IRS issues Q&A guidance on Sec. 965 transition tax issues for 2018 returns

Editor: Valrie Chambers, CPA, Ph.D.

On Dec. 12, 2018, the IRS released a new set of questions and answers (available at www.irs.gov that provides guidance on Sec. 965 reporting and payment requirements for 2018 tax returns, including obligations resulting from amounts included in income for the 2017 tax year.

The newly released questions and answers provide updates and clarifications to the procedures for not only making the second 2017 Sec. 965(h) installment payment due in 2019, but also making transition-tax payments for tax year 2018 (either in eight installments or in a lump sum). Taxpayers should carefully review the new questions and answers when calculating their 2018 and 2019 estimated tax payments. Taxpayers with Sec. 965 liabilities should also ensure that first quarter 2019 estimated tax payments are made separately and specifically applied to tax year 2019.

Background

The law known as the Tax Cuts and Jobs Act of 2017, P.L. 115-97, enacted Sec. 965, which imposes a one-time transition tax (toll charge) on the undistributed, nonpreviously taxed post-1986 foreign earnings and profits of certain U.S.-owned foreign corporations as part of the transition to a new territorial tax regime. In general, U.S. shareholders of the foreign corporations may elect to pay the toll charge in installments over eight years (Sec. 965(h)).

In March 2018, the IRS issued an initial set of questions and answers related to tax year 2017 return filing and payment obligations arising under Sec. 965. The IRS subsequently updated those questions and answers in April and June to provide additional guidance. The IRS explained that this prior set of questions and answers (available at www.irs.gov provides guidance to questions regarding tax year 2017 return filing and payment obligations arising under Sec. 965.

Overview and takeaways

In the newly released questions and answers, the IRS provided the following guidance:

As explained in the answer to Question 1, the entire amount of a 2017 toll charge is assessed as a liability for that year, even though a taxpayer that made a valid Sec. 965(h) election can pay the liability in eight annual installments.

The IRS will issue an installment notice and payment voucher for the second installment approximately six to eight weeks before its due date (six to eight weeks before April 15, 2019, for calendar-year taxpayers). The second installment payment should be made separately from any payment due for 2018 income tax because the installment is not part of the 2018 income tax liability. Unlike the first installment of a 2017 toll charge, the second installment can be made using the Electronic Federal Tax Payment System (EFTPS), as well as a number of other payment methods described in the answer to Question 1.

Consistent with the answer to Question 14 in the prior set of questions and answers, the IRS will not consider 2017 to be overpaid until the full amount of the taxpayer’s 2017 income tax liability, including the entire toll charge liability, is satisfied. Therefore, the IRS cannot allow, refund, or apply as a credit to another year any portion of properly applied 2017 tax payments until the entire 2017 income tax liability, including the full Sec. 965(h) net tax liability, is satisfied.

In general, Sec. 6402(a) allows the IRS to apply an overpayment as a credit against tax liability and refund any balance to the extent that the overpayment exists for the liability. Sec. 6402(b) further grants the IRS the authority to allow certain taxpayers to elect to credit an overpayment from one year to the succeeding year’s estimated income tax, to the extent that the amount constitutes an overpayment. In the case of a tax payable in installments, Sec. 6403 provides that if the taxpayer has paid as an installment of the tax more than the amount determined to be the correct amount of that installment, the overpayment shall be credited against the unpaid installments, if any. If the amount already paid, whether or not on the basis of installments, exceeds the amount determined to be the correct amount of the tax, the overpayment shall be credited or refunded as provided in Sec. 6402.

The Supreme Court in Jones v. Liberty Glass Co., 332 U.S. 524 (1947), provided that an overpayment is a payment in excess of what properly should have been due or collected as tax. Although certain U.S. shareholders may elect to pay their toll charge liabilities in installments under Sec. 965(h), the provision does not allow them to defer recognizing the liabilities beyond the tax year of inclusion. That is, the amount of income tax properly due for the 2017 tax period, including the full Sec. 965(h) liability, is the entire income tax liability for that period, even though a taxpayer may elect to pay the toll charge in installments.

Therefore, the new questions and answers continue to affirm the IRS’s position that an overpayment under Sec. 6402(a) does not exist for a 2017 income tax liability unless and until the entire liability is fully paid, including any amount of that liability that is subject to the Sec. 965(h) election to pay in installments. Instead, the IRS will apply excess 2017 tax payments to future toll charge installments.

Similarly, the answer to Question 2 explains that the entire amount of a 2018 toll charge is assessed as a liability for that year. A taxpayer that makes a valid Sec. 965(h) election can pay the liability in eight annual installments, the first of which is generally due on the unextended due date of the 2018 income tax return (April 15, 2019, for most calendar-year taxpayers).

A taxpayer should make two payments toward its 2018 income tax liability — one payment for the amount of income tax owed without regard to Sec. 965 and a second, separate payment for the entire Sec. 965 toll charge or the first installment, as applicable, if the liability is not otherwise satisfied by excess 2018 estimated tax payments. For 2018, toll charge payments can be made using a variety of methods, including EFTPS.

The most noteworthy guidance provided in the new set of questions and answers is found in the answer to Question 3, which addresses a situation where (1) a taxpayer made a Sec. 965(h) election for the 2017 tax year, fully paid the first annual installment, and has an unsatisfied but properly deferred payment obligation for the remaining portion of the 2017 toll charge, and (2) the taxpayer’s 2018 income tax payments (including estimated tax payments) exceed the 2018 tax year income tax liability.

Provided the taxpayer has timely paid the second installment of its 2017 toll charge, the IRS will not offset the 2018 overpayment against any future installments whose payment is properly deferred and not yet due. The IRS will instead refund the taxpayer’s 2018 overpayment or apply it as a credit to 2019 estimated tax (if the taxpayer requests).

That decision, which is obviously taxpayer-favorable, can be reconciled with the IRS’s position that it has no authority to issue a refund or credit under Sec. 6402 for a tax year that includes a Sec. 965 liability until the entire toll charge has been satisfied. Although the authority to issue a refund or credit for a particular tax year is conditional on the existence of an overpayment for that year, the decision to offset an overpayment from one tax year against a balance due for a different year (or type of tax) is discretionary rather than mandatory (see Northern States Power Co., 73 F.3d 764 (8th Cir. 1996)). And here such an offset would be inconsistent with congressional intent regarding a taxpayer’s ability to elect to pay its toll charge over eight installments.

The answer to Question 4 states that in the case of a taxpayer that has a 2018 toll charge liability, the IRS will not consider 2018 to be overpaid until the full amount of the taxpayer’s 2018 income tax liability, including the entire toll charge liability, is satisfied. Accordingly, it is the Service’s position that it cannot allow, refund, or apply as a credit to any other tax period any 2018 tax payments until both the regular 2018 income tax liability and the entire toll charge liability are satisfied. Instead, the IRS will apply excess amounts to future toll charge installments. This is consistent with the guidance provided for 2017 toll charge liabilities, set forth in the answers to new Question 1 and Question 14 in the prior set of questions and answers, as discussed above.

The answer to Question 5 explains that a taxpayer’s 2018 estimated tax payments (including a 2017 overpayment applied to 2018 estimated tax) are first applied to its 2018 regular tax liability, and then any excess is applied against the 2018 toll charge.

Finally, in the answer to Question 6 the IRS explains which forms should be completed and attached to the 2018 income tax return of a taxpayer that reported income under Sec. 965 on either its 2017 or 2018 tax return (or both).