An Overview of IRC Section 965

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An Overview of IRC Section 965

The tran­si­tion tax (also referred to as manda­to­ry repa­tri­a­tion) was imposed by the new U.S. tax law in IRC Sec­tion 965. The U.S. Depart­ment of Trea­sury and the Inter­nal Rev­enue Ser­vice (IRS) have been busy in issu­ing guid­ance to tax­pay­ers on how to deal with the tran­si­tion tax and are cur­rent­ly work­ing on reg­u­la­tions that are sup­posed to address many crit­i­cal issues and unre­solved areas of the new tax pro­vi­sion. Recent­ly, the IRS has released a list of Fre­quent­ly Asked Ques­tions (FAQs) with respect to the tran­si­tion tax imposed under IRC Sec­tion 965. This infor­ma­tion per­tains to the tax pay­ment oblig­a­tions and return fil­ing dead­lines, as well as oth­er areas rel­e­vant to report­ing the tran­si­tion tax on one’s indi­vid­ual income tax return for the 2017 and 2018 tax years, as applicable.Generally, pur­suant to IRC Sec­tion 965, cer­tain U.S. share­hold­ers of cer­tain for­eign cor­po­ra­tions are sub­ject to the tran­si­tion tax on pos­i­tive post-1986 accu­mu­lat­ed earn­ings and prof­its of such for­eign cor­po­ra­tions (Spec­i­fied For­eign Cor­po­ra­tions). A U.S. Share­hold­er is any U.S. per­son who holds at least 10 per­cent of a for­eign cor­po­ra­tion stock by vote (that def­i­n­i­tion was expand­ed from the 2018 tax years to include vote or val­ue). The Spec­i­fied For­eign Cor­po­ra­tion (SFC) is defined as a Con­trolled For­eign Cor­po­ra­tion (a for­eign cor­po­ra­tion where U.S. Share­hold­ers own more than 50 per­cent by vote or val­ue) or a for­eign cor­po­ra­tion that has at least one U.S. domes­tic cor­po­ra­tion as a U.S. Share­hold­er, even if the for­eign cor­po­ra­tion is not a CFC. The tran­si­tion tax has retroac­tive effect on most indi­vid­ual U.S. Share­hold­ers. Only pos­i­tive post-1986 earn­ings and prof­its of SFCs are sub­ject to the tran­si­tion tax. To the extent a SFC has earn­ings and prof­its deficit, U.S. Share­hold­ers of that SFC would not be sub­ject to the tran­si­tion tax. Pur­suant to IRC Sec­tion 965, the pos­i­tive earn­ings and prof­its of one SFC can be off­set by a deficit in anoth­er SFC owned by the tax­pay­er. The tran­si­tion tax is puni­tive for many U.S. per­sons who live and work out­side the Unit­ed States. There are lim­it­ed tax plan­ning oppor­tu­ni­ties, the cal­cu­la­tion of the tran­si­tion tax is com­plex, and sev­er­al areas have lots of uncertainty.The Ques­tions and Answers sec­tion below is based on and is pre­pared pur­suant to the IRS FAQ About Report­ing Relat­ed to Sec­tion 965 on 2017 Tax Returns (avail­able at: https://​www​.irs​.gov/​n​e​w​s​r​o​o​m​/​q​u​e​s​t​i​o​n​s​-​a​n​d​-​a​n​s​w​e​r​s​-​a​b​o​u​t​-​r​e​p​o​r​t​i​n​g​-​r​e​l​a​t​e​d​-​t​o​-​s​e​c​t​i​o​n​-​9​6​5​-​o​n​-​2​0​1​7​-​t​a​x​-​r​e​t​u​rns) (last vis­it­ed June 1, 2018). Where fea­si­ble, some expla­na­tions / term def­i­n­i­tions are added.

