Increased Section 965 Tax Audits for Deferred Foreign Income

Increased Section 965 Tax Audits for Deferred Foreign Income

Section 965 Compliance Campaign

Section 965 Compliance Campaign Tax Audits: Each year, the IRS introduces several new international enforcement campaigns. With the introduction of the TCJA, coupled with perceived non-compliance of transition tax requirements for US Persons with unreported deferred foreign income, the Internal Revenue Service has turned its focus to transition tax compliance. The purpose of these campaigns is to put US Taxpayers on notice of certain tax issues which the Internal Revenue Service will prioritize when it comes to enforcement. Back on July 6, 2020, the IRS introduced a new IRC 965 international tax compliance Campaign.  IRC 965 is the Treatment of deferred foreign income upon transition to participation exemption system of taxation. 

Let’s review the basics of Section 965 Tax Audits:

26 U.S.C. 965 Treatment of Deferred Foreign Income

As provided by the Internal Revenue Code:

      • (a) Treatment of deferred foreign income as subpart F income. In the case of the last taxable year of a deferred foreign income corporation which begins before January 1, 2018, the subpart F income of such foreign corporation (as otherwise determined for such taxable year under section 952) shall be increased by the greater of—

          • (1) the accumulated post-1986 deferred foreign income of such corporation determined as of November 2, 2017, or

          • (2) the accumulated post-1986 deferred foreign income of such corporation determined as of December 31, 2017.

      • Reduction in amounts included in gross income of United States shareholders of specified foreign corporations with deficits in earnings and profits

      • (1)In general In the case of a taxpayer which is a United States shareholder with respect to at least one deferred foreign income corporation and at least one E&P deficit foreign corporation, the amount which would (but for this subsection) be taken into account under section 951(a)

      • (1) by reason of subsection:

      • (a) as such United States shareholder’s pro rata share of the subpart F income of each deferred foreign income corporation shall be reduced by the amount of such United States shareholder’s aggregate foreign E&P deficit which is allocated under paragraph (2) to such deferred foreign income corporation.

      • (2) Allocation of aggregate foreign E&P deficit

      • The aggregate foreign E&P deficit of any United States shareholder shall be allocated among the deferred foreign income corporations of such United States shareholder in an amount which bears the same proportion to such aggregate as—

      • (A) such United States shareholder’s pro rata share of the accumulated post-1986 deferred foreign income of each such deferred foreign income corporation, bears to

      • (B) the aggregate of such United States shareholder’s pro rata share of the accumulated post-1986 deferred foreign income of all deferred foreign income corporations of such United States shareholder.

IRC 965 Transition Tax Audits & IRS Compliance Initiative

IRC 965 was developed in accordance with the significantly reduced corporate tax rate. Back when the TCJA was introduced, 965 was designed to ensure that certain foreign corporations with U.S. shareholders paid a one-time tax for money that was held or retained overseas — and not previously taxed.

Many shareholders have not paid this tax — simply because they never heard of it. Therefore, the IRS introduced this new international tax compliance group.

As provided by the IRS:

July 6, 2020

IRC 965 Section for Individuals (Compliance Campaign)

      • The campaign described below was identified through LB&I data analysis and suggestions from IRS employees. LB&I’s goal is to improve return selection, identify issues representing a risk of non-compliance and make the greatest use of limited resources.

      • The new campaign is:

      • IRC Section 965 for Individuals

      • Practice Area: Withholding and International Individual Compliance

      • Lead Executive: Deborah Palacheck, Director, Withholding and International Individual Compliance

      • Campaign Point of Contact: Ursula Gee, Withholding and International Individual Compliance

      • “Pursuant to the changes to IRC §965 under the Tax Cuts and Jobs Act, U.S. shareholders, including individuals, that directly or indirectly own at least 10% of the stock of a specified foreign corporation (SFC) are required to include in gross income their share of the SFC’s accumulated post-1986 deferred foreign income for the last taxable year of the SFC beginning before January 1, 2018, and report this amount on their returns for the taxable year in which or with which their SFC’s taxable year ends (generally, 2017 and/or 2018). The Internal Revenue Service will address noncompliance through soft letters and examinations.”

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