The Tax Cuts and Jobs Act has far-reaching changes for many American taxpayers; the Treasury Department and the IRS recently issued guidance on how the transition tax will be computed. Prior to 2018, US owners of foreign businesses did not pay American taxes on the organization’s earnings until they were distributed to the individual. Under the new Section 965, many such business owners will face a one-time repatriation tax as previously untaxed earnings will be included when calculating their American taxes. While some of the usual credits and exemptions may help reduce the tax liability, some business owners will see a significant increase in taxable income for 2017. The good news: these earnings will be taxed at lower rates than the marginal tax rate and can be paid in installments. However, the calculation of 965 inclusion can be complicated. Full or partial business owners should read on!
Who Is Subject to This New Tax?
Broadly speaking, any US persons with interest in a specified foreign corporation will report a Section 965 inclusion in their income on their American taxes. These companies include controlled foreign corporations (CFCs; organizations at least 50% controlled US shareholders), or foreign corporations at least 10% controlled by US domestic corporations.
How Much Income Will I Need to Include in My American Taxes?
In general, the value of a specified foreign corporation’s previously untaxed earnings as of November 2, 2017 or December 31, 2017 – whichever is greater – will be the Section 965 income amount for the owners, distributed in proportion to ownership percentages. These are reduced, however, by Subpart F earnings for 2017, previously taxed earnings, and effectively connected income.
If you have an interest in multiple specified foreign corporations, then they are all included in the calculation of Section 965 inclusion. If any of your companies are in a deficit position, those deficits may reduce the positive earnings position of the others for this purpose.
The amount actually reported on your return will be reduced further to reflect the transition tax levels to target effective tax rates of 15.5% and 8% for earnings above and below the aggregate cash position of the company or companies; we’ll dig into this a bit later. However, note that the aggregate cash position is based on the greater of the cash position on December 31, 2017 or the average of the December 31, 2015 and December 31, 2016 amounts.
Keep in mind that many of these rules are modified slightly for companies with off calendar-year tax years.
What is the Tax Rate Applied to My Section 965 Inclusion Amount?
The new rules provide for transition tax rates of 15.5% for inclusions up to the aggregate cash level for the specified foreign corporations and 8% for inclusions above that amount. However, your marginal tax rate does not reflect this. Only around 44% of earnings up to the company’s aggregate cash position and 23% of the remainder will be included in your adjusted gross income (AGI). If your marginal tax rate was 35%, you would pay the expected 15.5% and 8% rates. If you pay a different marginal rate in your American taxes, you may pay more or less than these amounts.
Will I Owe Taxes in 2017 on This Increase in AGI?
Some expats may see a significant increase in AGI as a result of the repatriation rules. Luckily, your American taxes – including those due on the repatriated assets – can be reduced using the Foreign Tax Credit. For further relief, the IRS allows you to apply for an 8-year payment plan. This may provide you with the relief you need so the effect on your 2018 cashflow will be minimized.
What Do I Need To Do Next?
First, you should confirm whether or not you have interest in a specified foreign corporation. Simply having an ownership position or voting right for a company may not be enough to subject you to these rules. On the other hand, if a domestic company owns 10% of a foreign corporation, you may be caught off guard and find that you are subject to this tax. After that, you should determine the company’s aggregate post-1986 earnings and profit, as well as the cash positions for each of the last three years. Then, crank through the calculations to see what – if anything – will be assessed on your American taxes!
Want Help Navigating Your Specific Situation?
Contact Greenback today with questions about your repatriation tax!