Whether you are a U.S. share­hold­er of a Cana­di­an or for­eign cor­po­ra­tion, a Cana­di­an tax accoun­tant or Cana­di­an lawyer who believes your clients may be sub­ject to the tran­si­tion tax, we are here to help.

A U.S. Share­hold­er of a Deferred For­eign Income Cor­po­ra­tion (DFIC), as well as a direct or indi­rect part­ner in a U.S. part­ner­ship, a share­hold­er of an S cor­po­ra­tion, or a ben­e­fi­cia­ry of anoth­er passthrough enti­ty that is a U.S. share­hold­er of a DFIC are sub­ject to report­ing under IRC Sec­tion 965. Note that U.S. Share­hold­er is defined as any U.S. per­son that owns (direct­ly, indi­rect­ly, or con­struc­tive­ly) 10 per­cent or more of the vot­ing stock in a for­eign cor­po­ra­tion. Note that for the tax years of for­eign cor­po­ra­tions begin­ning after Jan­u­ary 1, 2018, an expand­ed def­i­n­i­tion of the U.S. Share­hold­er applies. The term “U.S. per­son” includes indi­vid­u­als and enti­ties. DFIC is any Spec­i­fied For­eign Cor­po­ra­tion (SFC) that has accu­mu­lat­ed post-1986 deferred for­eign income (based on pos­i­tive earn­ings and prof­its) as of Novem­ber 2, 2017 or Decem­ber 31, 2017. SFC gen­er­al­ly includes Con­trolled For­eign Cor­po­ra­tions (CFCs) (more than 50 per­cent own­er­ship by vote or val­ue is required by U.S. Share­hold­ers) and any for­eign cor­po­ra­tions where a U.S. cor­po­ra­tion has at least 10 per­cent own­er­ship inter­est.

The IRS pro­vid­ed a detailed chart show­ing how the IRC Sec­tion 965 amounts should be report­ed on U.S. Share­hold­ers’ tax returns. Gen­er­al­ly, the tran­si­tion tax should be report­ed sep­a­rate­ly from the taxpayer’s oth­er­wise applic­a­ble U.S. tax lia­bil­i­ty. In addi­tion, the IRS requires attach­ing an IRC 965 Tran­si­tion Tax State­ment to be attached to the 2017 return.

Yes. If an indi­vid­ual is required to report an IRC Sec­tion 965 amount on their 2017 U.S. income tax return, they are also required to include an IRC 965 Tran­si­tion Tax State­ment. The state­ment can be filed in paper, attached to the 2017 income tax return, or filed elec­tron­i­cal­ly in PDF for­mat (.pdf), attached to your e‑filed return with a file name of “965 Tax”. If more than one Tran­si­tion Tax State­ment are attached, they all can be com­bined into a sin­gle .pdf file. Impor­tant­ly, the state­ment must be signed under penal­ties of per­jury. The IRS requires the tax­pay­er to main­tain prop­er records sup­port­ing the cal­cu­la­tions made on the Tran­si­tion Tax State­ment. These amounts and asso­ci­at­ed cal­cu­la­tions will be used in sub­se­quent report­ing years, even as the method of report­ing will like­ly change based on mod­i­fied instruc­tions to oth­er infor­ma­tion report­ing fil­ings such as Form 5471, Infor­ma­tion Return of U.S. Per­sons With Respect To Cer­tain For­eign Cor­po­ra­tions . The IRS pro­vides a sam­ple state­ment on its web­site. The sam­ple can be replaced by any state­ment that does not nec­es­sar­i­ly mir­ror the sam­ple state­ment, as long as the Tran­si­tion Tax State­ment con­tains the fol­low­ing infor­ma­tion:

