Penalty and Filing Relief for Taxpayers Subject to Section 965 Transition Tax

On June 4, the IRS announced penalty and filing relief for taxpayers affected by the transition tax on untaxed foreign earnings with three new items added to "Questions and Answers About Reporting Related to Section 965 on 2017 Tax Returns." The three new Q&As provide relief for taxpayers who were unable to comply with initial IRS payment guidance issued shortly before the April 17 filing deadline.

Background

On March 13, 2018, as part of its guidance and Q&As issued, the IRS advised that taxpayers had to make two separate payments with their 2017 tax returns or extensions: one for tax owed without regard to IRC Section 965 and a second for tax owed under Section 965 and not otherwise satisfied by another payment or credit. Many taxpayers who already had included their estimated liability under Section 965 still made the extra extension payment as a protective measure in order to provide time to understand how to evaluate the IRS guidance, and to calculate and report the precise tax liability under the new guidance. Out of caution, advisers often told taxpayers to make a specific payment for Section 965 even if such payment resulted in an overpayment of amounts due, based on the presumption that any overpayment would be refundable or applicable to offset estimated payments for 2018.

On April 13, 2018, the IRS updated its guidance by amending and supplementing its Q&As. In its April guidance, the IRS stipulated that any overpayments of regular tax made through the estimated payment process or as part of an extension payment would be applied to a taxpayer’s liability under Section 965. However, the April guidance also stipulated that any overpayments made with a taxpayer’s regular tax bill or that specifically were designated for Section 965 would be applied to the taxpayer’s liability under Section 965 until that liability was exhausted, notwithstanding the fact that 92 percent of the liability was not due until later years. 

Relief Provided

Following are the main takeaways from the new Q&As released on June 4:

• A taxpayers will not be subject to underpayment penalties on the first required 2018 estimated tax installment if he or she attempted to elect to credit the calculated overpayment from its 2017 tax return to the 2018 tax year. The taxpayer will need to make an estimated tax payment sufficient to satisfy both the underpayment of the first required estimated tax installment for 2018 and the full amount of the second required estimated tax installment for 2018 on or before the due date for the second installment (June 15, 2018, for calendar year taxpayers).
• An individual who fails to pay his or her first installment of tax due under Section 965(h) (installment payments) will not be required to accelerate payment of all subsequent installments if the 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 individual will need to pay the full amount of the first and second installments by the due date for his or her 2018 return (determined without regard to extensions). Note: The individual still will be liable for interest.
• If an individual with a net tax liability under Section 965 already has filed his or her tax return and did not make an election under Section 965(h), the individual can make the Section 965(h) election by filing a Form 1040X, “Amended U.S. Individual Income Tax Return.” The Form 1040X will need to be filed by the due date of the taxpayer’s 2017 tax return. Note that the IRS will treat the individual as if he or she had requested and received an extension.

The recent guidance provides important relief from harsh consequences of a failure to timely elect and an underpayment of extension or estimated payments, even though some of the offenses were created by the two previous IRS guidance releases. Furthermore, the one-time relief actually puts taxpayers on notice that if they persist in pursuing their election to spread Section 965 payments over eight years while in an overpayment position, they may be subject to penalties to the extent of the overpayment.