More than six months have passed since President Trump signed a sweeping tax bill into law, dramatically changing the way U.S. persons are taxed. The following includes frequently asked questions (FAQs) related to deemed repatriation that have risen over the past several months.
What is the Deemed Repatriation?
Section 965 of the Internal Revenue Code, added by the Tax Cut and Jobs Act of 2017, requires Specified Foreign Corporations (Controlled Foreign Corporations and Foreign Corporations with a 10% or greater U.S. C Corporation as a shareholder, SFCs) to include in income as of December 31, 2017, all deferred foreign income earned after 1986. Basically, this provisions equates to a deemed dividend of a SFC’s non-Previously Taxed Earnings and Profits. Losses in one SFC can offset the deferred foreign income of another SFC when calculating the income inclusion. To the extent that the SFCs have cash or cash equivalents, the deemed repatriation amount is taxed at 15.5%. To the extent the deemed repatriation exceeds the cash and cash equivalents, the excess amount is taxed at 8%. This is accomplished by calculating a deduction resulting in a net amount included in income which, when taxed at 35%, results in the appropriate 15.5% or 8% tax. If a taxpayer’s tax rate is other than 35%, the actual tax to be paid will be greater or less than 15.5% or 8%. By making an appropriate election with the tax return including the deemed repatriation, a taxpayer can pay the tax over 8 years, with 8% due for the first 5 years, then 15%, 20% and 25% due in years 6, 7 and 8.
For additional information on transition tax, please contact a member of Withum’s International Services Group by filling out the form below.
Deemed Repatriation needed to be reported as of December 31, 2017? Is it too late?
The IRS issued late guidance providing relief for taxpayers who did not complete calculations or who failed to correctly report the deemed repatriation on a tax return including the December 31, 2017 repatriation date. Essentially, if the amounts are reported and the tax is paid by April 15, 2019, taxpayers subject to the Deemed Repatriation will be considered to be in compliance.
What about SFC post-2017 earnings? Will they be subject to an annual Deemed Repatriation?
No! The post-2017 earnings of SFCs owned by C corporations will not be subject to tax – they will be eligible for a “participation exemption” when a dividend is declared and funds are repatriated back to the United States. Most of the rest of the world operates under a similar “territorial system” of taxation. Since U.S. corporation income tax will not be paid on these dividends, a foreign tax credit cannot be claimed. Note, the repatriation of earnings subject to the 2017 Deemed Repatriation discussed above will also not be subject to further U.S. taxation by ALL U.S. shareholders. An individual who owns a Controlled Foreign Corporation (CFC), either directly or through a pass-through entity, will not be able to claim a participation exemption. Individuals will be subject to U.S. income tax on the dividend income. These dividends may be considered qualified dividends, subject to preferential tax rates if the CFC is in a treaty country and the treaty contains an exchange of information article. Individuals can claim a foreign tax credit for any taxes withheld by the foreign jurisdiction on the dividend distribution.
What is a Territorial System of Taxation?
Under a Territorial System of Taxation, taxpayers are subject to income taxes in the jurisdiction where the income is earned. The U.S. is one of very few countries who subject their businesses and individuals to taxation on a World-wide basis. The Tax Cut and Jobs Act of 2017 changed the system of taxation for C corporations to a Modified Territorial System of Taxation. As discussed above, when a foreign subsidiary remits a dividend to its U.S. parent, the dividend will be exempt from further U.S. taxation. However, because of both the old “SubPart F” rules and the new GILTI provisions (see below), the U.S. has not moved to a fully territorial system, but will still require certain types of income to be reported to (and taxed by) the United States.
How do I calculate the Deemed Repatriation Amount?
The first step in calculating the Deemed Repatriation amounts for each SFC is to confirm that the entity’s Earnings & Profits have been properly calculated and reported on Form 5471, Schedule J. Earnings which were previously subject to U.S. tax under SubPart F are not included in the Deemed Repatriation amount. In addition to determining the Earnings & Profits (on both 2 November 2017 and 31 December 2017) on an entity-by-entity basis, the cash and cash equivalents for each entity (as of 31 December 2017, 2016 and 2015) must be determined. The higher of the Earnings & Profits on the two measurement dates determine the deemed repatriation. The deemed repatriation taxed at 15.5% is determined based on the higher level of cash and cash equivalents either on 31 December 2017 or the average of 31 December 2016 and 31 December 2015.
How do I report the Deemed Repatriation on my client’s tax return? How do I make the payment?
The IRS has provided a template for both the Section 965 Statement as well the elections to pay the tax over 8 years or defer the tax if the taxpayer is an S corporation shareholder within each locator. Both the Section 965 Statement and an Election, if applicable, must be separately and attached to the electronic filing copy of the appropriate return as a PDF. The tax is paid separately using a voucher or by making an electronic payment.