IRS Releases Q&A about Reporting Related to Section 965 on 2017 Tax Returns

March 2018

Summary

On March, 13, 2018, the Internal Revenue Service (IRS) provided additional information to help taxpayers meet their filing and payment requirements for the Section 965 in a question and answer format (the “FAQ”). The FAQ addresses basic information for taxpayers affected by Section 965.
 

Background

In general, Section 965(a) provides that for the last taxable year of a deferred foreign income corporation (DFIC)[1] that begins before January 1, 2018, the subpart F income of the corporation (as otherwise determined for such taxable year under Section 952) shall be increased by the greater of (1) the accumulated post-1986 deferred foreign income of such corporation determined as of November 2, 2017, or (2) the accumulated post-1986 deferred foreign income of such corporation determined as of December 31, 2017 (each such date, a “measurement date”).
 
Taxpayers may have to pay tax resulting from Section 965 when filing their 2017 tax returns. For example, Section 965 may give rise to a 2017 tax liability for a calendar year U.S. shareholder holding an interest in a calendar year specified foreign corporation.
 

Details

The instructions in the FAQ are for filing 2017 tax returns with an amount under Section 965. The FAQ states that failure to submit tax returns according to the instructions provided in the FAQ may result in difficulties in processing tax returns, including rejection, processing delays, or erroneous notices being issued.
 
The FAQ provides that Taxpayers who electronically file Form 1040 are requested to wait to file their tax returns on or after April 2, 2018, to provide the IRS time to make certain system changes to allow the returns to be accepted and processed.
 
The FAQ provides guidance on the following questions. Some of the key answers included in the FAQ have also been summarized below.

1. Who is required to report amounts under Section 965 on a 2017 tax return?

A person that is required to include amounts in income under Section 965 in its 2017 taxable year, whether because the person is a U.S. shareholder of a DFIC, or because the person is a direct or indirect partner in a domestic partnership, a shareholder in an S corporation, or a beneficiary of another passthrough entity that is a U.S. shareholder of a DFIC, is required to report amounts under Section 965 on its 2017 tax return. 

2. How are amounts under Section 965 reported on a 2017 tax return?

The FAQ includes an Appendix (Appendix: Q&A2) on how amounts under Section 965 are required to be reported on different types of tax returns. Appendix: Q&A2 does not address the reporting in other scenarios, including distributions made in 2017, which should be reported consistent with the Code and the current forms and instructions.

3. Is there any other reporting in connection with Section 965 required on a 2017 tax return?

A person that has income under Section 965 for its 2017 taxable year is required to include with its return an IRC 965 Transition Tax statement, signed under penalties of perjury and, in the case of an electronically filed return, in Portable Document Format (.pdf) with a filename “965 Tax”. See Appendix: Q&A3. Details relating to the information that must be included are provided in A3. Adequate records must be kept supporting the Section 965(a) inclusion amount, deduction under Section 965(c), and net tax liability under Section 965, as well as the underlying calculations of these amounts. Moreover, additional reporting may be required when filing returns for subsequent tax years, and the manner of reporting may be different.
 
4. What elections are available with respect to Section 965 of the Code on a 2017 tax return?

Section 965 permits multiple elections related to amounts included in income by reason of Section 965 or the payment of a taxpayer’s net tax liability under Section 965 (as determined under Section 965(h)(6)). Statutory elections can be found in Section 965(h), (i), (m), and (n). Furthermore, the Treasury Department and the IRS have announced another election that may be made with respect to the determination of the post-1986 earnings and profits of a specified foreign corporation. This election is described in Notice 2018-13, 2018-6 I.R.B. 341, Section 3.02.

5. Who can make an election with respect to Section 965 on a 2017 tax return?

The elections under Section 965 are limited to taxpayers with a net tax liability under Section 965 (in the case of Section 965(h), Election to pay liability in installments), taxpayers that are shareholders of S corporations and that have a net tax liability under Section 965 (in the case of Section 965(i), Special rules for S corporation shareholders), taxpayers that are REITs (in the case of Section 965(m), Special rules for U.S. shareholders which are REITs), or taxpayers with an NOL (in the case of Section 965(n), Election not to apply NOL Deduction). 
 
Thus, a domestic partnership or an S corporation that is a U.S. shareholder of a DFIC may not make any of the elections under Section 965. The FAQ also provides that in advance of April 2, 2018, the Treasury Department and the IRS intend to provide further guidance concerning the availability of the elections under Section 965 to direct and indirect partners in domestic partnerships, shareholders in S corporations, and beneficiaries in other passthrough entities that are U.S. shareholders of DFICs.
 
The election under Notice 2018-13, Section 3.02 may be made on behalf of a specified foreign corporation pursuant to the rules of §1.964-1(c)(3). For a discussion of Notice 2018-13, see our January Tax Alert.
 
In the case of a consolidated group (as defined in §1.1502-1(h)), in which one or more members are U.S. shareholders of a specified foreign corporation, the agent for the group (as defined in §1.1502-77) must make the elections on behalf of its members.

6. When must an election with respect to Section 965 be made?

An election with respect to Section 965 must be made by the due date (including extensions) for filing the return for the relevant year. However, even if an election is made under Section 965(h) to pay a net tax liability under Section 965 in installments, the first installment must be paid by the due date (without extensions) for filing the return for the relevant year.

