As a result of the enactment of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, the United States switched from a global to a territorial tax system, and certain U.S. taxpayers who held ownership in foreign entities were subject to a one-time Sec. 965 transition tax on untaxed foreign earnings. The IRS provided affected taxpayers various elections for paying this tax, including paying it in installments under Sec. 965(h) or deferring payment for S corporation shareholders under Sec. 965(i) until specific acceleration or triggering events occur. Even if such an event should occur, the IRS alleviates the tax burden by allowing transfer and consent agreements if the requirements are met. On June 27, 2019, the IRS released further guidance through its question-and-answer (Q&A) webpage (available at www.irs.gov) to further recap and clarify the rules for transfer and consent agreements set forth in Secs. 965(h) and (i) and Regs. Secs. 1.965-7(b) through (c).
Sec. 965 generally applies to U.S. shareholders, as defined under Sec. 951(b), in certain specified foreign corporations. A specified foreign corporation is either a controlled foreign corporation (CFC) or a foreign corporation with a corporate U.S. shareholder (Sec. 965(e)(1)). To the extent the foreign corporation has accumulated post-1986 earnings and profits that have not been previously taxed by the United States, Sec. 965 requires the U.S. shareholder to pay a transition tax on those earnings as of Nov. 2, 2017, or Dec. 31, 2017, in the foreign corporation's last tax year beginning before Jan. 1, 2018, as if the earnings had been repatriated to the United States.
Under Sec. 965(h), the taxpayer can elect to pay its Sec. 965 net tax liability in installments over eight years. The installment amounts are as follows: 8% of the tax for the first five installments, 15% for the sixth installment, 20% for the seventh installment, and 25% for the eighth and final installment (Sec. 965(h)(1)). However, if an acceleration event occurs, the unpaid portion of all the remaining installments becomes due. An acceleration event is:
An exception to this rule applies if the acceleration event is a covered acceleration as defined in Regs. Sec. 1.965-7(b)(3)(iii)(A)(1), and an eligible Sec. 965(h) transferor and an eligible Sec. 965(h) transferee (as defined in Regs. Sec. 1.965-7(b)(3)(iii)(B)(1)) enter into a transfer agreement with the IRS.
Under Sec. 965(i), a special rule applies to S corporation shareholders and allows the taxpayer to elect to defer the Sec. 965 net tax liability with respect to any S corporation that was a U.S. shareholder subject to Sec. 965. The taxpayer continues to defer the tax until a triggering event occurs. Sec. 965(i)(2)(A) and Regs. Sec. 1.965-7(c)(3)(ii) describe a few triggering events:
At the time of the triggering event, the entire amount of the deferred tax liability will be due unless (1) in the case of a stock transfer described in Sec. 965(i)(2)(A)(iii), a transfer agreement is entered into by an eligible transferor and an eligible transferee for stock transfers (Sec. 965(i)(2)(C)); or (2) the S corporation shareholder makes a Sec. 965(h) election to pay the transition tax over eight annual installments instead of immediately (Sec. 965(i)(4)). For specific triggering events described in Sec. 965(i)(2)(A)(ii), such as a liquidation or cessation of business, the Sec. 965(h) election can be made only with the IRS's consent (Sec. 965(i)(4)(D)).
Regs. Secs. 1.965-7(b)(3)(iii)(B) and 1.965-7(c)(3)(iv)(B) highlight the requirements necessary to make a valid transfer agreement for Sec. 965(h)(3) and Sec. 965(i)(2)(C) purposes. The transfer agreement must be timely filed within 30 days of the acceleration or triggering event, and a copy of the agreement must be attached to both the transferor's and transferee's tax returns (Regs. Secs. 1.965-7(b)(3)(iii)(B)(2) and 1.965-7(c)(3)(iv)(B)(2)). In addition, the agreement must be signed under penalties of perjury by the appropr iate parties (Regs. Secs. 1.965-7(b)(3)(iii)(B)(3) and 1.965-7(c)(3)(iv)(B)(3)).
The agreement must be titled "Transfer Agreement Under Section 965(h)(3)" or "Transfer Agreement Under Section 965(i)(2)" (see Regs. Secs. 1.965-7(b)(3)(iii)(B)(4) and 1.965-7(c)(3)(iv)(B)(4)), and the terms must include the following:
Regs. Sec. 1.965-7(c)(3)(v)(D) highlights the various requirements necessary to make a valid consent agreement for Sec. 965(i)(4)(D) purposes. Besides making a timely Sec. 965(h) election on the tax return and timely payment of the first installment, the consent agreement must be timely filed within 30 days of the triggering event, and a copy of the agreement must be attached to the shareholder's tax return (Regs. Sec. 1.965-7(c)(3)(v)(D)(2)). In addition, the shareholder must sign the agreement under penalties of perjury (Regs. Sec. 1.965-7(c)(3)(v)(D)(3)).
The agreement must be titled "Consent Agreement Under Section 965(i)(4)(D)" (see Regs. Sec. 1.965-7(c)(3)(v)(D)(4)), and the terms must include the following:
The IRS released new Q&As related to transfer and consent agreements that emphasize the more practical issues a taxpayer may encounter and provided citations to the primary source materials as discussed earlier.
Under Q&As No. 2, No. 3, and No. 5, the IRS indicates that a transfer or consent agreement should be filed with the IRS's Memphis Compliance Service Collection Operations at Memphis CSCO, 5333 Getwell Road MS 81, Memphis, TN 38118. All agreements will be considered timely filed only if they are filed within 30 days of the acceleration or triggering event date. However, for the death of a Sec. 965(i) transferor and related triggering event, the transfer agreement may be filed by the unextended due date of the transferor's final tax return (Regs. Sec. 1.965-7(c)(3)(iv)(B)(2)(iii)).
In Q&A No. 7, the IRS reminds taxpayers that if a Sec. 965(h) election is made, excess remittances in the year of a Sec. 965(i) triggering event cannot be refunded or credited to the next year's estimated income tax until the tax year's income tax liability is paid in full, including the Sec. 965(h) installments. The rationale behind this is that the previously deferred Sec. 965(i) net tax liability is immediately assessed as an addition of tax in the year of the triggering event. The Sec. 965(h) election only defers the payment, not the actual tax liability.
As such, with a Sec. 965(h) election in the year of a triggering event, the tax payments must be applied initially to the tax liability without Sec. 965, and the first Sec. 965(h) installment then to any succeeding Sec. 965(h) installments. Once the tax year's liability is fully satisfied, the taxpayer may receive a refund or credit to the next year's income tax if any excess remittances remain. Therefore, if the taxpayer plans to make a Sec. 965(h) election, the taxpayer must be careful of how much estimated tax payments are actually made for the tax year of a triggering event in order to get the most benefit out of the election.
Lastly, the IRS explains that the S corporation and transferor, if applicable, remain jointly and severally liable for a taxpayer's Sec. 965(i) net tax liability, even if a Sec. 965(h) election was made (Q&A No. 8). They will continue to be accountable for payments of the net tax liability, penalties, additions to tax, or other related amounts. The election does not alter the joint and several liabilities of the S corporation or transferor as discussed in Sec. 965(i)(5) and related Treasury regulations.
Editor Notes
Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or mcook@singerlewak.com.
All contributors are members of SingerLewak LLP.