Section 965 transition tax: What US expats need to know in 2026
Section 965 generally applied to the last taxable year of a specified foreign corporation that began before January 1, 2018, with the inclusion reported by the US shareholder in the tax year in which or with which that foreign corporation’s year ended. For many taxpayers this was 2017, but some reported Section 965 amounts for 2018.
Section 965 transition tax key facts – 2026
- Tax rate on cash and cash-equivalent assets: 15.5%
- Tax rate on illiquid, non-cash assets: 8%
- Measurement date: November 2, 2017 or December 31, 2017 – whichever yields higher E&P
- Section 965(c) deduction reduces the effective rate below the statutory rates
- Final 965(h) installment for the 2017 inclusion year: was generally due April 15, 2025
- Constitutional status: upheld by the Supreme Court in Moore v. United States on June 20, 2024
- Forms required: Form 965, Form 965-A for individuals, and Form 965-B for corporations and REITs
- 2026 relevance: transfer agreements, IRS audits under the Section 965(k) six-year window, active 965(i) deferrals, and possible IRC 965 transferee issues
Key components of Section 965
Section 965 imposes a one-time tax on the accumulated post-1986 earnings of specified foreign corporations owned by US shareholders: 15.5% on cash and cash-equivalent assets, and 8% on illiquid assets. The Section 965(c) deduction reduces the effective rate. Payment options include a lump sum or 8 annual installments under the Section 965(h) election.
1. Tax rate
Section 965 applies two statutory rates depending on asset type: 15.5% on cash and cash-equivalent holdings, and 8% on all other illiquid assets. The Section 965(c) deduction reduces these rates – the effective rate for individuals depends on their ordinary income bracket.
- Corporations: A tax rate of 15.5% applies to cash and cash equivalents, while an 8% rate applies to other assets.
- Individuals: Individual US shareholders pay Section 965 tax at ordinary income rates, up to 37% in 2026, reduced by the Section 965(c) deduction. The resulting effective rate on cash assets can be higher than 15.5% for top-bracket individuals because the corporate rate-equivalent system was not written around individual tax brackets.
2. Affected entities
Section 965 applies to US shareholders owning at least 10% of a specified foreign corporation. A specified foreign corporation generally means a CFC or a foreign corporation with a domestic corporate US shareholder.
US shareholders: Those owning at least 10% of a specified foreign corporation are subject to the tax.
Specified foreign corporations: Section 965 generally applies to CFCs and to certain foreign corporations that have at least one US shareholder that is a domestic corporation, excluding PFICs that are not also CFCs.
3. Payment options
Section 965 provides two payment structures: a lump-sum payment with the original 2017 return, or an 8-year installment plan under the Section 965(h) election. S corporation shareholders may additionally elect indefinite deferral under Section 965(i) until a triggering event occurs.
Installment payments: Taxpayers may elect to pay the Transition Tax in eight annual installments.
Deferral for S corporations: S corporation shareholders may elect to defer the Transition Tax until specific triggering events occur.
4. Compliance requirements
Section 965 requires reporting on Form 965, Form 965-A for individual shareholders, and Form 965-B for corporations and REITs. Form 965-A must be completed for each tax year in which an individual has net 965 tax liability outstanding and not fully paid at any point during the year.
Section 965 reporting requires the following 3 primary forms, although entity type determines which apply:
- Form 965: Detailed reporting on IRS Form 965 instructions is required.
- Form 965-A: Individual shareholders use this form to report net 965 tax liability.
- Form 965-B: Corporations and REITs use this form to report net 965 tax liability.
Section 965 reporting often overlaps with Form 5471 filing requirements for US shareholders of CFCs and the broader Foreign company tax reporting guide (2026).
Purpose of the Section 965 transition tax
Section 965 was enacted to tax accumulated foreign earnings that US multinationals had deferred from US taxation for decades under the prior worldwide tax system. Congress included IRC Section 965 in the Tax Cuts and Jobs Act, enacted December 22, 2017, as a one-time measure before the shift toward a territorial system.
The Transition Tax serves as a bridge from the previous worldwide tax system to the new territorial system.
It aims to tax accumulated foreign earnings that were previously deferred from US taxation.
