Shareholders of S Corps can defer payment of Transition Tax

by Foodman CPAs & Advisors
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Background

The Tax Cuts and Jobs Act (TCJA) includes a provision requiring U.S. Shareholder Taxpayers that own 10% or more of a Controlled Foreign Corporation (CFC) and other “Specified Foreign Corporations” to pay a “transition tax” regardless of whether earnings have actually been repatriated. 

According to the TCJA:

  • A U.S. Shareholder is a domestic corporation, partnership, trust, estate and a U.S. individual that owns 10% of the value of a foreign corporation. 
  • A Controlled Foreign Corporation is:  “any foreign corporation in which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly, indirectly, or constructively by U.S. shareholders on any day during the taxable year of such foreign corporation or more than 50% of the total value of the stock is owned directly, indirectly or constructively by U.S. shareholders on any day during the taxable year of the corporation”.
  • A “Specified Foreign Corporation” is a “Non- CFC” and Non-Passive Foreign Investment Company (“Non-PFIC”) foreign corporations with a “Corporate U.S. Shareholder” (a domestic Corporation) that owns 10% of the value of such foreign corporation.
  • Foreign earnings repatriated to the U.S. will be taxed at a tax rate of 15.5% for cash earnings (Earnings and Profits) and 8% for earnings invested in non-cash assets (property, plant, and equipment)
  • Foreign earnings subject to the charge is the greater of post-1986 through 2017 accumulated earnings and profits as of November 2, 2017 or December 31, 2017 (measurement dates) – whichever date generates a greater result.  
  • U.S. Shareholders have the option to pay the tax liability over an 8-year period, payable in annual installments of 8% of the transition charge for the first 5 years, 15% of the transition charge for the sixth year, 20% of the transition charge for the seventh year, and 25% of the transition charge for the eighth year.

Special deferral rule for S Corporation Shareholders

The TCJA provides that in the case of a S corporation which is a US Shareholder of a deferred foreign income corporation (for instance a CFC), that each shareholder of the S corporation may elect to defer payment of the shareholder's net tax liability with respect to the S corporation until the shareholder's tax year which includes a triggering event for the liability.   Any net tax liability payment which is deferred is assessed on the tax return as an addition to tax in the shareholder's tax year which includes the triggering event.

The Three Triggering Events

The triggering event for payment of the liability is whichever of the following occurs first:

  1. the corporation ceases to be an S corporation (determined as of the first day of the first tax year that the corporation is not an S corporation),
  2. a liquidation or sale of substantially all the assets of the S corporation (including in a title 11 bankruptcy or similar case), a cessation of business by the S corporation, the S corporation ceases to exist, or any similar circumstance,
  3. a transfer of any share of stock in the S corporation by the taxpayer (including by reason of death, or otherwise).

Further explanations

  • If there is a transfer of less than all of the Taxpayer's shares of stock in the S corporation, the transfer is the triggering event for so much of the Taxpayer's net tax liability with respect to the S corporation properly allocable to that stock.
  • A transfer of any share of stock in the S corporation by the Taxpayer (including by reason of death, or otherwise) is not treated as a triggering event if the transferee enters into an agreement with IRS under which the transferee is liable for net tax liability on the stock in the same manner as if the transferee were the Taxpayer.
  • If any shareholder of an S corporation elects to defer payment, the S corporation is jointly and severally liable for the payment and any penalty, addition to tax, or additional amount attributable thereto.
  • Any shareholder of an S corporation which makes a deferral election must report the amount of the shareholder's deferred net tax liability on the shareholder's tax return for the tax year for which the election is made and on the tax return for each tax year thereafter until the amount has been fully assessed on the returns.

Don’t be a victim of your own making.  If you are owner of an S Corp and you elect to defer the transition tax, consult your tax specialist.

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Foodman CPAs & Advisors
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