Section 965 Tax Installment Payments Are Not Guaranteed
The Section 965 transition tax. Taxpayers with international earnings are still grappling with their reporting and payment obligations under the "deemed repatriation" tax after its enactment by the Tax Cuts and Jobs Act of 2017. For a general primer on the Section 965 transition tax, see Freeman Law's previous articles: The Section 965 Transition Tax and The Section 965 Transition Tax And IRS Audits. Section 965 provides that a taxpayer may make an election to pay its tax liability in installment payments. However, as a recent Chief Counsel Advice noted, a domestic corporation that fails to report its Section 965 tax liability is not entitled to prorate its deficiency under Section 965(h)(4) of the Internal Revenue Code.
Section 965 Tax and Installment Payments, Generally
Generally, Section 965 requires that U.S. shareholders pay a tax on their pro rata share of the untaxed foreign earnings of certain "specified foreign corporations."1 That is, a specified foreign corporation's subpart F income is increased for its last tax year beginning before January 1, 2018.2 The income is subject to an effective tax rate of 15.5 percent or 8 percent.
A taxpayer (i.e., U.S. shareholder) may elect to pay the net tax liability under Section 965 in eight (8) installments in the following amounts: 8% of the net tax liability in each of the first five (5) installments, 15% of the net tax liability in the sixth installment, 20% of the net tax liability in the seventh installment, and 25% in the eighth installment.3 However, if the Internal Revenue Service ("IRS") has assessed a deficiency with respect to the taxpayer's net tax liability, Section 965(h)(4) applies as follows:
(4) Proration of deficiency to installments
If an election is made under paragraph (1) to pay the net tax liability under this section in installments and a deficiency has been assessed with respect to such net tax liability, the deficiency shall be prorated to the installments payable under paragraph (1). The part of the deficiency so prorated to any installment the date for payment of which has not arrived shall be collected at the same time as, and as a part of, such installment. The part of the deficiency so prorated to any installment the date for payment of which has arrived shall be paid upon notice and demand from the Secretary. This subsection shall not apply if the deficiency is due to negligence, to intentional disregard of rules and regulations, or to fraud with intent to evade tax.4
The Treasury Regulations further clarify the proration rule with respect to a deficiency:
(C) Exception for negligence, intentional disregard, or fraud. If a deficiency or additional liability is due to negligence, intentional disregard of rules and regulations, or fraud with intent to evade tax, the proration rule of this paragraph (b)(1)(ii) will not apply, and the deficiency or additional liability (as well as any applicable interest and penalties) must be paid on notice and demand by the Secretary or, in the case of an additional liability reported on a return increasing the amount of the section 965(h) net tax liability after payment of the first installment or on an amended return, with the filing of the return.5
On September 2, 2022, the IRS issued a Chief Counsel Advice ("CCA") related to a taxpayer's request for assistance involving Section 965(h)(4)'s application to an unreported tax liability due to a challenge to a regulation. The main facts presented were as follows:
A domestic corporation filed Form 1120, U.S. Corporation Income Tax Return, for its tax year ending in 2018 which included a statement electing to pay the section 965(h) net tax liability in eight installments under section 965(h)(1). The domestic corporation's return position did not reflect application of the Final Regulations. The Service determined a deficiency in the domestic corporation's tax resulting from the domestic corporation's position contrary to the Final Regulations.6
Based on the limited facts presented, the Chief Counsel Advice provided, in part, the following analysis:
On December 7, 2018, the Department of Treasury and the IRS published proposed Treas. Reg. section 1.78-1. Those regulations were finalized with no changes on June 21, 2019 and were applicable to the domestic corporation's tax year ending in 2018. The domestic corporation's return position did not reflect application of the Final Regulations. The resulting deficiency determined by the IRS (if assessed) is a deficiency due to negligence or intentional disregard of Final Regulations. Thus, under section 965(h)(4), the domestic corporation is not entitled to prorate the deficiency, and the deficiency is due on notice and demand under section 965(h)(4) and Treas. Reg. section 1.965-7(b)(1)(ii)(C).7
This Chief Counsel Advice highlights the exception to the general proration under Section 965(h)(1). In particular, under Section 965(h)(4), the deficiency is due on notice and demand regardless of whether the deficiency is due to negligence or international disregard. The CCA further notes that the result would be the same, as described above, even if (1) the domestic corporation filed a Form 8275-R, Regulation Disclosure Statement, or other disclosure, or (2) the domestic corporation's deficiency was due to its negligence or intentional disregard of any other rule or regulation (besides Treas. Reg. § 1.78-1) that would increase the Section 965(h) net tax liability. Accordingly, taxpayers should be mindful of a deficiency's effect on its election to pay its net tax liability in installments.
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1. A "United States shareholder" is defined under Section 951(b), and a "specified foreign corporation" is defined as any Controlled Foreign Corporation ("CFC") under Section 957 or a foreign corporation (other than a PFIC) that has a U.S. shareholder that is a domestic corporation.
2. See I.R.C. § 965(a).
3. See I.R.C. § 965(h)(1).
4. I.R.C. § 965(h)(4).
5. Treas. Reg. § 1.965-7(b)(ii)(C).
6. CCA 202235009 (Sept. 2, 2022).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.