FTR notification requirement for taxpayers under LB&I examination

Editors: Alexander J. Brosseau, CPA, and Greg A. Fairbanks, J.D., LL.M.

Generally, taxpayers with a foreign tax redetermination (FTR) must file amended returns to notify the IRS of changes to their U.S. tax liability for one or more prior years. However, an alternative notification procedure may apply to taxpayers under examination by the IRS’s Large Business and International (LB&I) Division. This item discusses when this LB&I notification procedure applies as well as interim guidance recently issued by the IRS for FTRs not covered by the express terms of the LB&I notification procedure.

Foreign tax redeterminations

To prevent double taxation, the Internal Revenue Code allows U.S. taxpayers to deduct or credit foreign taxes (Secs. 164 and 901). Sometimes, after a U.S. person has accrued or paid foreign taxes for a particular year, the amount of the foreign tax liability may change. This in turn may change U.S. tax liability for the prior year by increasing or reducing the allowable foreign tax credit (FTC). For a taxpayer that deducts foreign taxes, a refund reduces the deduction.

The FTR rules most often apply to taxpayers that elect the FTC. A taxpayer that deducts foreign taxes, however, also has an FTR if it receives a refund of foreign taxes paid and claimed as a deduction in a prior year. A special rule applies if a taxpayer credits foreign taxes in the year in which the FTR occurs but deducted foreign taxes in the prior year to which the FTR relates (see Regs. Sec. 1.901–1(c)(3)).

Congress created the FTR to ensure taxpayers claim the correct amount of FTC in these cases (Sec. 905(c)). Sec. 905(c)(1) requires a taxpayer to notify the IRS of changes to its accrued foreign tax if accrued taxes when paid differ from the amounts claimed as credits by the taxpayer, accrued taxes are not paid before the date two years after the close of the tax year to which such taxes relate, or any tax paid is refunded in whole or in part. Upon notification by the taxpayer, the IRS is required to redetermine the amount of tax for the tax year or years affected.

Regs. Sec. 1.905–3(a) expands the scope of FTRs to include any change in foreign tax liability and certain other identified changes that may affect a taxpayer’s U.S. tax liability.

FTR notification procedures

Generally, taxpayers notify the IRS of the FTR by filing amended returns, including amended Form 1118, Foreign Tax Credit — Corporations, or Form 1116, Foreign Tax Credit (Individual, Estate, or Trust), for the year in which they originally claimed the foreign taxes as credits (the relation–back year) (Regs. Sec. 1.905–4(b)). If the taxpayer is a partnership subject to the examination rules of the Bipartisan Budget Act of 2015, P.L. 114–74, the partnership must file an administrative adjustment request (AAR) and notify the IRS of the FTR even if the time to file an AAR has expired (Regs. Sec. ١.٩٠٥–٤(b)(٢)(ii)). If the partnership files an AAR outside the normal three–year statute of limitation in Sec. ٦٢٢٧, the partnership can make only adjustments required under Sec. 905(c).

If U.S. tax liability changes for a year or years following the relation–back year but before the year in which the FTR occurs, for example, because the amount of an FTC carryover increases or decreases, the taxpayer also must file amended returns for those years (affected years). Note, however, that no amended return is required for any year in which the FTR does not change the U.S. tax liability (Regs. Sec. 1.905–4(b)(1)(v)). In addition, taxpayers must notify the IRS of the FTR on the return for the tax year in which the FTR occurred by filing Form 1118, Schedule L (Regs. Sec. 1.905–1(d)(4)(iv)). Taxpayers must file Schedule L even if they are not required to file amended returns.

An amended return, or current–year tax return statement if no amended return is required, must include sufficient information for the IRS exam team to verify that the taxpayer properly calculated the FTR and its impact on U.S. tax liability. Regs. Sec. 1.905–4(c) lists the following information that must be provided:

1. The taxpayer’s name, address, identifying number, and tax year(s) that are affected by the FTR and, in the case of foreign taxes deemed paid, the name and identifying number, if any, of the foreign corporation;
2. The date(s) the foreign income taxes were accrued, if applicable; the date(s) the foreign income taxes were paid; the amount of foreign income taxes paid or accrued on each date (in foreign currency); and the exchange rate used to translate each such amount, as provided in Regs. Sec. 1.986(a)-1(a) or (b);
3. Information sufficient to determine any change to the characterization of a distribution; the amount of any inclusion under Sec. 951(a), 951A, or 1293; or the deferred tax amount under Sec. 1291;
4. Information sufficient to determine any interest due from or owing to the taxpayer, including the amount of any interest paid by the foreign government to the taxpayer and the dates received;
5. In the case of any foreign income tax that is refunded in whole or in part, the date of each such refund, the amount of such refund (in foreign currency), and the exchange rate that was used to translate such amount when originally claimed as a credit (as provided in Regs. Sec. 1.986(a)-1(c)) and the spot rate (as defined in Regs. Sec. 1.988-1(d)) for the date the refund was received (for purposes of computing foreign currency gain or loss under Sec. 988);
6. In the case of any foreign income taxes that are not paid on or before the date that is 24 months after the close of the tax year to which such taxes relate, the amount of such taxes in foreign currency, and the exchange rate that was used to translate such amount when originally claimed as a credit or added to previously taxed earnings and profits (PTEP) group taxes (as defined in Regs. Sec. 1.960-3(d)(1));
7. If a redetermination of U.S. tax liability results in an amount of additional tax due, and the carryback or carryover of an unused foreign income tax under Sec. 904(c) only partially eliminates such amount, the information required in Regs. Sec. 1.904-2(f); and
8. In the case of a passthrough entity, the name, address, and identifying number of each beneficial owner to which foreign taxes were reported for the tax year or years to which the FTR relates, and the amount of foreign tax initially reported to each beneficial owner for each such year and the amount of foreign tax allocable to each beneficial owner for each such year after the FTR is taken into account.

If an FTR reduces U.S. tax liability (e.g., an additional payment of foreign tax that increases FTCs), the taxpayer must notify the IRS by filing an amended return to obtain a U.S. tax refund within 10 years (Regs. Sec. 1.905–4(b)(1)(iii)). If an FTR increases U.S. tax liability (e.g., refund of foreign tax that reduces FTCs) the taxpayer must notify the IRS by filing an amended return by the extended due date of its return for the year in which the FTR occurs (Regs. Sec. 1.905–4(b)(1)(ii)).

If a taxpayer fails to notify the IRS of an FTR that increases U.S. tax liability, the IRS can impose a penalty of 5% of the deficiency per month late (for up to five months) (Sec. 6689). In addition, if the taxpayer does not notify the IRS of the redetermination, there is no statute of limitation, and the IRS can assess the additional tax owed at any time (Sec. 6501(c)(5), Sec. 905(c), and Regs. Sec. 1.905–4(d)).

FTR notification procedure for taxpayers in LB&I examinations

In limited circumstances, Regs. Sec. 1.905–4(b)(4)(i) provides that certain taxpayers under LB&I examination do not have to file amended returns for an FTR. Instead, they can provide a statement to the revenue agent conducting the examination. The requirements to fall within this exception, however, are so prescriptive that it rarely applies.

This alternative notification procedure applies only if: (1) the FTR occurs while the taxpayer is under examination by LB&I; (2) the FTR results in an adjustment to the amount of foreign taxes paid or deemed paid for a prior year; (3) the FTR results in an increase of U.S. tax liability and would generally require an amended return (e.g., a foreign tax refund for the relation–back year); (4) the relation–back year is currently under examination; and (5) the deadline for notifying the IRS of the FTR is after the later of the opening conference or the hand–delivery or postmark date of the audit notification letter (Regs. Sec. 1.905–4(b)(4)(i)).

Again, taxpayers meeting those requirements may be able to provide a statement to the revenue agent instead of amending their returns. If the FTR occurred before the exam began, the taxpayer must provide the statement to the exam team within 120 days of the later of the opening conference or the hand–delivery or postmark date on the audit notification letter (Regs. Sec. 1.905–4(b)(4)(ii)(A)). If the FTR occurs within 180 days of the commencement of the examination, the taxpayer must provide the statement to the exam team within 120 days of the FTR (Regs. Sec. 1.905–4(b)(4)(ii)(B)). If the FTR occurs more than 180 days after the commencement of the exam, the exam team has the discretion to accept the statement or to require the taxpayer to file an amended return. If the exam team accepts a statement more than 180 days after the commencement of the exam, the statement must be provided within 120 days of the FTR (Regs. Sec. 1.905–4(b)(4)(ii)(C)).