Who is subject to the Transition Tax?
Section 965 generally applied to US shareholders of deferred foreign income corporations for the SFC’s last taxable year beginning before January 1, 2018. November 2, 2017 and December 31, 2017 were key measurement dates for accumulated post-1986 deferred foreign income.
In IRS terms, a deferred foreign income corporation is a specified foreign corporation with accumulated post-1986 deferred foreign income as of the 2017 measurement dates.
The following 2 entity categories are subject to Section 965:
- US shareholders owning at least 10% of a specified foreign corporation are subject to the tax.
- This includes individuals, partnerships, trusts, estates, and corporations.
The rule works like a Subpart F income inclusion for US shareholders, so they should also understand it.
Section 965 transition tax vs. GILTI / NCTI
The Section 965 vs GILTI comparison is simple: Section 965 imposed a one-time tax on accumulated pre-2018 CFC earnings. GILTI was renamed Net CFC Tested Income (NCTI) under Public Law 119-21, commonly known as OBBBA, for years beginning after December 31, 2025. Section 965 applied once; NCTI applies every year.
The former GILTI rules now sit inside the Net CFC Tested Income (NCTI) guide for 2026, including how the high-tax exception may apply.
Section 965 taxed the accumulated past at 15.5% or 8%; NCTI taxes current CFC profits annually, with a 40% Section 250 deduction and a 90% deemed-paid foreign tax credit rule for domestic corporations starting after December 31, 2025.
| Aspect | Transition Tax (Section 965) | NCTI, formerly GILTI |
|---|---|---|
| Purpose | One-time levy on deferred foreign earnings during the shift from a worldwide to a territorial system | Annual inclusion of current CFC tested income |
| Tax rate | Corporations: 15.5% on cash, 8% on other assets. Individuals: ordinary rates reduced by the Section 965(c) deduction | Corporations: generally 12.6% before FTC after the 40% Section 250 deduction. Individuals: ordinary rates, with a Section 962 election available |
| Affected entities | US shareholders owning at least 10% of a specified foreign corporation | US shareholders of Controlled Foreign Corporations |
| Payment options | Option to pay in installments over 8 years | No 8-year installment rule |
| Inclusions | Accumulated post-1986 deferred foreign income | Current net CFC tested income |
| Compliance | Detailed reporting on IRS forms, including Form 965 and Form 965-A | Reporting requirements include Form 8992 and related schedules |
| QBAI reduction | N/A | Removed under OBBBA, so there is no QBAI computation for NCTI |
| FTC haircut | Section 965(g) reduces available foreign tax credits for amounts covered by the Section 965(c) deduction | 90% of deemed-paid foreign taxes, creating a 10% haircut for domestic corporations |
The following 4 features distinguish Section 965 from NCTI:
- Nature of tax: The Transition Tax is a one-time charge, while NCTI is an ongoing annual provision.
- Scope: The Transition Tax applies to accumulated foreign earnings, while NCTI applies to current CFC tested income.
- Tax rates: Different tax rates, deductions, and foreign tax credit limits apply to each provision.
- Compliance requirements: Section 965 uses Form 965 and Form 965-A, while NCTI generally uses Form 8992.
For 2026 CFC owners, compare this section with the GILTI high-tax exception (18.9% threshold in 2026).
How is the Section 965 transition tax calculated?
Section 965 tax is calculated by multiplying the US shareholder’s pro-rata share of SFC accumulated post-1986 E&P by the applicable cash or non-cash rate, then applying the Section 965(c) deduction. The resulting net 965 tax liability is reported on Form 965 and carried to the taxpayer’s return.
Based on our TFX client scenario: A US individual owns 100% of a foreign corporation with $500,000 in accumulated E&P, including $300,000 in cash and $200,000 in illiquid assets.
Simplified example:
If a corporate US shareholder had $300,000 of cash-position deferred income and $200,000 of remaining deferred income, the Section 965 rate-equivalent amounts would be $46,500 and $16,000, for a simplified total of $62,500 before considering foreign tax credits, other adjustments, and taxpayer-specific limitations.
Do not apply an additional Section 965(c) reduction after this simplified rate-equivalent calculation.
