On August 1, the IRS issued its first set of proposed regulations under the Tax Cuts and Jobs Act of 2017 (TCJA). These regulations interpret and apply the Sec. 965 transition tax, which levies a one-time tax on deferred earnings of U.S.-owned foreign corporations (specified foreign corporations, or SFCs) at reduced rates. Since many taxpayers will be required to report the impact of Sec. 965 on their 2017 tax returns, these regulations are of immediate relevance.

Fortunately, we’ve seen a preview of these regulations in a trio of IRS Notices and a Revenue Procedure released since the enactment of Sec. 965 as part of the TCJA. By and large, the proposed regulations affirm the interpretations of Sec. 965 provided in those Notices, including rules on determining earnings and profits (E&P), calculating cash equivalent balances, disregarding certain intercompany transactions, calculating the Sec. 965(c) participation exemption, and determining the allowable foreign tax credit.

Some of the noteworthy provisions applicable to companies, which either expand on the Notices or are entirely new, include the following:

• Sec. 861 expense allocations may not consider the Sec. 965(c) deduction as making toll-charge income exempt or excluded. Substantial questions, however, remain, about how Sec. 861 should be applied against the toll-charge and in future years.
• Distributions of PTI created by allocation of an E&P deficit (so-called Sec. 965(b) PTI) will not trigger Sec. 986(c) foreign currency gain or loss. The regulations do not, however, provide for how a distribution of PTI will be allocated between Sec. 965(a) and Sec. 965(b) PTI where both exist in the same SFC.
• The IRS clarified when underpayments of any installment could accelerate the remaining installments. If taxpayers underpay on an installment for reasons other than neglect, fraud, or intentional disregard, the deficiency is generally allocated to future installments. If the taxpayer fails to make a payment, or if an underpayment is due to neglect, fraud, or intentional disregard, the remaining installments may be accelerated.
• The regulations include substantial procedural rules on how a deferred Sec. 965 liability can be transferred from one taxpayer to another upon certain acceleration events that would otherwise cause any unpaid installments to become immediately due.
• Affiliated but non-consolidated corporations subject to Sec. 965 may share unused SFC E&P deficits if one of the corporations’ SFCs have a net E&P deficit.
• Taxpayers will increase their basis in stock of SFCs under Sec. 961 for the amount of the Sec. 965(a) inclusion. The regulations also provide an election to increase basis in stock of an SFC with positive E&P by the amount of any Sec. 965(b) deficit allocation and decrease basis in deficit SFCs by the same amount.
• The IRS reiterated the anti-abuse rules previously outlined in the Notices, whereby certain transactions or elections may be disregarded for purposes of calculating the tax liability associated with Sec. 965. For example, any change in accounting method made for an SFC during a year ending in 2017 or 2018 is disregarded for purposes of calculating the toll charge. Similarly, any check-the-box election filed on or after November 2, 2017, is ignored.

In addition to these company-focused provisions, the regulations provide that, for individuals, estates, and trusts subject to both the Sec. 965 and the Sec. 1411 net investment income tax of 3.8 percent, the Sec. 1411 tax is levied against the Sec. 965(a) inclusion amount without reduction for the Sec. 965(c) participation exemption. Such tax may, however, be deferred until the earnings subject to Sec. 965 are distributed to the taxpayer.

A&M Taxand Says:

While the regulations are not in force, they are the best guidance taxpayers will likely have before filing their 2017 returns. Taxpayers must now make decisions on any open questions and finalize their Sec. 965 calculations. This package of regulations confirms our concerns about further complexity and reaffirms the need for appropriate technology and tools to address these challenges. Over the coming weeks, we discuss additional insights gleaned from these regulations.