Double Taxation – Another Transition Tax Problem
By now, many taxpayers are figuring out the need and the methodology to file and pay the transition tax. However, there may be problems into the future as this law continues to appear to be unintended and ill-conceived for individual taxpayers.
The basics of the transition tax is a one-time tax to be paid on all accumulated earnings and profits of certain foreign subsidiaries. (for more information click here) This tax is due and payable even if the earnings and profits are not actually paid out as a dividend. The balance is that these earnings may be paid out at any time in the future tax free. Everything else aside, that seems to work out. However, the problem isn’t the future distributions, it is that you can’t distribute in the past, which will lead to double taxation.
Let’s take an example to review the logistics. Taxpayer has $100 of earnings and profits in a foreign subsidiary. Let’s assume taxpayer is required to pay $15 of transition tax on this amount. This $15 is paid on the 2017 tax return. Now, it is 2018 and taxpayer wants this money tax free…….but that is only tax free in the U.S. What if the foreign country charges a tax of $15 on this dividend, normally this would fully offset the $15 U.S. tax. The problem is though, there is no U.S. tax on taxpayer’s 2018 tax return to use this tax to offset through a foreign tax credit. The U.S. tax was in 2017; however, 2017 is over, taxpayer cannot go back and pay a dividend to match up with the tax paid in the foreign country. Furthermore, since no dividend was even considered by the end of 2017 there cannot even be made the argument that the tax was accrued for the 2017 year.
Our office has had discussions with authorities at the IRS, who are aware of this problem, but offer no real answers. There may be the possibility to pay the dividend in 2018, pay the foreign tax, and then carryback a credit, but this isn’t a perfect answer and is really the only possible option at this point. On the other hand, taxpayers may decide to opt for the election to be taxed as a corporation, possibly using indirect credits to avoid the transition tax and then deferring the tax to the future when there will be a foreign tax credit to use as an offset. As this is just in the beginning stages it is difficult to predict what may happen, but once again the misapplication of the transition tax to individuals has shown to create yet another problem.