Today’s post is for individuals living abroad who file their tax returns on June 15 and who have deemed repatriation income from their foreign corporations under section 965.
A quick introduction to section 965: In December of 2017, Congress passed laws that changed the US taxation of foreign income significantly. One of these laws is section 965.
There are many nuances to section 965, but here is the short version that covers what we need today: If you are a US citizen, green card holder, or other resident, or you are a US entity; and you own at least 10% of a foreign corporation, you might have a lot of income from the deemed repatriation of your share of the foreign corporations’ accumulated profits since 1986.
For example, suppose you are a US citizen, you are the sole shareholder of a foreign corporation, and the foreign corporation has $10,000,000 of accumulated profits since 1986. You would have deemed income of $10,000,000 under section 965.
There are some provisions to mitigate the impact of the deemed repatriation. One of these is the participation exemption. Another one is the installment plan. The installment plan is the topic of today’s post.
A person subject to section 965 can elect to pay the tax in 8 installments: 8% in each of the first 5 years, 15% in the 6th year, 20% in the 7th year, and 25% in the last year. IRC §965(h)(1). And the timely payment of an installment does not incur interest. H. Rpt. 115-466, 115th Cong., 611.
Given how back loaded the installment plan is, and using it does not trigger interest, it is generally a good idea to use the installment plan.
You make it by attaching the right statement to your tax return. This is question 7 of the IRS’s section 965 FAQ.
Because the due date of the return is a few months away (with extension), this post will skip the details of how to make the election.
This is question 10 of the IRS’s section 965 FAQ.
If you normally make payments using EFTPS, you can wire the first installment payment instead. There is no penalty for using wire instead of EFTPS for the first installment.
The installment payment must be made separately from any other payment. The wire must carry a 5 digit tax type code of 09650 in addition to the normal information you need to include with a wire payment.
Those who normally pay by check should send the check with a payment voucher, e.g. 1040-V.
The installment payment must be made separately from any other payment, i.e. using a separate voucher and with a separate check. You must write “2017 965 tax” on the front of the payment in addition to the normal information you need to include with a voucher payment.
This is question 13 of the IRS’s section 965 FAQ.
For your estimated tax payments, the IRS first applies the payment to your tax liability determined without regard to section 965. Then it applies any remaining apply to your section 965 tax liability, including the first installment.
If you overpaid your estimated quarterly taxes or did not separate out the first installment from your normal payment, the overpayment will be applied to your first installment.
It is a good idea to follow the IRS procedure and make it easier for the IRS to process the payments, but if you already paid the taxes together, some of it should be credited to the first installment.
“The first installment shall be paid on the due date (determined without regard to any extension of time for filing the return) for the return of tax for the taxable year…” IRC §965(h)(2).
For those who live in the US, the first installment was due April 17th, 2018.
For those who live outside the US, the IRS extended the first installment due date to June 15th, 2018. Notice 2018-26, §3.05(e).
“If there is an addition to tax for failure to timely pay any installment required under this subsection […] then the unpaid portion of all remaining installments shall be due on the date of such event…” IRC §965(h).
What the Code tells us is that if you do not pay an installment on time, and the late payment results in “an addition to tax”, then the entire balance of section 965 is due as of the date the installment payment was due.
For example, suppose your section 965 tax is $1,000,000. The first installment is $80,000, and it is due June 15. You pay nothing on June 15, but you pay the $80,000 with your tax return on October 15. The IRS assesses an “addition to tax” because of the late payment. Then the entire $1,000,000 becomes due retroactively as of June 15.
To trigger this acceleration, there must be an “addition to tax” for failure to timely pay the installment. For example, a timely payment of an installment does not incur interest. H. Rpt. 115-466, 115th Cong., 611. Presumably a late payment of an installment incurs interest like any other underpayment of tax. Is that interest an “addition to tax” that triggers acceleration?
Section 965 offers no definition of “addition to tax”, so we have to make inferences.
Chapter 68 of the Internal Revenue Code (sections 6651 to 6751) is labeled “additions to the tax, additional amounts, and assessable penalties”. Subchapter A of chapter 68 (sections 6651 to 6665) is labeled “additions to the tax and additional amounts”. If you look in these sections, you will see familiar penalties such as the failure to file penalty, the failure to pay penalty, negligence penalty, etc.
By contrast, interest is in chapter 67 (sections 6601 to 6631), which is labeled “interest”. This suggests that interest is not an “addition to tax”.
Based on the chapter labeling, my guess is that if the late payment or underpayment results in a penalty, then the entire payment is accelerated, because the penalty is an “addition to tax”. If the late payment or underpayment merely results in interest, then you merely owe interest, because the interest is not an “addition to tax”.
Our plan is to overestimate and ask the client to make a first installment payment that is an overestimate, to minimize the possibility that there would be an “addition to tax” that accelerates the entire tax under section 965.
For example, paying 12% instead of 8% in the first year is better than having to pay 100% in the first year because of an underpayment penalty.
If you are really short on cash, you can try to make just enough payment to avoid penalties. But keep in mind that we are not sure what exactly is an “addition to tax” that triggers acceleration of the entire tax due.
This is question 14 of the IRS’s section 965 FAQ.
If you overpay the first installment (or any installment), the IRS keeps the extra money and applies it to subsequent installments. You cannot get a refund of overpayment of an installment.
By contrast, if you overpay the entire tax liability, you can get a refund like normal.