In 2017, certain taxpayers were subject to a one-time tax on earnings in controlled foreign corporations under Section 965, also known as the transition tax. Since this was a newly created, one-time tax, it was overlooked or unknown by many taxpayers. However, for a few reasons, it seems that all applicable taxpayers will soon have to address the situation.
The IRS has created a group specifically designated to target taxpayers that did not report the transition tax. Next, many taxpayers are now receiving warning letters informing them to make sure that if they were subject to the transition tax that it has been reported, and if not, outlines procedures to amend the return. These procedures are slightly different than a standard amended return, which means they are likely to get a second review. Furthermore, any time the IRS sends a warning letter they are removing the “ignorance of the law” argument from anyone that is later found to not be in compliance.
Lastly, since this was a 2017 law, the statute of limitations will begin running on these tax returns next year. Therefore, some taxpayers may want to wait it out. The problem with this approach is that it is not clear if missing the transition tax would make Form 5471 “substantially incomplete.” If so, this would mean the statute of limitations would never run on the ENTIRE tax return. In either case, the filing of the Form 5471 already gives the IRS the information needed to determine if the transition tax applies. Also, if the Form 5471 has not been filed the statute of limitations definitely has not started and there is penalty exposure. These taxpayers may want to see if they are eligible for the streamlined program to report the Form 5471 and transition tax at the same time.
The transition tax offers several planning opportunities, and in many cases does not result in additional tax when using a Section 962 election. If it has not been reported, or even if the Form 5471 has not been reported, taxpayers might be able to use the streamlined program to get in compliance. Also, it is clear the IRS is making this a priority. Therefore, there is no excuse to not address it as soon as possible and get into compliance, and ignoring these warnings could lead to unnecessary headaches.
For more information on the transition tax click here.