About the Repatriation Toll Charge: If you own part of a foreign corporation you should read this all the way to the end. If you don’t own a foreign corporation you probably don’t need to read on because this is going to get ugly and it’s going to be really long, there is just no quick way to attempt to explain this toll charge.
As part of the Dec 2017 tax bill Congress included a provision that some call the repatriation tax, some call a toll charge, others would call it a Section 965 tax, deemed repatriation, or toll tax. I like to call it the toll charge myself so that’s what we’ll go with for this post.
The toll charge is imposed on individual shareholders of foreign corporations. This is going to be a brief overview, but I’ll hit the high points here. The foreign corporation needs to be at least 10% owned by US persons. It’s linked to the existing Subpart F, but I would say many taxpayers are unaware of Subpart F because they aren’t ordinarily subject to that tax. Let’s just go through an example of how this works.
A US citizen is living and working in Canada and through their work in Canada they have a professional corporation to contain their business activities. It’s a simple setup, they own 100% of the professional corporation. The taxpayer has ordinary business activity (minimal passive investment income) in the corporation so they have never been subject to the Subpart F rules.
Owning the corporation means disclosures like a 5471 or 8938 or increased FBAR reporting, but has never directly lead to a tax liability. When dividends are distributed from the company, income tax is paid in Canada and income tax is paid in the US (although a foreign tax credit likely wipes it out in the US). The toll charge takes a measure of the undistributed earnings of that corporation and taxes the individual on it based on the higher of the 11-8-2017 or the 12-31-2017 amount even though the corporation has not distributed the money to the individual. So if the accumulated earnings (retained earnings more or less) is $100k the toll charge will apply to that $100k balance.
It’s a bit cruel to tax corporations at the full tax rate so they put in a provision that you get a reduced rate, either 15.5% or 8% depending on what type of assets the corporation has. This is a simple example so if it’s all cash the tax rate is 15.5%, ie $15,500 of US tax incurred despite zero distribution of the earnings. Yikes, that’s a scary amount, but it doesn’t seem all that complicated yet.
There are various elections that you can make to go along with this toll charge, one of them is electing to be taxed as a corporation which would allow you to take a foreign tax credit for the deemed corporate taxes that are paid. In this case the corporate foreign taxes paid on $100k would have been $15k, so you get a $15k tax credit right? Not so fast. Since you are electing to be taxed as a corporation the foreign tax credit you are deemed to have paid needs to be included in your income, so you have extra income now. Plus the tax rate on this toll charge is less than the corporate tax rate would have been so you have to reduce your foreign tax credit for that discount. So your foreign tax credit gets cut about in half since the tax rate is about half of what it would have been as a corporation. It’s complicated, but your net toll charge is going to be something like $8k in this scenario.
If you don’t elect to be taxed as a corporation then you take the toll charge income and have it taxed individually instead to determine your toll charge liability. That means you can use any personal foreign tax credits you might have to offset this large addition of foreign income. Once again since the toll charge tax rates are reduced and lower than the individual rates any personal foreign tax credits you do utilize need to be reduced to account for the reduced tax rate. In the absence of any personal foreign tax credits your toll charge will be that full $15,500.
Another election you can make is to spread the tax over an 8 year period. This one almost always seems like a good idea, you just get to take your tax liablity and spread it interest free into the future over the 8 year period. Of course it isn’t a straight 1/8thper year, it starts at 8% of the tax liability and ramps up to 25% of the tax liability by the 8thyear so it’s backloaded during the 8 years. If at some point during those 8 years you sell the company or close the company the remainder of the toll charge becomes due immediately, so you can only defer it if you still have your interest in that company.
So when is it that you need to make all these elections and start paying your tax. Well the measurement date of 12-31-2017 is the key to that and might be the best part of news in this otherwise depressing post. If it’s a calendar year corporation then it was due with your 2017 tax return. If you missed that on your 2017 return you really need to address it immediately with an amended return. For fiscal year entities with some type of 2018 month year end the toll charge won’t be due until your 2018 tax return due date, either April 15thor June 15thdepending on where you live. So that’s the one bit of good news for the fiscal year foreign corporation owners this will be due and all of these calculations will be put into your 2018 tax return. I guess that leaves you time to plan, but since it’s based on the 12-31-2017 values you can’t plan to reduce your toll charge liability you can only plan for how you are going to pay it.
The toll charge and the associated calculations and elections are very challenging I suppose the silver lining here is that it’s a one-time thing. All the calculations and work needs to be done once, it’s not going to be an annual thing where the US taxes foreign corporations on their undistributed earnings.