The IRS has issued guidance (Notice 2019-01) on the treatment of previously taxed earnings and profits (or PTEP -- this also is referred to as “previously taxed income,” or PTI) and issues arising through tax reform.
The Notice offers taxpayers a preview of the guidance the IRS intends to issue in future proposed regulations. The IRS is proposing create a complex system for tracking and grouping amounts which have been previously included in a U.S. person’s taxable income. By way of background, when a taxpayer makes a distribution that would otherwise be characterized as a dividend, the PTEP rules generally provide an exclusion from gross income for amounts that are considered to come from earnings which were previously taxed. The changes to the international tax regime created by tax reform in some ways make these rules even more important.
The proposed rules call for an annual account consisting of 16 PTEP groups to be maintained by taxpayers for each separate foreign tax credit limitation basket provided for in Section 904. The 16 groups include the 10 groups previously identified in recently issued proposed foreign tax credit regulations and add six additional groups (see our Tax Flash
for more information on the foreign tax credit regulations). Nine of the aforementioned groups will comprise so-called Section 959(c)(1) PTEP, while the remaining seven will make up Section 959(c)(2) PTEP. While the Notice provides a system encompassing a significant volume of PTEP accounts, taxpayers should note that in practice, many of the PTEP accounts are expected to be used very infrequently.
The Notice also provides guidance on the ordering rules for distributions made from previously taxed income. Under existing rules, distributions of PTEP are first made from Section 959(c)(1) PTEP, and then to section 959(c)(2) PTEP using a last-in, first out (LIFO) approach. If there is E&P in a PTEP group in multiple Section 904 categories in a given year, the distribution is made on a pro rata basis from each category. The Notice also provides a special priority rule that applies to distributions of PTEP which are attributable to an income inclusion under Section 965(a) or PTEP created under Section 965(b) -- the so-called transition tax under TCJA. This special rule results in distributions from PTEP first coming from Section 965(a) PTEP, and then from Section 965(b) PTEP. The IRS said this rule is intended to exhaust the accounts related to Section 965 inclusions first, reducing the administrative burden on taxpayers.
The Notice also provides rules for situations in which PTEP exceeds current year E&P. This may arise, for example, when GILTI income inclusions are measured using a taxable income approach, which may exceed E&P. If this were to occur, the excess PTEP will reduce Section 959(c)(3) E&P (and may be reduced below zero).
The new PTEP rules are expected to be applicable to taxable years of U.S. shareholders ending after Dec. 14, 2018. Taxpayers may rely on the guidance provided in the Notice prior to the issuance of the regulations as long as the rules are applied consistently by the U.S. shareholder and all related persons. As such, calendar-year taxpayers need to consider the impact of these new rules in short order.
Partner, Washington National Tax Office
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