The IRS finalized regulations on Wednesday on the Sec. 965 transition tax, the “Transition Tax”, which was added to the Code by the law known as the Tax Cuts and Jobs Act. Sec. 965 applies to the last tax year of a deferred foreign income corporation (DFIC) that begins before Jan. 1, 2018.

Under Sec. 965, U.S. shareholders of specified foreign corporations must include foreign earnings and profits (E&P) amounts in income, which are then taxed at an 8% or 15.5% rate.

Section 965 requires United States shareholders to pay a transition tax on the foreign earnings of foreign corporations as if those earnings had been repatriated to the United States. Very generally, a specified foreign corporation means either a controlled foreign corporation, (“CFC”), or a foreign corporation that has a United States shareholder that is a domestic corporation.

The US Congress has recently debated upon the application of the “Transition Tax” on small entities. These are defined as companies with less than $25 million in revenues.

Section 965 and the final regulations generally affect U.S. taxpayers who are at least 10-percent shareholders of a foreign corporation. As an initial matter, Congress has ruled that foreign corporations are not considered small entities. Nor are U.S. taxpayers considered small entities to the extent the taxpayers are natural persons or entities other than small entities. Although the Treasury Department and the IRS received a number of comments asserting that a substantial number of small entities would be affected by the proposed regulations, those comments were principally concerned with U.S. citizens living abroad that owned foreign corporations directly or indirectly through other foreign entities. No small entity is affected in this scenario. Thus, the final regulations generally only affect small entities if a U.S. taxpayer that is a 10-percent shareholder of a foreign corporation is a small entity.

While comprehensive counts of all types of small businesses affected by section 965 and these regulations are not readily available, our estimation of section 965 suggest that very roughly 20,000 multinational domestic corporations are potentially subject to section 965, and that about half of these corporations have less than $25 million in gross receipts. Therefore, very roughly 10,000 small multinational corporations (defined as corporations with less than $25 million in gross receipts) are potentially subject to section 965. The in-house estimates further suggest that about 25% of these small multinational corporations would not owe any tax under section 965, because they do not have any accumulated E&P to which the tax would be applied.

Regardless of the number of small entities potentially affected by section 965 or the final regulations, the Treasury Department and the IRS have concluded that there is no significant economic impact on such entities as a result of the final regulations. Therefore, U.S. taxpayers must include Section 965 calculations in their 2017 or 2018 tax returns.

Weinstein & Co. has great experience and depth of knowledge in this area. Our tax professionals can advice on the best mitigation techniques in order to reduce or eliminate the tax burden.