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IRS Explains How To Calculate Transition Tax Liability

by Mike Godfrey,, Washington
12 April 2018

The US Internal Revenue Service and the Department of the Treasury have released comprehensive guidance on how to calculate liability to the Transition Tax, provided for in Section 965 of the Tax Cuts and Jobs Act, and explained elections available to taxpayers.

New Publication 5292 is intended to support taxpayers to prepare 2017 returns.

The "transition tax" applies to the untaxed foreign earnings of foreign subsidiaries of US companies.

Prior to the reform, US tax on the income of a foreign corporation could be deferred until the income was distributed as a dividend or otherwise repatriated by the foreign corporation to its US shareholders. A report from the Institute on Taxation and Economic Policy (ITEP) from March 2017 estimated that Fortune 500 companies are avoiding USD767bn in US federal income taxes by holding more than USD2.6 trillion offshore.

The transition tax seeks to regularize these holdings as part of the switch from a tax system with a worldwide corporate tax basis towards a territorial tax basis system, with a concessionary tax rate for newly repatriated income. The transition tax generally may be paid in installments over an eight-year period.

The tax functions by deeming to have been repatriated any untaxed foreign earnings of US companies' foreign subsidiaries. Foreign earnings held in the form of cash and cash equivalents are taxed at a 15.5 percent rate, and the remaining earnings are taxed at an eight percent rate.

The IRS said of the change:

"As a result of the amendment, certain taxpayers are required to include in income an amount (section 965(a) inclusion amount) based on the accumulated post-1986 deferred foreign income of certain foreign corporations that they own either directly or indirectly through other entities. Other taxpayers may have inclusions in income under section 951(a) by reason of section 965 due to ownership of deferred foreign income corporations (DFICs) through US shareholder pass-through entities."

"Section 965 also allows for a deduction (section 965(c) deduction). Section 965(a) inclusions and corresponding section 965(c) deductions are taken into account based on the last tax year of the relevant foreign corporations that begin before January 1, 2018."

"Certain taxpayers may make certain elections with respect to section 965. These elections include: (i) an election to pay the section 965 net tax liability over eight years, (ii) an election by S corporation shareholders to defer payment of the section 965 net tax liability with respect to such S corporation until a triggering event, (iii) an election by real estate investments trusts to take both section 965(a) inclusions and the corresponding section 965(c) deductions into account over eight years, (iv) an election not to apply a net operating loss, and (v) an election to use an alternative method to calculate post-1986 earnings and profits (post-1986 earnings and profits)."

The new publication defines the deferred income that will be liable to the transition tax and the types of entities covered by the regime.

It also covers which entities are obligated to report Section 965 amounts; how to report Section 965 amounts on 2017 tax returns; guidance for those taxpayers that may have to include Section 965(a) inclusion amounts in a return for the 2016 tax year; guidance on calculating Section 965 amounts, in a worksheet provided within the publication; and guidance on currency valuations.


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