IRS Updates Guidance for Transition Tax Installment Payments (article)
The Internal Revenue Service clarified recently a number of outstanding issues related to installment payments under the “deemed repatriation” or “transition tax” provisions of Internal Revenue Code Section 965. Many taxpayers who were U.S. shareholders of foreign corporations reported income under those provisions on 2017 calendar year returns filed in 2018. Many taxpayers elected to pay the resulting tax in eight installments under Section 965(h), and presently must consider the payment mechanics for the next installment.
Due Date for Transition Tax Installment Payments
In regulations that were finalized in January 2019, the IRS reiterated that all installment payments for the transition tax are due at the time for filing the taxpayer’s return, without regard to extensions of time. This means that for calendar-year individual and corporate taxpayers, the 2019 installment payment is due Monday, April 15, 2019 even if these taxpayers have an extension of time to file their 2018 tax returns until October. Additionally, a new set of Frequently Asked Questions (FAQ) issued by the IRS in December 2018 provides guidance on the identification of installment payments. The IRS says that it will send taxpayers notice of the impending due date, and a payment voucher, six to eight weeks before the due date—in other words, right about now. The installment payment should be made separately from any other payment of 2018 taxes.
Application of Overpayments
In the new FAQ that was issued in December 2018, the IRS restated its controversial position that all eight payments made pursuant to a Section 965(h) election on a 2017 return are payments of a 2017 tax liability. Thus, in its view, any payment that exceeds the combined total of the 2017 income tax liability and the first transition tax installment obligation does not result in an overpayment of income tax for 2017 unless the payment exceeds the entire tax liability for all remaining transition tax installment obligations. This position was roundly criticized as it effectively denies a taxpayer the ability to pay a liability for transition tax over installments, and unexpectedly caused shortfalls in income tax overpayments that were planned to cover 2018 estimated income tax deposit obligations.
In contrast, a separate FAQ indicates a different policy for outstanding transition tax installment obligations from prior years that become due in a current year. Overpayments for 2018 income tax liabilities and subsequent years will not be automatically applied against transition tax installment obligations pertaining to future years, and such income tax overpayments can be refunded or credited against 2019 estimated income tax deposit obligations. This favorable shift in policy applies only to overpayments in years that are subsequent to the original year that the installment election is made.
Acceleration Events for Transition Tax Installment Payments
In the final regulations, the IRS clarified the nature of events that can result in acceleration of the balance due under a Section 965(h) election to pay the transition tax over installments. Many taxpayers have undertaken or are considering certain restructurings that may now be tax-neutral, because recognition of an amount due under Section 965 gives rise to “previously taxed income” under Section 959. However, the final regulations provide for acceleration of the outstanding balance of transition tax installment obligations if there is “a liquidation, sale, exchange, or other disposition of substantially all of the assets of the person.…”
In our view, “the person” described in the regulation is the U.S. taxpayer that made the election. Many common restructurings (e.g., a check-the-box election that collapses a second-tier foreign subsidiary into a first-tier subsidiary of the U.S. parent) will not, as a matter of fact, involve substantially all of the assets of the multinational group, and therefore will not result in an acceleration. However, care should be taken to assess the risks involved in a significant restructuring where a Section 965(h) election is in place.
Taxpayers must plan for transition tax installment obligations due in 2018 at the original time for filing the return. But, unlike IRS policy that applies to the original year of an installment election, the IRS will not automatically apply income tax overpayments in subsequent years against any future installment obligations outstanding in those subsequent years. Taxpayers must remain mindful of certain events that will accelerate the remaining balance of transition tax installment obligations, however. For more information on the transition tax and the provisions for its payment, please contact your local CBIZ MHM tax advisor.
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