Editor: Mark G. Cook, CPA, CGMA
As a result of the enactment of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, the United States switched from a global to a territorial tax system, and certain U.S. taxpayers who held ownership in foreign entities were subject to a one-time Sec. 965 transition tax on untaxed foreign earnings. The IRS provided affected taxpayers various elections for paying this tax, including paying it in installments under Sec. 965(h) or deferring payment for S corporation shareholders under Sec. 965(i) until specific acceleration or triggering events occur. Even if such an event should occur, the IRS alleviates the tax burden by allowing transfer and consent agreements if the requirements are met. On June 27, 2019, the IRS released further guidance through its question-and-answer (Q&A) webpage (available at www.irs.gov) to further recap and clarify the rules for transfer and consent agreements set forth in Secs. 965(h) and (i) and Regs. Secs. 1.965-7(b) through (c).
Background: Sec. 965
Sec. 965 generally applies to U.S. shareholders, as defined under Sec. 951(b), in certain specified foreign corporations. A specified foreign corporation is either a controlled foreign corporation (CFC) or a foreign corporation with a corporate U.S. shareholder (Sec. 965(e)(1)). To the extent the foreign corporation has accumulated post-1986 earnings and profits that have not been previously taxed by the United States, Sec. 965 requires the U.S. shareholder to pay a transition tax on those earnings as of Nov. 2, 2017, or Dec. 31, 2017, in the foreign corporation's last tax year beginning before Jan. 1, 2018, as if the earnings had been repatriated to the United States.
Under Sec. 965(h), the taxpayer can elect to pay its Sec. 965 net tax liability in installments over eight years. The installment amounts are as follows: 8% of the tax for the first five installments, 15% for the sixth installment, 20% for the seventh installment, and 25% for the eighth and final installment (Sec. 965(h)(1)). However, if an acceleration event occurs, the unpaid portion of all the remaining installments becomes due. An acceleration event is:
- An addition to tax for failure to timely pay any required installment;
- A liquidation, sale, exchange, or disposition of substantially all of the taxpayer's assets, including in bankruptcy;
- A cessation of business by a person that is not an individual;
- An event that results in a person no longer being a U.S. person, including a resident alien becoming a nonresident alien;
- A person's becoming a member of a consolidated group;
- A consolidated group's ceasing to exist; or
- A determination by the IRS that an acceleration event has occurred because of a material misrepresentation in a transfer agreement.
An exception to this rule applies if the acceleration event is a covered acceleration as defined in Regs. Sec. 1.965-7(b)(3)(iii)(A)(1), and an eligible Sec. 965(h) transferor and an eligible Sec. 965(h) transferee (as defined in Regs. Sec. 1.965-7(b)(3)(iii)(B)(1)) enter into a transfer agreement with the IRS.
Under Sec. 965(i), a special rule applies to S corporation shareholders and allows the taxpayer to elect to defer the Sec. 965 net tax liability with respect to any S corporation that was a U.S. shareholder subject to Sec. 965. The taxpayer continues to defer the tax until a triggering event occurs. Sec. 965(i)(2)(A) and Regs. Sec. 1.965-7(c)(3)(ii) describe a few triggering events:
- The corporation ceases to be an S corporation;
- There is a liquidation, sale, exchange, or disposition of substantially all of the S corporation's assets;
- There is a cessation of business by the S corporation;
- The S corporation ceases to exist; or
- There is a transfer of any share of S corporation stock by the shareholder.
At the time of the triggering event, the entire amount of the deferred tax liability will be due unless (1) in the case of a stock transfer described in Sec. 965(i)(2)(A)(iii), a transfer agreement is entered into by an eligible transferor and an eligible transferee for stock transfers (Sec. 965(i)(2)(C)); or (2) the S corporation shareholder makes a Sec. 965(h) election to pay the transition tax over eight annual installments instead of immediately (Sec. 965(i)(4)). For specific triggering events described in Sec. 965(i)(2)(A)(ii), such as a liquidation or cessation of business, the Sec. 965(h) election can be made only with the IRS's consent (Sec. 965(i)(4)(D)).
Transfer agreements under Secs. 965(h)(3) and 965(i)(2)(C)
Regs. Secs. 1.965-7(b)(3)(iii)(B) and 1.965-7(c)(3)(iv)(B) highlight the requirements necessary to make a valid transfer agreement for Sec. 965(h)(3) and Sec. 965(i)(2)(C) purposes. The transfer agreement must be timely filed within 30 days of the acceleration or triggering event, and a copy of the agreement must be attached to both the transferor's and transferee's tax returns (Regs. Secs. 1.965-7(b)(3)(iii)(B)(2) and 1.965-7(c)(3)(iv)(B)(2)). In addition, the agreement must be signed under penalties of perjury by the appropriate parties (Regs. Secs. 1.965-7(b)(3)(iii)(B)(3) and 1.965-7(c)(3)(iv)(B)(3)).
