Part I: Introduction – What Is The Transition Tax?
“Tell me who you are. Then I’ll tell you how the law applies to you!” I’ll also tell you whether you are a “winner” or a “loser” under this law.
At the end of 2017, Congress was enacting the TCJA. A major purpose of the TCJA was to lower U.S. corporate tax rates from 35% to 21%. This was a huge benefit to U.S. multinationals. One Congressional concern was how to find additional tax revenue in order to compensate the Treasury Department for the reduction in tax revenue which would result in lower receipts from corporations. Congress needed to find some additional tax revenue. They found this additional tax revenue by creating “new income” from the past and taxing that newly created income in the present. In fact, Congress said:
“Let there be income! And there was income …“
Significantly, Congress didn’t create any real income. No taxpayer actually received any income. The income created by Congress was not “real income”. Rather it was “deemed income”. But, this “deemed income” was intended to appear on tax returns. Real tax was payable on this “deemed” income.
Such, is the beginning of the story of the IRC 965 Transition Tax. The Transition Tax was a benefit to U.S. multinationals and destroyed the lives of individual U.S. citizens living outside the United States who organized their businesses, lives and retirement planning (as did their neighbours) through small business corporations.
This post identifies different groups impacted by the Transition Tax and the “winners” and “losers”.
Introducing the IRC 965 U.S. Transition Tax
26 U.S. Code § 965 – Treatment of deferred foreign income upon transition to participation exemption system of taxation
(a) Treatment of deferred foreign income as subpart F income
In the case of the last taxable year of a deferred foreign income corporation which begins before January 1, 2018, the subpart F income of such foreign corporation (as otherwise determined for such taxable year under section 952) shall be increased by the greater of—
(1) the accumulated post-1986 deferred foreign income of such corporation determined as of November 2, 2017, or
(2) the accumulated post-1986 deferred foreign income of such corporation determined as of December 31, 2017.
Part II: The Reader’s Digest Version – The Six Faces Of The Transition Tax
The six “faces” of the 965 transition tax include the faces of five different kinds of “U.S. Persons”. The sixth face is the country where a U.S. citizen was living. Some are winners and some are losers. A list of winners and losers includes:
1. Winner: A U.S. C corp: Typically a U.S. multinational – Received value in return for being subjected to the transition tax
2. Winner: The individual shareholder of a U.S. S corp: Can opt to have the “deemed income inclusion” of 965 to NOT apply – Escaped the application of the transition tax
3. Winner: Green Card holder who is a “treaty nonresident”: Can escape U.S. taxation on “foreign source income – Escaped the application of the transition tax
4. Loser: A U.S. resident individual (U.S. citizen or resident): The Moores – Subject to the transition tax, received nothing in return and likely subject to double taxation
5. Biggest Loser: A U.S. citizen living outside the United States who is a tax resident of another country: More of a loser than the Moore’s – what if the Moores had lived in British Columbia Canada? – Subject to the transition tax, received nothing in return, likely subject to double taxation on business income earned and retained by their “foreign corporation”. But unlike the Moore’s they live outside the United States as “tax residents” of another country. Unlike the Moore’s their CFC was likely not a simple investment in the shares of another company. Rather their CFC was likely the equivalent of a pension, created and encouraged by the tax laws of their country of residence. While the Moore’s experienced “double taxation” on an investment, the U.S. citizen abroad experienced the confiscation of their retirement pension. Individual shareholders of a CFC who live in the United States were affected quite differently from individual shareholders who live outside the United States.
6. Indirect Loser: The countries where overseas Americans are resident were also damaged by the transition tax: Many countries (example Canada) incentivize the creation of private pension plans through the use of private corporations. The effect of the transition tax was effectively to “loot” the retained earnings of those private corporations that were intended to be pension plans for residents of other countries. This is a particularly ugly manifestations of U.S. citizenship taxation and is a graphic example of how US citizenship taxation operates to extract working capital from other sovereign countries.
Significantly the biggest losers in the application of the 965 transition tax are Americans living outside the United States!
The transition tax confiscated the retained earnings of their local business corporations. Because they are tax residents of other countries, there was no prospect of the corporation’s earnings being repatriated to the United States. The corporation’s earnings were the pension/retirement plans for those individuals.
To put it simply:
The Treasury Department – via IRC 965 – effectively “looted” the retained earnings of small business corporations located outside the United States. The justification for the “looting” was that more than 50% of the shares were “owned” by U.S. citizens. The 2017 US Transition Tax was the ugliest face of the Transition Tax and a particularly ugly manifestation of U.S. citizenship taxation!