Tag Archives: transition tax

Part 45 – “Some” examples where the U.S. creates unrealized “foreign income” before a realization event in the source country

Let There Be Income And There Was Income!

The United States has an increasing propensity to create “deemed income” in circumstances where the taxpayer has received no income to pay the tax.

In some cases the “deemed income” created is “foreign source” income. In other cases it is purely domestic source.

When the “deemed income” is “foreign source” income over which the other country has primary taxing rights, the “deemed income” event creates a U.S. tax owing before an actual realization event in the foreign country.

The implications are experienced by both the country of source and the individual taxpayer.

1. Impact on country of source: The U.S. collecting tax owing before the source country has the opportunity to tax it

2. Impact on individual taxpayer: The U.S. creating a deemed realization event resulting in real taxation means that the taxpayer is more likely to experience double taxation. The taxpayer will first pay the U.S. tax and then (when an actual realization event takes place) pay the tax in the country of source.

“Some” examples of “deemed realization” of foreign source income

Note that each of these examples in found in Subtitle A of the Internal Revenue Code (income tax)

877A Exit Tax,

951 Subpart F

965 Transition Tax,

951A GILTI

1291 PFIC

988 Phantom Capital Gains

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Interested in Moore (pun intended) about the § 965 transition tax?

Read “The Little Red Transition Tax Book“.

John Richardson – Follow me on Twitter @Expatriationlaw

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U.S. Canada Tax Treaty – 1980

7. Where at any time an individual is treated for the purposes of taxation by a Contracting State as
having alienated a property and is taxed in that State by reason thereof and the domestic law of the
other Contracting State at such time defers (but does not forgive) taxation, that individual may elect in
his annual return of income for the year of such alienation to be liable to tax in the other Contracting
State in that year as if he had, immediately before that time, sold and repurchased such property for an
amount equal to its fair market value at that time

https://www.irs.gov/pub/irs-trty/canada.pdf

Paragraph 7 provides a rule to coordinate U.S. and Canadian taxation of gains in circumstances where an individual is subject to tax in both Contracting States and one Contracting State deems a taxable alienation of property by such person to have occurred, while the other Contracting State at that time does not find a realization or recognition of income and thus defers, but does not forgive taxation. In such a case the individual may elect in his annual return of income for the year of such alienation to be liable to tax in the latter Contracting State as if he had sold and repurchased the property for an amount equal to its fair market value at a time immediately prior to the deemed alienation. The provision would, for example, apply in the case of a gift by a U.S. citizen or a U.S. resident individual which Canada deems to be an income producing event for its tax purposes but with respect to which the United States defers taxation while assigning the donor’s basis to the donee. The provision would also apply in the case of a U.S. citizen who, for Canadian tax purposes, is deemed to recognize income upon his departure from Canada, but not to a Canadian resident (not a U.S. citizen) who is deemed to recognize such income. The rule does not apply in the case death, although Canada also deems that to be a taxable event, because the United States in effect forgives income taxation of economic gains at death. If in one Contracting State there are losses and gains from deemed alienations of different properties, then paragraph 7 must be applied consistently in the other Contracting State within the taxable period with respect to all such properties. Paragraph 7 only applies, however, if the deemed alienations of the properties result in a net gain.

https://www.irs.gov/pub/irs-trty/canatech.pdf

Protocol to Canada/U.S. Tax Treaty 2007 – Article VIII – Replacing Article XIII Paragraph 7 in the 1980 Treaty

3. Paragraph 7 of Article XIII (Gains) of the Convention shall be deleted and replaced by the following:

7. Where at any time an individual is treated for the purposes of taxation by a Contracting State as having alienated a property and is taxed in that State by reason thereof, the individual may elect to be treated for the purposes of taxation in the other Contracting State, in the year that includes that time and all subsequent years, as if the individual had, immediately before that time, sold and repurchased the property for an amount equal to its fair market value at that time.

https://home.treasury.gov/system/files/131/Treaty-Canada-Pr2-9-21-2007.pdf

Technical explanation of the 2007 Protocol

Paragraph 3

Paragraph 3 of Article 8 of the Protocol replaces paragraph 7 of Article XIII.

The purpose of paragraph 7, in both its former and revised form, is to provide a rule to coordinate U.S. and Canadian taxation of gains in the case of a timing mismatch.

Such a mismatch may occur, for example, where a Canadian resident is deemed, for Canadian tax purposes, to recognize capital gain upon emigrating from Canada to the United States, or in the case of a gift that Canada deems to be an income producing event for its tax purposes but with respect to which the United States defers taxation while assigning the donor’s basis to the donee. The former paragraph 7 resolved the timing mismatch of taxable events by allowing the individual to elect to be liable to tax in the deferring Contracting State as if he had sold and repurchased the property for an amount equal to its fair market value at a time immediately prior to the deemed alienation.

