Proposed Regulations on One-Time Transition Tax Released

| 8/9/2018
Proposed Regulations on One-Time Transition Tax Released
On Aug. 1, Treasury and the IRS released proposed regulations for the one-time transition tax. Prior to the proposed regulations, many taxpayers and tax practitioners were reliant on less formal guidance. The IRS’ Questions and Answers About Reporting Related to Section 965 on 2017 Tax Returns website has been continually updated as issues and questions have surfaced throughout 2018. In addition to the website, the IRS also issued three significant notices that provide additional guidance on the transition tax (Notice 2018-07, Notice 2018-13, and Notice 2018-26).

The proposed regulations generally conform to the previously released guidance with some additional modifications and clarifications that taxpayers and tax practitioners have been eagerly awaiting. Despite an abundance of comments and requests by the public, the proposed regulations generally do not adopt those comments and requests.

The proposed regulations have been submitted to the Office of the Federal Register (OFR) for publication. The final document published by the OFR after its review will be open for public comment for 60 days.

Highlights of the proposed regulations include:

Proposed Regulation 1.965-1: Overview, general rules, and definitions
  • Provides that a domestic partnership is treated as a foreign partnership if certain conditions are satisfied (an expansion of Notice 2018-26 and Notice 2010-41)
  • Provides Section 962 election guidance consistent with Section 5 of Notice 2018-26 and clarifies that a taxpayer making an election under Section 962 will be allowed a Section 965(c) deduction with respect to the tax imposed under Section 11, corporation tax, rather than Section 1, individual tax
  • Rejects requests to allow specified foreign corporations (SFCs) that are not controlled foreign corporations (CFCs), and consequently generally did not track earnings and profits (E&P) under U.S. tax principles, an alternative measurement method for determining the SFCs’ E&P and cash position, such as audited financials
  • Provides that the cash measurement dates for an SFC on a 52- or 53-week tax year are actual year-ends rather than the last day of the month closest to the year-end, a reversal of the position contained in Notice 2018-26
Proposed Regulation 1.965-2: Adjustments to earnings and profits and basis
  • Provides a new election that is available to allow basis adjustments when an E&P deficit corporation’s E&P deficit is taken into account to reduce a U.S. shareholder’s Section 965(a) inclusion; allows for an increase in the basis of an affected deferred foreign income corporation (DFIC) in the amount of E&P deficit allocated to the DFIC and a reduction in basis of an affected E&P deficit corporation in the amount of E&P deficit allocated to any DFIC
Proposed Regulation 1.965-3: Section 965(c) deductions
  • Clarifies that the Section 965(c) deduction will not be available to taxpayers paying net investment income tax under Section 1411 or the excise tax under Section 4940 (see discussion under Proposed Regulation 1.965-7, and note that the election to spread payments related to Section 965 over eight years does not apply to any impact on the taxes under Section 1411 and 4940)
  • Proposed Regulation 1.965-4: Disregard of certain transactions
  • Consistent with Notice 2018-26, generally provides anti-avoidance rules disregarding certain transactions and rules disregarding certain changes in accounting methods and entity classification elections; also clarifies that the transaction will be disregarded even if a reduction in tax liability by reason of Section 965 is offset by an equal amount of tax increase under a different provision and rejects requests for a de minimis exception
  • Clarifies that the anti-avoidance rules apply to U.S. shareholders with a change to their “Section 965 elements,” even if it results in an increased tax liability
Proposed Regulation 1.965-7: Elections, payments, and other special rules
  • Does not provide for an eight-year installment election for nonincome taxes including the Section 1411 tax on net investment income of individuals and the Section 4940 excise tax on the net investment income of most U.S. private foundations
  • Consistent with Notice 2018-26, clarifies that election not to apply net operating losses applies to losses incurred in the year of inclusion as well as carryovers and carrybacks
Proposed Regulation 1.965-8: Affiliated groups, including consolidated groups
  • Generally provides that consolidated groups will be treated as a single U.S. shareholder for purposes of allocating E&P deficits under Section 965(b) and making certain elections with respect to an SFC; however, provides that the single U.S. shareholder treatment will not apply when determining each shareholder’s Section 965(a) inclusion, including when determining the deemed tax paid credit and the deduction allowed under Section 965(c), which still will be based on the consolidated group’s cash basis
Proposed Regulations 1.965-5 and 1.965-6 address foreign tax credits and allocation or apportionment of expenses. Treasury and the IRS have indicated additional regulations are expected. The proposed regulations generally take the position that current law is adequate or clarify the obvious, for example, that taxpayers cannot claim indirect foreign tax credits when the denominator under Section 902 is zero.

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