Primary Requirements
Sec. 965 generally requires U.S. shareholders to pay a “transition tax” on the untaxed foreign earnings of certain specified foreign corporations (SFCs) as if those earnings had been repatriated to the United States.
More specifically, Sec. 965(a) provides rules for the last tax year of a deferred foreign income corporation (DFIC) that begins before January 1, 2018. For this year, the subpart F income of the corporation (as otherwise determined for such tax year under Sec. 952) is increased by any previously untaxed, noneffectively connected post-1986 earnings and profits (E&P) of the corporation measured as of one of two measuring dates (pre-2018 accumulated deferred foreign income). U.S. shareholders of one or more SFCs must include in income their pro rata share of the corporation’s pre-2018 accumulated deferred foreign income less their pro rata share of any other SFC’s E&P deficits.
Under Sec. 965(c)(1), a U.S. shareholder of a DFIC who’s required to include a Sec. 965(a) inclusion amount in income may deduct, in the tax year of the inclusion amount, a “Code Sec. 965(c) deduction amount” equal to the sum of the shareholder’s 8% rate equivalent percentage — as defined in Sec. 965(c)(2)(A) — of the excess (if any) of the Sec. 965(a) inclusion amount over the amount of such shareholder’s “aggregate foreign cash position” plus the shareholder’s 15.5% rate equivalent percentage — as defined in Sec. 965(c)(2)(B) — of so much of the U.S. shareholder’s aggregate foreign cash position as doesn’t exceed the Sec. 965(a) inclusion amount.
Other Key Provisions
There are other important provisions as well. For instance, Sec. 965(h)(1) provides that, in the case of a U.S. shareholder of a DFIC, the U.S. shareholder may elect to pay the net tax liability under Sec. 965 in eight installments.
Meanwhile, Sec. 965(i) provides that a shareholder of an S corporation that is itself a U.S. shareholder of a DFIC can elect to defer payment of its net tax liability under Sec. 965 with respect to such S corporation until the shareholder’s tax year that includes a triggering event with respect to such liability.
Under Sec. 965(m)(1)(B), a real estate investment trust (REIT) that’s a U.S. shareholder of a DFIC can elect, in lieu of including any amount required to be considered under Sec. 951(a)(1) because of Sec. 965 in the tax year in which it would otherwise be included in gross income, to include such an amount in gross income in eight installments. This would be in relation to, and for purposes of, the calculation of REIT taxable income under Sec. 857(b).
Sec. 965(h)(3) provides that an acceleration event occurs when there’s:
- An addition to tax for failure to timely pay an installment required under Sec. 965(h),
- A liquidation or sale of substantially all the assets of the person who made the Sec. 965(h) election (including in a Title 11 or similar case),
- A cessation of business by the person who made the Sec. 965(h) election, or
- Any similar circumstance.
However, as explained in a proposed regulation, the “eligible Code Sec. 965(h) transferee exception,” the unpaid portion of all remaining installments won’t be due as of the date of the acceleration event if the acceleration event is a “covered acceleration event” and other conditions are met. Sec. 965(i)(2) and Sec. 965(m)(2)(B)(ii), as well as proposed regs with respect to those sections, provide similar rules to Sec. 965(h)(3) and the proposed regs thereunder, with respect to S corporation or REIT U.S. shareholders.
Pursuant to IRS guidance (IR 2018-53), a taxpayer that had income under Sec. 965 for its 2017 tax year was required to include with its return an “IRC 965 Transition Tax Statement,” on which it reported not only its total net tax liability under Sec. 965, but also various other items of information under Sec. 965 including, for example, the taxpayer’s total amount required to be included in income under Sec. 965(a) and the taxpayer’s aggregate foreign cash position. No numbered tax form was required.
Final Forms and Instructions Issued
Taxpayers that reported income under Sec. 965 in a tax year beginning in 2017 or 2018 tax year, or both, must complete and attach Form 965, “Inclusion of Deferred Foreign Income Upon Transition to Participation Exemption System,” to their 2018 income tax returns. Such taxpayers may include a:
- U.S. shareholder of a DFIC,
- Direct or indirect partner in a domestic partnership,
- Shareholder in an S corporation, or
- Beneficiary of another pass-through entity, which is a U.S. shareholder of a DFIC.
In addition, taxpayers that would be required to include amounts in income under Sec. 965 but for an aggregate foreign E&P deficit allocated in accordance with Sec. 965(b) must also complete Form 965 and attach it to their 2018 income tax returns.
Individual taxpayers (or a taxpayer taxed like an individual) who have a Sec. 965 net tax liability in either tax year 2017 or 2018 (or both) must file Form 965-A, “Individual Report of Net 965 Tax Liability,” with their 2018 income tax returns. If they made a Sec. 965(h) or Sec. 965(i) election, such taxpayers must continue to file Form 965-A with their income tax returns annually if they have any Sec. 965(h) net tax liability or Sec. 965(i) net tax liability remaining unpaid at any time during a tax year.
A corporate taxpayer that has a Sec. 965 net tax liability in either tax year 2017 or 2018 (or both) must file Form 965-B, “Corporate and Real Estate Investment Trust (REIT) Report of Net 965 Tax Liability and Electing REIT Report of 965 Amounts,” with its 2018 income tax return. If it made a Sec. 965(h) election or a Sec. 965(m) election, it must continue to file Form 965-B with its income tax return each year as long as it has any Sec. 965(h) net tax liability remaining unpaid at any time during a tax year or is an electing REIT with any Sec. 965 amount not taken into account at any time during a tax year.
There’s one exception: An organization exempt from tax under Sec. 501(a) is required to complete Form 965 only if the Sec. 965 amounts are subject to tax under Sec. 511 (unrelated business income) or Sec. 4940 (private foundation investment income).
Schedules Also Released
Besides Forms 965, 965-A and 965-B, the IRS has issued a series of eight Form 965 schedules. Schedules A, B, and C function together to determine a taxpayer’s Sec. 965(a) inclusion amounts as follows:
- Schedule A calculates a U.S. shareholder’s Sec. 965(a) inclusion amount.
- Schedule B determines the accumulated post-1986 deferred foreign income of a DFIC.
- Schedule C lists a U.S. shareholder’s pro rata share of the aggregate foreign E&P deficits from E&P deficit foreign corporations.
Schedules D and E determine a taxpayer’s Sec. 965(c) deduction. Schedule D determines the U.S. shareholder’s pro rata share of the cash position of each SFC, while Schedule E identifies the cash position of each SFC.
Schedules F, G and H assist taxpayers in calculating their deemed paid and disallowed foreign taxes. Schedules F and G assist the taxpayer in calculating the foreign taxes deemed paid with respect to its Sec. 965(a) inclusion amount. Schedule H provides a calculation of the foreign tax credits disallowed with respect to the Sec. 965(a) inclusion in the 2017 and 2018 tax years.
Completely and Correctly
To determine whether you’re subject to Sec. 965, work closely with your CPA. If you are, it will be critical to complete all forms and schedules completely and correctly.
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