  • The amount of income includ­ed under IRC Sec­tion 965;
  • The taxpayer’s aggre­gate for­eign cash posi­tion [a defined term under IRC Sec­tion 965©(3)], if it applies to the tax­pay­er;
  • The deduc­tion amount claimed under IRC Sec­tion 965©;
  • The taxpayer’s deemed paid for­eign tax­es with respect to the total amount required to be includ­ed in income;
  • The taxpayer’s dis­al­lowed for­eign tax cred­its under IRC Sec­tion 965(g);
  • The Taxpayer’s total net tax lia­bil­i­ty under IRC Sec­tion 965;
  • The amount of the net tax lia­bil­i­ty under an elec­tion to pay the lia­bil­i­ty in install­ments IRC Sec­tion 965;
  • The amount of the net tax lia­bil­i­ty under the spe­cial pro­vi­sions for S cor­po­ra­tions, the pay­ment of which has been deferred;
  • A list of the applic­a­ble elec­tions made by the tax­pay­er, which was pro­vid­ed for in IRS Notice 2018–13. The sam­ple state­ment pro­vid­ed by the IRS asks whether or not an elec­tion was made and whether a sub­se­quent attach­ment is attached to the tax return. If you are cre­at­ing your own state­ment, indi­cate that an elec­tion was made and whether an attach­ment is includ­ed in the fil­ing.

There are var­i­ous elec­tions that can be made with respect to the income includ­ed on a 2017 U.S. tax return pur­suant to IRC Sec­tion 965, includ­ing:

  • Elec­tion to pay tax lia­bil­i­ty aris­ing as a result of the IRC Sec­tion 965 inclu­sion in eight back­loaded install­ments;
  • Elec­tion to pay deferred S cor­po­ra­tion share­hold­er net tax lia­bil­i­ty in install­ments;
  • Elec­tion to defer inclu­sion of IRC Sec­tion 965 amounts by Real Estate Invest­ment Trusts (REITs);
  • Elec­tion Not to Apply Net Oper­at­ing Loss (NOL) deduc­tion;
  • Elec­tion to Use Alter­na­tive Method to Com­pute Post-1986 Earn­ings and Prof­its Under Sec­tion 3.02 of Notice 2018–13.

The fol­low­ing per­sons are eli­gi­ble to make an elec­tion as per IRC Sec­tion 965 of the Code:

  • Tax­pay­ers who have a net tax lia­bil­i­ty pur­suant to IRC Sec­tion 965(h);
  • Tax­pay­ers who have a net tax lia­bil­i­ty and are share­hold­ers of S cor­po­ra­tions pur­suant to IRC Sec­tion 965(i);
  • Tax­pay­ers who are REITs (Real Estate Invest­ment Trusts) pur­suant to IRC Sec­tion 965(m);
  • Tax­pay­ers with a NOL (Net Oper­at­ing Loss) pur­suant to IRC Sec­tion 965(n).
A domes­tic part­ner­ship or an S cor­po­ra­tion that is a U.S. share­hold­er of a DFIC may not make any of the elec­tions under IRC Sec­tion 965. IRS Notice 2018–26, sec­tion 3.05(b) pro­vides fur­ther infor­ma­tion about applic­a­ble elec­tions for direct and indi­rect part­ners in U.S. part­ner­ships, share­hold­ers of S cor­po­ra­tions and ben­e­fi­cia­ries in oth­er passthrough enti­ties that are U.S. Share­hold­ers of DFICs. Treas. Reg. §1.964–1©(3) and IRS Notice 2018–13, Sec­tion 3.02 dis­cuss how an elec­tion can be made on behalf of an SFC.

The IRC Sec­tion 965 elec­tion must be made by the due date (includ­ing exten­sions) for fil­ing the income tax return for the rel­e­vant tax year. For an elec­tion to pay net tax lia­bil­i­ty in install­ments the first install­ment must be paid by the due date (with­out exten­sions) for fil­ing the return for the rel­e­vant tax year.

