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2017 Tax Reform: Guidance on return filing and tax payment for transition tax (deemed repatriation)

With the March 15 and April 17 deadlines approaching for various filers, IRS has released guidance in a Frequently Asked Questions (FAQ) format that addresses basic information ‎for taxpayers affected by Code Sec. 965, as added by the Tax Cuts and Jobs Act (P.L. 115-97, 12/22/2017), including how to report such income and how to pay the associated tax liability.

Background. Code Sec. 965 generally requires U.S. shareholders to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the U.S.

This provision allows taxpayers to reduce the amount of such inclusion based on deficits in earnings and profits with respect to other specified foreign corporations. The effective tax rates applicable to such income inclusions are adjusted by way of a participation deduction set out in Code Sec. 965(c). A reduced foreign tax credit applies to the inclusion under Code Sec. 965(g).

Under Code Sec. 965(h), taxpayers may elect to pay the transition tax in installments over an 8-year period. Generally, a specified foreign corporation means either a controlled foreign corporation (CFC) or a foreign corporation (other than a passive foreign investment company, that is not also a CFC) that has a U.S. shareholder that is a domestic corporation.

Code Sec. 965 applies with respect to the last tax year of certain specified foreign corporations beginning before Jan. 1, 2018, and the amount included in income under this provision is includible in the U.S. shareholder’s year in which or with which such a specified foreign corporation’s year ends. Taxpayers may have to pay tax resulting from Code Sec. 965 when filing their 2017 tax returns. For example, Code Sec. 965 may give rise to a 2017 tax liability for a calendar year U.S. shareholder holding an interest in a calendar year specified foreign corporation.

New guidance. The FAQs provide information on filing 2017 tax returns that include an amount under Code Sec. 965. The following are some of the highlights of the information provided.

The FAQs provide that a person that is required to include amounts in income under Code Sec. 965 in its 2017 tax year—whether because the person is a U.S. shareholder of a deferred foreign income corporation or because it is a direct or indirect partner in a domestic partnership, a shareholder in an S corporation, or a beneficiary of another passthrough entity that is a U.S. shareholder of a deferred foreign income corporation—is required to report amounts under Code Sec. 965 on its 2017 tax return. (FAQs, Q&A 1)

Amounts required to be reported on a 2017 tax return should be reported on the return as reflected in the table included in Appendix: Q&A 2. The table reflects only how items related to amounts included in income under Code Sec. 965 should be reported on a 2017 tax return. It does not address the reporting in other scenarios, including distributions made in 2017, which should be reported consistent with the Code and the current forms and instructions. (FAQs, Q&A 2)

The FAQs provide that a person that has income under Code Sec. 965 for its 2017 tax year is required to include with its return an “IRC 965 Transition Tax Statement,” signed under penalties of perjury and, in the case of an electronically filed return, in Portable Document Format (.pdf) with a filename of “965 Tax”. The IRC 965 Transition Tax Statement must include the information specified. A model statement is included in Appendix: Q&A 3. Adequate records must be kept supporting the Code Sec. 965(a) inclusion amount, deduction under Code Sec. 965(c), and net tax liability under Code Sec. 965, as well as the underlying calculations of these amounts. Further, additional reporting may be required when filing returns for subsequent tax years, and the manner of reporting may be different. (FAQs, Q&A 3)

The FAQs note that Code Sec. 965 allows multiple elections related to amounts included in income by reason of Code Sec. 965 or the payment of a taxpayer’s net tax liability under Code Sec. 965 . Statutory elections can be found in Code Sec. 965(h), (i), (m), and (n). Further, IRS has announced another election that may be made with respect to the determination of the post-’86 earnings and profits of a specified foreign corporation. This election is described in Notice 2018-13, 2018-6 I.R.B. 341, Section 3.02.  (FAQs, Q&A 4)

The elections under Code Sec. 965 are limited as follows: to taxpayers with a net tax liability under Code Sec. 965 (in the case of Code Sec. 965(h)); taxpayers that are shareholders of S corporations and that have a net tax liability under Code Sec. 965 (in the case of Code Sec. 965(i)); taxpayers that are REITs (in the case of Code Sec. 965(m)); or taxpayers with an NOL (in the case of Code Sec. 965(n)). Thus, a domestic partnership or an S corporation that is a U.S. shareholder of a deferred foreign income corporation may not make any of the elections under Code Sec. 965.   (FAQs, Q&A 5)

The FAQs provide that an election with respect to Code Sec. 965 must be made by the due date (including extensions) for filing the return for the relevant year. If an election is made under Code Sec. 965(h) to pay a net tax liability under Code Sec. 965 in installments, the first installment must be paid by the due date (without extensions) for filing the return for the relevant year.  (FAQs, Q&A 6)

A person makes an election under Code Sec. 965 or the election provided for in Notice 2018-13, Section 3.02, by attaching to a 2017 tax return a statement signed under penalties of perjury and, in the case of an electronically filed return, in Portable Document Format (.pdf), for each such election. Each such statement must include the information specified. Model statements are included in Appendix: Q&A 7. (FAQs, Q&A 7)

The FAQs provide the following instructions on how a taxpayer pays the tax resulting fromCode Sec. 965 for a 2017 tax return. A taxpayer should make two separate payments as follows: one payment reflecting tax owed without regard to Code Sec. 965, and a second, separate payment reflecting tax owed resulting from Code Sec. 965 (the Code Sec. 965 Payment). Both payments must be paid by the due date of the applicable return (without extensions). The Code Sec. 965 Payment must be made either by wire transfer or by check or money order. This may be the first year’s installment of tax owed in connection with a 2017 tax return by a taxpayer making the election under Code Sec. 965(h), or the full net tax liability under Code Sec. 965 for a taxpayer who does not make such election and does not make an election under Code Sec. 965(i). For the Code Sec. 965 Payment, there is no penalty for taxpayers electing to use wire transfers as an alternative to otherwise mandated EFTPS payments. Accordingly, taxpayers that would normally be required to pay through EFTPS should submit the Code Sec. 965 Payment via wire transfer or they may be subject to penalties.  (FAQs, Q&A 10)

References: For the treatment of pre-2018 deferred foreign income treated as subpart F income under Code Sec. 965, see FTC 2d/FIN ¶ O-2700 et seq. IR 2018-53, 3/13/2018; IRS webpage, “Questions and Answers about Reporting Related to Section 965 on Tax Returns” (Mar. 3, 2018).

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