Moore v. United States (2024)
The US Supreme Court upheld Section 965 in a 7–2 ruling in Moore v. United States, issued June 20, 2024. The Court held that the mandatory repatriation tax is constitutional because Congress may attribute realized and undistributed income of an American-controlled foreign corporation to American shareholders. The full text of Moore v. United States (June 2024) is the official source for the ruling.
What Moore v. United States decided
Charles and Kathleen Moore challenged the Section 965 tax after their 2017 liability increased by about $15,000 on a 13% stake in KisanKraft, an Indian corporation. The Moores argued no realization event occurred at the shareholder level. The Supreme Court rejected that argument in a 7–2 majority opinion by Justice Kavanaugh. The ruling does not decide whether realization is required for all income taxes, and it does not address wealth taxes or unrealized appreciation.
Practical implications for Section 965 taxpayers
The Moore ruling has 3 direct consequences for US shareholders in 2026: constitutional refund claims are weaker, Section 965(h) obligations remain in place, and the decision supports pass-through-style taxation of foreign corporate income. Net CFC Tested Income (NCTI), which replaced GILTI effective January 1, 2026, applies annually to current CFC profits, while Section 965 was a one-time transition tax on accumulated pre-2018 foreign earnings.
The following 3 practical points matter most:
- No refunds for unconstitutionality – the IRS can reject refund requests based only on Moore-type arguments.
- Installment plan unaffected – the ruling did not cancel or modify Section 965(h) obligations.
- Precedent for NCTI – the ruling supports Congress’s ability to attribute certain foreign corporate income to US shareholders.
Section 965 transferee liability
A Section 965 transferee can be a buyer or recipient who assumes unpaid Section 965 obligations through a valid transfer agreement after an acceleration or triggering event. Official IRS guidance ties these agreements to Section 965(h)(3) and Section 965(i)(2), while Schedule 2, line 20 reports Section 965 net tax liability installments from Form 965-A.
Accuracy note: IRC Section 965(l) is not the general property transferee rule. Official guidance describes Section 965(l) as a recapture rule for expatriated entities that claimed a Section 965(c) deduction; transfer agreements generally fall under Section 965(h)(3) or Section 965(i)(2).
Transferee liability under Section 965 transfer rules arises in the following 2 situations:
- An eligible Section 965(h) transferee assumes unpaid installment obligations through Form 965-C.
- An eligible Section 965(i) transferee assumes S corporation deferral obligations through Form 965-D.
Taxpayers who receive an IRS notice identifying an IRC 965 transferee issue should take the following 3 steps before responding:
- Obtain the original taxpayer’s Form 965-A or Form 965-B to verify the reported Section 965 net tax liability amount.
- Confirm that the transfer date, triggering event, and unpaid balance match IRS records.
- Review collection due process rights (IRS Publication 1660) before signing a response or agreement.
Section 965: key rules and compliance requirements
Section 965 compliance involves 5 areas that US shareholders most frequently misunderstand: installment payment rules, annual reporting requirements, special rules for S corporations, available exceptions, and consequences of non-compliance. Each area below uses specific figures and IRS-backed rules for 2026 review.
1. Section 965 installment payments: schedule and final status
US shareholders who elected the Section 965(h) installment plan paid the Transition Tax across 8 annual installments without interest. The 8th installment equals 25% of the total net Section 965 tax liability. For a 2017 inclusion year, the final installment was generally due April 15, 2025; for a 2018 inclusion year, the final installment can fall in 2026.
The Section 965 Transition Tax provides an option for taxpayers to pay their net tax liability in eight annual installments.
This provision aims to ease the financial burden of the tax and provide flexibility in payment.
a) Specific rules and eligibility criteria
The following 3 rules apply to the Section 965(h) installment election:
- Election to pay in installments: Taxpayers must make an affirmative election to pay in installments. This election is irrevocable once made.
- Interest: Late installment payments accrue interest at the IRS underpayment rate, which is the federal short-term rate plus 3 percentage points under IRC Section 6621(a)(2), from the due date of the missed installment.
- Triggering events: Certain events, such as the sale of the business, can accelerate the installment payments, requiring the entire remaining balance to be paid immediately.
