An Overview of the US Transition Tax: The Transcript
Did you miss our April 3rd webinar on the newly introduced US transition tax and all of its implications for Americans living abroad?
In case you did, we’re happy to announce that the event’s full transcript is now available for your perusal.
Please feel free to download the transcript below and share with your colleagues and extended network.
We’d like to take this opportunity to thank both John Richardson and Dr. Karen Alpert for participating in our event and providing our community with plenty of food for thought on what is undoubtedly a highly controversial tax.
If you have any follow-up questions for either of our panelists, please make sure to submit them below. They would be happy to take a crack at them.
Here are some of the event’s main highlights!
Who does the transition tax affect?
Karen Alpert: “It applies to US shareholders, which is a defined term in the Internal Revenue Code that basically consists of any US person that owns 10 percent or more of a foreign corporation and so to US shareholders that own a specified foreign corporation, which would basically be any controlled foreign corporation or any corporation with a US domestic corporation that owns 10 percent. So it's really broad.”
John Richardson: “The practical impact of this for people outside of the United States would be if they have what are called controlled foreign corporations. And a controlled foreign corporation would be where you would have a United States shareholder who owns 10 percent or more of a corporation that's collectively owned by 50 percent or more of United States shareholders…It's being interpreted by the tax compliance community to mean that, if you have a small business corporation—say, a dentist or doctor office or a shoe store outside the United States—it's an incorporated business. It's not a business that's eligible to check a box selection and you have 10 percent more of it. Then you're caught up in this. It's extremely serious and I would argue an egregious overreach of US tax jurisdiction.”
What impact could this tax have if applied to non-resident individuals who are US shareholders of CFCs? More specifically, what is the impact on the individual? And what is the impact on the tax base of the country where the CFC is incorporated to the local economy?
Karen Alpert: “What's happening is the IRS is coming into these local corporations that are owned by local residents, often citizens of the countries where they're living. And the IRS is coming in and saying, ‘We're going to tax your retained earnings before your local country has a chance to apply tax to that.’ And there are ways you can get foreign tax credits to offset the US tax. But given the short timeframe between when the law was enacted on December 22nd and the end of the tax year that it applied to—December 31st—there's going to be a lot of people who haven't had the time to create foreign tax where they live if that's what they wanted to do to offset the US tax. So there's going to be some double taxation happening here. And it's going to be the US coming in and grabbing money out of the local economy.”
John Richardson: “Focusing on the individual, there's something about the world of tax where there's a disconnect between what it says and what it actually means. For a lot of the small business corporations, particularly in Canada and maybe less so in Australia, depending on basically how the retirement planning or social security system of the different countries works, the retained earnings or the undistributed earnings in these corporations actually function as people's private pension plans. So, for an individual in Canada or a similar country to be subjected to this particular regime actually results in either the outright confiscation or the severe erosion of their private pension plans.”
How is the transition tax calculated? Can anyone demonstrate how the tax will be calculated after reviewing a balance sheet?
Karen Alpert: “If we're going to get back to our balance sheet, you need two numbers to calculate the tax correctly. You need to know the post-1986 earnings and profits (E&P) reduced by amounts previously taxed in the US. It's not on any balance sheet I've ever seen but you can roughly…approximate that number with your retained earnings. But you have to calculate it all using GAAP, the US’s generally accepted accounting principles. So we're talking about foreign corporations here. They're not using GAAP, right? So you have to restate your balance sheet using GAAP and figure out what the retained earnings would be. And you have to do it using your tax accounting method. So you're going to have to account for some timing differences like tax depreciation and some permanent differences as well...It's a really complex computation to figure out your earnings and profits…Then you also need to know the market value of your cash and cash equivalents. And that's market value, not book value. So that's not on your balance sheet either. So you got two numbers you need, but neither one of them are really on your balance sheet, right?”
John Richardson: “The very fact that this has to be done according to US accounting rules would make compliance impossible without actually taking all those books and records really to the inception of the corporation and getting them redone completely, which cannot be done because nobody keeps books and records back to that point. And even if it could be done, you’d need to be looking at hundreds of thousands of dollars of accountant fees. People who are going to comply with this, the best I think they're going to be able to do is a best effort type of thing… I think that this may be a seminal moment in people's acceptance of what the United States might call citizenship taxation. But in all practical terms, it's really imposing worldwide taxation on tax residents of other countries that don't live in the United States. It's outrageous.”
How will this transition tax affect the renunciations of US citizenship?
Karen Alpert: “So for those who weren't planning on renouncing and really didn't think they could afford to pay the exit tax and then they're all of a sudden faced with this transition tax. I think that their answer is going to be to hide, to say: ‘That's it, we can't comply anymore, we're going to possibly renounce without complying or just try and stop complying with US taxes.’ Because it can be a really big hit for some people and especially if you're in Canada and a Canadian citizen where the US can't collect the tax from you anyways. They can send you bills all they want. But Canada will not help them collect against a tax that was incurred while they were Canadian citizens. So I think you’re going to see compliance rates drop. They may or may not formally renounce. But they're going to stop complying and try to hide from being a US citizen, I think.”
John Richardson: “A lot of people enter the US tax system with small business corporations under, say, FATCA’s streamlined program where these assets were fully disclosed. And it was agreed that the corporate income was not subject to US taxation. Now just a few years later, they're saying, ‘oops, sorry, we lied. It is subject to US taxation.’ I would think that those people who had entered the streamlined program who came into compliance who had not been in compliance will have a very strong sense of betrayal over this and I think justifiably so. It is very likely in my view that fewer and fewer people will now enter the US tax system.”