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Checklist for Section 965 Transition Tax

By Renee Foshee, JD, LLM, CPA-San Angelo
September 2018

Tax year 2017 (2018 filing year) is the transition year for a new method of taxing the earnings in controlled foreign corporations and specified foreign corporations. Affected taxpayers must attach a transition tax statement and include specific information in their 2017 tax returns. Taxpayers have until the extended due date of the 2017 federal income tax return to make certain elections. Some taxpayers may want to amend their 2017 tax return to add mandatory statements or make appropriate elections by Oct. 15, 2018.

This is a brief outline of items to consider when filing the 2017 tax return:

Affected taxpayers are U.S. shareholders of controlled foreign corporations and 10 percent U.S. corporate shareholders of foreign corporations. If the U.S. shareholder is a flow-through entity (partnership or S corporation), the entity must follow reporting instructions and attach an IRC 965 Transition Tax Statement[1] (see “Mandatory Statements” below); however, the partner or shareholder must report Section 965 amounts and can make elections. 

The Section 965 transition tax is a tax on the accumulated deferred foreign income of a foreign corporation. 

Background 

The Tax Cuts and Jobs Act of 2017[2] (TCJA) changed the way that offshore earnings from investments in controlled foreign corporations will be taxed for tax years beginning after Dec. 31, 2017. Before the 2017 tax year, shareholders could defer earnings in controlled foreign corporations unless or until an anti-deferral provision such as Subpart F required some portion of the amount to be included in income.[3] After 2017, taxpayers also will need to consider the provisions of the global intangible low tax income (GILTI)[4]. The GILTI provision is in addition to and does not replace the existing anti-deferral provisions.

Calculation of the Transition Tax

The IRS published How to Calculate Section 965 Amounts and Elections Available to Taxpayers[5] to aid in calculation of the transition tax. The publication includes worksheets and instructions for use in calculating the applicable tax. 

Net investment income tax[6] (NIIT) applies to the repatriation tax for taxpayers whose income exceeds certain thresholds. The IRS indicated in proposed regulations (REG-104226-18) that the gross amount of the Section 965, rather than the net after deductions from Section 965 and the foreign tax credit, is subject to the 3.8 percent NIIT.[7] The installment payment provision for the transition tax does not apply to make NIIT payable in installments.

Mandatory Statements 

Tax returns with Section 965 income are required to include the IRC 965 Transition Tax Statement, which is signed under penalties of perjury.[8] If the return is filed electronically, a PDF of the signed statement must be attached to the return. [9]

Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, must be filed for a specified foreign corporation to report the transition tax even if the foreign corporation is not a controlled foreign corporation.[10]

Reporting of the Tax 

Transition tax amounts must be reported on the return. Guidance on what to report and how to report by type of taxpayer is found in Appendix:  Q&A2, 965 Q&A.[11]

Payment of the Tax 

Payment of the tax was due April 18, 2018. If the taxpayer files an election,[12] payments can be made in installments, but the initial installment was due April 18, 2018. Some taxpayers may have relief from late installments.

Relief for Some

  • Individual taxpayers whose transition tax is less than $1 million, make the election to pay by installments, and pay both the first and second installment payments by April 15, 2019, will not be subject to a penalty for missing the first payment due by April 17, 2018.[13]
  • Taxpayers who elect to pay transition tax by installments may have underpaid 2018 estimated tax payments because the IRS will apply the 2017 overpayment to future transition tax installments (see “CAUTION”). If that is the case, taxpayers who have underpaid 2018 estimated tax installments will have relief from underpayment of estimated tax if they made sufficient 2018 estimated tax payments to cover the first and second installments by June 15, 2018.[14]
  • Taxpayers who failed to make the installment election on their originally filed 2017 return can file an amended return on or before the extended due date of the return.[15]
  • Regulated investment companies (RICs) have excise tax relief for certain 2017 Section 965 inclusions.[16]

CAUTION

For taxpayers who overpaid 2017 income tax and have unpaid transition tax liability, the IRS has indicated[17] that it will apply overpayments of tax to the unpaid amount of the transition tax. Even if the taxpayer has elected to pay the transition tax in installments, the IRS will apply the overpayment of income tax to future transition tax installment payments. Taxpayers who have unpaid transition tax should not expect overpayments to be refunded or applied to estimated tax liability for the following year.

Elections

Elections must be made by the due date including extension for filing the tax return for the year.[18] 

  • Elections are made by attaching a statement, signed under penalties of perjury, to the tax return.[19]
  • Specific information must be included in the statement.[20]
  • Flow-through entities cannot make elections under Section 965.[21]

Here are the available elections: 

  • Election to Pay Net Tax Liability under Section 965 in Installments under Section 965(h)(1). – Taxpayers can elect to pay Section 965 transition tax payments over an eight-year period. The schedule for installments is 8 percent of the liability for each of the first five installments, 15 percent of the liability for the sixth installment, 20 percent of the liability for the seventh installment and 25 percent for the eighth installment.[22]
  • S Corporation Shareholder Election to Defer Payment of Net Tax Liability under Section 965 under Section 965(i)(1)[23]
  • Statement for Real Estate Investment Trusts Electing Deferred Inclusions under Section 951(a)(1) by Reason of Section 965 under Section 965(m)(1)(B)[24]
  • Election Not to Apply Net Operating Loss Deduction under Section 965(n)[25]
  • Election under Section 3.02 of Notice 2018-13 to Use Alternative Method to Compute Post-1986 Earnings and Profits[26]
  • Individual Election to Treat 965 Amounts as if the Amounts Were Received by a Corporation – The election does not include reducing the 965 amount by any deduction.[27]

The IRS has released the following guidance on Section 965: Notice 2018-07, Notice 2018-13, Notice 2018-26, Revenue Procedure 2018-17, Revenue Procedure 2018-47 and Section 965 Q&A.

