Foreign Corporation and the Transition Tax

by Tom Andrews, CPA

The tax reform bill that was passed at the end of 2017 is now of primary concern for any tax payers that are about to file their 2018 income tax returns.  While the new tax bill has provided many benefits to the average US taxpayer there are also some provisions of this tax reform bill that may have negative implications.  One of the more notable provisions that may have negative consequences in the yachting community is the section 965 transition tax.   

The reason this provision of the tax code may have an adverse effect on the yachting community is that some yacht brokers, owners, and management companies  use a foreign corporation when conducting business outside of the United States.  The advantage in doing so is that in many cases the income earned through those foreign corporations would be deferred until the income was repatriated back to the United States.  The section 965 transition tax diminishes that advantage and now requires a mandatory deemed repatriation of the previously untaxed earnings.  Under this provision a 15.5% rate applies to earnings attributable to liquid assets, and an 8% rate applies to earnings attributable to illiquid assets. 

The use of foreign corporations to defer income has been a controversial loophole that is most discussed during the election cycles.  Some may recall that part of President Trumps Making America Great narrative was to close this loophole and force multinational companies to start paying tax on previously untaxed income.  A common example is that of companies like Apple that have kept hundreds of billions of untaxed income offshore.  This provision of the tax code will force Apple to repatriate these funds back to the United States and could force them to pay in upwards of 40 billion dollars of United States income tax.  The theory is that many of these companies will now use this cash to make capital improvements in the United States.

While the narrative of forcing large multinational corporations to pay tax on their hordes of cash has been popular in some circles there is also criticism of this tax law and how it may have unintended consequences on small businesses.  For example an expatriate that opens a small business overseas may end up being burdened by the complicated tax regulations that were more intended to collect tax from very large corporations that have the resources to hire international tax attorneys and CPA’s.  While nobody will feel sympathy for taxpayers losing their tax loophole there certainly are some circumstances in which this tax law could have been more thought out.  As with many aspects of tax reform the federal government can always do better in recognizing the needs of the small business. As with any complicated tax position I encourage the reader to consult with a tax attorney or CPA that specializes in expat tax issues to examine how the new tax reform laws will impact their ownership in a foreign corporation.

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