States have grappled with all the income tax changes made by the Tax Cuts and Jobs Act, including IRC Sec. 965. Under the new law, taxpayers must report untaxed foreign earnings and profits (E&P) and pay repatriation transition tax. Many states have enacted legislation or provided guidance on the treatment of IRC Sec. 965.
How and When Do Taxpayers Report Federal IRC Sec. 965 Tax Liability?
IRC Sec. 965 imposes a tax on the accumulated foreign earnings and profits of U.S. shareholders of certain controlled foreign corporations (CFCs). The tax applies to untaxed foreign earnings and profits from post-1986 tax years. IRC Sec. 965(c) allows a deduction for part of the earnings that reduces the overall tax rate.
Taxpayers must report IRC Sec. 965 income and tax liability on their 2017 federal income tax return. They must include an IRC Sec. 965 Transition Tax Statement with their return. This transition statement shows a taxpayer’s:
- IRC Sec. 965 gross income;
- IRC Sec. 965(c) deduction; and
- IRC Sec. 965 tax liability.
Taxpayers transfer amounts from the transition tax statement as follows:
- corporations add IRC Sec. 965 tax liability to other income tax liability reported on their federal return;
- individuals include IRC Sec. 965 net income in federal ordinary income; and
- S corporations, partnerships, and other pass-through entities report the IRC Sec. 965 income and deduction to their owners like other distributive items.
Taxpayers can elect to report federal IRC Sec. 965 liability in installments over an 8-year period.
How Do States Treat IRC Sec. 965 Income?
In almost half of the states, corporate income taxpayers must add IRC Sec. 965 to their federal taxable income base. Addback rules can vary from state to state. Differences generally involve the addback amount and whether it applies to:
- IRC Sec. 965 gross income;
- IRC Sec. 965 income minus the deduction; or
- the IRC 965(c) deduction only.
Some states have adopted similar addback rules for individual income taxpayers.
Caution: Federal Adjusted Gross Income Starting Point
Individuals cannot treat the absence of specific state reporting rules as a free pass. The starting point for computing individual income tax in most states is federal adjusted gross income. An individual’s federal adjusted gross income includes IRC Sec. 965 net income.
Do States Allow Deductions or Exclusions for IRC Sec. 965 Income?
Some states, like California, allow corporate income taxpayers to exclude all IRC Sec. 965 income. But most states that have addressed IRC Sec. 965 income:
- treat it like dividend income; and
- allow a dividends received deduction for all or part of that income.
In some of these states, taxpayers must exclude IRC Sec. 965 income from their apportionment formula.
A few states permit taxpayers to include the IRC Sec. 965 tax in their deduction for taxes paid. Oregon is unique because it provides a credit to corporate income taxpayers that pay the tax.
Can Taxpayers Pay State IRC Sec. 965 Tax Liability in Installments?
Oklahoma and Utah are the only states that grant taxpayers the option to pay IRC Sec. 965 tax liability in installments.
By Timothy P. Bjur