IRS announces changes to Sec. 965 transition tax rules

By Martin Milner, J.D., LL.M., Washington; Joshua Ruland, J.D., Washington; and Trey Whitten, CPA, Houston

Editor: Michael Dell, CPA

In Notice 2018-78, Treasury and the IRS announced certain amendments to the rules included in the proposed regulations under Sec. 965 (Sec. 965 proposed regulations) that were issued on Aug. 1, 2018 (REG-104226-18). The notice announces that the final regulations will include the following:

  • A transition rule extending the due date and providing limited revocability for the basis election under Prop. Regs. Sec. 1.965-2(f)(2) until 90 days after the Sec. 965 proposed regulations are finalized;
  • A rule treating a consolidated group as a single U.S. shareholder for the purposes of disregarding certain assets in calculating the aggregate foreign cash position of the U.S. shareholder; and
  • Relief on the deadline to file an election under the Sec. 965 proposed regulations for taxpayers eligible for the extended due date of their income tax return in response to Hurricane Florence.
Basis election under Prop. Regs. Sec. 1.965-2(f)(2)

Under Prop. Regs. Sec. 1.965-2(f)(2), a Sec. 958(a) U.S. shareholder may elect to make certain basis adjustments to the stock of each deferred foreign income corporation (DFIC) and each earnings and profits (E&P) deficit foreign corporation (basis election). Under the Sec. 965 proposed regulations, the basis election must be made by the due date (taking into account extensions, if any) of the Sec. 958(a) U.S. shareholder's return for the first tax year that includes the last day of an inclusion year of the Sec. 958(a) U.S. shareholder's DFIC or E&P deficit foreign corporation. As used here, the inclusion year is the last tax year that begins before Jan. 1, 2018. If this due date occurred before Sept. 10, 2018, however, a transition rule in the proposed regulations would require the basis election to be made by Oct. 9, 2018.

To alleviate the burden of making a binding basis election before the proposed regulations are finalized, the final regulations will include two rules addressing the timing and revocability of the election. Taxpayers whose income tax return is due before the date that is 90 days after the date that the final regulations are published must make the basis election no later than 90 days after the publication of the final regulations. In addition, the final regulations will allow taxpayers that made a basis election before final regulations were issued to revoke that election no later than 90 days after the publication date of the final regulations.

Key takeaway: With a more reasonable due date and limited revocability for the basis election, taxpayers that previously decided not to make the election based on the impracticality of performing the requisite due diligence should reconsider that decision.

Application of Prop. Regs. Sec. 1.965-3(b) to consolidated groups

Under Prop. Regs. Sec. 1.965-3(b), a U.S. shareholder (within the meaning of Sec. 958(a)) may disregard certain assets for purposes of determining its aggregate foreign cash position. Prop. Regs. Sec. 1.965-8(e) specifies that all members of a consolidated group that are U.S. shareholders of a specified foreign corporation (SFC) are treated as a single U.S. shareholder for certain enumerated purposes that do not include Prop. Regs. Sec. 1.965-3(b).

To prevent the overstatement of the aggregate foreign cash position, the IRS plans to modify the final regulations so that all consolidated group members that are U.S. shareholders of an SFC are also treated as a single U.S. shareholder for purposes of Prop. Regs. Sec. 1.965-3(b).

Key takeaway: This update aligns the aggregate foreign cash position calculation more closely with the anticipated result of the rules as originally described in Sections 3.01(b) and (c) of Notice 2018-07.

Relief in connection with Hurricane Florence

The IRS recently announced disaster relief by extending the due date to Jan. 31, 2019, for income tax returns of taxpayers affected by Hurricane Florence (affected taxpayers) (IR-2018-187, NC-2018-03, SC-2018-01). Under the notice, the IRS provides a postponement for affected taxpayers that have elections for Sec. 965 or transfer agreements that are due on or after Sept. 7, 2018, and before Jan. 31, 2019. Those taxpayers are granted until Jan. 31, 2019, to file those elections or transfer agreements. Taxpayers who believe they are entitled to this relief are instructed to mark "Hurricane Florence" on the top of the relevant Sec. 965 election statement or transfer agreement and, in the case of a transfer agreement, to note which party to the agreement is an affected taxpayer.

EditorNotes

Michael Dell is a partner at Ernst & Young LLP in Washington.

For additional information about these items, contact Mr. Dell at 202-327-8788 or michael.dell@ey.com.

Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP. Ernst & Young previously published versions of these items as Tax Alerts.

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