IRS has updated Questions and Answers (Q&As) regarding the Code Sec. 965 transition tax on its website. The new Q&As provide guidance on “transfer agreements” which are filed in connection with transfers that are intended to avoid accelerating the payment of remaining installments under a Code Sec. 965(h) election or triggering deferred tax liability under Code Sec. 965(i).
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. 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.
Observation: The Tax Cuts and Jobs Act (TCJA), which enacted Code Sec. 965, provides for a shift from the pre-2018 “worldwide” tax system to a “participation exemption system”;in for more details, see 2017 Tax Reform: Checkpoint Special Study on foreign income, foreign persons tax changes in the “Tax Cuts and Jobs Act” (12/28/2017). 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 would not be subject to U.S. tax on that income until it was “repatriated” to the U.S. via dividend. The transition tax effectively bridges the old rules with the new by taxing certain previously untaxed foreign income.
Under Code Sec. 965(h), taxpayers may elect to pay the transition tax in installments over an 8-year period. Code Sec. 965(h)(3) provides that where a person has made a Code Sec. 965(h) election, and an “acceleration event” occurs (e.g., a cessation of business by the taxpayer), the unpaid portion of all remaining installments is generally due on the date of that event. However, as explained in Prop Reg § 1.965-7(b)(3)(iii), the “eligible section 965(h) transferee exception,” the unpaid portion of all remaining installments will not be due as of the date of the acceleration event if the acceleration event is a “covered acceleration event” and a Code Sec. 965(h)(3) transfer agreement is entered into by an eligible Code Sec. 965(h) transferor and an eligible Code Sec. 965(h) transferee.
Special rules apply with respect to S corporation shareholders. Under Code Sec. 965(i), each shareholder, other than a domestic pass-through entity, of an S corporation that is a U.S. shareholder of a deferred foreign income corporation may elect to defer payment of the shareholder’s “Code Sec. 965(i) net tax liability” with respect to the S corporation until the shareholder’s tax year which includes a triggering event (e.g., the corporation ceasing to be an S corporation) with respect to the liability. A transfer of any share of stock in the U.S. corporation by the taxpayer is generally considered a triggering event; however, if the shareholder with respect to which the triggering event occurs and an eligible Code Sec. 965(i) transferee enter into a transfer agreement under Code Sec. 965(i)(2)(C) with IRS, the net tax liability with respect to the S corporation won’t be assessed in the shareholder’s tax year that includes the triggering event.
Code Sec. 965, which was enacted as part of the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017), 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.
IRS provides more details on transfer agreements. IRS has issued new Q&As that provide guidance on transfer agreements under Code Sec. 965(h)(3) and Code Sec. 965(i)(2)(C).
The Q&As state that transfer agreements under Code Sec. 965(h)(3) and Code Sec. 965(i)(2)(C) should be filed at: Memphis CSCO, 5333 Getwell Road MS 81, Memphis, TN 38118, and will be considered timely filed if filed by the date provided in (as-yet unissued) final regs. (Q&A 18)
In addition to the terms of agreement that are required to be included in a Code Sec. 965(h)(3) transfer agreement under the proposed regs (see Prop Reg § 1.965-7(b)(3)(iii)(A)(2)), IRS also needs the eligible Code Sec. 965(h) transferee’s consent to the immediate assessment of the remaining unpaid amounts in order to process a Code Sec. 965(h)(3) transfer agreement. (IRS noted that, while the eligible Code Sec. 965(h) transferor’s Code Sec. 965(h) net tax liability remaining unpaid will be immediately assessed against the eligible Code Sec. 965(h) transferee, the remaining installments will not become immediately due as long as the transferee agrees to be liable for the remaining installments in the same manner as the transferor and meets other requirements of Code Sec. 965(h).)
This consent may be given by including the following statement directly above the perjury jurat and the signatures of the eligible Code Sec. 965(h) transferor and eligible Code Sec. 965(h) transferee:
By signing this transfer agreement, [the eligible section 965(h) transferee] waives the right to a notice of liability and consents to the immediate assessment of the portion of the eligible section 965(h) transferor’s section 965(h) net tax liability remaining unpaid, as shown in paragraph [insert paragraph number of the transfer agreement]. [The eligible section 965(h) transferee] understands that by signing this agreement, [the eligible section 965(h) transferee] will not be able to contest this liability in Tax Court, except as additional transferee or fiduciary liability is determined for this year.
Alternatively, this consent may be given by an eligible Code Sec. 965(h) transferee’s inclusion of an executed Form 870T, Waiver of Restrictions on Assessment and Collection of Transferee or Fiduciary Liability, with the Code Sec. 965(h)(3) transfer agreement filed with IRS, consenting to the immediate assessment of the portion of the eligible Code Sec. 965(h) transferor’s Code Sec. 965(h) remaining unpaid net tax liability. (Q&A 19)
If a taxpayer has previously filed a transfer agreement under Code Sec. 965(h)(3) or Code Sec. 965(i)(2)(C), the transfer agreement should be re-filed at the address shown above, and should include the requisite consent language or Form 870T. (Q&A 20)
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.; United States Tax Reporter ¶9654.
