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Transition Tax Is Not the Same Thing as GILTI Tax

Transition Tax Is Not the Same Thing as GILTI Tax
Ines Zemelman, EA
01 October 2018

One time event vs annual tax

Do not confuse Transition Tax with GILTI Tax: the former is a one-time event; the latter is annual tax starting from 2018 tax year.  Transition Tax is levied on the deemed repatriation of post-1986 accumulated earnings of a foreign corporation that have not been taxed by the IRS in the past.

GILTI tax is the global analogy to the Alternative Minimum Tax (AMT) - it is the share that any US owner of Controlled Foreign Corporation (CFC) must pay to the IRS every year, regardless of whether he has other taxable income or not.

Calculation of untaxed Earnings and Profits starts from the year where the foreign corporation became a Controlled Foreign Corporation. If the corporation was inherited by a US person in 2016, then the calculation of earnings and profits subject to Sec 965 inclusion starts in 2016.  Prior earnings and profits are disregarded


Also, if the individual owned the corporation in the past, yet met the Substantial Presence test or become a Green Card holder in 2016 - then the calculation of untaxed earnings and profits starts in the year where he became a US person.

Likewise, US owners of CFC who expatriated prior to November 2, 2017 do not pay Transition Tax. If they are not covered expatriate then accumulated earnings and profits in the CFC will never be taxed by the IRS.

Net Invest Income Tax (NIIT), Sec 965, and GILTI

Net Investment Income Tax (NIIT) does not apply to Sec 965 deemed repatriation income and does not apply to GILTI income. However, NIIT applies to dividends distributions. On the flip side, dividends distributions from the CFC incorporated in the country with a Tax Treaty are qualified and taxed at the preferential rate of 15% ,while GILTI income and Deemed Repatriation income are taxed at the ordinary rate.

The individual owner of a CFC may take Sec 962 election to have Sec 965 income (deemed repatriation income) or GILTI income taxed at the corporate rate of 21%. If they take the election, they may apply corporate tax paid by CFC in the resident country as a foreign tax credit. Foreign tax credit will be calculated on form 1118 (foreign tax credit for corporations) instead of form 1116 (foreign tax credit for individuals). Therefore, the individual tax return will involve manual calculations and will not qualify for e-filing.

The words "Will be furnished upon request" - on form 5471 or on the Transition Tax Statement should never be used. If used, the return will be considered incomplete and have high risk of triggering an audit.  

If the CFC owner has state tax obligations - they should review them carefully. Each state has a different position - check individually. Some states include Sec 965 income to the same extent that federal return does. Other states disallow Sec 965(c) deduction taken on the federal return and require full Sec 965(a) inclusion to become part of state taxable income.

The open question related to state reporting of Transition Tax - how does this can apply to the taxpayers who became state residents recently, perhaps only in 2017? Should they include to state taxable income earnings and profits accumulated over the time that they were not resident of that state?  This, and other remaining challenges and outstanding issues that have not been addressed will require further IRS guidance.

Uncertain examples

When Transition tax is calculated for a US partnership - Sec 965 income is passed through to the individual partners. However, Sch K in its current version does not have a section for reporting of partner share of Sec 965 income. How to report partner share of Sec 965 inclusion?

Should Sec 965 inclusion be reported on Sch I of form 5471 or not?

Do not expect the IRS to have answers to any of your questions related to Sec 965 or GILTI tax - if you call and ask questions you will not get meaningful answers, because this is all still TBD.

Ines Zemelman, EA
Founder of TFX