For homeland Americans and corporations, the transition tax is a pretty good deal. In order to repatriate money to a US, a tax needs to be paid, which can be paid over eight years, and voila, those future foreign earnings can now be exempt from US taxation. But for Americans overseas who own businesses, the transition tax can be a complete disaster, and compliance will difficult for many and impossible for a few.
Update June 6, 2018: The IRS is allowing anyone who did not make a timely election on their already filed 2017 Form 1040 to amend prior to October 15, 2018 to elect to pay the transistion tax in installments. FAQ section referenced below.
Joining our podcast is John Richardson of Citizenship Solutions and David Sutherland, a CPA from Montana, both of whom have in-depth experience helping US taxpayers deal with the insanity of the US tax code. While in this podcast discussed cross-border taxation with Canada is discussed at length, the issues also impact US persons living in other countries as well.
This is the heart of the problem: In many countries, every business is done through a corporation. The default rule for any corporation controlled by a US persons is that a Form 5471 needs to be filed. The problem is Form 5471 was designed for large multinationals with the ability to bear huge compliance costs. Yet, a Form 5471 is what say, a US-born dentist working in Ottawa for example would need to file with the US, attached to their Form 1040, in addition to their Canadian tax return. Schedule J of Form 5471 calculates retained earnings, that is the transistion tax base.
Year after year, earnings were retained in Canada with a fixed, known, and manageable tax consequences. Individuals have left hundreds of thousands, even millions reinvested in their foreign corporations.
But Section 965 changes all of this with deemed repatriation on these undistributed earnings.— even though there was no actual repatriation. Rather, a tax was assessed out of the blue, basically a confiscatory property tax unlike any other. Without warning.
These undistributed earnings are usually deployed as investments, say for a dentist office, for example. Yet the transition tax now deems a disposition, meaning a US taxpayer now has a tax bill even though they might have a very difficult time paying for.
While Section 965 allows for the transition tax to be paid for over a 8-year period, it still may become impossible for some US taxpayers to come up with a tax bill.
Section 965 was written in haste and it clearly shows. If the Congress wants people to comply with the IRS, it has to make it at least possible to do so.
If you need help trying to figure out what to do about this transition tax, feel to contact us.
Q17: If an individual has filed his or her 2017 tax return, but has not made the section 965(h) election, may the individual file another 2017 return on which he or she makes the election?
A17: Yes. If an individual with a net tax liability under section 965 in the individual’s 2017 tax year has already filed his or her tax return and did not make an election under section 965(h), such individual can make the section 965(h) election by filing a Form 1040X that complies with the procedures set forth in these FAQs (including, for example, the IRC 965 Transition Tax Statement(s) described in Q&A 3 and the election statement described in Q&A 7) on or before the due date of the individual’s 2017 return, taking into account any additional time that would have been granted if the individual had made an extension request. For this purpose, the IRS will treat the individual as if he or she had requested aQ17 for and received the extension.