August 11, 2020

By Joshua Ashman, CPA & Nathan Mintz, Esq.

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IRS Has Added the Transition Tax Concept of Deferred Foreign income to its List of Compliance Campaigns

Despite recent staff shortages and human resource challenges due to COVID-19, the IRS continues to march forward with its campaigns focused on international tax compliance.

In this regard, the IRS has just announced its newest compliance campaign – focusing on transition tax compliance for foreign company owners. The new campaign will home in on whether a company’s “deferred foreign income” was correctly determined for purposes of applying the transition tax.

What is Deferred Foreign Income?

As we’ve discussed previously, the transition tax was a one-time mandatory repatriation tax imposed on certain foreign company owners as part of the 2017 Trump Tax Reform.

Under Section 965 of the Code, the tax was imposed on the undistributed, non-previously taxed earnings and profits (E&P) of certain US-held foreign corporations. Any such E&P held as of December 31, 2017 was designated as “deferred foreign income” potentially subject to the transition tax.

Under Section 965, the portion of the deferred foreign income comprising cash or cash equivalents was required to be taxed at the rate of 15.5%, while any remaining deferred foreign income was required to be taxed at the rate of 8%, although these rates could be higher for individuals and owners of companies with fiscal-year ends.

Due to the unprecedented and sweeping nature of the transition tax, the complexities of its calculation, and the hurried first-year application of a series of new rules (including rules for deferral and installment payments), many U.S. owners of foreign companies were likely prone to errors in determining their deferred foreign income amount and transition tax liability.

Deferred Foreign Income as a Compliance Campaign

As the IRS puts it, “greater levels of compliance risk” has triggered this new deferred foreign income compliance campaign, which will likely involve examining 2017 (and sometimes 2018) tax returns that include foreign corporation ownership disclosures with inclusions of deferred foreign income.

This compliance campaign comes on the heels of a series of other compliance campaigns focusing on international tax issues, such as the foreign tax credit, FATCA filings, tax withholding compliance, and foreign trust reporting compliance, among others.

Deferred Foreign Income Compliance Campaign to Begin with Soft Letters

As part of its announcement, the IRS stated that it plans to address most noncompliance with so-called “soft letters,” which are generally warning letters intended to encourage self-correction and voluntary compliance.

We commend this less aggressive approach, especially given the suddenness of the transition tax at the time, as well as the complexities of the rules, some of which have since been adjusted and amended, both in terms of calculating the tax as well as reporting it on the tax return.

Contact Us for Help with Deferred Foreign Income Compliance

If you are a foreign company owner who has yet to file or pay the transition tax, we can discuss your best options for catching up with the IRS. With the increased focus on international tax compliance and the current soft approach by the IRS, now is an opportune time for you and your company. Choosing the best way forward requires a careful analysis of your particular facts and circumstances.

Our experts at Expat Tax Professionals are available to help discuss your options and guide you through each step of the disclosure process. Please contact us for more information.

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