In the aftermath of the largest tax bill in decades, taxpayers and practitioners alike are now left to digest the resulting impact. While each of the hundreds of new pages of legislative text has its own importance, one method of analyzing the new law is to triage what should be addressed first.
One of the most significant reforms to come out of the Tax Cuts and Jobs Act (TCJA) is the change to the US international tax system. The TCJA provides for a transition from the world-wide system of taxation currently employed by the US, to a modified territorial system where income earned abroad no longer has the incentive to be left offshore as dividends paid to the US may be exempt from tax.
However, the new system also comes with a cost of entry in the form of IRC § 965. This is a mandatory (read: not elective), one-time charge against deferred earnings held offshore in Controlled Foreign Corporations (CFCs). This tax will be imposed whether cash is returned to the US or not. Computed on the total earnings and profits (E&P) of the CFC, cash on hand at specific measurement dates will be subject to a 15.5% tax rate and any remaining E&P will be taxed at 8%.
Although the concept of repatriation seems straightforward, the computation contains many steps. The first step, which is not in the statute, requires the taxpayer to assess their confidence in their historical E&P amounts. Traditionally, some taxpayers considered foreign E&P only incidental to tax and many taxpayers only evaluated these amount as needed for specific transactions such as paying dividends back to the US. This means that some of these amounts may have not been kept in accordance with US Treasury Regulations, and some taxpayers may not have a truly accurate picture of their new liability.
Built into this new tax are provisions to help alleviate this one-time hit. For example, taxpayers may elect to pay the tax through installments over an 8 year period, surprisingly without an interest charge. There are also special provisions even more favorable to S corporation shareholders. Additionally, those subject to this tax will want to tax advantage of other attributes to lower their tax liability. For example, foreign tax credits are permitted to proportionally offset tax due; previously taxed income (PTI) is taken into account; and various netting rules are allowed for foreign corporations in deficit positions.
Taxpayers should be on alert now due to the provisions’ timing. Although the majority of the recent tax reforms take effect for tax years beginning after Dec. 31, 2017, taxpayers will be required to report this income, and pay the tax, on their 2017 tax return. While this outcome might not be a surprise for those following past reform proposals, it ensures that the first impacts of reform will be felt much sooner than many people realized. This amount must be reported, paid, and certain important elections must be made on the next filed tax return. For some this may be as soon as March or April, 2018.
It is also important to note that failure to comply with these new rules may be costly. The new law explicitly extends the IRS’s statute of limitations to audit this calculation to six years, as opposed to the normal three. Furthermore, failure to elect to pay the amount in installments could result in an initial lump sum due. Given these consequences for noncompliance, each taxpayer filing a Form 5471 will want to determine if this deemed repatriation impacts their return.
To indicate the urgency in this area, one of the first pieces of IRS guidance issued was related to this repatriation calculation. The IRS and Treasury recently published Notice 2018-07, highlighting specific answers to compute the new tax that were left blank in the statute. There are still questions to be answered regarding this specific tax, as well as the new tax regime due to many aspects of the new territorial system being left to regulations. Should you have any questions regarding how you will be effected by the tax reform, the new international tax provisions, or any other complex tax issue please contact Steven Miller, alliantgroup, LP’s National Director of Tax, at Steven.Miller@alliantgroup.com.