The agreement must be titled "Transfer Agreement Under Section 965(h)(3)" or "Transfer Agreement Under Section 965(i)(2)" (see Regs. Secs. 1.965-7(b)(3)(iii)(B)(4) and 1.965-7(c)(3)(iv)(B)(4)), and the terms must include the following:
- A statement that the transferee assumes the transferor's liability;
- A statement that the transferee (and, if applicable, the transferor) agrees to comply with all the conditions and requirements of the appropriate Code sections and Treasury regulations;
- The name, address, and taxpayer identification numbers (TINs) of the transferor and transferee;
- The amount of unpaid remaining net tax liability or unpaid deferred net tax liability for Sec. 965(h) and Sec. 965(i), respectively;
- A copy of the transferor's most recent Form 965-A, Individual Report of Net 965 Tax Liability, or Form 965-B, Corporate and Real Estate Investment Trust (REIT) Report of Net 965 Tax Liability and Electing REIT Report of 965 Amounts, as applicable;
- A detailed description of the acceleration or triggering event;
- A representation that the transferee is able to pay the net tax liability being assumed;
- If the transferor continues to exist, an acknowledgment that the transferor and any successor will remain jointly and severally liable for the net tax liability;
- A statement as to whether the leverage ratio of the transferee and its affiliated group members after the event exceeds 3-to-1;
- For Sec. 965(h) purposes, a certification by the transferee waiving the right to a notice of liability and consenting to the immediate assessment of the remaining unpaid net tax liability; and
- Any additional information, representation, or certification required by the IRS in publications, forms, instructions, or other guidance.
Consent agreements under Sec. 965(i)(4)(D)
Regs. Sec. 1.965-7(c)(3)(v)(D) highlights the various requirements necessary to make a valid consent agreement for Sec. 965(i)(4)(D) purposes. Besides making a timely Sec. 965(h) election on the tax return and timely payment of the first installment, the consent agreement must be timely filed within 30 days of the triggering event, and a copy of the agreement must be attached to the shareholder's tax return (Regs. Sec. 1.965-7(c)(3)(v)(D)(2)). In addition, the shareholder must sign the agreement under penalties of perjury (Regs. Sec. 1.965-7(c)(3)(v)(D)(3)).
The agreement must be titled "Consent Agreement Under Section 965(i)(4)(D)" (see Regs. Sec. 1.965-7(c)(3)(v)(D)(4)), and the terms must include the following:
- A statement that the shareholder agrees to comply with all the conditions and requirements of the appropriate Code sections and Treasury regulations;
- The name, address, and TIN of the shareholder;
- The amount of unpaid deferred net tax liability for Sec. 965(i);
- A representation that the shareholder is able to pay the net tax liability;
- A statement as to whether the leverage ratio of the shareholder and all subsidiary members of its affiliated group after the event exceeds 3-to-1; and
- Any additional information, representation, or certification required by the IRS in publications, forms, instructions, or other guidance.
New guidance from IRS Q&As and observations
The IRS released new Q&As related to transfer and consent agreements that emphasize the more practical issues a taxpayer may encounter and provided citations to the primary source materials as discussed earlier.
Under Q&As No. 2, No. 3, and No. 5, the IRS indicates that a transfer or consent agreement should be filed with the IRS's Memphis Compliance Service Collection Operations at Memphis CSCO, 5333 Getwell Road MS 81, Memphis, TN 38118. All agreements will be considered timely filed only if they are filed within 30 days of the acceleration or triggering event date. However, for the death of a Sec. 965(i) transferor and related triggering event, the transfer agreement may be filed by the unextended due date of the transferor's final tax return (Regs. Sec. 1.965-7(c)(3)(iv)(B)(2)(iii)).
The IRS emphasizes the consent agreement must be filed by the S corporation shareholder, not the S corporation, as the affected taxpayer is the shareholder (Q&A No. 4). If the S corporation has more than one shareholder, each shareholder must file his or her own consent agreement for certain triggering events in order to be permitted to pay the Sec. 965(i) tax in installments under Sec. 965(h). In addition to the consent agreement, the taxpayer is still required to make a timely Sec. 965(h) election (see Q&A No. 6). This signed election statement must be attached to the taxpayer's tax returns; and the appropriate Form 965-A or Form 965-B, which tracks the Sec. 965 tax liability, must be updated for the triggering event, election, and installment payments.
In Q&A No. 7, the IRS reminds taxpayers that if a Sec. 965(h) election is made, excess remittances in the year of a Sec. 965(i) triggering event cannot be refunded or credited to the next year's estimated income tax until the tax year's income tax liability is paid in full, including the Sec. 965(h) installments. The rationale behind this is that the previously deferred Sec. 965(i) net tax liability is immediately assessed as an addition of tax in the year of the triggering event. The Sec. 965(h) election only defers the payment, not the actual tax liability.
As such, with a Sec. 965(h) election in the year of a triggering event, the tax payments must be applied initially to the tax liability without Sec. 965, and the first Sec. 965(h) installment then to any succeeding Sec. 965(h) installments. Once the tax year's liability is fully satisfied, the taxpayer may receive a refund or credit to the next year's income tax if any excess remittances remain. Therefore, if the taxpayer plans to make a Sec. 965(h) election, the taxpayer must be careful of how much estimated tax payments are actually made for the tax year of a triggering event in order to get the most benefit out of the election.
Lastly, the IRS explains that the S corporation and transferor, if applicable, remain jointly and severally liable for a taxpayer's Sec. 965(i) net tax liability, even if a Sec. 965(h) election was made (Q&A No. 8). They will continue to be accountable for payments of the net tax liability, penalties, additions to tax, or other related amounts. The election does not alter the joint and several liabilities of the S corporation or transferor as discussed in Sec. 965(i)(5) and related Treasury regulations.
EditorNotes
Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or mcook@singerlewak.com.
All contributors are members of SingerLewak LLP.