The election under former paragraph 7 was not available to certain non-U.S. citizens subject to tax in Canada by virtue of a deemed alienation because such individuals could not elect to be liable to tax in the United States. To address this problem, the Protocol replaces the election provided in former paragraph 7, with an
election by the taxpayer to be treated by a Contracting State as having sold and repurchased the property for its fair market value immediately before the taxable event in the other Contracting State. The election in new paragraph 7 therefore will be available to any individual who emigrates from Canada to the United States, without regard to whether the person is a U.S. citizen immediately before ceasing to be a resident of Canada. If the individual is not subject to U.S. tax at that time, the effect of the election will be to give the individual an adjusted basis for U.S. tax purposes equal to the fair market value of the property as of the date of the deemed alienation in Canada, with the result that only post-emigration gain will be subject to U.S. tax when there is an actual alienation. If the Canadian resident is also a U.S. citizen at the time of his emigration from Canada, then the provisions of new paragraph 7 would allow the U.S. citizen to
accelerate the tax under U.S. tax law and allow tax credits to be used to avoid double taxation. This would also be the case if the person, while not a U.S. citizen, would otherwise be subject to taxation in the United States on a disposition of the property.

In the case of Canadian taxation of appreciated property given as a gift, absent paragraph 7, the donor could be subject to tax in Canada upon making the gift, and the donee may be subject to tax in the United States upon a later disposition of the property on all or a portion of the same gain in the property without the availability of any foreign tax credit for the tax paid to Canada. Under new paragraph 7, the election will be available to any individual who pays taxes in Canada on a gain arising from the individual’s gifting of a property, without regard to whether the person is a U.S. taxpayer at the time of the gift. The effect of the election in such case will be to give the donee an adjusted basis for U.S. tax purposes equal to the fair market value as of the date of the gift. If the donor is a U.S. taxpayer, the effect of the election will be the realization of gain or loss for U.S. purposes immediately before the gift. The acceleration of the U.S.
tax liability by reason of the election in such case enables the donor to utilize foreign tax credits and avoid double taxation with respect to the disposition of the property.

Generally, the rule does not apply in the case of death. Note, however, that Article XXIX B (Taxes Imposed by Reason of Death) of the Convention provides rules that coordinate the income tax that Canada imposes by reason of death with the U.S. estate tax.

If in one Contracting State there are losses and gains from deemed alienations of different properties, then paragraph 7 must be applied consistently in the other Contracting State within the taxable period with respect to all such properties. Paragraph 7 only applies, however, if the deemed alienations of the properties result in a net gain.

Taxpayers may make the election provided by new paragraph 7 only with respect to property that is subject to a Contracting State’s deemed disposition rules and with respect to which gain on a deemed alienation is recognized for that Contracting State’s tax purposes in the taxable year of the deemed alienation. At the time the Protocol was signed, the following were the main types of property that were excluded from the
deemed disposition rules in the case of individuals (including trusts) who cease to be residents of Canada: real property situated in Canada; interests and rights in respect of pensions; life insurance policies (other than segregated fund (investment) policies); rights in respect of annuities; interests in testamentary trusts, unless acquired for consideration; employee stock options; property used in a business carried on through a permanent establishment in Canada (including intangibles and inventory); interests in most Canadian
personal trusts; Canadian resource property; and timber resource property.

https://home.treasury.gov/system/files/131/Treaty-Canada-Pr2-TE-9-21-2007.pdf

Model U.S. Tax Treaty 2016

The following provision appears first in the 2016 Model Tax Treaty. There is at present no technical explanation discussing the treaty. Therefore, it must be interpreted based on the presumed intent (which can be gleaned in part from the Canada U.S. Tax Treaty). Significantly, this provision is intended to prevent double taxation resulting from the deemed “alienation” of property upon severing tax residency. It is far narrower than the Article XIII – Paragraph 7 of the Canada U.S. Tax Treaty.

Article 13 – Paragraph 7

7. Where an individual who, upon ceasing to be a resident (as determined under paragraph 1
of Article 4 (Resident)) of one of the Contracting States, is treated under the taxation law of that
Contracting State as having alienated property for its fair market value and is taxed in that
Contracting State by reason thereof, the individual may elect to be treated for purposes of
taxation in the other Contracting State as if the individual had, immediately before ceasing to be
a resident of the first-mentioned Contracting State, alienated and reacquired such property for an
amount equal to its fair market value at such time.

https://home.treasury.gov/system/files/131/Treaty-US-Model-2016_1.pdf

Part 37 – 2023: US Supreme Court To Hear Moore Appeal In Lawsuit Against @USTransitionTax – Great News!

