Proposed Section 965 Regulations Issued for Transition Tax

For the TCJA, Congress enacted a one-time transition tax on offshore earnings of a specified foreign corporation (SFC). U.S. shareholders of an SFC are required to include in income undistributed, non-taxed post-1986 foreign earnings and profits (E&P). Such accumulated E&P inclusion is reduced by specified percentages and is intended to result in an effective tax rate of 15.5% (for E&P deemed to be held in cash and cash equivalents), and 8% on all other E&P. Individuals and trusts are subject to tax at slightly higher rates.

Prior to the issuance of the proposed regulations, IRS guidance provided further details on the implementation of Section 965 to assist taxpayers in calculating their transition-tax liability. The proposed regulations largely follow the previous IRS guidance, while also providing additional guidance in certain areas. 
Below are certain key highlights of the proposed regulations:

Basis Adjustments 

U.S. shareholders of an SFC may elect to increase their basis in SFC stock by the amount of deficit allocated from an E&P deficit foreign corporation, along with a corresponding decrease in basis in such deficit foreign corporation stock.  U.S. shareholders making this election must apply it to all SFCs, consistently.  Taxpayers should analyze the consequences of making such an election, because in certain circumstances a reduction in basis could trigger capital gains tax. 

Anti-Avoidance Rules

The proposed regulations modify the anti-avoidance language previously provided in Notice 2018-26 with respect to transactions, accounting method changes, and entity classification elections made by taxpayers. The anti-avoidance rule under the new proposed regulations will apply when there is a “change in the amount of the Section 965 element,” rather than a change in the Section 965 tax liability.  A change in the Section 965 element could include, 1) a reduction in the Section 965(a) inclusion; 2) a reduction in foreign cash position; or 3) an increase in deemed paid foreign income taxes.

Foreign Tax Credit

The proposed regulations also provide that no foreign taxes paid or accrued by a taxpayer as the result of distributing Section 965(a) previously taxed E&P will be allowed as a deduction (or credit) for the applicable percentage of the Section 965(c) deduction applied against the Section 965(a) inclusion.

Individuals

Individual shareholders making a Section 962 election (election to be taxed at corporate tax rates) may apply the Section 965(c) deduction in determining their Section 965(a) income inclusion. Conversely, individual shareholders subject to the Section 1411 net investment tax on their transition tax inclusion are not able to apply the Section 965(c) deduction in determining the amount of net investment tax due with respect to the transition tax income inclusion.

Section 958(b)(4)

The proposed regulations did not provide any additional guidance on the repeal of Section 958(b)(4), because the U.S. Treasury advised that this was beyond the scope of the proposed regulations.

The above highlights are just a few of the important areas covered by the proposed regulations, which will be considered final 60 days after they are published in the Federal Register. Taxpayers should immediately consider the impact of the proposed regulations on their transition tax liability and consult with their tax advisor regarding these complex considerations. 

For more information, please contact James Wall, Principal, International Tax Services, at 646-254-7460 or James.Wall@CohnReznick.com or Christina Lee, Partner, International Tax Services, at Christina.Lee@CohnReznick.com or at 646-254-7450 or James Robbins, Principal, International Tax Services, at James.Robbins@CohnReznick.com or at 646-762-3033 or Eytan Burstein, Director, International Tax Services, at 973-403-7992 or Eytan.Burstein@CohnReznick.com.