7. How is an election with respect to Section 965 made on a 2017 tax return?

A person makes an election under Section 965 or the election provided for in Notice 2018-13, by attaching to a 2017 tax return a statement signed under penalties of perjury and, in the case of an electronically filed return, in Portable Document Format (.pdf), for each such election. Q&A7 provides details relating the information that must be provided.  Model statements are included in Appendix: Q&A7 with links below.

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 Trust 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

8. Is a Form 5471 with respect to all specified foreign corporations with respect to which a person is a U.S. shareholder required to be filed with the person’s 2017 tax return, regardless of whether the specified foreign corporations are CFCs?

Yes. In order to collect information relevant to the calculation of a U.S. shareholder’s Section 965(a) inclusion amount, a person that was a U.S. shareholder of a specified foreign corporation during its 2017 taxable year, including on the last day of such year, and owned stock of the specified foreign corporation on the last day of the specified foreign corporation’s year that ended during the person’s year must file a Form 5471with respect to the specified foreign corporation completed with the identifying information on page 1 of Form 5471 above Schedule A, as well as Schedule J. The exceptions to filing in the instructions to Form 5471 otherwise will continue to apply. Notice 2018-13, Section 5.02 also provides an exception to filing Form 5471 for certain U.S. shareholders considered to own stock by “downward attribution” from a foreign person. The IRS intends to modify the instructions to the Form 5471 as necessary. 
 
9. Are domestic partnerships, S corporations, or other passthrough entities required to report any additional information to their partners, shareholders, or beneficiaries in connection with Section 965?

Yes, the information listed in A9 of the FAQ should be attached as a statement to Schedule K-1, if applicable.

10. How should a taxpayer pay the tax resulting from Section 965 for a 2017 tax return?

A taxpayer should make two separate payments as follows: one payment reflecting tax owed without regard to section 965 of the Code, and a second, separate payment reflecting tax owed resulting from section 965 of the Code (the 965 Payment). Both payments must be paid by the due date of the applicable return (without extensions). The 965 Payment must be made either by wire transfer or by check or money order. A10 provides additional details.

11. If not already filed, when should an individual taxpayer electronically file a 2017 tax return?

Individual taxpayers who electronically file their Form 1040 should file on or after April 2, 2018. Individual taxpayers who file a paper Form 1040 can do so at any time.

12. If a person has already filed a 2017 tax return, what should the person do?

The person should consider filing an amended return based on the information provided in the FAQ and Appendices. Failure to submit a return in this manner may result in processing difficulties and erroneous notices being issued. Failure to accurately reflect the net tax liability under Section 965 in total tax could result in interest and penalties.

In order to amend a return, a person would file the applicable form for amending the return pursuant to regular instructions and would attach:
  • Amended versions of forms and schedules necessary to follow the instructions in the FAQ
  • Any election statements
  • The IRC 965 Transition Tax Statement included in Appendix: Q&A3
For further guidance, see the FAQ
 

BDO Insights

The FAQ provides welcomed guidance on various procedural aspects related to Section 965. Hopefully, the additional guidance that should be forthcoming in advance of April 2, 2017, clearly addresses various open issues and questions related to Section 965.  BDO can assist our clients with calculating their income tax liability under Section 965 and help with understanding the various procedural aspects related to Section 965, including the rules discussed in the FAQ.  
 

For more information, please contact one of the following practice leaders:
 
Joe Calianno
Partner and International Technical Tax Practice Leader, National Tax Office
  Monika Loving
Partner and International Tax Practice Leader

 
Annie Lee
Partner
  Chip Morgan
Partner

 
Robert Pedersen
Partner
  William F. Roth III
Partner, National Tax Office

 
Jerry Seade
Principal
  Natallia Shapel
Partner

   
Sean Dokko
Senior Manager, National Tax Office
 
[1] For purposes of Section 965, a DFIC is, with respect to any U.S. shareholder, any specified foreign corporation of such U.S. shareholder that has accumulated post-1986 deferred foreign income (as of a measurement date) greater than zero.  Section 965(d)(1).  The term “accumulated post-1986 deferred foreign income” means the post-1986 earnings and profits of the specified foreign corporation except to the extent such earnings and profits (A) are attributable to income of the specified foreign corporation that are effectively connected with the conduct of a trade or business within the United States and subject to tax under Chapter 1 (effectively connected income), or (B) in the case of a controlled foreign corporation (CFC), if distributed, would be excluded from the gross income of a U.S. shareholder under section 959 (previously taxed income).  Section 965(d)(2). See Section 965(d)(3) for more details on “post-1986 earnings and profits.”
 
Section 965(e)(1) provides that the term “specified foreign corporation” means (A) any CFC, and (B) any foreign corporation with respect to which one or more domestic corporations is a U.S. shareholder (10-percent corporation).  For purposes of sections 951 and 961, a 10-percent corporation is treated as a CFC solely for purposes of taking into account the subpart F income of such corporation under section 965(a).  Section 965(e)(2).  However, if a passive foreign investment company (as defined in section 1297) with respect to the shareholder is not a CFC, then such corporation is not a specified foreign corporation.  Section 965(e)(3).