Transition Tax (Sec. 965)

The IRS has released Publication 5292 (How to Calculate Section 965 Amounts and Elections Available to Taxpayers). Section 965 Transition Tax Code, which was amended by the Tax Cuts and Job Act (TCJA, P.L. 115-97, 12/22/2017), requires certain foreign corporations to increase their subpart F income for their last tax year that begins before Jan. 1, 2018, by the amount of their deferred foreign income. The publication provides a workbook and instructions to assist in calculating "section 965 amounts," and also includes worksheets for taxpayers who may be able to make certain elections with respect to Code Sec. 965.

A Brief Background of the Section 965 Transition Tax Code

Sec. 965, as amended by TJCA, imposes a transition tax on untaxed foreign earnings of foreign subsidiaries of U.S. companies, by deeming those earnings to be repatriated.

More specifically, the Section 965 Transition Tax Code(a) provides that, for the last tax year of a deferred foreign income corporation (DFIC) that begins before Jan. 1, 2018 (such year of the DFIC, the "inclusion year"), the subpart F income of the corporation (as otherwise determined for such tax year under Code Sec. 952) is increased by the greater of (1) the accumulated post-'86 deferred foreign income of such corporation determined as of Nov. 2, 2017, or (2) the accumulated post-'86 deferred foreign income of such corporation determined as of Dec. 31, 2017 (each such date, a "measurement date," and the greater of the accumulated post-'86 deferred foreign income of the corporation as of the measurement dates, the "Code Sec. 965(a) inclusion amount").

Furthermore, under Code Sec. 965(b)(1), the Code Sec. 965(a) inclusion amount which would otherwise be taken into account under Code Sec. 951(a)(1) by a U.S. shareholder with respect to a DFIC is reduced by the amount of such U.S. shareholder's aggregate foreign earnings and profits (E&P) deficit which is allocated to such DFIC under Code Sec. 965(b)(2).

With regard to the Section 965 Transition Tax Code, the term "aggregate foreign E&P deficit" means, with respect to any U.S. shareholder, the lesser of: (I) the aggregate of such shareholder's pro rata shares of the specified E&P deficits of the E&P deficit foreign corporations of such shareholder; or (II) the aggregate of such shareholder's pro rata shares of the Code Sec. 965(a)) inclusion amounts of all DFICs of such shareholder. (Code Sec. 965(b)(3)(A)(i)) The term "E&P deficit foreign corporation" means, with respect to any taxpayer, any specified foreign corporation with respect to which such taxpayer is a U.S. shareholder, if, as of Nov. 2, 2017, (i) such specified foreign corporation has a deficit in post-'86 earnings and profits, (ii) such corporation was a specified foreign corporation, and (iii) such taxpayer was a U.S. shareholder of such corporation. (Code Sec. 965(b)(3)(B)) The term "specified E&P deficit" means, with respect to an E&P deficit foreign corporation, the amount of such corporation's deficit in post-'86 earnings and profits as of Nov. 2, 2017. (Code Sec. 965(b)(3)(C))

For purposes of Section 965 Transition Tax Code, a DFIC is, with respect to any U.S. shareholder, any specified foreign corporation of such U.S. shareholder that has accumulated post-'86 deferred foreign income (as of a measurement date) greater than zero. Code Sec. 965(e)(1) provides that the term "specified foreign corporation" means (A) any controlled foreign corporation (CFC), and (B) any foreign corporation with respect to which one or more domestic corporations is a U.S. shareholder.

A U.S. shareholder of a DFIC is allowed a deduction for the tax year in which the above rules apply in an amount equal to the sum of: (i) the U.S. shareholder's 8% rate equivalent percentage of the excess (if any) of: (a) the amount so included as gross income, over (b) the amount of the U.S. shareholder's aggregate foreign cash position, plus (ii) the U.S. shareholder's 15.5% rate equivalent percentage of so much of the amount described in item (i)(b) (above) as does not exceed the amount described in item (i)(a) (above). (Code Sec. 965(c)(1))

The 8% rate equivalent percentage is, as to any U.S. shareholder for any tax year, the percentage which would result in the amount to which that percentage applies being subject to a 8% rate of tax determined by only taking into account a deduction equal to that percentage of the amount and the highest rate of tax specified in Code Sec. 11 for the tax year. (Code Sec. 965(c)(2)(A)) The 15.5% rate equivalent percentage is, with respect to any U.S. shareholder for any tax year, the percentage determined under the 8% equivalent percentage definition applied by substituting a 15.5% rate of tax for the 8% rate of tax. (Code Sec. 965(c)(2)(B))

The term "aggregate foreign cash position" means, with respect to any U.S. shareholder, the greater of (i) the aggregate of such U.S. shareholder's pro rata share of the cash position of each specified foreign corporation of such U.S. shareholder determined as of the close of the inclusion year or (ii) a somewhat similar calculation involving earlier tax years. Each date used in this calculation is a "cash measurement date." (Code Sec. 965(c)(3)(A))

The cash position of any specified foreign corporation includes, among other things, the net accounts receivable (receivables net of payables) of such corporation and any obligation with a term of less than one year ("short-term obligation"). (Code Sec. 965(c)(3)(B))

Note new guidance: Publication 5292 detailing Section 965 Transition Tax Code notes that a person who is a U.S. shareholder of a DFIC may be required to report the amounts needed to compute its U.S. tax liability resulting from Code Sec. 965 (i.e., section 965 amounts). In addition, a direct or indirect partner in a domestic partnership, a shareholder in an S corporation, or an owner or beneficiary of another domestic pass-through entity that is a U.S. shareholder of a DFIC may also be required to report its section 965 amounts. For example, if a domestic partnership is a U.S. shareholder of a DFIC, its partners may be required to report their share of the partnership's Code Sec. 965(a) inclusion amounts.

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