Pennsylvania offers guidance on the state income tax treatment of IRC Sec. 965 repatriation income for corporate and personal taxpayers.
Repatriation Transition Tax
The federal Tax Cuts and Jobs Act (P.L. 115-97) imposed a tax, the repatriation transition tax, on untaxed earnings and profits (E&P) of foreign corporations accumulated after 1986 and before 2018. For most taxpayers, the transition tax is assessed in the last tax year beginning before January 1, 2018.
In addition, the Act includes a deduction that effectively reduces the federal tax on the repatriated income from 35% to either 15.5% or 8%.
The transition tax income and deduction will not be included in federal taxable income before special deductions and the net operating loss deduction.
Corporate Income Tax Treatment
The transition tax is subject to the Pennsylvania corporate net income tax.
In Pennsylvania a corporation’s income tax base begins with federal taxable income before the net operating loss deduction and special deductions, “unless the context clearly indicates otherwise.” Pennsylvania has determined that this is an instance where the context clearly indicates otherwise.
In the federal transition tax statement, both the transition tax income and the deduction are included in calculating taxable income. Thus, Pennsylvania reasons transition tax income is included in its definition of federal taxable income before the net operating loss deduction and special deductions.
Transition Tax Deduction
The transition tax deduction is included for Pennsylvania corporate income tax purposes. Pennsylvania does not incorporate federal “special deductions” into taxable income. Pennsylvania reasons the transition tax deduction is not a special deduction because it is under IRC Sec. 965. Thus, the transition tax deduction is included when determining the state income tax.
Pennsylvania Dividends Received Deduction
Pennsylvania allows a deduction for corporations that receive dividends from a foreign corporation, such as a subpart F income dividend. Because Pennsylvania treats transition tax income as subpart F income, it treats transition tax income as a dividend. Thus, transition tax income is subject to the Pennsylvania dividends received deduction.
Personal Income Tax Treatment
Pennsylvania personal income tax is imposed on dividends.
A dividend is a distribution in cash or property made out of (E&P) whether current or accumulated. When corporation makes a cash distribution to an individual, the distribution is a dividend subject to individual income tax.
The transition tax is imposed even though no distribution of cash or property occurs. The repatriation is a “deemed dividend” that does not involve an actual distribution. A taxpayer reports this deemed dividend income regardless of whether they receive a Form 1099-DIV.
Pass-through entities required to report the transition tax on Schedule K, line 11 (Form 1065) or line 10 (Form 1120S) as other income should remove the income from the Pennsylvania tax base.
The pass-through entity should use Schedule M of the PA-20S/PA-65 for the adjustment. In addition, the taxpayer should include a statement explaining the adjustment with the return.
When an actual distribution of cash out of earnings and profits is made to the pass-through entity, it should be reported on Schedule B, line 5 of the PA-20S/PA-65.
Information Notice Corporation Taxes and Personal Income Tax 2018-1: Tax Cuts and Jobs Act of 2017, Pennsylvania Department of Revenue, April 20, 2018, ¶204-628