June 26, 2023 – Great News! – The US Supreme Court Agrees To Hear Moore 965 Transition Tax Case!

A direct link to the Supreme Court site which will track the progress and filings of all briefs (including what are expected to be a large number of amicus briefs) is here.

The brief from the CATO Institute frames the question addressed to the Supreme Court as follows:

QUESTION PRESENTED

Whether Congress may levy income tax on a tax-payer who has not realized income.

What follows is a twitter thread (which I will continually update) which includes commentary, resources and general information about the appeal.

Litigation against the 965 Mandatory AKA transition tax has come from two sources.

The first source was from U.S. tax lawyer Monte Silver. His challenge to the tax was based generally on procedural grounds and specifically on the failure of U.S. Treasury to comply with the provisions of the Regulatory Flexibility Act. Despite a heroic, valiant and determined effort the Supreme Court refused to hear his cert petition. As a result, in May 2023, his challenge came to an end. Monte Silver’s challenge focused on the legality of the Treasury Regulations insofar as they applied to US citizens living outside the United States.

The second source is the Charles Moore case. This case is arguing that the tax is unconstitutional. Although brought on behalf of an individual shareholder of a CFC, the case makes no mention of the application of the tax to Americans abroad. On June 26, 2023 (about a month after denying the cert petition in the Silver case) the U.S. Supreme Court agreed to hear the Moore case. To be clear, this case is attacking the constitutionality of the tax (not the procedural aspects) head on. Much will be written about this issue and the case.

On September of 2019 I wrote a post describing the Moore lawsuit arguing that the Section 965 Transition Tax AKA Mandatory Repatriation Tax is unconstitutional. Although the Moore’s were not successful in the District Court and Appeals court, the Supreme Court of the United States has agreed to hear the case!

The Cert Petition

The Cert petition was based on an appeal from the 9th Circuit and a dissenting judgment from the plaintiff’s application to rehear the case in the 9th Circuit.

The original 9th Circuit decision is here.

The decision of the 9th Circuit denying the request (with the dissent) to rehear the Moore case is here.

An excellent article discussing the history of the Moore “Transition Tax” ligation is here.

The cert petition in CHARLES G. MOORE and KATHLEEN F. MOORE, Petitioners, v. UNITED STATES OF AMERICA,Respondent, includes:
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Post 36 – The Little Red @USTransitionTax Book – About the 965 Mandatory Repatriation Tax

June 2023 – The fight against the 965 Transition AKA Mandatory Repatriation Tax Continues

On June 26, 2023 the U.S. Supreme Court agreed to hear the Moore appeal to the constitutionality of the U.S. Transition Tax. For those who don’t know, the transition is found in S. 965 of the Internal Revenue Code and was part of the 2017 TCJA. It was intended (in part) to be a “trade off” pursuant to which:

1. U.S. corporations would have the corporate tax rate lowered from 35% to 21%.

2. The U.S. Claimed to adopt “territorial taxation” for its corporations. Generally this meant that profits earned outside the United States would not be taxed by the United States.

3. The U.S. adopted the 951A GILTI rules which exposed the lie of moving to territorial taxation (the profits earned outside the United States were taxed before being distributed. They were then not taxed a second time on distribution).

4. The U.S. adopted that 965 transition AKA mandatory repatriation tax which was a retroactive tax on the retained earnings of CFCs which had not been distributed and therefore not subjected to U.S. taxation.

In a nutshell:

The 965 transition tax was a one time retroactive tax (going back to profits accrued since 1986) on earnings that were not subject to taxation at the time that they were earned. This is incredible stuff!!

But, (as usual) little thought was given to the fact that some CFCs were owned by individuals. No thought was given to the fact that many Americans living outside the United States had small business corporations in their country of residence.

For U.S. citizens in Canada, their small business corporations (in many cases) were actually their private pension plans. To put it simply:

The 965 transition AKA mandatory repatriation tax confiscated the pension plans of many Americans abroad. Frankly this is/was one of the most egregious offences against Americans abroad ever perpetrated by Congress and the Treasury.

In 2018 I began writing a number of blog posts about various aspects of this issue. These are written mostly from the perspective of Americans abroad who are dual “tax residents” (of other countries and of the United States). I don’t think the Moore’s are tax residents of India.

