In late 2017 our Trusted Servants(TM) in Congress blessed us with a new tax law.

Among other features, the new law contained a spectacular Come to Jesus that absolutely hammered our minimultinational clients.

I speak, of course, of Section 965.

Section 965

Consider a foreign corporation owned by an American living abroad. The foreign corporation operates an ordinary business.  Dry cleaning.  Gas station.  Utterly mundane.  It paid tax on its profits in its home country every year.

But the U.S. never taxed those profits.  The general rule (in Ye Olden Days) was simple: you didn’t pay U.S. tax on foreign corporation profits until you take the money out of the foreign corporation.

This rule had been in place since forever. As a result, many foreign corporations (owned by American shareholders) had large pools of profits built up over the years — profits that had not been paid out as dividends to the shareholders, or distributed in some other way.  Why would this be true?  Simple!  The corporation needed the money for working capital.  It reinvested—rather than distributed—its free cash flow.

At the end of 2017, all of this came to a halt.  Congress said that all of the undistributed earnings would be immediately taxable.  Decades and decades of operations, retaining and reinvesting earnings — all taxable now.

Nose/dead bear

We got a lot of calls about this in late 2017 and early 2018.  When we did the math for people, they would usually say “That’s forked.”  (Well, many of them have a funny accent from living abroad for decades, so they don’t pronounce the vowel sound correctly.)

Section 965 blew our clients’ retirement plans to hell, and worse.  Tax liabilities — giant lump sums — of millions of dollars.  Bang.  Imagine being told that you owe $20 million in tax.  And you’re fully compliant and paid up for tax in your home country.

A large number of people I talked to essentially decided that the government could go stick its nose in a dead bear’s bum.

At last year’s AICPA National Tax Conference I had the temerity to tell this experience to a room of 100 or so people. Vigorous nodding in the audience commenced, so I know I am not alone in this experience.

I spoke to a few people after my speech and they reported the same thing.  One CPA said he had 25 of these clients who said no to Section 965 and used Words Similar to Certain Types of Cutlery when announcing their decision to him.

The government’s reaction: special rules for offers in compromise

I suspect the government knows it has a bit of a problem here.

A recent (March 23, 2020) memorandum from the Treasury Department announced new guidelines for Offers in Compromise involving Section 965 liabilities.  Its internal control number is SBSE-05-0320-0026 (PDF) and I encourage you to read it.

I suspect that there are a lot of people who need to look at offers in compromise as part of a strategy to clean up a Section 965 mess.

For practitioners

You, the practitioners out there, are going to see a lot of this.  I am seeing it already:  people are shopping (unsuccessfully) for a CPA who will sign off on a bullshit 2019 Form 5471 for a CFC that never played the Section 965 game.

For American entrepreneurs

For those of you who reacted like a normal person and said “Hell no” to Section 965 in 2017, you’re going to hit a wall.

If you didn’t run your CFC through the Section 965 grinder in 2017 and pay the tax (or get on the installment plan to pay the tax), your CPA will not be able to prepare a correct Form 5471 for 2018. Or 2019. Etc.  The basic financial data is wrong.

Your CPA won’t sign a bullshit tax return.  That puts the CPA’s license at risk and makes it hard to pay the mortgage and educate the children.

That means you lose your tax return preparer.  You have to shop for someone else.  You will probably get rejected by one CPA after another.  You will ultimately see that you have three choices:

  • Lie to a new CPA so he/she agrees to prepare your tax return and Form 5471;
  • Find a new CPA who is willing to do skanky stuff; or
  • Clean up your messes.

Long-term stability in tax law: folly

I highly recommend Nassim Nicholas Taleb’s book, Antifragile.  Actually, read all of his books:  The Black Swan, Fooled by Randomness, Antifragile, and Skin in the Game.  He has another book — a book of aphorisms — titled The Bed of Procrustes.  I’m kinda meh about that one, even though I own it..

Section 965 did not create a problem.  It revealed a problem.

The problem was our reliance on Federal tax law and a supposed perception of permanence.  This is an example of systemic risk:  the system on which you base your decisions can shift underneath you, despite your best efforts in matters within your control.

As long as you rely on the permanence of a tax law, you have placed your fate in the hands of the Federal government.  Everything operates just fine for decades until it doesn’t, and then it doesn’t work at all, in a spectacular way.

Since the early 1960s, American business had operated under the basic principle that a foreign corporation is its own thing, and a foreign corporation’s operating profit is not touched by the U.S. tax system.  Then one day in 2017, the rules changed.  Systemic risk.  You need to be aware of systemic risk, and governments one of the biggest sources of systemic risk.

Consider the turkey (this is one of Taleb’s illustrations of his point.). This graph could just as well be an illustration of a CFC’s tax life, up until the fateful Section 965 event.

Life of a Turkey

Become antifragile

Remember how Social Security benefits used to be totally tax-free?  Then “well, let’s tax some people a little bit on their Social Security” happened. Any tax benefit extended by Congress will sooner or later be snatched away.  Unless of course you are rich enough to own a Senator or two.

Clean up your messes.  Don’t leave yourself exposed to systemic risk in the form of Congressional whim.


Wow.  I started this blog post just intending to post the new offer in compromise memorandum, and ended up talking about Nassim Taleb and ranting a bit. That’s what “work at home because of  predictable systemic risk in the form of yet another viral pandemic” will do for you.

Ping me on Twitter — I’m @philiphodgen.