The Tax Cuts and Jobs Act which was signed on December 22, 2017, has changed how the IRS taxes the US shareholders of foreign corporations. The brand new U.S. tax law will affect everything from how corporate assets are financed to how business are structured. The shifts of the US tax policy towards a territorial system of corporate taxes will affect multinationals and national competitiveness. There is a one time mandatory transition tax on the deferred income arisen from foreign corporations and this provision applies to all types of U.S. persons which include U.S. resident individuals, domestic estates and trusts, domestic partnerships, S corporations and domestic corporations. Transition tax is imposed on U.S. taxpayers whether or not any cash or other property is actually distributed.
Under the old worldwide system of taxation, dividends distributed from foreign subsidiaries are taxed upon repatriation to the US shareholders. Under the limited territorial system, the dividends from foreign subsidiaries are no longer taxed upon repatriation. For the prior earnings and profits accumulated in the foreign subsidiaries, there is a one time transition tax which the first payment towards the tax due is due on the original filing due date of 2017, that is, April 17th.
Any US person who owns 10% or more in a foreign corporation is subject to the transition tax if:
- The foreign corporation is a controlled foreign corporation (CFC), or
- The foreign corporation has a corporate US shareholder
Any foreign corporation meets the above requirements is called a specified foreign corporation (SFC). A US person can own 10% or more in a foreign corporation through direct, indirect ownership or through constructive ownership. However, a US person must have direct or indirect ownership in a foreign corporation to be subject to the mandatory repatriation tax.
If a U.S. person owns stocks in multiple foreign corporations. Each of the stock ownership needs to be analyzed separately.
Does it affect you or your clients? If the taxpayer is a US tax resident (for individuals – determined by citizenship, green card status or residency under SPT) and the answer is ‘YES’ to one of the below questions, the taxpayer potentially is affected by the new transition tax (aka expatriate tax) law and a payment of the expatriate tax liability is required by the original due date of the 2017 tax return (i.e. April 17th). Please consult someone with international tax experience immediately. Any person that is subject to the new tax in 2017 must pay either 100% of the tax or 8% of the tax if making deferred election by the original due date for filing their tax return.
- Are you a 10% or more shareholder of a foreign corporation and the foreign corporation is considered a controlled foreign corporation (CFC)?
- Are you a 10% or more shareholder of a foreign corporation and the foreign corporation has a 10% or more corporate U.S. shareholder?
- Are you a 10% or more shareholder of a foreign corporation and the foreign corporation owns a US corporation subsidiary and a foreign corporate subsidiary?
- Are you a 10% or more shareholder of a foreign corporation and together with your spouse, your children, your parents, you own more than 50% of a foreign corporation.
If any of the scenarios above applies to you, you would need to consult some experienced international tax consultant. A detailed review of your situation is required and very likely, E&P calculation and adjustments are required for the foreign corporation. The applicable tax rate on the mandatory repatriation depends on a calculation of the cash and other current assets owned by the foreign corporation. Under this new law, the analysis and data required to determine a taxpayer’s exposure to the transition tax will be complex.
