What is the Repatriation Tax and How Does it Work, Example

What is the Repatriation Tax and How Does it Work, Example

What is the Repatriation Tax?

Recently, in the case of Moore, the Supreme Court ruled in favor of the U.S. government’s Mandatory Repatriation Tax under IRC Section 965. This was a big blow to taxpayers who have money overseas held in certain types of foreign corporations that have not yet been taxed by the U.S. government. The concept behind the repatriation tax is that as part of the Tax Cuts and Jobs Act (TCJA), the U.S. government requires certain taxpayers who have previously untaxed income in foreign corporations to pay one-time repatriation tax on the income — even if that income has not been distributed and even if technically the income was not being repatriated back to the United States. In other words, the U.S. government will tax some foreign business owners on overseas income and that has previously gone untaxed in prior years. It is a very far-reaching statute because it goes back more than 30 years in terms of aggregate previously untaxed income (1986/1987). It is important to note that the concept of taxing income that has not yet been distributed or repatriated back to the United States is nothing new. The United States has been taxing Subpart F income for more than 50 years and that tax is based on the taxpayer’s ownership share in certain controlled foreign corporations (in connection with E&P) — with certain Subpart F income being taxed even if it is not yet been distributed and/or repatriated back to the United States. Let’s look at the basics of how the repatriation tax works and how it impacts US taxpayers.

Section 965

• “Treatment of deferred foreign income as subpart F income In the case of the last taxable year of a deferred foreign income corporation which begins before January 1, 2018, the subpart F income of such foreign corporation (as otherwise determined for such taxable year under section 952) shall be increased by the greater of—

  • the accumulated post-1986 deferred foreign income of such corporation determined as of November 2, 2017, or

  • the accumulated post-1986 deferred foreign income of such corporation determined as of December 31, 2017.”

Accumulated Post-1986 Deferred Foreign Income

• • • ‘The term “accumulated post-1986 deferred foreign income” means the post-1986 earnings and profits except to the extent such earnings—

      • (A) are attributable to income of the specified foreign corporation which is effectively connected with the conduct of a trade or business within the United States and subject to tax under this chapter, or

      • (B) in the case of a controlled foreign corporation, if distributed, would be excluded from the gross income of a United States shareholder under section 959. To the extent provided in regulations or other guidance prescribed by the Secretary, in the case of any controlled foreign corporation which has shareholders which are not United States shareholders, accumulated post-1986 deferred foreign income shall be appropriately reduced by amounts which would be described in subparagraph (B) if such shareholders were United States shareholders.”

How Does Section 965 Work?

Section 965 requires certain taxpayers who have deferred foreign income for purposes of section 965, to increase their subpart F income for that year to include the repatriation income. In other words, for purposes of section 965 deferred foreign income that qualifies as income that is reportable under mandatory repatriation (sec 965) will be reported as a Category of subpart F income in either the Taxpayers 2017 or 2018 tax return — and will be determined as of either November 2nd, 2017 or December 31st, 2017.

When Does Section 965 Apply?

For purposes of the deferred income under Section 965, it does not apply to all foreign corporations. Rather, it refers to Specified Foreign Corporations and Controlled Foreign Corporations. For individuals, this is primarily going to be income held in a Controlled Foreign Corporation and in situations with this taxpayer has ownership of a CFC with previously untaxed income. We have separate materials regarding controlled foreign corporations, but from a baseline perspective, CFC is a foreign corporation that is owned more than 50% by U.S. shareholders, with U.S. shareholders defined as having at least a 10% interest. A specified foreign corporation is different, and it involves domestic corporation shareholders having ownership of foreign corporations.

*If the taxpayer has some corporations that have negative earnings and other corporations that have positive earnings, there can be some offset so that it aggregates between all CFCs.

What if the Money is Not Repatriated Back to the U.S.?

Even though it is referred to as the Repatriation Act, it does not mean that the taxpayer has to actually transfer the money back to the United States to be subject to the Mandatory Repatriation Tax. In other words, even if the Taxpayer has not transferred the money back to the United States, the income overseas is still subject to the mandatory repatriation tax.

Basic Section 965 Example

This introductory example is for illustrative purposes only — Michelle is a U.S. citizen. She has a 70% interest in a controlled foreign corporation. There is $900,000 of previously untaxed income that Michelle’s foreign Corporation retained because in the foreign country where the foreign corporation is located and operates, owners of the corporation can keep money in the corporation which is later used for retirement purposes and receives a lower tax rate.

The $900,000 is subject to the Mandatory Repatriation Tax.

Depending on what type of assets the company has and whether Michelle has ownership in any other types of controlled foreign corporations will impact the overall net effective mandatory repatriation tax that she will owe, but from a baseline perspective, these types of facts will typically result in Michelle having a mandatory repatriation tax.

Limited Exceptions to 965

There are some exceptions, exclusions, and limitations involving the mandatory repatriation tax that may apply, but for the most part, taxpayers who have ownership of a controlled foreign corporation that has previously untaxed income in the corporation will likely be subject to some mandatory repatriation tax.

Section 965 and IRS Streamlined

In recent years, the IRS got wind of the fact that taxpayers were submitting to the Streamlined Procedures in years following the mandatory repatriation tax but not paying the mandatory repatriation tax because the 2017 or 2018 tax returns (in which the mandatory repatriation tax was relevant) was not part of the three-year compliance. As a result, the IRS updated their instructions last year to include the fact that taxpayers still must go back and complete the mandatory repatriation tax, if applicable, even if these years (2017/2018) were not part of the actual streamlined submission procedure. In addition, taxpayers who must do this are also not able to stretch the payment out to eight years like other taxpayers who were not in the program. So, for taxpayers who may have a mandatory repatriation tax, it is important to carefully evaluate the total applicable taxes that may be under the streamlined procedures.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

This resource may help taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.