Transition Tax on Untaxed Foreign Earnings

IRS Provides Guidance on Transition Tax Applicable to Certain Untaxed Foreign Earnings

Tax Reform News | Brady Ware CPAsOn December 29, 2017, IRS released Notice 2018-07 providing preliminary guidance on the “transition tax” that was enacted as part of tax reform legislation, the Tax Cuts and Jobs Act.

Newly enacted Internal Revenue Code Section §965 imposes a tax on untaxed accumulated post-1986 foreign earnings by deeming such earnings repatriated upon transition to the new territorial system of taxation. The specific transition tax rate depends on how foreign earnings are held. Foreign earnings held in cash or cash equivalents are taxed at 15.5%, with remaining earnings taxed at 8%. A taxpayer may elect to pay this transition tax over an eight-year period.

Notice 2018-07 provides a summary of the newly enacted code section in addition to providing clarity on several aspects of the transition tax. Specifically, it addresses:

  • Allocation between multiple inclusion years, related party transactions, and treatment of derivatives and hedging transactions, as it relates to determining a taxpayer’s Aggregate Foreign Cash Position;
  • Adjustments to a taxpayer’s post-1986 Deferred Foreign Income to reflect transactions and distributions among Specified Foreign Corporations, ownership by non-U.S. shareholders, and previously taxed income;
  • Basis adjustments to reflect appropriate gain recognized by U.S. shareholders;
  • Principles for consolidated returns; and
  • Adjustments related to foreign currency gain or loss.

The notice incorporates examples to illustrate the application of the above guidance.

The notice further provides that Treasury and IRS intend to issue regulations consistent with the guidance provided by Notice 2018-07 at a future date. Until such regulations are issued, taxpayers may rely on Notice 2018-07.

Though this notice is only the first step in understanding how to navigate these new complex rules and compute the transition tax, it is well-received by the industry as it not only provides some much-needed clarity, but it also gives tax practitioners comfort in knowing that more guidance from Treasury and IRS can be expected in the future.

For a copy of IRS Notice 2018-07, please see the link below:

https://www.irs.gov/pub/irs-drop/n-18-07.pdf

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