Proposed regulations REG-104226-18[28] were issued by the IRS on Aug. 9, 2018, and are still within the comment period, so there may be further changes. The IRS has not yet revised the instructions to Form 5471, but, for tax year 2018, has released draft Forms 965 and Schedules A, B, C, D, E, F, G.[29] Instructions to Form 965 and schedules have not yet been released.

If you have questions, please see your tax advisor.

https://www.irs.gov/businesses/section-965-transition-tax

https://www.irs.gov/newsroom/questions-and-answers-about-reporting-related-to-section-965-on-2017-tax-returns


[1] Appendix:  Q&A2, Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns [hereinafter referred to as “965 Q&A”] located at https://www.irs.gov/newsroom/questions-and-answers-about-reporting-related-to-section-965-on-2017-tax-returns.

 

[2] P.L. 115-97, 131 Stat. 2054 (2017).

 

[3] Provisions that could cause inclusion of foreign earnings of controlled foreign corporations are Subpart F (Secs. 951-965), investments in U.S. property (Sec. 956), and actual or deemed dividends (Sec. 316; 1248).

 

[4] IRC Secs. 951A and 250(a)(1)(B).

 

[5] IRS Publication 5292 (April 6, 2018) is located at https://www.irs.gov/pub/irs-pdf/p5292.pdf.

 

[6] IRC Sec. 1411.

 

[7] Prop. Reg. 1.965-3(f)(3), Guidance Regarding the Transition Tax under Section 965 and Related Provisions, 83 Fed. Reg. 39514, 39558 (Aug. 9, 2018) located at https://www.gpo.gov/fdsys/pkg/FR-2018-08-09/pdf/2018-16476.pdf.

 

[8] IRS published a model statement located at https://www.irs.gov/pub/irs-news/Appendix%20-QA3_IRC-965-Transition-Tax-Statement_Fillable.pdf. Wording for the model statement was originally published in Appendix:  Q&A3, 965 Q&A.

 

[9] As of the date of this publication, the Instructions to Form 5471 (Rev. December 2017) have not been updated to reflect reporting of the Section 965 tax.

 

[10] Q8, 965 Q&A.

 

[11] The IRC 965 Transition Tax Statement must be attached to the return in addition to reporting the 965(a) amount, 965(c) deduction, foreign tax credit, and reporting of net tax liability under Section 965 and amounts to be paid in installments under Section 965(h) or deferred under Section 965(i) in addition to any applicable election statements. See Q3 and Appendix:  Q&A2, 965 Q&A.

 

[12] See, Election Statements later in this article.

 

[13] Q16, 965 Q&A, and IR-2018-131, “IRS offers penalty, filing relief to many subject to new transition tax on foreign earnings” (June 4, 2018), located at https://www.irs.gov/newsroom/irs-offers-penalty-filing-relief-to-many-subject-to-new-transition-tax-on-foreign-earnings.

 

[14] Q15, 965 Q&A.

 

[15] Q17, 965 Q&A and IR-2018-131.  The election is IRC sec. 965(h). 

 

[16] See Rev. Proc. 2018-47 for details.

 

[17] See Q10, 965 Q&A, and IRS Chief Counsel Memorandum (Aug. 2, 2018) available at https://www.irs.gov/pub/lanoa/pmta_2018_16.pdf.

 

[18] Q6, 965 Q&A.

 

[19] Q7, 965 Q&A.

 

[20] Titles of statements are found in Q7, 965 Q&A. Information to be included in the various elections is found in Prop. Reg. 1.965-7.

 

[21] Q5, 965 Q&A.

 

[22] IRC Sec. 965(h).  Prop. Reg. 1.965-7(b).

 

[23] IRC Sec. 965(i).  Prop. Reg. 1.965-7(c).

 

[24] IRC Sec. 965(m). Prop. Reg. 1.965-7(d).

 

[25] IRC Sec. 965(n).  Prop. Reg. 1.965-7(e).

 

[26] Election is described in Notice 2018-13, Section 3.02. Prop. Reg. 1.965-7(f).

 

[27] Prop. Reg. 1.962-1; 1.962-2; and see, 83 Fed. Reg. 39518-19 & 39524.

 

[28] Ibid, https://www.gpo.gov/fdsys/pkg/FR-2018-08-09/pdf/2018-16476.pdf.

 

[29] https://www.irs.gov/downloads/irs-dft.