IRC Section 965, which was enacted by the Tax Cuts and Jobs Act, imposed a mandatory, one-time transition tax on the undistributed foreign earnings of specified foreign corporations. Section 965 requires certain U.S. owners to include their pro rata share of the undistributed foreign earnings in their income under the Subpart F regime. Section 965(h) permits taxpayers to elect to pay the transition tax in eight annual installments. Taxpayers that owed a transition tax for 2017 and made a timely election under Section 965(h) were required to make their first annual installment payment in 2018.
FAQs for 2017 transition tax
The IRS published FAQs that describe how to pay the transition tax, including how to make the Section 965(h) election and pay in installments for the 2017 tax year. According to the FAQs, taxpayers that made a Section 965(h) election for 2017 transition tax and fully and timely paid the first installment due are not eligible for a refund or credit of their 2017 estimated tax overpayment. Instead, any overpayment of income tax for 2017 would be applied against future installments of the 2017 transition tax. As a result, taxpayers that planned to credit 2017 overpayments against their 2018 first-quarter estimated tax unexpectedly had to come up with cash to make their first-quarter 2018 estimated tax payment. Other taxpayers that filed IRS Form 4466, “Corporation Application for Quick Refund of Overpayment of Estimated Tax,” for “quickie refund claims” for 2017 overpayments of estimated tax were disappointed when these refund claims were denied and previously expected cash was unavailable for use in 2018.
The IRS chief counsel has advised the IRS that this result is legally required, and taxpayers have been unsuccessful in persuading the IRS to change its position. House Ways and Means Committee Chairman Kevin Brady has put forth legislation that would change this result and allow a refund or credit of Section 965(h) overpayments, but it does not seem likely to be enacted during the lame-duck session of Congress, and it is unclear whether it will be enacted in the next Congress.
FAQs for 2018 transition tax
Last week, the IRS published new Section 965 FAQs for the 2018 tax year. The 2018 FAQs reiterate the position taken in the 2017 FAQs and provide that any overpayment of 2018 income tax will not be eligible for refund or credit if a taxpayer has a 2018 transition tax liability and elects to pay the tax in installments.
The 2018 FAQs do provide some good news for taxpayers. The FAQs clarify that taxpayers that elected to pay the 2017 transition tax in installments and that do not have a transition tax liability for 2018 may be eligible to receive a refund or credit of any overpayment of their 2018 income tax that is not otherwise offset under the normal rules.
The recently released 2018 FAQs demonstrate that the IRS has not changed its position and will not be refunding 2018 overpayments if a taxpayer elects to pay a 2018 transition tax in installments. As such, it appears unlikely that taxpayers will have relief without a legislative fix. Affected taxpayers that have not yet paid all of their estimated tax for 2018 have an opportunity to review their estimated tax computations to reduce overpayment. However, taxpayers that elected to pay their 2017 transition tax in installments but do not owe transition tax for 2018 will not have their refund or credit requests denied solely because they are paying transition tax under a valid Section 965(h) election.