U.S. 10% Shareholder Taxpayers have a new Mandatory “Transition Tax”

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The “Tax Cuts and Jobs Act” (the “Act") has 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”.  This mandatory “transition tax” or “repatriating charge” is due by U.S. Shareholder Taxpayers regardless of whether earnings have actually been repatriated.  Although the “Act” provides a payment plan for this repatriation charge, many U.S. Taxpayers might be faced with an unexpected tax burden.  The unexpected tax burden applies to both U.S. Individuals and Corporations but particularly to U.S Individuals with respect to their 10% ownership in CFCs as the definition of U.S. Shareholder now includes U.S. Persons that own 10% or more of the value of a foreign corporation (as wells as the voting power).  This new definition of a U.S. Shareholder based on “value” versus “low or no voting stock” increases the situations in which a foreign corporation will be treated as a CFC.

Definitions

Under the Mandatory Repatriation provision of the Act:

  • 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 “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.
  • The IRS defines a Controlled Foreign Corporation as:  “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”.

Tax System

Prior to the passage of the Act, the U.S had a worldwide “extra-territorial” tax system for U.S. citizens, Permanent Residents and domestic U.S. corporations; all of their worldwide income was subject to U.S. tax whether earned in the U.S or abroad.  Nonetheless, U.S. shareholders of a foreign corporation generally were not “taxed” on their shares of that foreign corporation’s undistributed earnings.  As a result, U.S. shareholders of foreign corporations have allowed foreign corporate earnings to accumulate offshore not subject to U.S. tax.  The “Act” changes this tax deferral approach making it more expensive for a 10% or greater U.S. shareholder of a foreign corporation - as they must now include their proportional share of its earnings in their gross income.

This is what the mandatory “transition” tax provision dictates under the “Act”:

  • Foreign earnings that have been accumulated offshore by U.S. Shareholders that own at least 10% or more of the total value of a foreign corporation are deemed repatriated to those U.S. Shareholders as if actually repatriated. 
  • 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

U.S. Shareholders (domestic corporations, partnerships, trusts, estates and U.S. individuals) that own 10% or more of foreign corporations should plan immediately.  This mandatory repatriation tax takes away much of the incentive that U.S.  Taxpayers had for keeping previously accumulated foreign earnings outside of the U.S.  Although the “Act” provides a repayment plan and a reduced tax rate for repatriation, many U.S. Taxpayers might need to access these foreign earnings and to pay an unexpected tax. 

Don’t be a victim of your own making.  Consult your tax specialist now if you are a U.S. Taxpayer faced with this unforeseen tax event.    

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