The statement provided in lieu of an amended return includes the same information a taxpayer would include if it were filing an amended return to report the FTR, plus a declaration signed by a person authorized to sign the return of the taxpayer: “Under penalties of perjury, I declare that I have examined this written statement, and to the best of my knowledge and belief, this written statement is true, correct, and complete” (Regs. Sec. 1.905–4(b)(4)(iii)).

FTR interim guidance

As discussed above, the regulations’ LB&I notification procedure applies only if the relation–back year is under IRS examination when the FTR occurs and the due date for amending the prior year’s return has not passed before the examination begins. In August 2024, the IRS issued interim guidance for taxpayers under LB&I exam that failed to file an amended return for a relation–back year by the date required in the regulations and whose FTR would increase U.S. tax liability for the relation–back year or any other prior year up to the year in which the FTR occurs (IRS Memo LB&I–04–0824–0010 (Aug. 6, 2024), Interim Guidance on Foreign Tax Redeterminations for Taxpayers Under Exam, Where the Relation–Back Tax Year Is Not Under Exam). The memo proposes a new Internal Revenue Manual section under Part 4.61 incorporating the guidance.

The interim guidance potentially applies more broadly than the LB&I notification procedure discussed above because it does not require the relation–back year to be under audit and does not require notification before an amended return for the relation–back year would be due. Again, the rule applies only to taxpayers under examination by LB&I. Another significant limitation is that the rule applies only to “immaterial” FTRs.

Under the interim guidance, if the FTR occurs during or before the examination and the affected year is the exam year or a prior year, then exam may accept “immaterial FTRs” in the open exam year. The calculation of the FTR is determined based on the relation–back year and affected years.

To evaluate the FTR calculation and immateriality, the IRS interim guidance instructs exam teams to obtain pro forma tax returns (or their equivalent) for the relation–back year and all affected years. The taxpayer must provide the exam team with (1) the type of FTR that occurred; (2) the year the FTR occurred; (3) the relation–back year; (4) the direct and indirect effect for the FTR on tax items in each affected year; (5) the relevant currency translation rates for the FTR; and (6) the effect of the FTR on U.S. tax liability for each affected year.

To determine whether an FTR is immaterial, the interim guidance gives the exam team the following five factors that should be considered: (1) the amount of the FTR liability for each affected year and its relation to U.S. tax liability; (2) the FTR event type (e.g., a difference between an amount accrued in year 1 and paid in year 2 versus an FTR arising from a foreign audit); (3) the cooperation of the taxpayer (including voluntary disclosure of FTR to exam); (4) the aggregate amount of FTR and FTR liability for all affected years; and (5) any other factors the exam team considers appropriate.

When evaluating the amount of the FTR liability and its relation to U.S. tax liability, the exam team is instructed to consider the taxpayer’s FTC position in the relevant Sec. 904 categories, the effect on any high–tax elections or high–tax kick–out, the effect on earnings and profits, the effect on global intangible low–taxed income and Subpart F calculations, the effect on Sec. 965, and the effect on any other item the exam team deems relevant.

When evaluating the FTR event type, an FTR is less likely to be material if it is because of reasonable differences between the amount of foreign taxes paid versus foreign taxes claimed as a credit. However, an FTR is more likely to be material if it results from foreign–initiated adjustments (e.g., a foreign authority assesses additional tax after audit).

Under the interim guidance, if exam concludes the FTR is immaterial, the exam team may input the immaterial FTR as a stand–alone adjustment for the open exam year (instead of requiring the taxpayer to file amended returns for relation–back and affected years). Alternatively, the exam team may permit the taxpayer to submit a payment directly, and the payment would not be attributed to any specific tax year).

Some new flexibility, but amended returns still may be a burden

Taxpayers must notify the IRS of an FTR, usually by filing an amended return. For taxpayers subject to LB&I’s jurisdiction and that have FTRs that increase U.S. tax liability, regulations and IRS interim guidance provide some flexibility with alternative notice procedures. Taxpayers in LB&I examinations with FTRs should pay close attention to the alternative procedures that may allow them to avoid the burden of filing amended returns.

Editors

Alexander J. Brosseau, CPA, is a senior manager in the Tax Policy Group of Deloitte Tax LLP’s Washington National Tax office. Greg Fairbanks, J.D., LL.M., is a tax managing director with Grant Thornton LLP in Washington, D.C.

For additional information about these items, contact thetaxadviser@aicpa.org.

Contributors are members of or associated with Deloitte Tax LLP or Grant Thornton LLP as noted in the byline.

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