part of the submission.

As provided by the IRS:

• • • • • The “transition tax” per section 965 of the Internal Revenue Code generally treats the accumulated post-1986 deferred foreign income (DFI) of a Specified Foreign Corporation (SFC) as Subpart F income. Section 965(a) defines DFI as the greater of the DFI of such SFC determined as of November 2, 2017 or December 31, 2017. For general information on the transition tax, see Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns.

        • A taxpayer who uses the Streamlined Filing Compliance Procedures to come into compliance remedies a specific number of tax years, generally the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed.

        • Taxpayers that own SFCs and have a section 965(a) inclusion using the Streamlined Filing Compliance Procedures must come into compliance for the section 965 transition tax in their submission and include the tax year in which the transition tax inclusion might occur (generally 2017 and/or 2018) even if that tax year would not be within the standard three-year lookback period.

        • In other words, the lookback period for any submission to the Streamlined Filing Compliance Procedures involving SFCs with a section 965(a) inclusion in 2017 must include tax year 2017 and include all subsequent tax years.

        • 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.

        • Since the disclosure scope for a submission to the Streamlined Filing Compliance Procedures with a SFC will include tax years 2017 and/or 2018 and forward, noncompliant years prior to the submission scope may have previously untaxed Subpart F income or section 956 amounts.

        • Absent the Subpart F income or section 956 amounts being reported by the taxpayer, making a submission to the Streamlined Filing Compliance Procedures does not constructively provide the taxpayer with Previously Taxed Earnings & Profits (PTEP) for pre-disclosure years.

        • In other words, a taxpayer using the Streamlined Filing Compliance Procedures must strictly comply with the Internal Revenue Code for purposes of section 965 and computing PTEP. Taxpayers must properly account for and report Subpart F income and section 956 amounts in their submission, and only amounts included in income by the taxpayer prior to the submission period and amounts included as part of the submission will constitute PTEP.

        • Please include “Section 965” written in red at the top of the first page of each delinquent or amended tax return and at the top of each information return. The addition of “Section 965” should be after the annotation of “Streamlined Foreign Offshore” or “Streamlined Domestic Offshore” written in red.

IRS Hypothetical for a Streamlined Foreign Offshore Submission:

• • • • • Taxpayer A is a U.S. citizen who has lived abroad for her entire adult life. On January 1, 2010, Taxpayer A formed a foreign entity classified as a corporation for U.S. income tax purposes, Foreign Co. B. Taxpayer A owns 51% of Foreign Co. B, which has a calendar year end, and manages a successful and profitable business through Foreign Co. B. Taxpayer A has not filed U.S. individual income tax returns for the last ten years, and she has never filed an extension of time to file any of her income tax returns.

        • Taxpayer A also has never reported her signature or other authority over various foreign bank accounts, including the bank accounts of Foreign Co. B, on FBARs. Her failure to file income tax returns and FBARs was non-willful. On August 1, 2021, Taxpayer makes a submission to the Streamlined Foreign Offshore Procedures (SFO). Taxpayer A’s SFO submission includes a Form 14653 and delinquent income tax returns for tax years, 2017, 2018, 2019, and 2020. Taxpayer A separately electronically filed FBARs with FinCEN.

        • Taxpayer A must file Forms 5471 reporting her ownership of Foreign Corp. B, and Taxpayer A must address the section 965 transition tax on her 2017 income tax return including completing a Form 965. Taxpayer A must write in red ink on the top of the first page of each of her delinquent income tax returns and at the top of each information return “Streamlined Foreign Offshore Section 965.

IRS Audit Campaign for Repatriation Tax Act

The IRS has been pursuing the IRC 965 issues for a while, and the Streamlined Procedures notice was just the icing on the case:

As provided by the IRS:

• • • Practice Area: Withholding and International Individual Compliance

    • Lead Executive: Deborah Palacheck, Director, Withholding and International Individual Compliance

    • Campaign Point of Contact: Ursula Gee, Withholding and International Individual Compliance

      • 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.

Golding & Golding: About Our International Tax Law Firm

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

Contact our firm for assistance with getting compliant.