The Tax Cuts and Jobs Act was signed into law on Dec. 22, 2017. This law provides for the amendment of IRC Section 965, a code section that previously allowed for a limited, one-time foreign earnings repatriation at a favorable rate. While most of the new tax law provisions are effective beginning in the 2018 taxable year, this “transition tax” is effective for the 2017 taxable year for most taxpayers impacted by it.
This transition tax requires certain U.S. shareholders to include the accumulated E&P of specified foreign corporations in their current year income as of Dec. 31, 2017. This income is taxed at favorable rates, and can be paid over an 8-year period (without interest) provided a timely election and tax is paid to the Internal Revenue Service.
Application of Transition Tax
The transition tax applies to U.S. shareholders of specified foreign corporations (“SFCs”). For the 2017 tax year, a U.S. shareholder is a U.S. person (which can be an individual, corporation, partnership, etc.) that owns at least 10 percent of the vote of the outstanding stock of the foreign corporation. To some, the inclusion of individuals (who do not benefit in the future from the participation exemption) was not expected.
There are two types of SFCs. First, all controlled foreign corporations (“CFCs”) are SFCs. This type was fully anticipated. Second, foreign corporations with respect to which one or more U.S. corporations is a U.S. shareholder are also SFCs even if they do not qualify as CFCs. This was probably not anticipated by most taxpayers. The second category pulls in individual 10% shareholders if there is a 10 percent domestic corporate shareholder.
There are established rules regarding whether or not a foreign corporation qualifies as a CFC, and the ownership required to qualify as a U.S. shareholder. But what about U.S. shareholders of non-CFC foreign corporations?
As an example, if a foreign corporation has two U.S. shareholders, an individual that owns 10 percent and a U.S. corporation that owns 10 percent, both of the U.S. shareholders are subject to the transition tax even if 80 percent of the foreign corporation is foreign-owned. Furthermore, if the individuals actually own the foreign corporation through a U.S. partnership that owns 10 percent, even though they may own a very small percent, they may still be pulled in by this provision. Thus U.S. shareholders will need to know who all the other shareholders of the foreign corporation are in order to determine whether the transition tax applies.
To prevent overlooking the transition tax requirement, the international tax advisors at Moore Stephens Doeren Mayhew recommend all U.S. persons that own at least 10 percent of a foreign corporation directly or as part of a partnership that owns 10 percent review the ownership of their foreign investment. Contact us if you need assistance with this review.
Want to reach the author? Email James Miesowicz or contact him at 248.244.3115.
This article is a reprint from Moore Stephens Doeren Mayhew’s GlobalVIEW.