Confusion Regarding Transition Tax on Foreign Earnings

Chad Silver

Chad Silver

Managing Partner of Silver Tax Group, author of the book "Stop the IRS". Practicing a variety of tax issues, regulations, laws and rights. Specializing exclusively on tax matters involving IRS audits, negotiation, settlements & compromises.

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Under 26 U.S. Code § 965, shareholders throughout the U.S. must pay a transition tax on foreign earnings from specific foreign corporations. The IRS deems this tax as a repatriation of the income.

Lawmakers entitled 26 U.S. Code § 965 as: “Treatment of deferred foreign income upon transition to participation exemption system of taxation.” Unfortunately, the content of this statute is even more complex than its title.

The deferred foreign income that this statute concerns

The transition tax applies to 10 percent shareholders in these foreign corporations. However, in instances where taxpayers have interests in more than one corporation, they may adjust their income inclusions through a “participation deduction” under § 965 (c). (For example, if earnings from one corporation contains positive earnings and another has negative earnings, there may be adjustments made.)

There is a special election section under § 965 (h). This allows for taxpayers to pay this transition tax over an eight-year installment period. This section specifically prescribes the amounts each installment payment should be.

Also, there are certain exceptions that apply for those wondering if they owe this tax. This tax only applies if specific foreign earnings remained untaxed.

Compliance with offshore requirements

There are a large number of requirements holders of offshore assets need to declare when filing their income taxes. In complying with 26 U.S. Code § 965, the IRS provides a certain amount of guidance regarding reporting requirements. However, the answers the IRS provides will likely result in taxpayers having additional questions. And the penalties for not reporting income correctly to the IRS are real and substantial.

The professional assistance from an experienced tax attorney can prevent reporting problems from arising to begin with. They can help you understand what you do need to report. In the event you are in trouble with the IRS, attorneys can help you explore the options you have for penalty relief.

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