I haven’t written about the transition tax for a long time. That said, the fact that the U.S. Supreme Court is going to hear the Moore Case has reminded me of this issue. This means that more posts will be written. Each post is really a chapter. The posts have been designated as chapters which collectively compose the “Little Red Transition Tax Book”.

Therefore, this post (which I will add to) is “The Little Red Transition Tax Book”.

The posts include:

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Part 34 – 2019: Treasury Fails To Prevent @MonteSilver1 lawsuit against @USTransitionTax From Proceeding – Case To Be Heard On The Merits

What Happened

The judgment is here.

We win!!!!!

About The Transition Tax

As part of the 2017 TCJA, Congress imposed a retroactive tax, without any realization event, on the retained earnings of Controlled Foreign Corporations. Although intended to be the the “trade off” for lowering the Corporate Tax rate from 35% to 21%, it was interpreted to apply to the small business corporations owned by Americans abroad. (The tax compliance industry aggressively promoted this damaging interpretation of the law.) In any event, this imposed significant and life altering consequences on Americans abroad (particularly in Canada) for whom their small business corporations were really their pension plans. I documented the history, damage and madness of this in a series of posts about the transition tax. The law was interpreted (in various ways) and the regulations were drafted in an extremely punitive manner. What needs to be most understood is that a law intended for the Apples, Googles, etc. was interpreted to apply in the same way to individuals (your friends and neighbors) who owned small business corporations.

About The Regulatory Flexibility Act

Title 5 of the U.S. Code of Laws deals with how the U.S. Government works. Subtitle 5 is the Administrative Procedure Act. Subtitle 6 is the Regulatory Flexibility Act. At the risk of over-generalization, the purposes of the Regulatory Flexibility Act are to require the Government to consider the effect that certain rules/regulations have on small businesses and undertake specific procedural steps in relation to this consideration.

Learn About the Regulatory Flexibility Act

An excellent site providing education about the Regulatory Flexibility Act is here. Although written in the context of the EPA, the description offers the following introduction to the Regulatory Flexibility Act:

The Regulatory Flexibility Act (RFA), 5 U.S.C. §§ 601 et seq, was signed into law on September 19, 1980. The RFA imposes both analytical and procedural requirements on EPA and on other federal agencies. The analytical requirements call for EPA to carefully consider the economic impacts rules will have on small entities. The procedural requirements are intended to ensure that small entities have a voice when EPA makes policy determinations in shaping its rules. These analytical and procedural requirements do not require EPA to reach any particular result regarding small entities.

The key is that Government is required by law to consider the economic effect of regulations on small business entities.

And here …

Monte Silver’s Lawsuit Against the Transition Tax – Treasury Did NOT Consider The Impact Of The Transition Tax Regulations on Small Business Entities (including those run by Americans Abroad

The lawsuit was not (like other lawsuits) against the Transition Tax per se. Rather the lawsuit was about the the failure of U.S. Treasury to comply with the procedural requirements of the Regulatory Flexibility Act. Predictably, the Government argued that the lawsuit lacked standing. On December 24, 2019 a U.S. District Court Judge ruled that the plaintiff (Mr. Silver) did have standing. The reason was that his lawsuit was not against the transition tax itself. Rather the lawsuit was against U.S. Treasury causing injury resulting from the failure of Treasury to comply with the requirements mandated in the Regulatory Flexibility Act.

Congratulation to Monte Silver for an incredibly important win. The success of his lawsuit opens the door to many similar lawsuits (GILTI anyone?) down the road.

Earlier posts

In November of 2018 I first wrote about Mr. Silver’s lawsuit.

That post included the following earlier interviews.

Speaking with Monte Silver …

Interview 1 – October 16, 2018

Interview 2 – November 15, 2018

John Richardson – Follow me on Twitter @Expatriationlaw

Part 33 – US residents bring suit alleging that the Section 965 US Transition Tax is Unconstitutional

A lawsuit alleging that the Section 965 transition tax is unconstitutional affords the opportunity to write Part 33 in my series of posts about the U.S. Transition Tax.

