The Internal Revenue Service (IRS) has moved to issue-based examinations where they focus on specific compliance areas they consider the ripest for additional assessments. These compliance campaigns are announced by the IRS in a list continually updated. In the international area, the transition tax (Section 965) has been included on this list and is receiving additional attention as returns for 2017 may have closed on the normal three-year statue of limitations (SOL) to make additional assessments.
However, there is a particular provision extending the SOL to six years, but only for the net tax liability resulted from the income inclusion. This issue becomes more complicated when the net tax liability flows from income earned through partnerships and S corporations – which have their own special rules for taxable income adjustments.
The IRS has issued some guidance on the SOL issues in the form of a LB&I memorandum, as well as an earlier Chief Counsel memorandum. These provide instructions to IRS agents to be careful about the SOL issue and avoid having the period expire for other issues for 2017 or 2018 while the SOL remains open for the transition tax.
The IRS is already backed up in completing its tasks as the result of a number of recent major tax acts as well as the COVID-19 pandemic (and even some carryover from government shutdowns). However, they appear to be trying to start examinations for 2017 and are focusing on the transition tax issues. We are seeing standardized information document requests, such as IDR-Form 4564, related to the transition tax that are being issued on IRS examinations for 2017. This is highlighting the importance of having properly documented the calculation, and having the needed financial statement information for your foreign corporations deemed to have distributed all of their prior profits (earnings and profits) as of the Dec. 31, 2017.
The SOL issue can result in complexity in determining what period of time the IRS has to assess additional taxes related to transition tax when the income flowed through a partnership or S corporation. While the three-year SOL is the standard, it is easy (especially when dealing with international reporting issues) to fall into the six-year period. Some of these traps may only apply to the specific issue not properly reported on in the tax returns, but it is not that far to fall into an issue that keeps the entire tax return open for review. For instance, failure to file a complete and accurate Form 5471 and report all Subpart F income may result in your tax return being open for additional assessments for six years or longer. (See Sec. 6501(c)(8)(A) and Sec. 6501(e)(1)(C).) Click here for a chart we prepared addressing some of the SOL rules.
If you would like to discuss the SOL issue related to the transition tax, or even your preparedness for an IRS examination on this issue, please contact an international tax advisor at Moore Doeren Mayhew.