With and Without: Calculating and Reporting Your Toll Tax Liability Calculating & Reporting: Sec. 965 Toll Tax iability
Since we last addressed the Sec. 965 toll tax in this blog, the IRS has issued additional guidance including a Q&A on Sec. 965 reporting (IRS QA, as of June 4 update), IRS Notice 2018-26, and a guide to Sec. 965 calculation and available elections (IRS Pub. 5292). In this post, we review the requirements under Sec. 965 and IRS guidance for information required to be included on the 2017 tax return for C corporations. At this point in the year, calendar-year taxpayers should have completed Sec. 965 modeling for 2017 financial statement purposes, have paid the first installment of the 965 tax liability, and have completed (or be in the midst of performing) an E&P study to support the final Sec. 965 calculation.
Calculating Sec. 965 Liability: With and Without Defined
For the last tax year beginning before January 1, 2018, Sec. 965 increases the subpart F (Sec. 952) income of a specified foreign corporation (SFC) by its accumulated post-1986 deferred foreign income (deferred income). The inclusion amount is reduced by E&P deficits (Sec. 965(b)). Foreign tax credits (FTC) are available, but are haircut by the participation exemption percentage (55.7–77.1% depending on aggregate foreign cash position, Sec. 965(g)).
A taxpayer’s Sec. 965 net tax liability is defined in Sec. 965(h)(6)(A) as the excess of:
- “(i) such taxpayer’s net income tax for the taxable year in which an amount is included in the gross income of such United States shareholder under section 951(a)(1) by reason of this section, over
- (ii) such taxpayer’s net income tax for such taxable year determined—
- (I) without regard to this section, and
- (II) without regard to any income or deduction properly attributable to a dividend received by such United States shareholder from any deferred foreign income corporation [DFIC].”
Subparagraph (B) clarifies that “net income tax” means the regular tax liability reduced by the credits allowed under subparts A, B, and D of part IV of subchapter A.
This statutory language requires that the taxpayer’s tax liability is determined first with Sec. 965 and dividends from DFICs and then without. The difference between the with and without calculations is the Sec. 965 net tax liability. The IRS has decided that this with and without calculation is to be presented by completing most of the return without the effect of Sec. 965 and attaching a short Sec. 965 transition tax statement which includes:
- Total amount required to be included in income by reason of section 965(a).
- Aggregate foreign cash position, if applicable.
- Total deduction under section 965(c).
- Total deemed paid foreign taxes associated with the total amount required to be included in income by reason of section 965(a).
- Total deemed paid foreign taxes disallowed pursuant to IRC 965(g)(1).
- Total net tax liability under section 965.
- Amount of the net tax liability under section 965 to be paid in installments under section 965(h), if applicable.
- The amount of the net tax liability under section 965, the payment of which has been deferred, under section 965(i) [relating to shareholders of S corporations] of the Code, if applicable.
- Listing of applicable elections.
The net tax liability is then included on Schedule J of the 1120.
One difficulty with the required presentation is that the income from the Sec. 965 inclusion would not be reflected in taxable income as shown on the return. Accordingly, the amounts shown on Page 1 of the 1120 for deductions which are limited by taxable income, such as the Sec. 199 Domestic Production Activities Deduction (limited to taxable income) and the Sec. 170 deduction for charitable contributions (10% of taxable income), will not reflect the actual benefit that the taxpayer received from these deductions. In the case of a taxpayer which would have incurred a loss but for the Sec. 965 inclusion, these deductions would not appear at all.
The IRS also notes that distributions made during 2017 are to be reported consistent with the Code and the current forms and instructions (IRS QA 2). If the taxpayer has significant Sec. 965 inclusions and is therefore making 2017 distributions out of PTI instead of E&P, the presentation on the return (form 1120 Schedule C and form 1118) will be misleading. The FTCs reported on form 1118 also will not reflect the increased foreign source income and FTC limitation from the deemed Sec. 965 inclusion or the Sec. 965(g) haircut.
For these reasons, some of our clients are considering substantiating their Sec. 965 net tax liability amounts by including an additional statement showing a side-by-side comparison of Page 1 items calculated with and without Sec. 965. This statement can be similar to the format of Form 1120X.
Reporting Sec. 965 Liability: Elections and Other Statements
Sec. 965 and proposed IRS regulations provide for a number of elections which affect the calculation, timing, and payment of the Sec. 965 liability. These elections are attached to the 965 transition tax statement included with the return for the year of inclusion (IRS QA 7).
|Provision Under Which Election is Made||Title|
|Section 965(h)(1)||Election to Pay Net Tax Liability Under Section 965 in Installments under Section 965(h)(1)|
|Section 965(i)(1)||S Corporation Shareholder Election to Defer Payment of Net Tax Liability Under Section 965 Under Section 965(i)(1)|
|Section 965(m)(1)(B)||Statement for Real Estate Investment Trusts Electing Deferred Inclusions Under Section 951(a)(1) By Reason of Section 965 Under Section 965(m)(1)(B)|
|Section 965(n)||Election Not to Apply Net Operating Loss Deduction under section 965(n)|
|Notice 2018-13, Section 3.02||Election Under Section 3.02 of Notice 2018-13 to Use Alternative Method to Compute Post-1986 Earnings and Profits|
The IRS will also require filing forms 5471 for SFCs which are not Controlled Foreign Corporations (CFCs) (IRS QA 8). Finally, IRS Notice 2018-26 anticipates that the IRS will require documentation of the U.S. shareholder’s aggregate foreign cash position (Section 3.05(a)) and will also require statements if taxpayers wish to rebut the presumption that certain transactions are made with a principle purpose of reducing Sec. 965 tax liability (Section 3.04(a)(ii)–(iv)).
We hope you find this post helpful as you begin considering your company’s Sec. 965 reporting obligations. We are currently anticipating that Sec. 965 proposed regulations will be issued by the end of July and will continue to highlight important developments in this blog.