Tax-Expatriation

The “965 Hammer” (aka the “Transition” or “Repatriation” Tax) for USCs Residing Overseas

Posted on September 8, 2018 Updated on September 8, 2018

Small businesses around the world commonly operate through companies established in their country of operation.  According to the U.S. Tax Foundation, with admittedly outdated information from the year 2014, there were 1.7 million traditional C corporations, compared to 7.4 million partnerships and S corporations; even more sole proprietorships operating in the U.S.

I could not find similar data for other countries around the world, which is where Section 965 takes us.

USCs who live outside the U.S. and operate a business through a corporate entity in their country of residence (e.g., Canada, Mexico, UK, France, South Africa, Japan, Brazil, Hong Kong, Sweden, etc.) can be shocked when they learn how the new tax provision of IRC Section 965 works. 

People read about the Administration and Congress’s goal to tax mega-technology companies such as Google, FaceBook, Microsoft and the like on their accumulated overseas profits in low tax jurisdictions.  See, for instance, U.S. companies will pay billions in tax on offshore cash piles from CNN Money (by Alanna Petroff)   and Apple Leads These Companies With Massive Overseas Cash Repatriation Tax Bills from FORTUNE (by Lisa Marie Segarra, January 18, 2018).

Hence, new IRC Section 965 imposes a one-time mandatory repatriation tax on accumulated earnings and profits of foreign corporations.  The tax is paid by the U.S. shareholder.  This makes policy sense, if the goal is to tax U.S. based taxpayers, especially mega companies with billions or 100s of millions of dollars of offshore un-taxed cash.  In the past, much of these offshore profits could avoid U.S. taxation indefinitely as long as they were not actually repatriated in the form of dividends to the U.S. shareholder(s).

However, most people at the time were not expecting that this same repatriation tax would befall USCs living overseas arising from their local business operations. 

Probably Congress and the Administration did not contemplate the fallout to these USC taxpayers.  They were focusing on a different group of taxpayer.  Nevertheless, Section 965 imposes immediate U.S. individual taxation on the “phantom income” (i.e., when no dividends are distributed to the USC shareholder) of the USC shareholder.

The next few posts will be dedicated to trying to explain in plain English how the “965 Hammer” (as I am affectionately calling it) applies to USCs residing in their home country with a business or investment assets held in a corporation.

The due date under the statute for paying this 965 tax has “come and past”; however, the IRS has granted certain extensions of time.  These will be discussed in subsequent posts.

Importantly, a timely election under Section 965(h)(1) must be made by the due date (including extensions) for filing the return for the relevant year.  For USCs residing outside the U.S., that due date was June 15th, 2018 and hopefully all USCs filed an automatic extension (IRS Form 4868) by that date, which would extend your due date to October 15, 2018 and the time to file the 965(h)(1) election. 

Q&A 16 of the IRS website (Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns) addresses key provisions here –

Posted: 06/04/2018

Q16: If an individual fails to timely pay his or her first installment of tax due under section 965(h), will the IRS assess an addition to tax for failure to pay?  Will the taxpayer’s requirement to pay all subsequent installments be accelerated under section 965(h)(3)?

. . . However, the IRS has determined that, if an individual’s net tax liability under section 965 in the individual’s 2017 taxable year is less than $1 million, the individual makes a timely election under section 965(h), and the individual did not pay the full amount of the first installment by the due date under section 965(h)(2), the failure to make the payment will not result in an acceleration event under section 965(h)(3) so long as the individual pays the full amount of the first installment (and its second installment) by the due date for its 2018 return (determined without regard to extensions). . . 

A USC’s extensions and elections are very important here.  A later post will explain how a USC residing outside the U.S. can obtain an additional extension at the discretion of the IRS.  This can extend the due date of the 2017 income tax returns (IRS Form 1040) from the extended October 15th date to a further extended date of December 15th, 2018; for which the 965 election must be correctly made by the USC individual shareholder of a non-U.S. corporation.