Final transition tax regulations provide certainty for taxpayers

People in businessThe IRS released final regulations on Jan. 16 implementing the transition tax rules enacted by the Tax Cuts and Jobs Act (TCJA). The guidance generally adopts regulations proposed in August, but also contains numerous targeted changes that correct nuances or clarify ambiguities in the proposed regulations.

In general, Section 965 imposes a transition tax on previously untaxed post-1986 foreign earnings and profits (E&P) of certain foreign corporations owned by a U.S. shareholder. Section 965 deems those earnings to be repatriated and results in an income inclusion for the U.S. shareholder of the foreign corporation. Foreign earnings considered held in the form of cash and cash equivalents are taxed at a 15.5% rate, while the remaining earnings are taxed at an 8% rate.

The package is the first set of final regulations released by the IRS addressing rules enacted by the TCJA. The Section 965 final regulations are relatively consistent in both structure and substance with those previously proposed (see our previous Tax Flash on the proposed Section 965 regulations). In fact, a substantial portion of the preamble was dedicated to defending Treasury’s position to adopt large portions of the proposed regulations without change.

Despite containing limited changes, the rules do provide taxpayers with certainty. Taxpayers had been operating without final rules for over a year. A lack of final rules impacted financial reporting and impeded their ability to accurately calculate their Section 965 liability for both 2017 and 2018 tax years.

Final regulations Final regulations were released under Sections 962, 965, and 986. Though predominately consistent with the proposed regulations, the rules do contain a number of deviations and additions. In many cases, the changes provide much-needed clarifications, and landed in favor of taxpayers. Notable aspects of the final regulations include:

  • A commodity exception that excludes certain actively traded commodities and derivatives from the definition of cash position
  • Limits on the downward-basis adjustments to the stock of an E&P deficit foreign corporation to the available basis with the result that gain is not recognized (referred to as the “to-the-extent rule”) when the basis adjustment election is made
  • An increased de minimis threshold preventing downward attribution to partnerships from partners that own less than 5% to partners that own less than 10% and extending the de minimis threshold to trusts

Additionally, a number of favorable changes were made to the anti-abuse rules. Although the proposed structure and approach to the anti-abuse rules remains intact, several meaningful changes were made providing an added level of certainty for taxpayers. Most notably, the regulations:

  • Provide an explicit exception for certain incorporation transactions
  • Govern the date of liquidation for certain liquidation transactions targeted by the anti-abuse rules
  • Modify the “element” test with respect to the rule that disregards certain accounting method changes
  • Make the “specified payment” rule that disregards certain payments between specified foreign corporations optional

The rules are generally retroactively effective for the last taxable year of a foreign corporation that begins before Jan. 1, 2018 (and with respect to United States persons, the taxable years in which or with which such taxable years of the foreign corporations ends). However, the basis-adjustment election in the final regulations has a due date tied to the publication of the regulations in the federal register. Taxpayers will now have up to 90 days after the publication of the regulations to make the basis election if their tax returns were otherwise due before the final regulations are published. The Federal Register is not being published during the partial government shutdown, so the deadline for this election will likely be delayed until at least 90 days from when a government spending deal is reached. Assuming the regulations are officially published prior to June, 2019, the provisions with the explicit effective date tied to Jan. 1, 2018, should ultimately be unaffected by the delayed publication of the final regulations in the Federal Register.

Next steps Though the changes appear targeted, taxpayers should still carefully evaluate them. The rules could impact a number of taxpayers in both positive and negative ways. In some cases, taxpayers may be able to amend 2017 returns or modify their 2018 computations to reduce their overall Section 965 tax liability.

Taxpayers should also take note of certain important due dates included in the regulations. In addition to the 90-day window to make the basis-adjustment election discussed above, taxpayers also have a limited period of time to file certain transfer agreements that would have otherwise been due. The transition rules were updated to provide that if a triggering event or acceleration event occurs on or before Dec. 31, 2018, the transfer agreement must be filed by Jan. 31, 2019, in order to be considered timely filed. Failure to timely file such agreement could accelerate the Section 965 liability.

For more information contact:
David Sites
Washington National Tax Office 
T +1 202 861 4104

David Zaiken
Managing Director
Washington National Tax Office 
T +1 202 521 1543

Cory Perry
Senior Manager
Washington National Tax Office 
T +1 202 521 1509

Mike Del Medico
Washington National Tax Office 
T +1 202 521 1522

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