IRS Announces Transition Tax Added to Examination Target List

In 2017, the IRS identified and announced 13 campaigns meant to build out a more supportive infrastructure for international reporting and compliance, and further, the Large Business and International's (LB&I) overall goal to "improve return selection, identify issues representing a risk of noncompliance, and make the greatest use of limited resources."[1] This ever-growing list puts taxpayers on high alert as to which areas the IRS will spend its time and resources auditing in upcoming years. Practically speaking, these are the big-ticket items that taxpayers should focus on correctly reporting on their returns.

In July, the LB&I added a new campaign to its list, bringing the overall total to 59. The new campaign focuses on U.S. shareholders who should be reporting and paying taxes, under Section 965, on the deferred income of a specified foreign corporation. For those who need a quick refresher, Section 965, also known as the "transition tax," was added to the Internal Revenue Code by the Tax Cuts and Jobs Act (TCJA) in 2017 and was meant to end the deferral of income by U.S. shareholders abroad in foreign corporations. Section 965 requires taxpayers who own at least 10% of stock (directly or indirectly) in a specified foreign corporation to include their share of the specified foreign corporation's deferred income accumulated after 1986 through the end of 2017 in gross income. This inclusion amount is then to be treated as if it had been repatriated to the U.S. in 2017, and the taxpayer is required to pay tax, at a preferential rate (generally, 15.5% for liquid assets and 8% for non-liquid assets), on those reported earnings.

It should come as no surprise that the transition tax has become an area of targeted enforcement by the IRS, since the goal of the tax is to bring in revenue lost due to the domestic tax rate cuts enacted in the TCJA. Per its press release, the IRS says it will focus on U.S. shareholders who are required under Section 965 to report and pay tax on their deferred foreign income in 2017 (and/or 2018). Enforcement will be done through the use of "soft letters" from the IRS, asking taxpayers to voluntarily self-correct and report income, as well as through full IRS examinations.

If you’re not sure whether you had Section 965 liability to report, or you’ve received one of these soft letters from the IRS, our tax professionals are available to discuss your options with you. Contact Schneider Downs for more information.