IRS releases much-needed guidance on new 'Repatriation Tax'

16/03/2018 Kristin Konschnik, Butler Snow LLP,

On 13 March 2018, the IRS released a series of Frequently Asked Questions and sample forms providing some guidance to taxpayers who need to report and pay a tax liability under new Internal Revenue Code Section 965 (the so-called “transition” or “repatriation” tax). 

A discussion of the transition tax is beyond the scope of this article but very broadly a foreign company with significant US owners (at least 10 percent) must determine its accumulated “earnings and profits” (i.e., retained earnings) as of 2 November and 31 December 2017 and the significant US owners will be taxed on their share of the higher of these two numbers, even if the company does not distribute anything to them. 

The tax rate applicable to this “deemed repatriation” of profits depends on whether the foreign company’s assets are treated as held in cash or non-cash assets as of 31 December 2017. For 2017, profits held in cash or cash equivalents are taxed at a top rate of 17.5 percent for individuals (15.5 percent for corporations) and those held in non-cash assets are taxed at a top rate of 9.05 percent for individuals (8 percent for corporations).

Many US individual owners of foreign companies must calculate and pay the transition tax (or at least the first installment) by 15 April 2018.  The US owner can elect to pay the tax over 8 years without interest, with eight percent of the total amount due in each of the first 5 years, 15 percent in the sixth year, 20 percent in the seventh year and 25 percent in the eighth year. US shareholders in S corporations (a type of “hybrid” US corporation) can elect to defer their transition tax in its entirety until certain “triggering events” occur.

While questions still remain, the FAQs provide some guidance regarding how and when taxpayers need to report and pay their transition tax liability.  The FAQs make clear that elections with respect to the transition tax (such as the installment election and the S corporation shareholder deferral election) must be made by the due date of the electing US shareholder’s 2017 US federal income tax return, including extensions. 

However, because the first installment payment (or the total tax liability) is due on the unextended due date of the US shareholder’s return, the relevant amounts must be calculated before this unextended due date. The transition tax should be paid separately from the taxpayer’s regular US tax liability for the 2017 tax year.

The FAQs also set out where on the relevant tax forms taxpayers must report amounts related to the calculation of the transition tax liability.  The FAQs require a taxpayer with income subject to the transition tax to include an IRC 965 Transition Tax Statement that sets out specified information related to the transition tax calculation. The taxpayer must retain adequate records to support the calculation of the components of the transition tax.

The US shareholder must attach statements to their 2017 US federal income tax returns to make any relevant elections. The FAQs include forms for taxpayers to use to elect to pay the transition tax in installments and for S corporation shareholders to make the deferral election the latter cannot file their returns electronically and must file paper returns. 

S corporations, partnerships and trusts must include a statement with IRS Form Schedule K-1 issued to each owner, partner or beneficiary setting out the relevant owner’s share of certain components of the transition tax, including any foreign tax credits treated as paid with respect to the repatriated profits.  

Before 2 April, the US Treasury Department and the IRS intend to provide additional guidance regarding the availability of certain elections to direct and indirect partners in US partnerships, shareholders in S corporations and beneficiaries of other flow-through entities such as trusts. 

Individual taxpayers who electronically file their US federal income tax return should do so on or after 2 April 2018, while those that file a paper return can do so at any time.  If the taxpayer has already filed their 2017 return, they should file an amended return to comply with the election and reporting mechanics set out in the FAQs to avoid the potential assessment of interest and penalties.

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