Although it feels like we just finished addressing the transition tax, and for many people we did, it has been roughly a year since it was implemented. Despite having a year for clarification, there is not a lot of helpful information from the IRS at this point. However, we must do our best to work through the uncertainty and unintended consequences that will extend well into the future.
While there may be many questions, there are three common themes we keep encountering. Here is what we know as we close 2018.
As explained in a previous post (see here), the nature of the transition tax in some cases causes a pure double tax when it is eventually paid out from the foreign country. Unfortunately, there is no new relief for this situation. The only thing that can be done as an immediate fix is to pay a dividend before year end, pay the taxes in the foreign country for 2018, then carryback the foreign taxes paid to 2017 when the transition tax applied. This should have been discussed at the time of the 2017 filings; however, if not, it is not too late, there is still one month to take action. As a disclaimer, while this sounds like a straightforward fix, there are a lot of things to consider if going this route, including the actual taxes in the foreign country and the application of the foreign tax credit in both 2017 and 2018.
Ordering of Future Distributions
Based on current law, there appears to be a favorable outcome on this front. Future distributions from a CFC should first come out of the previously taxed income, then out of the non-taxed earnings. This means that taxpayers should be able to tap into the earnings from the transition tax giving them tax free distributions. Well, as mentioned above, tax free at least for U.S. purposes. Nevertheless, as you can see from the new form, discussed below, it might not be that easy as there are many different baskets of earnings and profits to consider when a distribution is made. Although, the current rules probably are enough to determine the proper treatment, further guidance would be very good to confirm the process. Hopefully, this is in the works from the IRS.
Right away it was obvious that due to the nature of the law there was going to be at least several new things to track and record. The current forms did not have enough detail for these items. Therefore, the IRS has created a new Schedule J to Form 5471. See here. This form is only a draft, but it shows two things. First, that the IRS is addressing the issue or is at least aware. Also, the way this law was written has created a lot of administrative work and reporting that will last well beyond the one-time tax.