Be aware of continued impact of U.S. tax reform on 2018 returns

By Staff

While U.S. tax reform had a significant impact on expats and shareholders of foreign corporations last year, it is critical for taxpayers to be aware of the ongoing relevance of these new provisions as they look ahead to their filing for 2018, Oakville-based U.S. tax attorney (NY, DC) Alexey Manasuev tells

As Manasuev, principal of U.S. Tax IQ explains, the Tax Cuts and Jobs Act, enacted in December 2017, made a number of critical changes aimed at U.S. citizens and Green card holders residing in Canada and outside the United States.

One of the most important developments for the 2017 tax filing year for certain U.S. shareholders was the one-time transition tax — also referred to as mandatory repatriation — imposed by Internal Revenue Code (IRC) Section 965, he says.

IRC Section 965 requires U.S. shareholders to pay a transition tax on the accumulated post-1986 deferred earnings of Specified Foreign Corporations.

Also, those who have been hardest hit are U.S. citizens and Green card holders who do not live in the United States, and own shares in non-U.S. corporations — called Specified Foreign Corporations (SFCs) that include Controlled Foreign Corporations (CFCs) or other foreign corporations with a 10 per cent U.S. corporate shareholder, Manasuev says.

The transition tax was relevant for 2017 tax year filing for U.S. shareholders of calendar year-end CFCs. The tax due date for filing 2017 returns has generally been April 17, 2018, for U.S. resident taxpayers or June 15, 2018, for U.S. persons residing in Canada or elsewhere.

However, he says, transition tax needs to be top of mind for a number of taxpayers this year when it comes to 2018 tax compliance.

Specifically, U.S shareholders whose foreign corporations have a fiscal year end (other than Dec. 31) must remit transition tax, if applicable, with their 2018 tax return, Manasuev says.

These taxpayers, he says, may have to go as far back as 2015 to determine the transition tax to be reported on 2018 tax return. They will also have to consider the blended rates as different tax rates applied for 2017 and 2018.

“For many of those taxpayers, the transition tax will become reality now.”

Even for taxpayers who filed 2017 tax returns, says Manasuev, it is important to follow developments with respect to transition tax — for example, taxpayers may have foregone transition tax altogether because they filed too early or may have conducted incorrect calculations before the IRS issued final regulations.

These taxpayers, he notes, may need to consider amending their 2017 tax return which may result in a higher or lower liability, depending on the circumstances.

In addition, taxpayers can elect to pay transition tax owing over an eight-year period, he says — but for any taxpayers who elected to pay instalments and failed to make a payment, Manasuev says the IRS may provide some relief from penalties.

"Certain late-payment penalties associated with IRC Section 965 transition tax may be waived dependent on estimated tax payments having been made by June 15, 2018, and for those who elected instalment payments, that these are completed by April 15, 2019. Taxpayers need to look into those rules,” he adds.

“Tax advisers should really ensure that their clients understand the rules and they report transition tax properly,” says Manasuev.

Another issue that taxpayers need to consider as a result of U.S. tax reform is the new Global Intangible Low-taxed Income (GILTI) tax, which applies to any U.S. shareholders
of CFCs.

Manasuev says prior to the changes, the Subpart F regime would have subjected certain passive income of a CFC to tax, while some of the other income would have been exempt.

“Now, with GILTI, that other income may be subject to tax, which also raises a lot of other issues for individual shareholders of CFCs. They do not get certain deductions and do not qualify for 100 per cent dividend receipt deduction under IRC Section 245A, whereas corporate shareholders do qualify,” he says.

“So, the burden for U.S. individual shareholders of CFCs is much higher than for corporate shareholders of CFCs.”

However, Manasuev says there are planning opportunities for certain taxpayers who are affected by GILTI.

One way to mitigate the impact of the tax, he says, is to make an IRC Section 962 election to be treated as a corporation.

“An IRC Section 962 election does not go all the way to protect individual shareholders from GILTI when they make that election, but it will reduce the tax quite significantly.”

Taxpayers need to be aware that they need to make that election on a timely basis, says Manasuev — they should also complete calculations to ensure they are prepared to make the election past the 2018 tax year, as they may be unable to revoke it.

“They need to consider the fact that after having made the election under Section 962, they will be stuck with it, because revoking the election will require the consent of the IRS, which may not be easily granted” he says.

Another area of the new law that may affect how taxpayers structure their business relates to the repeal of IRC Section 968(b)4 that did not allow downward attribution from foreign entities.

“That rule, having been repealed, now puts a lot of pressure on any structures where you have a foreign subsidiary or own a foreign entity through a partnership or subsidiary. Before, it was not considered a CFC, but now, it may be.

“Many taxpayers probably do not understand the analysis and think they’re OK — but unfortunately the repeal provision acts in a lot of mysterious ways and a lot of them are not advantageous to taxpayers.”

Also affecting companies going into next tax year, says Manasuev, are new partnership audit rules in place that govern who has the authority to represent the business before the IRS. Under the new rules, he says, the IRS has replaced the former “tax matters partner” with a “tax partnership representative.”

“Many taxpayers do not realize, even in a U.S. partnership that has foreign partners, they have to have a U.S. person that is a partnership representative — and not only a U.S. person in general, but with boots on the ground in the U.S. So, there are certain requirements that people need to evaluate because this is one of the quite burdensome provisions.”

Manasuev says the IRS will not discuss the case in the absence of the partnership representative.

“The return will need to include this information starting with the 2018 tax year return, or it will not be accepted by the IRS. This is something many taxpayers or their tax return preparers may not be aware of.”

Ultimately, given the complexity of international tax in general, and especially in view of U.S. tax reform, now is the time to start planning and ensuring you are in compliance ahead of the 2018 deadline.

“You really need to make sure you find a qualified U.S. tax advisor, who has experience, knowledge and the ability to provide you with help. You do not want to take advice from someone who does not know and understand what they are doing and then be burdened with the penalties,” Manasuev says.

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