The Tax Cuts and Jobs Act enacted into law in December has far-reaching implications for how multinational companies (MNCs) will be taxed and how they will conduct business going forward. One of the major changes addresses deemed repatriation (also called the “transition tax”) which, for certain taxpayers, will affect their 2017 tax returns, and therefore require immediate attention.
One of the major objectives of the current administration’s tax reform plan was to encourage businesses operating abroad to “repatriate” foreign earnings back to the U.S. by offering a more attractive tax rate—one that is more consistent with favorable rates in other countries.
The deemed repatriation provisions enacted in the tax reform package affect all taxpayers who own 10% or more of a foreign corporation and is effective for the 2017 tax year. The rule imposes a one-time tax on U.S. shareholders of certain foreign corporations. That means affected taxpayers must make detailed calculations now to determine what they owe for the tax year ending Dec. 31, 2017.
Before now, U.S. shareholders of foreign corporations generally did not have to pay federal income tax on such earnings, as long as those profits remained overseas. If they did, they would be subjected to a hefty 35% U.S. income tax on their repatriated earnings from their foreign subsidiaries, which could be reduced by income taxes they had paid to foreign countries.
The repatriation of overseas cash has been a tricky obstacle for MNCs, with most taking a wait-and-see approach. That approach has resulted in more than $2.5 trillion in offshore profits held in foreign bank accounts as MNCs have waited for a U.S. tax break.
The transition tax requires certain U.S. shareholders to pay tax on the amount of untaxed earnings at a reduced tax rate. Now, these overseas earnings will be deemed “repatriated” and taxed based on the following transition tax rates:
- 15.5% on cash and cash-equivalent assets, and
- 8% on non-cash assets
There is an election to pay the transition tax in increasing installments over eight years, of 8% for the first five years, 15% in year six, 20% in year seven and 25% in year eight.
The IRS has issued two notices to date (IRS Notice 2018-07 and 2018-13), and has indicated that it will continue to provide additional guidance to address many of the details and unknowns that still remain.
Because the rules for calculation of the transition tax are quite complex, it is essential that all U.S. taxpayers with foreign subsidiaries work with a qualified tax professional in order to estimate the potential impact for financial statement reporting purposes and ensure calculations are correct for tax return compliance purposes. Skoda Minotti can assist in these areas and will also continue to provide updates as they become available.
Watch for Additional Updates on International Tax Reform
This repatriation provision is part of a larger international tax reform package and should be viewed within the context of this overall plan. In addition to the Global Intangible Low-Taxed Income, or “GILTI” blog we have posted, which addresses a new category of income, watch for additional posts on the following topics:
- Base erosion (BEAT)
- Participation Exemption/Foreign Dividends
- Foreign-Derived Intangible Income
- Interest Expense Limitation