The more we read the new tax law and know our clients and other advisors expect us to be able to explain the policy and the details, the more we want to throw our arms up in the air and go on vacation – a long enough one so by the time we get back all the confusion will have sorted itself out, clear/concise regulations will have been issued, and wait. . . Christmas wishes are over. So we’re left to handle the rules as best we’re able. Here’s some input on a few more of the international provisions.
Certain foreign branch losses transferred to specified 10-percent owned corporations. Many US persons operate outside the US via a branch, which often results from an entity classification (“check-the-box”) election. New §91 provides that if a USCo transfers substantially all of the assets of a foreign branch to a specified 10% owned ForCo (as defined in new §245A) with respect to which it is a US Shareholder after such transfer, USCo includes in gross income an amount equal to the transferred loss amount. This provision could see a lot of use as the new Participation Exemption and the change in individual vs corporate tax rates could potentially result in more deferral structures and fewer flow-through tax vehicles such as branches.
The definition of transferred loss amount is a great example of the law’s unnecessary complexity. It’s essentially the: (1) sum of foreign branch losses post 31 December 2017; over (2) the sum of (i) any taxable income of the branch after incurring the loss; and (ii) any amount recognized under §904(f)(3) on account of the transfer. So, instead of modifying §904(f)(3), taxpayers and their advisors now need to analyze that section and §91 to provide proper advice on applicable transactions. §904(f)(3) income is foreign source, but income generated under the new rule is US source. So much for simplification.
Speaking of asset transfers. . . .The new law repeals the active trade or business exception under §367. This change means people will have to get more intimate with the rest of §367, find alternative transactions or simply pay more tax if there’s appreciated property.
We love the Participation Exemption but there’s a price to pay. Congress amended §965 to provide the ForCo distributing, or deemed to be distributing, the qualifying dividend has increased Subpart F income by the greater of the accumulated post-1986 deferred foreign income of such ForCo determined as of November 2 or December 31, 2017. Taxpayers must determine the relevant attributes (see below) at two different dates, one of which is not a “normal” reporting cycle date. So right off the bat there are not only two calculations, but also potential headaches depending on how easy it is to generate November 2 figures.
Separately, taxpayers may elect not to apply the NOL deduction to the deemed repatriation. This allows them potentially to maximize foreign source income. How does the income recognition work? For the 2017 tax year if you’re a calendar year USCo, the deferred foreign income faces US tax at a 15.5% rate for cash, net accounts receivable, fair market value of personal property which is of a type that is actively traded and for which there is an established financial market, commercial paper, certificates of deposit, foreign currency, any obligation with a term of less than one year and any asset which the Secretary identifies as being economically equivalent to any asset described above, versus an 8% rate for other assets. For those of you interested, read §245A(c) for just how convoluted Congress makes the tax code. Again, if we described things to our clients the way Congress does to us, we’d be fired and, frankly, should be. [Note: We love policy. We hate politics. When we say Congress, we’re talking about all 535 folks, not one party or the other, and not necessarily just about the current Congress. There’s inefficiency regardless of which party is the majority.]
So how do you calculate the income? Accumulated post-1986 deferred foreign income means the post-1986 E&P except to the extent the E&P: (1) Is attributable to income effectively connected with a US trade or business; or (2) In the case of a CFC, if distributed, would be excluded from gross income under §959 (as previously taxed income, PTI).
How and When do Taxpayers pay the tax? Taxpayers may elect to pay the net tax liability in 8 annual installments (8% in each of the first 5 installments; 15% in the 6th installment; 20% in the 7th installment; and 25% in the 8th installment). If we can don our CEO hats for a minute, we might think, This is a pretty good deal as there’s lower tax rates in the earlier years and, perhaps, we can lobby to get the law changed in those later years where the tax bill is higher. On the downside, we have to come up with significant cash today to pay the first year’s tax, due in 2018. In any case, we’re fans of the move in the direction of a territorial system. Companies benefit, are arguably more competitive and will truly need to figure out how to pay the current year tax liability.
S Corporation US Shareholders have an additional benefit as each shareholder of the S corporation may elect to defer payment of the net tax liability until the year which includes a triggering event. Those events are: (1) Cessation of S Corporation status; (2) Liquidation or sale of substantially all the assets of the S Corporation, a cessation of business, S Corporation ceases to exist, or any similar circumstance; or (3) A transfer of any share of stock in the S Corporation by the taxpayer (including by reason of death, or otherwise). One price to pay for deferral is the creation of joint and several liability for the S Corporation shareholder and the S Corporation.
There’s additional rules if the benefiting shareholder becomes an expatriated entity at any time during the 10-year period beginning on the date of enactment of the law. The shareholder forfeits the benefits, unless it is deemed to continue to be a US company under the expatriation rules. Again, regulations will dominate and (hopefully) provide significant guidance here.