The elec­tion is made by attach­ing a state­ment, signed under penal­ties of per­jury, to a 2017 U.S. income tax return. Note that all elec­tions must be accom­pa­nied by a sep­a­rate IRC Sec­tion 965 state­ment rel­e­vant to the par­tic­u­lar elec­tion being made by the tax­pay­er. In case of an e‑filed return, the Tax­pay­er must attach a PDF for any elec­tion (see Answer 3 above). For exam­ple, the elec­tion to pay net tax lia­bil­i­ty in install­ments would include the antic­i­pat­ed install­ment pay­ment sched­ule and the net tax lia­bil­i­ty that is eli­gi­ble for install­ment pay­ments. The elec­tion to defer pay­ment of net tax lia­bil­i­ty for a S cor­po­ra­tion share­hold­er would include the name of the S cor­po­ra­tion, the tax iden­ti­fi­ca­tion num­ber of the S cor­po­ra­tion, and the net tax lia­bil­i­ty. The State­ment for Real Estate Invest­ment Trusts Elect­ing Deferred Inclu­sions would include the antic­i­pat­ed install­ment sched­ule. The Elec­tion Not to Apply Net Oper­at­ing Loss Deduc­tion would include the amount to be tak­en into account for the deduc­tion and the tax­es deemed to be paid by the cor­po­ra­tion. The elec­tion to use the Alter­na­tive Method to Com­pute Post-1986 Earn­ings and Prof­its who include the name of the SFC, the corporation’s tax­pay­er iden­ti­fi­ca­tion num­ber and ref­er­ence to IRS Notice 2018-03.

Yes. Form 5471 is an inter­na­tion­al infor­ma­tion return and is required to be filed, even if an SFC is not a CFC because it pro­vides the IRS with the infor­ma­tion used to:

  1. Cal­cu­late the U.S. Shareholder’s IRC Sec­tion 965 inclu­sion amount;
  2. Deter­mine if the tax­pay­er was a U.S. Share­hold­er of a SFC dur­ing the SFC’s 2017 tax year or on the last day of such year, and owned stock of the SFC on the last day of the SFC’s year that end­ed dur­ing the taxpayer’s year.
The tax­pay­ers must com­plete the iden­ti­fy­ing infor­ma­tion on page 1 of Form 5471 above Sched­ule A, as well as Sched­ule J. There are excep­tions to fil­ing Form 5471 that con­tin­ue to apply. Please refer to the instruc­tions to Form 5471 to deter­mine which excep­tions may be rel­e­vant to your case. You can find the form here: https://​www​.irs​.gov/​f​o​r​m​s​-​i​n​s​t​r​u​c​t​i​ons. U.S. Share­hold­ers who are not oth­er­wise under the oblig­a­tion to file Form 5471, must review the instruc­tions to deter­mine their tax fil­ing cat­e­go­ry. The IRS and the Depart­ment of Trea­sury announced in Notice 2018–13, sec­tion 5.02, that they intend on issu­ing reg­u­la­tions to pro­vide relief from fil­ing of Form 5471 for those tax­pay­ers who are con­sid­ered to own stock in for­eign cor­po­ra­tions by “down­ward attri­bu­tion” due to the repeal of IRC Sec­tion 958(b)(4).

Sched­ule K‑1, which is used to report each share­hold­er’s share of income, loss­es, deduc­tions and cred­its and sub­se­quent­ly used by the share­hold­ers to report this infor­ma­tion on their tax return, should also include a sep­a­rate state­ment, attached, for each DFIC for which such passthrough enti­ty has an IRC Sec­tion 965(a) inclu­sion amount. The fol­low­ing infor­ma­tion should be includ­ed on Sched­ule K‑1:

  1. The partner’s, shareholder’s, or beneficiary’s share of the partnership’s, S corporation’s, or oth­er passthrough entity’s IRC Sec­tion 965(a) inclu­sion amount, if applic­a­ble;
  2. the deduc­tion amount under IRC Sec­tion 965©, if applic­a­ble; and
  3. infor­ma­tion nec­es­sary to com­pute the deemed paid for­eign tax cred­it for the IRC Sec­tion 965(a) inclu­sion amount for a U.S. cor­po­rate share­hold­er or an indi­vid­ual U.S. Share­hold­er mak­ing an elec­tion under IRC Sec­tion 962 to be treat­ed as a cor­po­ra­tion. IRS Notice 2018–26, Sec­tion 3.05(b) pro­vides fur­ther infor­ma­tion relat­ed to the appli­ca­tion of IRC Sec­tion 965 for the enti­ties list­ed above.