The original timing rules are discussed in IRS Notice 2018-26 (installment election rules).
b) Required installment and the percent due
The 8 installment payments are distributed as follows, as a percentage of the total net Section 965(h) tax liability:
- Installments 1 to 5: 8% of the total tax liability is due for each of the first five installments.
- Installment 6: 15% of the total tax liability is due.
- Installment 7: 20% of the total tax liability is due.
- Installment 8: 25% of the total tax liability is due.
c) Payment methods
Various payment methods are available, including electronic payments through EFTPS.gov, wire transfers, and mailing checks or money orders.
Specific instructions and payment codes may apply, depending on the payment method chosen. IRS guidance says Section 965(h) installment payments should be made separately from current-year income tax payments and identified as Section 965 payments.
d) Status of installments in 2025–2026
For calendar-year taxpayers who elected Section 965(h) for a 2017 inclusion year, the 8th and final installment was generally due April 15, 2025. A missed installment can trigger acceleration of the unpaid balance under Section 965(h)(3). In 2026, these rules still matter for missed payments, 2018 inclusion-year installment schedules, IRS audit issues, and active S-corp Section 965(i) deferral elections.
In 2026, Section 965 installment rules remain relevant for the following 3 groups:
- Taxpayers with unresolved missed installments, acceleration risk, or interest exposure.
- Taxpayers under IRS audit within the Section 965(k) six-year assessment window.
- S-corp shareholders with an active Section 965(i) deferral election.
2. What are the reporting requirements?
Section 965 reporting requires Form 965 for US shareholders, Form 965-A for individual shareholders tracking net tax liability and installments, and Form 5471 for shareholders of certain foreign corporations. The IRS uses these forms to track the Section 965(a) inclusion amount, the Section 965(c) deduction, and the remaining installment balance.
Section 965 compliance requires the following 3 primary forms, although additional forms may apply depending on entity type:
- Form 965: Used to report the Section 965(a) inclusion amount, the deduction under Section 965(c), and the net tax liability under Section 965.
- Form 965-A: Individual US shareholders use this form to report their share of the Section 965(a) inclusion amount, the deduction under Section 965(c), and their net tax liability under Section 965.
- Form 5471: May be required for US shareholders of certain foreign corporations.
3. Impact on S corporations
S corporation shareholders may elect under Section 965(i) to defer the full Transition Tax liability until a triggering event occurs. Triggering events include the S corporation ceasing to be an S corporation, liquidation, sale, or transfer events tied to the shareholder’s stock.
For S corporation shareholders, the Transition Tax presents unique considerations:
- Deferral option: Shareholders may elect to defer the Transition Tax indefinitely until a triggering event occurs, such as a sale of shares, liquidation, or cessation of the S corporation’s business.
- Special rules: The deferral option is subject to specific rules and conditions. Careful planning and understanding of these rules are needed to take advantage of this provision.
- Potential pitfalls: Failure to comply with the requirements or properly elect the deferral can result in unexpected tax liabilities.
S corporation shareholders with current CFC income should also review how the Section 962 election reduces NCTI liability for individual CFC owners.
4. Exceptions and exemptions
Section 965 includes two main reduction mechanisms: the accumulated deficit offset under Section 965(b), and the Section 965(c) deduction. A US shareholder may use deficits in one specified foreign corporation to reduce positive E&P in another specified foreign corporation when the ownership and measurement rules are met.
A US shareholder may reduce the Section 965 inclusion by applying accumulated deficits in E&P of related SFCs under Section 965(b). The deficit SFC must be owned by the same US shareholder as the SFC with positive E&P on the measurement date, which is November 2, 2017 or December 31, 2017.
Other exceptions: Detailed analysis of the law may reveal other exceptions applicable to specific situations.
5. What are the consequences of non-compliance?
Non-compliance with Section 965 carries 4 categories of consequences: failure-to-pay penalties, failure-to-file penalties, interest on unpaid liability, and potential acceleration of installment obligations. The IRS also has an extended 6-year assessment period under Section 965(k) for tax tied to Section 965 inclusions.
The following 4 consequences apply to Section 965 non-compliance:
- Failure-to-pay penalty: 0.5% of unpaid Section 965 tax per month, up to 25% of the total liability under IRC Section 6651(a)(2).
