How Do Repatriation Tax Rules Work?

Repatriation Tax - How it Works
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A repatriation tax holiday that is part of the recent tax changes could be a benefit to some companies and some individuals holding profits overseas, but it also means they must pay tax on cash and other assets now held abroad. The 2017 Tax Cuts and Jobs Act allows companies to repatriate profits they hold in foreign countries. Since U.S. businesses have an estimated $2.6 trillion in cash and other assets outside the U.S., the flow of these assets into the U.S. could help stimulate the economy.

This repatriation tax is necessary because the new tax law also changes the way foreign profits of controlled foreign corporations are taxed.

This article discusses how the repatriation tax works and how it affects many U.S. corporations, corporate shareholders, and others who do business outside the U.S. The tax was due for the 2017 tax year, payable by April 17, 2018.

What is a Repatriation Tax?

Repatriation in general means bringing a person or an asset back into a country. A repatriation tax is a tax on money repatriated or brought into the country. A corporation that does business in a foreign country may be keeping profits within that country in order to avoid U.S. taxes. The repatriation tax part of the 2017 tax law is considered a tax holiday because it is a one-time reduction in the tax level for special circumstances.

The IRS calls this a transition tax and says this tax is due by "U.S. shareholders," including

"...domestic corporations, but could also include other U.S. persons, such as individuals, S corporations, partnerships, estate, trusts, cooperatives, REITS, RICs and tax-exempt organizations."

Why a Repatriation Tax Holiday Now?

The new 2017 tax law proposes changing the laws for taxing profits of companies doing business abroad (called Controlled Foreign Corporations (CFCs). These corporations operate overseas and have U.S. shareholders who have 50 percent or more of the control of that corporation.

Because of the global nature of the economy, many companies do business in multiple countries. Many countries operate on a worldwide tax system that taxes companies that do business abroad and individuals who live and work abroad only when they bring their earnings back to their home country. According to the Tax Foundation, this worldwide tax system discourages the flow of profits from companies doing business abroad back into the U.S.

The change in tax law involves a switch in U.S. taxes to a territorial tax system. A territorial tax system exempts businesses from paying tax on offshore income (earned outside the U.S).

The one-time repatriation tax is a first step to this territorial system.

Dividend.com says,

The idea is that this lower rate should persuade firms to make the decision to bring this cash home and use it here in the United States for investment rather than have it just sit in an overseas checking account.

How Does the Repatriation Tax Work?

Companies and shareholders repatriating profits (bringing them into the U.S.) pay a one-time tax rate of 15.5 percent on cash and 8 percent on equipment, which is lower than the current U.S. corporate tax rate of 21 percent.

The profits that can be repatriated are post-1986 profits through 2017 that have not already been taxed in the U.S. The tax must be paid by the 2018 tax date, April 17, 2018. But the tax may be paid in installments over an eight-year period.

What Could Be the Effects of the Repatriation Tax?

The purpose of this holiday is to give incentives to companies repatriating profits they have sitting in overseas accounts, by giving them a break on the taxes.

This repatriation tax holiday isn't new; a similar tax provision was put into place in 2004 as part of the American Jobs Creation Act. At that time, about $312 billion of corporate cash was brought back into the U.S. at a tax rate of 5.25 percent. So the tax revenues were a benefit, but this cash was used to pay dividends to stockholders and share buybacks, not to increase capital assets.

Another effect may be the attempt by U.S. companies to shift taxable profits from the 15 percent tax category (for cash) to the 8 percent category (for equipment). This sounds like a good thing because it would mean businesses would be investing in capital, but there are some loopholes in this category.

More Information from the IRS

The IRS has issued Notice 2018-7 which gives more detailed information on this repatriation tax. The relevant section of the U.S. Tax Code is Section 956.

What If You Think You Might Owe This Tax?

It's not clear how individual taxpayers are affected by this repatriation tax. Talk to a tax professional who has some expertise in this area of tax law. If you missed the April 17, 2018 deadline and you find you owe this tax, you should pay as soon as possible to avoid increasing fines and penalties.