The tax is paid via wire trans­fer, check or mon­ey order. Tax­pay­ers that would nor­mal­ly be required to pay through the Elec­tron­ic Fed­er­al Tax Pay­ment Sys­tem pro­vid­ed by the U.S. Depart­ment of Trea­sury should sub­mit the IRC Sec­tion 965 pay­ment via wire trans­fer or they may be sub­ject to penal­ties. Please refer to the spe­cif­ic pro­ce­dure for using wire pay­ment or check or mon­ey order pay­ment as there is a spe­cif­ic tax code num­ber and/or infor­ma­tion to write on the form of the pay­ment. There are two sep­a­rate pay­ments that are made with respect to a taxpayer’s 2017 income tax return and IRC Sec­tion 965. One pay­ment is with respect to tax owed with­out tak­ing into account IRC Sec­tion 965 and the oth­er is a sep­a­rate pay­ment made with regards to the tax owed from IRC Sec­tion 965 that is not oth­er­wise sat­is­fied by a pay­ment or cred­it. If the tax­pay­er receives an exten­sion of time to file pur­suant to Trea­sury Reg­u­la­tions §1.6081–5(a)(5) or (6), the taxpayer’s due date for the IRC Sec­tion 965 pay­ment is also extend­ed. Oth­er­wise, both pay­ments must be paid by the due date of the applic­a­ble return, with­out exten­sions.

Elec­tron­ic fil­ers should file on or after April 2, 2018. Tax­pay­ers who file via paper are required to file before the due date of their applic­a­ble return.

The IRS will apply 2017 esti­mat­ed tax pay­ments to a taxpayer’s 2017 net income tax lia­bil­i­ty with­out regard to IRC Sec­tion 965 and with­out regard to any income or deduc­tion prop­er­ly attrib­ut­able to a div­i­dend received by such U.S. share­hold­er from any DFIC. The remain­ing esti­mat­ed tax pay­ments will then be applied to the tax lia­bil­i­ty that arose from the IRC Sec­tion 965 cal­cu­la­tion, includ­ing amounts sub­ject to install­ment pay­ments with the rel­e­vant elec­tion.

No. A tax­pay­er may not receive a refund or cred­it of any por­tion of prop­er­ly applied 2017 tax pay­ments unless and until the amount of pay­ments exceeds the entire unpaid 2017 income tax lia­bil­i­ty, includ­ing all amounts to be paid in install­ments in sub­se­quent years.  If a taxpayer’s 2017 tax pay­ments exceed the 2017 net income tax lia­bil­i­ty, deter­mined with­out regard to IRC Sec­tion 965 and the first annu­al install­ment, which is due in 2018, pur­suant to an elec­tion under IRC Sec­tion 965(h), the excess will be applied to the next suc­ces­sive annu­al install­ment, which would due the fol­low­ing year in 2019. This would con­tin­ue to annu­al install­ment due in the fol­low­ing year of 2020 and beyond.

Engage the ser­vices of a qual­i­fied U.S. tax pro­fes­sion­al who is com­fort­able with the new leg­is­la­tion and its appli­ca­tion.

The fil­ing dead­line and the tax pay­ment dead­line is June 15, 2018, pro­vid­ed cer­tain require­ments are met. An exten­sion till Octo­ber 15, 2018 is avail­able by fil­ing Form 4868, but the tax pay­ment dead­line can­not be extend­ed.

Con­sult with US Tax IQ today to receive the right advice on plan­ning, prepa­ra­tion and com­pli­ance.

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