Transition Tax
on overseas
retained earnings

Sec. 965 imposes a transition tax on accumulated foreign earnings of U.S. companies by deeming those earning repatriated as of January 1, 2018.   Under this law, a US shareholder owning at least 10% of a deferred foreign income corporation (DFIC) generally must include in income his or her share of the accumulated post-1986 earnings. This is a mandatory tax and it must be paid by every US taxpayer with accumulated earnings in a foreign corporation on or before April 17, 2018. 

Generally, you are subject to the transition tax if you are a U.S. shareholder of a deferred foreign income company (DFIC) with accumulated earnings and profits.  

A DFIC is any specified foreign corporation of a U.S. shareholder that has accumulated post-1986 deferred foreign income greater than zero as of the measurement date.

Section 965(e)(1) defines a specified foreign corporation as any controlled foreign corporation (CFC) and any foreign corporation with respect to which one or more domestic corporations is a Unites States shareholder.  

A U.S. shareholder is a U.S. person who owns directly, indirectly, or constructively 10 percent or more of the total combined voting power of all classes of stock of a foreign corporation entitled to vote. A U.S. person is a U.S. citizen or resident for tax purposes, a domestic entity including partnership, corporation, or estate trust.

Constructive ownership generally means a U.S. person is considered to own shares owned by certain related family members and certain related business entities. The new tax laws expanded attribution rules treating a US person as constructively owning certain stock of a foreign corporation that is held by a foreign person.

In order to calculate the transition tax, the accumulated post-1986 deferred foreign income is determined as of November 2, 2017 or December 31, 2017. The greater of the two amounts is used to calculate the transition tax.

Corporation’s accumulated post-1986 Earnings & Profits for the periods in which the corporation was a specified foreign corporation are subject to this tax.

The accumulated post-1986 deferred foreign earnings except to the extent such earnings are attributable to (ECI) effectively connected income with a US trade or business, to the extent such earnings were previously taxed income (PTI), Subpart F income or investment income as well as current year distributions.

Per IRS guidance, the cash position of any specified foreign corporation is the sum of:

• Cash held by such corporation,
• The net accounts receivable of such corporation (accounts receivable net of accounts payable, and
• The fair market value of the following assets held by such corporation:
  • Personal property which is of a type that is actively traded and for which there is an established financial market;
  • Commercial paper, certificates of deposit, the securities of the Federal government and of any State or foreign government;
  • Any foreign currency;
  • Any note receivable with a term of less than one year.

For most individuals and calendar-year domestic corporations, the transition tax is generally due April 17, 2018 even if the due date of the taxpayer’s return is extended to a later date.  There are some special rules for shareholders of S corporations and Real Estate Investment Trust (REITs). 

The Act provides a special rule for S corporations. Yes, only shareholders of S corporations can elect to defer the transition tax. Shareholders of S Corporation can elect to maintain deferral on such foreign income until the S corporation changes its status, sells substantially all its assets, ceases to conduct business, or the electing shareholder transfers its S corporation stock.   

Yes, at the election of the U.S. shareholders, the tax liability is payable over a period of up to eight years.  The payments for each of the first five years equals 8% of the net tax liability. The amount of the sixth installment is 15%, 20% for the seventh year and 25% in the eighth or final year. 

Corporate tax rates are 15.5% on earnings and profits related to cash assets and 8% transition tax on the rest of the accumulated earnings and profits.

For individuals, the accumulated earnings and profits attributable to cash assets will be subject to transition tax at approximately 17.5%, excluding the net investment income tax; and earnings and profits attributable to non-cash assets will be approximately 9.1%. There is an election for individuals to be treated as corporate shareholders for purposes of the transition tax. This election will lower the transition tax rates; however, other tax considerations should be analyzed before making this election.