Section 965 Transition Tax



IRS is working to alert potentially impacted taxpayers about new tax filing and tax payment obligations arising under recently revised Internal Revenue Code section 965.[1] An overview of section 965 is discussed below.

What is section 965?

Section 965 requires United States shareholders (as defined under section 951(b)) to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. Very generally, a specified foreign corporation means either a controlled foreign corporation, as defined under section 957 (“CFC”), or a foreign corporation (other than a passive foreign investment company, as defined under section 1297, that is not also a CFC) that has a United States shareholder that is a domestic corporation. Section 965 allows U.S. shareholders to reduce the amount of the income inclusion based on deficits in earnings and profits with respect to other specified foreign corporations. The effective tax rates applicable to income inclusions are adjusted by way of a participation deduction set out in section 965(c). A reduced foreign tax credit applies to the inclusion under section 965(g). Taxpayers may elect to pay the transition tax in installments over an eight-year period.

Taxpayers may have to pay a section 965 transition tax when filing their 2017 tax returns. The tax is payable as of the due date of the return (without extensions). The IRS recently issued guidance on the calculation of the tax and filing for 2017 in the form of answers to frequently asked questions (FAQs) which can be found, along with additional IRS news releases on section 965, and other topics relating to tax reform and the Tax Cuts and Jobs Act.

What taxpayers are impacted?

It is important that all potentially impacted taxpayers are aware of the requirements under section 965. U.S. shareholders of specified foreign corporations need to be aware that an income inclusion may be required for 2017 and certain elections, which may have a significant impact on a taxpayer’s 2017 payment and filing obligations, must be made no later than the due date for a taxpayer’s 2017 tax return. U.S. shareholders include domestic corporations, but could also include other U.S. persons, such as individuals, S corporations, partnerships, estate, trusts, cooperatives, REITS, RICs and tax-exempt organizations. Notably, all U.S. shareholders of a CFC previously filing a Form 5471 should determine if there is an obligation to file and pay the tax under section 965 for 2017. Note, however, that even if a United States shareholder has not previously filed Form 5471, the United States shareholder may be subject to tax under section 965.

What do potentially impacted taxpayers need to know?

Taxpayers should be aware of their income tax obligations under section 965. See for details on the manner of computation and reporting of the new section 965 tax (including information for 2017 filings). The new tax applies to the last taxable year of specified foreign corporations beginning before January 1, 2018, and the tax is includible in the U.S. shareholder’s tax year in which or with which the specified foreign corporation’s year ends.

If you were a U.S. shareholder of one or more CFCs or other specified foreign corporations, section 965 requires you to take the following actions:

  1. You must determine if you held an interest in one or more specified foreign corporations whose tax year ends with or within your 2017 taxable year.
  2. You must determine the amount, if any, of previously untaxed earnings and profits to be included in income on your 2017 tax return.
  3. A U.S. shareholder that is required to pay the tax with respect to a 2017 inclusion must do so either in one lump sum, or, pursuant to an election, in eight annual installments. See IRC Section 965(h).
  4. Failure to properly comply with the reporting and payment obligations could result in the imposition of interest and/or the assertion of tax penalties.

Taxpayers must keep adequate records to support the calculation of tax pursuant to section 965. Additional information and worksheets, including reporting for 2018, will be made available on to aid taxpayers in complying with section 965. Note that reporting section 965 net tax liability for 2018 may differ from reporting for 2017.

The IRS plans to monitor compliance with the provisions of section 965. Follow-up inquiries may occur if the IRS determines that the required filings and/or payments are not made. Please see tax reform for updated information as it becomes available.

[1] All section references are to the Internal Revenue Code unless otherwise stated.