IRS provides more guidance on the section 965 transition tax
On March 13, 2018, the U.S. Internal Revenue Service (IRS) posted a list of Frequently Asked Questions (FAQs) and answers on IRS.gov to address how taxpayers are to report and pay the section 965 transition tax on 2017 returns. Failure to follow the FAQs may result in difficulties in processing tax returns, including rejection, processing delays, or erroneous notices being issued.
The IRS is asking individuals who file Form 1040 electronically to wait until April 2, 2018, to file their return so the IRS can make adjustments to their systems. Paper filers may file at any time. The IRS is also recommending that taxpayers who have already filed a 2017 tax return consider filing an amended return based on the information contained in the FAQs and appendices.
Section 965 in general
Section 965, as newly enacted by the Tax Cuts and Jobs Act (Pub. L. No. 115-97), imposes a mandatory one-time transition tax on untaxed foreign earnings of foreign subsidiaries of U.S. shareholders by deeming those earnings to be repatriated. 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 tax due may be paid immediately or in installments over a term of eight years with no interest.
Reporting amounts under section 965
A U.S. shareholder of deferred foreign income corporation (DFIC), a direct or indirect partner in a U.S. partnership, a shareholder in an S corporation, or a beneficiary of another pass-through entity that is a U.S. shareholder of a DFIC, are required to report amounts under section 965.
The appendix to FAQ 2 explains how taxpayers should report items related to section 965. For example, individual taxpayers are to report the net section 965 inclusion on Form 1040, Line 21, Other Income, and write “SEC 965” on the dotted line to the left of Line 21. Corporate taxpayers are to report the net section 965 inclusion and associated foreign tax credits on a separate schedule, and are not to report those amounts on Form 1120 or Form 1118.
Taxpayers with income under section 965 are required to attach a section 965 Transition Tax Statement to their return. A model statement is provided. The statement must be signed under penalties of perjury, and in the case of an electronically filed return, in pdf format with the filename “965 tax." Records must be kept supporting:
- the section 965(a) inclusion amount,
- the participation deduction set out in section 965(c),
- the net tax liability under section 965, and
- the underlying calculations of these amounts.
Form 5471 must be filed with the 2017 return of a U.S. shareholder of a specified foreign corporation (SFC), even if the SFC is not a controlled foreign corporation (CFC). The IRS intends to modify the instructions to the Form 5471 as necessary.
A statement containing information about the section 965 inclusion must be attached to the Schedule K-1 of U.S. partnerships, S corporations, or other pass-through entities. Such statement must include the investor’s share of the U.S. partnership’s, S corporation’s, or other pass-through entity’s:
- section 965(a) inclusion amount,
- section 965(c) participation deduction, and
- deemed paid foreign tax credits (needed if the investor desires to make an election under section 962 to be taxed at corporate income tax rates on section 951(a) income only).
Section 965 related elections
The FAQs provide guidance on the four section 965 elections, e.g., the installment payment election or S corporation shareholder election to defer payment, as well as a fifth election, announced in Notice 2018-13, to use an alternative method to compute the post-1986 earnings and profits of a DFIC.
The FAQs confirm that:
- U.S. partnerships, S corporations, or other pass-through entities cannot make any related section 965 election for their investors.
- Any related section 965 election is to be made with a taxpayers’ return, filed by the due date including extensions. Thus, no elections are required to be filed with the request for extension.
- If an election is made to pay the section 965 net tax liability in installments, the first installment must be paid by the original due date of the return.
For each election, a statement must be attached to the return and signed under penalties of perjury, and in the case of an electronically filed return, in pdf. format. FAQ 7 contains a table describing the multiple section 965 related elections together with model statements.
Paying the section 965 tax liability
2017 tax liabilities must be paid in two separate payments: one payment for taxes owed, without regard to section 965, and a second payment for the section 965 tax liability. Both payments must be made by the due date of the applicable return (without extensions).
For the payment owed without regard to section 965, normal payment procedures apply. Details for paying the section 965 tax liability are provided in FAQ 10.
The Treasury Department and the IRS have already released Notice 2018-07, Notice 2018-13, and Rev. Proc. 2018-17 regarding section 965. The IRS plans to issue additional guidance and other information on IRS.gov in the weeks ahead.