Section 965 Transition Tax: More than Just a 2017 Matter

The Tax Cuts and Jobs Act of 2017 (TCJA) included a new tax under Section 965 for certain accumulated post-1986 deferred foreign income of a specified foreign corporation.  As a one-time toll charge, the tax applied only to income determined in the corporation’s last tax year beginning before January 1, 2018 and, therefore, was generally due with the tax return filing for the 2017 tax year.  However, pursuant to an election, a taxpayer could pay the tax liability in eight annual installments or, for shareholders of United States S corporations of a deferred foreign income corporation, delay payment entirely until the occurrence of a triggering event.

When is the 965 installment payment due?

If you made a Section 965(h) election on your 2017 tax return filing to pay your Section 965 Transition Tax (“Transition Tax”) liability in installments, then 2020 marks the third annual installment of Section 965 Transition Tax due.  A payment equal to 8 percent of the Section 965 net tax liability must be made by the due date for the tax return for your 2019 taxable year (extensions of the return filing do not apply to the Transition Tax installment payment).  Therefore, this year’s installment payment must be made by the following dates:

  • Calendar year filers: July 15, 2020 (original April 15, 2020 due date postponed to July 15, 2020; see COVID-19 guidance below)
  • Fiscal year filers: the unextended due date of the tax return.

Additionally, the installment payment should be made separately from any tax due on the applicable taxpayer’s 2019 income tax return because the payment does not relate to an assessment of tax on the 2019 tax year return; rather, the Transition Tax relates to an income tax liability assessed to the 2017 tax year and needs to be credited accordingly.

The IRS should issue an installment notice and payment voucher for the third installment to taxpayers who have elected the installment option under Section 965.  The notice will provide both the total amount of unpaid 2017 Transition Tax remaining and the amount due under the third installment.  Payment options include mail, fed wire, and credit card or direct pay via EFTPS.gov.

COVID-19 IRS GuidanceThe IRS has provided specific confirmation that for any taxpayer whose federal income tax return due date has been postponed from April 15, 2020 to July 15, 2020, the due date of that taxpayer’s Section 965 installment payment has also been postponed to July 15, 2020.  However, please note that extensions of the 2019 return filing to October 15, 2020 remain inapplicable to the Section 965 installment payment.  Therefore, July 15, 2020 is the ultimate due date for installment payments due by calendar year filers.  Moreover, the COVID-19 postponement does not apply to any future installment payments beyond 2020.  There is also no postponement of the payment due dates for fiscal year filers.  

Did you have an acceleration event?

Certain transactions or events could cause the Transition Tax installment payments to accelerate and become immediately due.  Such events would include a liquidation or sale of substantially all of the taxpayer’s assets, the complete cessation of business, or the taxpayer ceasing to be a US person.  However, the law does permit the buyer of substantially all of the assets of the taxpayer to enter into an agreement with the IRS to step into the shoes of the selling taxpayer and assume liability for the remaining installment payment period.

Additionally, a failure to timely remit payment of the installment amount by the due date would constitute an acceleration event.

Special rules for S corporation shareholders

For shareholders of United States S corporations with a Transition Tax liability, Section 965(i) permitted an election of complete deferral of the net tax liability with respect to the S corporation until the shareholder’s future tax year that includes a triggering event.  Triggering events include ceasing to be an S corporation, a liquidation or sale of substantially all of the S corporation’s assets or the S corporation ceases to do business, and a transfer of any share of the S corporation’s stock by the shareholder.  If a triggering event occurs, the shareholder of the S corporation must pay the entire lump sum of transition tax liability deferred or may choose to elect the installment method of payment under Section 965(h), although the election does require consent from the IRS under certain triggering events.  The election would be due on the due date for the tax return of the year in which the triggering event occurs.

If a triggering event occurred in 2019 and you choose to make a Section 965(h) election, or receive consent from the IRS, then the first installment of net tax liability equal to 8 percent of the total liability would be due, as described above, on the due date for the return of tax for your 2019 taxable year (no regard is given to an extension for the tax return filing).

Reporting forms

Form 965 as well as either Form 965-A (for individual taxpayers and entities taxed like individual taxpayers—for example, certain trusts and estates) or Form 965-B (for corporate taxpayers and REITS) must be attached to the 2019 income tax return.  These forms must continue to be filed as part of the annual tax return filing as long as any Transition Tax liability remains unpaid pursuant to the installment payment election under Section 965(h) or the S corporation shareholder election under Section 965(i).

Additional reporting forms:

  • Form 965-C:  Must be attached where a Section 965(h) election is in place and an acceleration event has occurred, but the transferee/purchaser agrees to enter into an agreement with the IRS to assume the installment payments.
  • Form 965-D:  Must be attached where a Section 965(i) election for an S corporation shareholder is in place and a triggering event occurs, but the transferee/purchaser agrees to assume liability.
  • Form 965-E:  Must be attached where a Section 965(i) election is in place and, where certain triggering events have occurred, the taxpayer seeks the IRS’s consent to elect the installment method under Section 965(h).
We can help

If you believe that you may have had an acceleration or triggering event or are unsure about how a transaction undertaken in the prior or current tax year may affect your Transition Tax election, reach out to the Elliott Davis team.  Additionally, if you are unsure about how the postponement of the filing and payment deadlines under COVID-19 guidance affect your situation, reach out to the Elliott Davis team for assistance.