- Failure-to-file penalty: 5% of unpaid Section 965 tax per month, up to 25% under IRC Section 6651(a)(1). This penalty can apply when Form 965 is not filed by the return due date.
- Interest: Interest may accrue on unpaid tax liabilities, increasing the overall cost of non-compliance.
- Section 965(k) extended assessment: the IRS has 6 years, instead of the standard 3, to assess tax attributable to Section 965 inclusions.
Bottom line
Section 965 still matters in 2026 for US expats with old CFC ownership, unresolved installment balances, S-corp deferrals, transfer agreements, or IRS notices. The original Transition Tax applied to 2017 or 2018 inclusion years, but reporting and collection issues can still surface years later.
Section 965 transition tax – what you need to remember in 2026
- Tax applied to the 2017 year in most cases – but IRS audit exposure can extend under Section 965(k)
- Final Section 965(h) installment for a 2017 inclusion year was generally due April 15, 2025
- Section 965(i) deferral for S-corps can still be active for eligible shareholders
- Moore v. United States, decided June 20, 2024, confirmed the mandatory repatriation tax is constitutional
- Transfer agreements under Section 965(h) and Section 965(i) still matter when unpaid 965 tax liability moves between parties
The Section 965 Transition Tax is a complex and multifaceted provision that requires careful consideration and planning.
Whether you are an individual or a business entity, understanding the nuances of Section 965 is essential for compliance and strategic planning.
FAQs on Section 965 transition tax for US expats in 2026
Yes, Section 965, also known as the Transition Tax, is a one-time tax. It was enacted to tax previously deferred foreign earnings as the US shifted from a worldwide tax system to a territorial system.
Section 965(a) defines the amount that must be included in a US shareholder’s income as a result of the Transition Tax. Section 965(b) provides adjustments to the amount, particularly related to deficits in earnings and profits among specified foreign corporations. Together, they determine the net tax liability.
The final Section 965 regulations provide detailed guidance on the calculation and reporting of the Transition Tax. They include specifics on the tax rates, affected entities, payment options, and compliance requirements. The regulations were finalized to clarify the implementation of the tax provision.
Taxpayers have the option to pay the Transition Tax in eight annual installments. Specific percentages are due each year, starting with 8% for the first five installments, then increasing to 15%, 20%, and 25% for the final three installments.
A simplified example of a Section 965 Transition Tax is a US C corporation with $1,000,000 of cash-position deferred foreign income. The Section 965 rate-equivalent result would be $155,000 before considering foreign tax credits, other adjustments, and taxpayer-specific limits.
Yes. The US Supreme Court upheld Section 965 in a 7–2 ruling in Moore v. United States on June 20, 2024. The ruling rejected the Moores’ constitutional challenge to the mandatory repatriation tax.
An IRC 965 transferee generally refers to a taxpayer connected to assumed or transferred Section 965 obligations, often through a Section 965(h) or Section 965(i) transfer agreement. IRS processing guidance references Schedule 2, line 20 for Section 965 net tax liability installments from Form 965-A.
Yes, for the original transition tax years. The Section 965(h) installment election had to be made by the due date of the original income tax return, including extensions, while each installment is due on the unextended due date of the return.
Section 965 generally applied to 2017 and 2018 tax year returns, but it can still matter in 2026. Current issues include Form 965-A tracking, S-corp 965(i) deferrals, transfer agreements, IRS audits, and streamlined filing submissions that must include 2017 or 2018 when Section 965 applies.
Section 965 was a one-time tax on accumulated pre-2018 CFC earnings. NCTI, formerly GILTI, is an annual inclusion under Section 951A for current net CFC tested income. Section 965 uses Form 965 and Form 965-A; NCTI generally uses Form 8992.
Missing a Section 965(h) installment can trigger acceleration of the entire unpaid balance. Late payment may also accrue interest from the missed installment’s due date, and failure-to-pay additions can apply under general IRS penalty rules.
US shareholders may reduce Section 965 liability using foreign tax credits, but Section 965(g) limits credits for taxes connected to amounts covered by the Section 965(c) deduction. The final benefit depends on foreign taxes paid, the deduction, and the shareholder’s tax profile.
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