Transition Tax
on overseas
retained earnings

 

Transition Tax Overview

To promote the repatriation of capital, the US government has transformed the US international corporate tax system, moving from a worldwide corporate tax system, where corporations pay tax based on their global earnings, to a hybrid territorial tax system, where foreign income is exempt only if the foreign country’s tax system is similar to that in the home country.

 

How does it work?

To accomplish this, the US government passed a mandatory transition tax, section 965 of the Internal Revenue Code, which can be described as a one-time tax on trillions of dollars retained overseas, that under the old regime escaped tax until repatriation to the US.  Therefore, if you own a foreign corporation, either under your personal name or through a US corporation, you are most likely subject to this mandatory transition tax.

Section 965 imposes a transition tax on retained earnings of foreign companies, both to US shareholders and to tax residents, who directly or indirectly own more than 10% of the shares of the foreign company.

The transition tax will be calculated on the foreign company’s retained earnings as of October 30, 2017 or December 31, 2017, whichever is greater.

This law is a great opportunity for Americans to repatriate their retained earnings abroad at a discount rate and payable on installments.

Applicable Rates

Corporate Shareholders’ Rate Individual Shareholders’  Rate
15.5% on earnings and profits related to cash assets, and 17.5% on earnings and profits related to cash assets, and
8% transition tax on the rest of the accumulated earnings and profits. (this is calculated under a complex mechanism). 9.1% transition tax on the rest of the accumulated earnings and profits. (this is calculated under a complex mechanism).

To facilitate the payment of taxes, the law allows you to pay the balance of taxes over a period of up to eight years. The first payment should be sent to the Internal Revenue Service before April 17, 2018 to avoid penalties and interest.

For example, if your American corporation is a shareholder in a foreign company with retained earnings of  $1,000,000 in cash, you can repatriate those earnings by paying $ 155,000 distributed over eight years. The first installment would be $ 12,400, or 8% of the tax debt. As you can see, you can repatriate $ 1,000,000 and pay only $ 12,400 the first year.

To help you understand the new transition tax laws, we have compiled several articles, updates and commonly asked questions on this transition tax law that you can use to analyze your situation:

Transition Tax FAQs
IRS Questions & Answers
Elections for Section 965
Reporting Instructions
Transition Tax Statement
IRS Updates & Notices

 

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