Section 965 Transition Tax: Yes, some issues are likely to persist for years after you've paid the tax.

• Author: Singer, Jay
• Position: Part 5 - Special Section on the Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (TCJA) added Section 965 to the Internal Revenue Code to tax earnings held offshore by controlled foreign corporations (CFCs) going back to 1987. In general, this transition tax is the price that U.S. persons who have accumulated earnings in CFCs must pay for the ability to repatriate earnings tax-free going forward. (1) Given that it is generally too late to engage in planning to mitigate the transition tax, this article focuses principally on issues that are likely to persist for years after a taxpayer has paid the transition tax. After providing a brief overview of the transition tax, this article addresses issues associated with distributions of previously taxed earnings and profits (PTEP) created by the transition tax, issues that are likely to be contentious in an Internal Revenue Service audit of the transition tax, and events that can trigger an acceleration of Section 965 tax liability otherwise deferred until future years. As of this writing, the final regulations under Section 965 have been released but not yet published in the Federal Register.

Transition Tax

The transition tax imposes two different rates of tax on post-1986 earnings and profits (E&P) for deferred foreign income corporations (DFICs). A DFIC is, with respect to any U.S. shareholder, any controlled foreign corporation or foreign corporation of such U.S. shareholder "which has accumulated post-1986 deferred foreign income [as of either November 2, 2017, or December 31, 2017] greater than zero." (2) The transition tax imposes a 15.5 percent tax rate on DFIC cash earnings and profits and an eight percent tax rate on DFIC noncash earnings and profits. (3) In addition, Section 965(b) permits U.S. shareholders of multiple CFCs to use earnings and profits deficits of certain CFCs to offset positive earnings and profits in other CFCs. Earnings and profits that are fully taxed under Section 965(a) are referred to as "[S]ection 965(a) previously taxed earnings and profits," whereas earnings and profits that are not taxed because they were offset by an earnings and profits deficit of another CFC under Section 965(b) are referred to as "[S]ection 965(b) previously taxed earnings and profits." Section 965(g) has made foreign tax credits available to offset the transition tax subject to a "haircut." Under Section 965(h), taxpayers are permitted to elect to pay the transition tax in installments over eight years. Section 965 provides special rules and elections for S corporations and real estate investment trusts owning DFIC stock. (4) Section 965(n) provides an election not to use net operating losses to offset Section 965 tax liability.

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