IRS Issues Notice for Computing "Transition Tax"

On December 29, the Internal Revenue Service (IRS) and Treasury Department published Notice 2018-07 (Notice), providing guidance for computing the “transition tax” under the new Tax Cuts and Jobs Act enacted one week earlier.

Under the new law, a transition tax will now be imposed on net foreign earnings of nondomestic subsidiaries of U.S. companies by designating those earnings as repatriated. A result of efforts to transition the country to a territorial tax system, the levy is expected to generate billions of dollars in revenue over next eight years. Foreign earnings held in the form of cash and cash equivalents will be taxed at a 15.5% rate, with remaining earnings taxed at an 8% rate. The transition tax can be paid in installments over an eight-year period.

The guidance is 22 pages long and discusses how the IRS will determine the two types of income – those related to cash and cash equivalents, and remaining earnings – with the overall goal to eliminate double counting and double non-counting in determining cash position and earnings. The Notice elaborates on loans among related entities: for purposes of the cash position of a specified foreign corporation, for instance, loans between related companies are not treated as cash. The Notice also addresses the circumstance when a U.S.-based shareholder and a foreign corporation have different taxable years and the aggregate cash position needs to be determined.

Finally, the Notice indicated that the IRS intends to issue further regulations clarifying how foreign earnings are to be computed and rules that will assist taxpayers by providing certain additional information needed for computing their transition tax. For more information on computing the transition tax, contact us.