Enacted on December 22, 2017 the Tax Cuts and Jobs Act introduced a one-time toll-charge or transition tax on accumulated undistributed earnings of foreign corporations that have not been previously taxed by the United States. With fast approaching tax deadlines, we are sharing this timely alert to begin this process with you. Read on for valuable information about how this new tax law can directly impact your tax filing obligations to ensure accuracy and avoid costly consequences.
Who is Taxed?
The toll-charge is imposed on all U.S. shareholders of any controlled foreign corporation (CFC) and of any non-CFC with at least one U.S. corporate shareholder. A U.S. shareholder is a U.S. person that owns (directly or through attribution) at least 10% (by vote or value) of the shares of a foreign corporation. A CFC is a foreign corporation in which U.S. shareholders, alone or together, own (directly or through attribution) more than 50% (by vote or value) of the shares of such foreign corporation.
What is Taxed?
The tax is imposed on the pro-rata share of U.S. shareholders’ accumulated earnings of foreign corporations. Accumulated Post-86 earnings are measured on two testing dates: November 2, 2017 and December 31, 2017. The greater amount is the applicable inclusion amount.
Each U.S. shareholder, who is subject to the tax, should be entitled to a participation exemption deduction—effectively reducing income tax. The deduction is 55.7% of income subject to the 15.5% rate, and 77.1% of income subject to the 8% rate.
What is the Tax Rate?
The 2017 tax rate for a taxpayer is the marginal tax rate applicable to that taxpayer. For the 2017 tax year, the corporate maximum marginal rate is 35% and for individuals the maximum marginal rate is 39.6%. The 55.7% and 77.1% participation exemption deductions were fixed to provide an approximate targeted effective toll-charge tax rate for corporate taxpayers of 15.5% and 8%. These targeted rates apply to cash, and cash equivalents and residual earnings, respectively. However, for individuals, the comparable toll-charge tax rates are 17.5% and 9%, after applying the participation exemption deductions of 77.1% and 55.7% to cash, cash equivalents and residual earnings, respectively. As a result, individual taxpayers would pay the toll-charge tax at a higher rate than corporate taxpayers.
The targeted 15.5% rate is after allowing a participation exemption deduction of 55.7% of the amount of earnings represented by cash and cash equivalents. The cash and cash equivalents amount is measured as the higher amount at two testing dates. These testing dates are different from the testing dates used to determine the includable amount of earnings and profits. The testing dates for cash and cash equivalents are December 31, 2017 (or fiscal year-end, if applicable) and the average of the cash and cash equivalents holdings at December 31, 2015 and 2016 (or prior two fiscal years-end, if applicable).
The targeted 8% rate is after allowing a participation exemption deduction of 77.1% of the residual earnings, if any. The residual earnings amount is determined by reducing total includable earnings by the amount of applicable cash and cash equivalents related earnings.
When is Tax Due?
The entire toll-charge tax liability is due on April 17, 2018, unless the taxpayer makes a special installment payment election. This installment payment election allows the deferral of the payment of the toll-charge tax over an eight-year period, with the first payment due on April 17, 2018. The amount payable will be limited to 8% of the tax each year from 2018 to 2022, then 15% in 2023, 20% in 2024 and 25% in 2025.
The 2017 income tax liability, excluding the toll-charge tax, is required to be paid on the regular due dates and cannot be deferred with the installment payment election.
Your Immediate Action Plan
Treasury and the IRS will be issue interpretive guidance on how to navigate these new rules. The rules provide for an acceleration of the entire tax liability where an understated installment amount is paid in any year.
April 17, 2018 is an extremely important date for most U.S. shareholders required to pay the toll-charge tax and the toll-charge tax is the first order of business. To meet the tight deadline, you will want to keep the following action items top of mind when working with your Friedman advisor:
(i) to determine the amount of the tax;
(ii) to elect the eight-year installment payment plan; and
(iii) to make the first estimated payment under that installment plan.
Given the immediacy of the Transition Tax Toll-Charge filing, errors can be an adverse consequence. For example, the invalidation of the deferred-payment election would result in having to pay the entire toll-charge tax in 2018.
Consult with your Friedman LLP International Tax Advisor to ensure that due attention and effort are deployed to gather the required information to accurately determine the tax liability, if any, relating to the toll-charge. In some cases, the information and/or documents may not be available in the U.S. and the cooperation of the foreign corporation will be required.