Assessment statutes of limitation and the Sec. 965 transition tax

By John Keenan, J.D.; Matt Cooper, J.D.; and Michael Troy, J.D., Washington, D.C.

Editor: Alexander J. Brosseau, CPA

Sec. 965 imposed a one-time transition tax on certain earnings accumulated in foreign corporations. Since it was enacted as part of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, Sec. 965 has quickly become an area of focus for the IRS, with its Large Business and International Division (LB&I) launching two campaigns directed at examining Sec. 965 reporting issues. This focus on Sec. 965 is reflected by LB&I's release of a memorandum (LB&I-04-1120-0020) to provide guidance to its revenue agents and field examiners on Sec. 965(k), which provides a six-year limitation period for assessment of a net transition tax liability. As the IRS focuses more attention on Sec. 965, it is vital that taxpayers with Sec. 965 tax liabilities and their advisers understand the potentially applicable periods of limitation on assessment.

Overview of Sec. 965

In general, Sec. 965 requires U.S. shareholders to pay a tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. A specified foreign corporation means either a controlled foreign corporation (CFC), as defined under Sec. 957, or a foreign corporation (other than a passive foreign investment company, as defined under Sec. 1297, that is not also a CFC) that has a U.S. shareholder that is a domestic corporation. Sec. 965 applies in the case of the last tax year of a deferred foreign income corporation that begins before Jan. 1, 2018.

Sec. 965 has its own limitation period on assessment in Sec. 965(k), which provides that, notwithstanding Sec. 6501, the period for assessing a net tax liability under Sec. 965 does not expire before the date six years after the date the U.S. shareholder's tax return is filed reporting the Sec. 965 tax liability.

LB&I memo on statute considerations for exams with Sec. 965 issues

The LB&I memo provides guidance for field examiners on how to navigate the overlapping periods of assessment in Secs. 965(k) and 6501(a). The LB&I memo initially notes that, despite the election in Sec. 965(h) that allows a taxpayer to pay the Sec. 965(h) net tax liability over eight annual installments, a taxpayer's Sec. 965 tax liability is a liability of the original year of inclusion and not the year of payment. This means that the Sec. 965(k) six-year period for assessment begins with the original year of the Sec. 965 inclusion, not the tax year in which each deferred payment is made.

Next, the LB&I memo provides guidance to examiners who have been assigned Sec. 965 campaign cases with limited time remaining on the Sec. 6501(a) three-year statute of limitation, including guidance on the authority to allow the Sec. 6501(a) three-year statute of limitation to expire on the portion of the taxpayer's income tax liability that is not covered by the Sec. 965(k) six-year statute of limitation.

The LB&I memo cautions examiners about allowing the Sec. 6501(a) three-year assessment period to expire, noting that the Sec. 965(k) six-year period of assessment applies only to a taxpayer's Sec. 965 net tax liability and does not apply to the taxpayer's entire return. Before an examiner allows the Sec. 6501(a) limitation period to expire, the examiner must timely and properly request the taxpayer to extend the assessment statute of limitation. Where the taxpayer will not voluntarily agree to extend the Sec. 6501(a) assessment period, the examiner must discuss with the team manager whether to allow the Sec. 6501(a) assessment period to expire. The team manager has the ultimate authority and responsibility to decide whether it is in the government's best interest to let the Sec. 6501(a) assessment statute expire. The decision on each case should be documented, discussed, and approved in writing by the territory manager.

These stringent procedures indicate the complexity both the IRS and taxpayers face from these overlapping statutes of limitation. These issues are further compounded for partnerships that have to deal with the intricacies of the partnership audit and litigation procedural regimes.

Chief Counsel memo on TEFRA/BBA and periods of assessment under Sec. 965 and Sec. 6501

The LB&I memo does not provide technical guidance on the interaction of Secs. 6501 and 965(k), nor does it address the complexities involved when applying the partnership audit and litigation procedural regimes. The IRS Office of Chief Counsel provided some guidance in a Chief Counsel memorandum (CCM) dated May 26, 2020 (PMTA-2020-08), that addressed the period of limitation for adjustments related to Sec. 965 for: (1) partnerships subject to the Tax Equity and Fiscal Responsibility Act (TEFRA), P.L. 97-248, audit procedures; (2) partnerships subject to the Bipartisan Budget Act of 2015 (BBA), P.L. 114-74, centralized partnership audit regime; and (3) partnerships not subject to consolidated audit procedures.

Secs. 965 and 6501: While the CCM provides an overview of the assessment periods in Secs. 965(k) and 6501, it highlights some of the exceptions to the Sec. 6501(a) three-year assessment period that may apply. For example, Sec. 6501(e)(1)(C) provides that if a taxpayer omits from gross income an amount properly includible in it under Sec. 951(a) (i.e., Subpart F income), the tax may be assessed, or a court proceeding to collect it may be commenced without an assessment, at any time within six years after the return is filed. Unlike the period in Sec. 965(k), which is limited to the assessment of the Sec. 965 net tax, Sec. 6501(e)(1)(C) extends the assessment period for the entire tax return.

The CCM also highlights Sec. 6501(e)(1)(A), which provides a six-year limitation period when a taxpayer omits from gross income an amount greater than 25% of the gross income reported on the return. It must be an omission of gross income; an overstatement of deductions does not qualify. In addition, items that are adequately disclosed are not included in the calculation of omitted items (Sec. 6501(e)(1)(B)(iii)).

