Forgot About the 2017 Transition Tax? It Hasn’t Forgotten You.

Section 965 of the Internal Revenue Code — better known as the one-time “transition tax” enacted in 2017 under the Tax Cuts and Jobs Act (TCJA) — may feel like ancient history. However, for S corporation shareholders who made a section 965(i) deferral election, the obligation did not disappear. It was merely postponed, and it continues to carry annual compliance obligations and potential exposure.

Why Section 965 Still Matters

As part of the TCJA, Congress introduced section 245A, which generally allows U.S. C corporations a dividends-received deduction for certain foreign-source dividends, effectively exempting future repatriations from U.S. federal income tax. To prevent a windfall on previously untaxed earnings, Congress enacted section 965 as a one-time transition tax. 

Section 965 required U.S. shareholders — including individuals and corporations with at least 10% ownership in a controlled foreign corporation or "specified foreign corporation" — to pay tax on accumulated, untaxed foreign earnings as if they had been repatriated. Taxpayers could elect to pay the one-time tax over eight years, and S corporation shareholders could elect to defer payment entirely until a "triggering event" occurs (e.g., the sale or liquidation of the business).

While C corporations generally benefit from section 245A on a going forward basis, individuals do not. Nevertheless, individuals remain subject to section 965. As a result, many S corporation shareholders incurred transition tax liabilities without the benefit of a corresponding exemption, making the section 965(i) deferral election valuable at the time, and still relevant today, as the deferral remains in place if the tax has not been fully paid.

Ongoing Compliance: Annual Reporting Is Required

A section 965(i) election defers payment — it does not eliminate the liability. Taxpayers must file Form 965-A, Individual Report of Net 965 Tax Liability with their U.S. federal income tax return every year until the deferred amount is fully satisfied.

Missing this annual reporting requirement can have costly consequences. Failure to file Form 965-A on time can trigger a 5% addition to tax on the amount required to be reported, creating exposure even in years when no triggering event has occurred. 

Triggering Events: When Deferral Is Put at Risk

The most significant risk arises when a transaction triggers the deferred liability. Common triggering events include:

• Termination of S corporation status;
• Liquidation or substantial asset disposition;
• Cessation of business; and
• Transfers of S corporation stock, including sales, gifts, and transfers at death.

Even partial transfers can trigger a proportionate share of the liability.

Once triggered, the deferred tax generally becomes due in full in that year. Taxpayers may be able to make an election to pay the tax in eight installments, but the election must be made timely with the tax return for the triggering year. Failure to do so can result in immediate full payment and late election relief is not available.

Transfer Exception: Strict Requirements and Deadlines

Deferral may continue when a stock transfer results in a change in ownership for U.S. federal income tax purposes — including transfers occurring at death — but only if specific requirements are met. To preserve deferral:

• The transferee must qualify as a single U.S. person who becomes a direct shareholder; 
• A Form 965-D, Transfer Agreement Under Section 965(i)(2), must be filed on time; and
• The agreement must be attached to both parties’ income tax returns.

For most transfers, Form 965-D is due within 30 days of the transfer. This deadline is absolute — no extensions are allowed, and no late election relief is available. Missing the deadline results in automatic acceleration of the deferred liability.

Special Rule: Transfers at Death

Transfers occurring by reason of death follow a different deadline. In these cases, Form 965-D is due by the unextended due date of the decedent’s final income tax return, not within 30 days. 

This distinction is critical. When the beneficiary is not immediately determined, the rules may treat the transaction as two transfers — first from the decedent to the estate and then from the estate to the beneficiary. In those cases:

• Decedent-to-estate transfer: Form 965-D is due by the unextended due date of the decedent’s final income tax return.
• Estate-to-beneficiary transfer: Form 965-D is due within the standard 30-day period.

Missing either deadline can accelerate the deferred liability.

Why This May Be Overlooked

Section 965(i) issues frequently arise in routine transactions, such as estate planning, gifts, buyouts, or internal restructurings. Because the original election dates back to 2017, it is rarely top of mind. 

The challenge is not the technical rules but the execution: rigid compliance requirements, short deadlines, and severe consequences for missteps.