Part 22 of this series included a discussion of a paper by Sean P. McElroy which argued that the Section 965 repatriation tax was unconstitutional for the following reasons explained in the abstract:

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Part 32 – So, you have received a letter saying that your @USTransitiontax is also subject to the 3.8% NIIT


This is Part 32 of my series of blog posts about the Sec. 965 transition tax. I recently received a message from a person who says that he was assessed a Section 1411 Net Investment Income Tax assessment on the amount of the Section 965 transition tax. Although not intended as legal advice, I would like to share my thoughts on this. I don’t see how the transition tax could be subject to the NIIT.
Let’s look at it this way:
Why Section 965 Transition Tax Inclusions Are NOT Subject To The Sec. 1411 Net Investment Income Tax
A – The Language Of The Internal Revenue Code – NIIT Is Not Payable On Transition Tax Inclusions

I see no way that the language of the Internal Revenue Code leads to the conclusion that the transition tax can be subject to the NIIT.
My reasoning is based on the following two simple points:
1. The NIIT is based on Net Investment Income which is generally defined as dividends, interest and capital gains as per this tweet:


2. Subpart F income by legal definition (controlling case law) is NOT interest, dividends or capital gains as per this tweet


B – The Purpose Of The Section 965 Transition Tax
3. The whole point of the transition tax is to go after active income that was not subject to U.S. tax when it was earned. There is nothing about the transition tax that converts active income into investment income by making it a subpart F inclusion as per this tweet:


Therefore, (and this is speculation on my part) the NIIT charge must be based on something specific to your tax filing – likely treating the transition tax inclusion as meeting the definition of Net Investment Income – specifically Dividends, Interest or Capital Gains.
Under no circumstances should you or anybody else impacted by this simply pay a NIIT surcharge on the transition tax, without a careful and meticulous investigation of the reasons for it. Have a good look at your tax return.
The mandatory disclaimer: Obviously this is not intended to be legal advice or any other kind of advice. It is simply intended to give you the framework to discuss this issue with your tax preparer if you were one of the unfortunate victims who received an NIIT tax assessment on your acknowledged transition tax liability.
John Richardson – Follow me on Twitter @Expatriationlaw

Part 31 – "Double Taxation Disguised as Tax Reform": Jackie Bugnion comments in @TaxNotes on @USTransitionTax and #GILTI

https://twitter.com/worldnewsreader/status/1132961693598986241

This is Part 31 of my series of blog posts about the Sec. 965 transition tax. It is a “guest post” by Jackie Bugnion who is the former tax direction of ACA. The article explores the impacts of the Section 965 transition tax and GILTI on the lives of Americans abroad. Ms. Bugnion places the transition tax and GILTI in the context of the U.S. system of citizenship-based taxation.

This article is reproduced with thanks to the author Jackie Bugnion and the publisher Tax Analysts.

Bugnion-4-29

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John Richardson – Follow me on Twitter @Expatriationlaw

The United States imposes a separate and more punitive tax system on US dual citizens who live in their country of second citizenship

Prologue

Do you recognise yourself?

You are unable to properly plan for your retirement. Many of you with retirement assets are having them confiscated (at this very moment) courtesy of the Sec. 965 transition tax. You are subjected to reporting requirements that presume you are a criminal. Yet your only crime was having been born in America (something you didn’t even choose) and attempting to live as a U.S. tax compliant American outside the United States. Your comments to my recent article at Tax Connections reflect and register your conviction that you should not be subjected to the extra-territorial application of the Internal Revenue Code – when you don’t live in the United States.

The Internal Revenue Code: You can’t leave home without it!

Continue reading

Part 30 – Treasury issues final @USTransitionTax Regs with no relief for #Americansabroad


This is Part 30 of my series of blog posts about the Sec. 965 transition tax.
Because of the importance and significance of this news I am writing this post without having read the 305 pages of Treasury regulations which relate to the Sec. 965 transition tax which are found here. I am relying on Monte Silver’s analysis which concludes that the regulations propose NO regulatory relief for the small businesses of Americans abroad. This is disappointing after the lobbying efforts that have been undertaken.
The attitude of U.S. Treasury
Assuming no relief for Americans abroad, coupled with the vast campaign that was undertaken to educate Treasury, we can assume that the denial of relief was intentional and with full recognition of the harm caused to a political minority, who do not even live in the United States.
To put it simply: It is the intention of U.S. Treasury to confiscate the retirement assets of Canadians with Canadian Controlled Private Corporations and similarly situated individuals in other countries. No other conclusion is possible.
The attitude of Congress – As I have previously said:
The problem is NOT that Congress doesn’t care about Americans Abroad. The problem is that they con’t care that they don’t care!
The only remedy is with the courts and I strongly suggest that you support the transition tax lawsuit being organized by Monte Silver.
The attitude of the Courts
I anticipate that Monte Silver’s lawsuit (described in the previous paragraph) is now inevitable.
Here is what actually has happened this week …
First – as reported on January 15, 2019 before issuing final regulations …

Second – and on January 16, 2019 – for the encore the final Sec. 965 regulations are issued and guess what?

For further commentary I refer you to Monte Silver at Americans for Small Business.
For those who can stomach it, the final (supposedly) regulations are here.
John Richardson
Follow me on Twitter: @ExpatriationLaw