Additionally, the CCM addresses Sec. 6501(c)(8)(A), which provides that the assessment statute of limitation does not expire any earlier than three years after the required information about certain cross-border transactions or foreign assets is actually provided to the Treasury secretary by the person required to file the return. The scope of the extension is limited if a failure to provide information on cross-border transactions or foreign assets is shown to be due to reasonable cause and not willful neglect. In cases in which a taxpayer establishes reasonable cause, the assessment statute of limitation is suspended only for the item or items related to the failure to disclose (Sec. 6501(c)(8)(B)).

Finally, the CCM analyzes the way the adjustment periods for the TEFRA and BBA audit regimes interact with Sec. 965 adjustments.

TEFRA: TEFRA rules generally apply to all partnerships' tax years beginning before Jan. 1, 2018, except for small partnerships that meet a small-partnership exception (Secs. 6031(a) and 6231(a)(1)(B)). Under TEFRA, adjustments to partnership items are made at the partnership level.

For TEFRA partnerships, Sec. 6229(a) sets forth a minimum three-year period for assessing any income tax that is attributable to any partnership item or affected item. The three-year period runs from the later of the date the partnership return was filed or the due date. A partner's period of limitation under Sec. 6501 cannot expire before the minimum period in Sec. 6229(a) (seeRhone-Poulenc Surfactants & Specialties, LP, 114 T.C. 533, 550—51 (2000)). This minimum period can be extended under certain conditions.

Because Sec. 6229 has a minimum period within which no partner's Sec. 6501 period can expire, if the partner's Sec. 6501 period of limitation is open for a reason unrelated to Sec. 6229 (e.g., under Sec. 6501(c)(8) or (e)(1)(C)), assessments may be made against that partner for any tax attributable to partnership items and affected items.

Under Sec. 965, the IRS may adjust Sec. 965(a) inclusion amounts and Sec. 965(c) deduction amounts reportable by a partnership. These are partnership items of the partnership (Sec. 6231(a)(3); Regs. Sec. 301.6231(a)(3)-1). Any adjustments to these partnership items would affect the corresponding Sec. 965(a) inclusions and corresponding Sec. 965(c) deductions and foreign tax amounts reported by the partners. The Sec. 965(a) inclusion amount and the Sec. 965(c) deduction amount reported by the partnership may be adjusted for the tax year for which those amounts are required to be reported, so long as either the Sec. 6229 minimum period applies or the partner reported an item that would be affected by those adjustments in a year in which the partner's period of limitation on assessment of those items is open.

BBAIn general, the BBA regime is effective for tax years beginning on or after Jan. 1, 2018. Under the BBA, any adjustment to a partnership-related item (defined as any item or amount that is relevant in determining the tax liability of any person under Chapter 1 of the Internal Revenue Code) is determined at the partnership level (Sec. 6221(a); Regs. Sec. 301.6241-1(a)(6)(ii)). Pursuant to Sec. 6235(a), the BBA regime provides for a general three-year period for making adjustments to partnership-related items. This period can be extended by special circumstances (Sec. 6235(c)).

The CCM observes the unique aspect of the limitation's provisions under the BBA regime; Sec. 6235 provides a period of limitation for adjustments and not a period of limitation on making assessments. This means that Sec. 6235 does not affect the period to assess a tax attributable to an adjustment of a partnership-related item. The memo explains that under the BBA, an extension per Sec. 965(k) does not automatically extend the IRS's ability to make an adjustment under Sec. 6235.

However, circumstances can extend the period for making an adjustment. These are in Sec. 6235(c)(2), which provides for an extended adjustment period if the partnership omits from gross income amounts includible as described in Sec. 6501(e)(1)(A) or (C).

The CCM addresses how the BBA rules interact with the three major Sec. 965 adjustment categories. For adjustments to Sec. 965(a) inclusions, the IRS would have six years to make an adjustment because they are gross income required to be included under Sec. 951(a) (Sec. 6235(c)). Because Sec. 965(c) deduction amounts and Sec. 965(c) deductions are not gross income, they are not required to be included under Sec. 951(a). Therefore, if the partnership fails to properly report a Sec. 965(c) deduction amount or Sec. 965(c) deduction, such a failure will not result in the application of the special rule under Sec. 6235(c)(2), which means that the IRS will have three years to make adjustments to the partnership for that tax year (assuming no other special rules applied).

Lastly, the CCM addresses scenarios in which a taxpayer under the BBA fails to furnish required information to the IRS as described in Sec. 6501(c)(8). In these cases, Sec. 6235(c)(5) provides that a period of limitation on making adjustments does not expire before the assessment date, as determined under Sec. 6501(c)(8). This could affect a taxpayer's period of assessment for its Sec. 965 liability by extending the limitation period to six years.

Period of limitation fornon-TEFRA/non-BBA partnerships: There is no unified method of examining partnerships that are not subject to either the TEFRA partnership procedures or the centralized partnership audit regime under the BBA. Accordingly, the relevant statute of limitation for making an assessment of tax, including a net tax liability under Sec. 965, is the partner's applicable statute of limitation under Secs. 965(k) and 6501, including any applicable suspensions or extensions.

Insights on future IRS enforcement efforts

These limitation period rules will become increasingly important as the IRS continues to conduct more examinations of Sec. 965 issues. Both the LB&I memo and the CCM provide helpful insights for taxpayers and tax advisers on how these provisions overlap and interact, as well as how the IRS will implement these rules.

EditorNotes

Alexander J. Brosseau, CPA, is a senior manager in the Tax Policy Group of Deloitte Tax LLP’s Washington National Tax office.

For additional information about these items, contact Mr. Brosseau at 202-661-4532 or abrosseau@deloitte.com.

Contributors are members of or associated with Deloitte Tax LLP.

This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional adviser. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.

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