What Is the Mandatory Repatriation Tax?

The Tax Cuts and Jobs Act (TCJA) of 2017 introduced a one-time tax known as the mandatory repatriation tax. This tax, under Section 965 of the Internal Revenue Code, transitioned the U.S. from a worldwide tax system to a territorial one. Previously, taxpayers could defer U.S. tax on foreign corporate income until it was repatriated. The Section 965 tax imposed a tax on these accumulated offshore earnings, regardless of whether the funds were actually brought back to the U.S.

This tax targeted profits held overseas by certain U.S.-owned foreign corporations, preventing a windfall for companies that had deferred U.S. tax for years. The tax treated these offshore profits as if they had been repatriated, paving the way for a new system where most foreign profits of U.S. companies would be exempt from further U.S. tax.

Determining Applicability of the Tax

The mandatory repatriation tax’s reach was specifically defined by ownership structures. The tax was triggered for a “U.S. shareholder” who held an interest in a “specified foreign corporation” (SFC). A U.S. shareholder is a U.S. person—such as an individual, partnership, or corporation—that owns 10% or more of the total combined voting power or value of all classes of stock of a foreign corporation.

An SFC is defined as either a “controlled foreign corporation” (CFC) or any other foreign corporation that has at least one U.S. corporation as a shareholder. A CFC is a foreign corporation where more than 50% of its stock, by vote or value, is owned by U.S. shareholders. The tax was levied on the U.S. shareholder, not the foreign corporation itself, and required them to include their pro-rata share of the SFC’s untaxed foreign earnings in their income for the 2017 tax year.

Calculating the Repatriation Tax Liability

The calculation of the Section 965 tax liability began with determining the tax base, which was the U.S. shareholder’s portion of the “accumulated post-1986 deferred foreign income” of the specified foreign corporation. This figure represented the untaxed earnings and profits that the foreign corporation had accumulated since 1986. The measurement was taken as of one of two dates in 2017: November 2 or December 31, whichever yielded a greater amount of accumulated income to prevent taxpayers from artificially reducing their earnings.

Once the total accumulated deferred foreign income was determined, it had to be segregated into two distinct categories. The first category consisted of assets held as cash or cash equivalents, which included items like currency, bank deposits, and commercial paper. The second category included all other assets, representing earnings that had been reinvested into the business in non-liquid forms, such as property, plant, and equipment.

The portion of the income attributed to cash and cash equivalents was taxed at a rate of 15.5%, while the remaining income associated with non-cash assets was taxed at a lower rate of 8%. For example, if a U.S. shareholder’s pro-rata share of an SFC’s accumulated income was $1 million, with $600,000 held in cash and $400,000 in other assets, the tax would be calculated as (15.5% x $600,000) + (8% x $400,000), resulting in a total liability of $125,000 before any credits.

U.S. shareholders were permitted to use a portion of the foreign income taxes already paid on the deferred foreign income to offset the U.S. repatriation tax liability. However, taxpayers could only claim a credit for a percentage of the foreign taxes paid, corresponding to the applicable U.S. tax rate. This limitation prevented the foreign tax credits from completely eliminating the U.S. tax liability.

Payment and Reporting Obligations

Taxpayers could elect to pay their repatriation tax liability in installments over an eight-year period. This election was particularly helpful for those who faced a large tax bill on earnings that were not necessarily liquid. The payment schedule was back-loaded, requiring smaller payments in the initial years and larger payments later.

The installment plan required 8% of the total tax liability to be paid in each of the first five years. The payment then increased to 15% in the sixth year, 20% in the seventh year, and the final 25% in the eighth year. An acceleration event, such as the sale of the business or liquidation, would typically make the remaining unpaid installment balance due immediately.

All taxpayers with a Section 965 tax liability were required to file Form 965, Inclusion of Deferred Foreign Income Upon Transition to Participation Exemption System. This form was filed as part of the taxpayer’s income tax return for the year of the inclusion, which was generally 2017 or 2018 depending on the entity’s fiscal year. The form detailed the calculation of the accumulated deferred foreign income, the allocation between cash and non-cash assets, the resulting tax liability, and any election to pay in installments.

Certain taxpayers had access to special elections. For instance, shareholders of S corporations could elect to defer payment of the tax indefinitely until a triggering event occurred, such as the S corporation ceasing to exist, the shareholder selling their stock, or the business distributing the previously taxed earnings. Making this election required an annual report of the deferred liability.