IRS launches new enforcement campaign on section 965 transition tax

The IRS has officially turned its attention to how companies are calculating amounts owed under the section 965 transition tax. On November 4, 2019, the IRS Large Business and International Division (LB&I) announced a new compliance campaign focused on assuring taxpayer compliance with section 965. A list of LB&I’s current campaigns is available on the IRS website.

Section 965 was added to the Internal Revenue Code as part of the Tax Cuts and Jobs Act (TCJA) enacted on December 22, 2017, and requires US shareholders to pay a one-time transition tax on the untaxed foreign earnings of controlled foreign corporations and certain foreign corporations that have a US shareholder that is a domestic corporation. The transition tax imposes two different tax rates on post-1986 earnings and profits:  (1) 15.5 percent on cash earnings and profits, and (2) 8 percent on noncash earnings and profits.

Because the amount of the transition tax is based on the calculation of earnings and profits, the IRS is concerned that taxpayers may incorrectly calculate their earnings and profits to lower their transition tax payment. The IRS will also focus on how taxpayers determine whether the earnings are cash or noncash (which determines whether the earnings are subject to a 15.5 percent or 8 percent tax rate).

The IRS specified that the campaign will start with 2017 returns and generally requires looking at both the 2017 and 2018 tax returns. The IRS’s announcement of the campaign further states that it is “anticipated that returns selected as part of the 965 campaign will also be risked and, if appropriate, examined for other materials issues, especially issues related to TCJA planning.” Based on this broad language, taxpayers subject to the section 965 transition tax should be aware that their entire returns may be examined by the IRS should their Section 965 transition tax trigger IRS scrutiny under this campaign. It is expected that the IRS will begin examining taxpayers under this campaign starting in January 2020.

Taxpayers should anticipate that LB&I will closely review all relevant calculations and should maintain adequate records to substantiate their section 965 transition tax positions, particularly documentation that taxpayers can rely on to support a “reasonable cause” defense if the IRS asserts penalties. This documentation should be kept in a manner that allows the IRS to easily understand the taxpayer’s thought processes and tie back the numbers in a way that supports both what the taxpayer included in the calculation, and what the taxpayer determined should be excluded. Moreover, considering the complexity of the transition tax calculation, taxpayers should consider having advisors review the calculations and underlying assumptions to identify pressure points in their analyses. This exercise would be particularly valuable for taxpayers who prepared their calculations internally.

Norton Rose Fulbright’s US tax team is strategically situated to handle any controversies arising from this new campaign. Our US team includes former members of the US Department of Justice Tax Division and IRS Office of Chief Counsel. Our experience in handling tax controversies in both private practice and the government enables us to provide our clients with unique insight regarding any potential civil and criminal tax exposures. We have represented individuals and corporations in numerous IRS examinations involving enforcement campaigns and international tax issues.