The 965(i) Election for S Corporation Shareholders

The Tax Cuts and Jobs Act of 2017 (TCJA) changed how the United States taxes foreign earnings. A component of this legislation was Section 965, which established a one-time transition tax on the untaxed foreign earnings of certain specified foreign corporations. These earnings were treated as if they had been repatriated to the U.S., requiring shareholders to pay tax on the accumulated profits. The constitutionality of this transition tax was upheld by the U.S. Supreme Court in 2024.

For shareholders of S corporations, who report company income on their personal returns, this created an immediate tax obligation. The law included the Section 965(i) election to address this. This election does not eliminate the tax but allows eligible S corporation shareholders to defer payment of their net tax liability until a “triggering event” occurs.

Eligibility for the Deferral Election

To qualify for the Section 965(i) deferral, a taxpayer must be a United States shareholder of an S corporation. A U.S. shareholder is a U.S. person who owns at least 10% of a foreign corporation’s voting power. The S corporation itself must be a U.S. shareholder in a specified foreign corporation (SFC), which is a controlled foreign corporation (CFC) or another foreign corporation with a U.S. corporation as a shareholder.

The election is made by each S corporation shareholder individually, not by the S corporation. Therefore, shareholders in the same S corporation can make different choices. A shareholder must have a net tax liability from the deemed repatriation of foreign earnings to be eligible, as there is otherwise no tax to defer. The responsibility for the election rests with the individual shareholder based on the income inclusion on their personal tax return.

Making the 965(i) Election

A shareholder must first calculate their total net tax liability under Section 965. This is the difference between their total tax liability for the year with the inclusion and what their liability would have been without it. This calculation determines the amount of tax that can be deferred.

The shareholder must then prepare a formal election statement to attach to their federal income tax return for the year of the inclusion. The statement must contain the shareholder’s name and taxpayer ID, the S corporation’s name and ID, the total deferred liability, and a declaration made under penalties of perjury.

The election statement must be filed with the shareholder’s tax return by its due date, including extensions. The shareholder must also file Form 965, “Inclusion of Deferred Foreign Income Upon Transition to Participation Exemption System,” and indicate on the form that they are making the Section 965(i) election.

Triggering Events and Ending the Deferral

The deferral from a Section 965(i) election ends when a “triggering event” occurs. The first event is the S corporation losing its S corporation status. If the entity terminates its S election or ceases to qualify, the deferral period for all electing shareholders ends.

Another triggering event is the disposition of the business or its assets. A liquidation, sale, exchange, or other disposition of substantially all of the S corporation’s assets will terminate the deferral. The deferral also ends if the S corporation ceases its business operations.

A transfer of the shareholder’s stock in the S corporation is also a triggering event. This includes transfers from a sale, gift, or the shareholder’s death. The deferred tax becomes payable upon this change in ownership because the deferral does not automatically pass to a new owner.

An exception to the stock transfer rule exists. The deferral can continue if the stock is transferred to an eligible U.S. person who agrees to assume the liability for the deferred tax through a formal agreement with the IRS. An exception may also apply to a liquidation or sale of assets, but this requires obtaining consent from the IRS.

Post-Election Responsibilities and Payment

When a triggering event occurs, the shareholder must report it on their tax return for the year the event took place. This report notifies the IRS that the deferral period has ended.

The full amount of the deferred tax liability is payable on the original due date of the tax return for the year of the triggering event, without extensions. For instance, if a triggering event occurs in 2025, the tax is due by the filing deadline in April 2026, not the extended deadline.

Some taxpayers may have also made a Section 965(h) election, allowing the transition tax to be paid in eight annual installments. If a shareholder with a 965(i) deferral experiences a triggering event, any remaining installment payments under a 965(h) election are accelerated. The entire unpaid balance of the net tax liability becomes due.