Transition Tax on Foreign Company Owners Added to IRS List of Compliance Campaigns
On Monday, the IRS added the one-time “transition tax” on foreign company owners to its growing list of compliance campaigns. The addition of the transition tax continues a trend of increased IRS focus on international tax compliance.
Only a couple of weeks ago, we blogged about five new international tax compliance issues that were added to its audit strategy. This time, the IRS further stated that it may start dropping some of its domestic issue campaigns in order to ensure it has the resources to tackle the transition tax and other new international tax compliance campaigns.
Brief Overview of the Transition Tax
For those of you who are still new to Trump’s massive tax reform legislation enacted late last year, here’s a brief explanation of how the transition tax works:
As part of the transition to a so-called participation exemption system (which we describe more fully here), new Section 965 of the Internal Revenue Code uses the mechanics under Subpart F to impose on U.S. shareholders owning at least 10% of a foreign subsidiary a one-time mandatory “repatriation tax” or “transition tax” on the undistributed, non-previously taxed post-1986 foreign earnings and profits (“E&P”) of a “specified foreign corporation.” A specified foreign corporation is defined as (i) any CFC, and (ii) any foreign corporation with respect to which one or more domestic corporations is a 10% United States shareholder. The portion of the E&P comprising cash or cash equivalents is taxed at the rate of 15.5%, while any remaining E&P is taxed at the rate of 8%.
Section 965 does not distinguish U.S. corporate shareholders from other U.S. shareholders, so the transition tax potentially applies to any U.S. person (including an individual) owning at least 10% of a foreign subsidiary. The transition tax rates can be slightly higher for U.S. individual shareholders whose effective tax rate was higher than 35% for the 2017 tax year.
Section 965 specifies, importantly, that the transition tax applies to the greater of the accumulated post-1986 deferred foreign income (essentially the previously untaxed earnings and profits) of the foreign corporation determined as of November 2, 2017 or as of December 31, 2017. In order to prevent pre-transition tax avoidance planning, the section adds that E&P is determined by essentially ignoring dividends distributed during the 2017 taxable year (other than dividends distributed to another specified foreign corporation).
New IRS Campaign on Transition Tax Compliance
Due to the complexity and urgency of this year’s transition tax, it doesn’t surprise us that the IRS has made it one its compliance priorities.
According to its Monday announcement, the IRS engaged in an outreach campaign earlier this year to leverage the reach of trade groups, advisors and other outside stakeholders to raise awareness of filing and payment obligations under the transition tax rules. It seems that the feedback received led the IRS to believe that compliance reviews would be necessary to ensure that taxpayers properly fulfilled their transition tax obligations.
What This Means for US Expats
As the IRS begins to focus more heavily on international tax compliance issues, it will become more important than ever for expats to file their U.S. taxes timely and accurately.
At Expat Tax Professionals, our team of experts will carefully prepare your tax return, so that if you end up getting audited, your return will withstand the scrutiny of the IRS. If you are a U.S. expat who needs help with tax return preparation, please contact us and we’ll get the process started immediately.
By Ephraim Moss, Esq. & Joshua Ashman, CPA