IRS Announces Section 965 Compliance Campaign

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This week the IRS announced a new Section 965 compliance campaign in it’s LB&I division.

While U.S. corporations have owed the vast majority Section 965 transition taxes, this compliance campaign focuses on individual returns — i.e., Form 1040 filers who are required to file Form 5471.

“Pursuant to the changes to IRC §965 under the Tax Cuts and Jobs Act, U.S. shareholders, including individuals, that directly or indirectly own at least 10% of the stock of a specified foreign corporation (SFC) are required to include in gross income their share of the SFC’s accumulated post-1986 deferred foreign income for the last taxable year of the SFC beginning before January 1, 2018, and report this amount on their returns for the taxable year in which or with which their SFC’s taxable year ends (generally, 2017 and/or 2018). The Internal Revenue Service will address noncompliance through soft letters and examinations.”

What is Section 965?

Section 965 requires United States shareholders (as defined under section 951(b)) to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States.

Previously, foreign income in many cases could only be taxed when the U.S. shareholder received a distribution, such as a dividend, from the foreign entity.

Section 965 was expanded with the Tax Cuts and Jobs Act of 2017.

All U.S. shareholders of Controlled foreign Corporations (CFCs) were subject to a section 965 transition tax on their previously untaxed earnings and profits starting with their 2017 tax returns.

A U.S. shareholder that is required to pay the tax with respect to a 2017 inclusion must do so either in one lump sum, or, pursuant to an election, in eight annual installments. That election, if desired, was required to be made on a timely filed 2017 tax return.

Who does section 965 apply to?

U.S. shareholders of Controlled Foreign Corporations (CFCs) are subject to the section 965 transition tax.

U.S. Shareholders

Under IRC 951(b), a U.S. shareholder is a U.S. citizen or U.S. tax resident who owns 10% or more of the total voting power of a foreign corporation.

In determining the voting power, you must consider direct, indirect, and constructive ownership attributions of stock.

Controlled Foreign Corporation

A foreign corporation is a controlled foreign corporation (CFC) for a particular year if, on any day during such year, U.S. Shareholders own more than 50% of the:

  1. total combined voting power of all classes of stock, or
  2. total value of the stock

Indirect ownership

Stock in a foreign corporation that is owned directly by a foreign entity is considered to be owned indirectly by the shareholders, partners or beneficiaries of that foreign entity in proportion to their ownership in the foreign entity. IRC 958(a)

Constructive ownership

Under IRC 958(b), an individual shall be considered as owning the stock owned, directly or indirectly, by:

  1. His/her spouse; and
  2. His/her children, grandchildren, and parents.

For purposes of income attribution, only direct and indirect ownership are used.

However, in determining U.S. shareholder and CFC status, all stock held directly, indirectly, or constructively are considered.

What should non-compliant taxpayers do?

If taxpayers are non-compliant with their foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule a consultation to see how we can help.

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