IRS Releases New FAQs Detailing Reporting Requirements for Transition Tax
Just a few days in the wake of the March 15 “pass-through” deadline and less than a month out from the April 17 corporate and individual deadline, we’ve found ourselves with a brief moment to come up for air and digest the most recent guidance provided by the IRS on certain mechanics related to the new Section 965 “transition tax.” The IRS has attempted to clear up the procedures for reporting and paying the tax for the 2017 tax year. As many of our clients in the tech industry have spent countless resources on computing the liability, the IRS has now provided reasonable direction on how to go about actually reporting and paying the amount due in a manner that will allow the IRS to associate the payment with the transition tax.
As a quick refresher, every U.S. shareholder of a “specified foreign corporation” (SFC) is required to compute and pay a “transition tax” or “toll charge” on the unrepatriated earnings of the SFC as of the close of the SFC’s last tax year beginning before January 1, 2018 (regardless of whether the earnings are repatriated back to the U.S.). The term SFC includes controlled foreign corporations (CFCs) as well as non-CFCs that have at least one shareholder that is a domestic corporation owning 10 percent or more of the foreign corporation. The tax is due with the tax return of the U.S. shareholder for its tax year within which the SFC’s tax year ends. However, an election may be made to pay the tax over an 8-year period under a prescribed installment schedule. Notwithstanding, at least some of the tax (8 percent under the installment plan) will be due by April 17 for calendar year taxpayers that own calendar year SFCs.
This most recent IRS guidance came in the form of Frequently Asked Questions (FAQs) and provides these key takeaways:
Who Must Report Toll Charge
Many individual taxpayers have been surprised to discover that they are subject to the toll charge. The guidance provides unequivocally that in addition to direct U.S. Shareholders of SFCs, indirect owners (via partnerships, S Corporations, or other pass-through entities) of such U.S. Shareholders must also report the toll charge. For example, a U.S. individual owning any interest in a domestic partnership is required to report the toll charge if such partnership is a U.S. Shareholder (i.e. holds more than 10 percent) of an SFC with undistributed earnings and profits.
Mandatory Use of New Reporting Form
The IRS has provided a new form, IRC 965 Transition Tax Statement, which must be attached to the return of taxpayers subject to the toll charge. The form is to be completed by following the instructions relating to the taxpayer’s classification (i.e. domestic corporation, partnership, individual, etc.). For example, domestic corporations will exclude the toll charge inclusion and deduction from Form 1120, and instead, report such income and deductions on lines 1 and 3 of the new form. The net inclusion amount, however, is to be reported on Schedule J of Form 1120. Taxpayers may find these new reporting protocols under Appendix Q&A2 of the guidance.
Taxpayers must also report certain other information on the Transition Tax Statement, such as the foreign cash positions, the deemed paid foreign taxes related to the toll charge, the amount of disallowed foreign taxes, a listing of elections made by taxpayer, the net toll charge amount to be paid in installments, etc.
Making the Election for Installment Payments
Taxpayers may elect to pay the toll charge liability over an eight-year period. This election is available to individuals or corporations. Note that pass-through entities may not make the election; but rather the election may be made by any of the owners of such pass-through entity. The election must be filed by the due date of the U.S. shareholder’s federal return plus any extensions. Note, however, that the first installment payment must be made by the original due date without any extensions. For many taxpayers, this amount (8 percent of the total toll charge liability) will be due by April 17.
Note, as IRS forms are modified and adapted to new tax rules, we expect to see a specific form related to the transition tax in 2018. Until then, it is critical to comply with the recent FAQ guidance and, of course, if you need any further assistance, please don’t hesitate to contact A&M’s team of transition tax specialists. Electronic Filing The IRS has asked individuals who electronically file their form 1040 to hold off on filing until April 2 to give the IRS time to adjust their systems.
Early Birds Beware
FAQ 12 cautions anyone subject to the transition tax that filed their return prior to the release of the FAQs to file an amended return to bring their reporting into conformity with the instructions in the FAQs. Failure to do so may result in processing difficulties and erroneous notices being issued. The same advice should apply to persons filing after the release of the FAQs, but who do not report in conformity with the FAQs on their initial return.
Open Questions
The IRS should be commended for the level of urgency and thoroughness they have devoted to guidance thus far on matters relating to the Tax Cuts and Jobs Act (TCJA). Their task is a daunting one. Given the scope of the TCJA, it is inevitable that there will continue to be open questions and confusion. For example, these recent FAQs have led to some confusion as to whether net operating losses may be applied to reduce the transition tax liability. While there is no doubt that Congress intended for NOLs to be usable, the reporting instructions provided by the FAQs appear to frustrate that intent. Also, the federal reporting procedure set forth in the FAQs may have some curious state income tax implications.
We’d love to get your thoughts: Does the guidance leave any of your questions unanswered in terms of reporting and paying the transition tax? Please call or email us and let us know!
Author: Rebecca Lara
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