The TCJA Section 965 Stands: The Latest Court Decision

A recent court decision ruled transition tax enacted within the 2017 Tax Cuts and Jobs Act (TCJA) is constitutional. 

Section 965 of the TCJA requires U.S. shareholders to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations. The idea is to tax the foreign earnings as if those earnings had been repatriated to the United States. The transition tax rates vary from 8% to 17.5% depending on how much of accumulated earnings were related to cash assets and whether the U.S. shareholder was a corporation or an individual.

For most individuals and calendar-year domestic corporations, the transition tax was generally due April 17, 2018—even if the due date of the taxpayer’s return was extended to a later date. Some taxpayers were able to elect to pay the tax in installments over a period of up to eight years.

Concerns have arisen over the years regarding the constitutionality of Section 965. Many felt the idea of a retroactive tax imposed on individuals for “income” they never actually received was not fair. There was also a concern due process was violated because of the short notice in implementing the transition tax.

However, a federal court in Washington State ruled on Nov. 19, 2020, that Section 965 was part of the larger plan to enact a territorial tax system and was used as a reasonable method to prevent undistributed earnings and profits from escaping taxation on the effective date of the TCJA. The pre-TCJA structure of the international tax rules was one of deferral of accumulated earnings of foreign companies, not a permanent exemption. Congress has no legal obligation to keep taxpayer-favorable rules in place indefinitely.

The court admitted that, while taxpayers received little notice of the application of the transition tax, it did not surprise knowledgeable international tax advisors. As a result, due process was not denied with Section 965.

U.S. shareholders who have not yet addressed the transition tax liability should do so sooner than later.  Consult your international tax CPA for guidance in these and other complex foreign interest matters.

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