PTEP Taxation
INTERNATIONAL HIGHLIGHT
Understanding IRC Section 965 and Section 962 for Previously Taxed Earnings and Profits from Foreign Income
Since the Tax Cuts and Jobs Acts( TCJA) was passed, taxpayers have been waiting for guidance on whether distributions from foreign income taxed in 2017 would be taxed or not. In the meantime, the name of previously taxed income( PTI) has even been changed to previously taxed earnings and profits( PTEP).
To finally address some of these issues, the IRS issued proposed regulations under Section 959.
Deferred income in majority U. S.-owned foreign corporations, also known as controlled foreign corporations( CFCs), was subject to tax under Section 965 in installment payments over a period of eight years as part of a transition to a participation exemption system of taxation( sometimes called a territoriality system of taxation). However, the various types of earnings and profits( E & P) that could be held by a CFC, as well as an annual layering of the E & P types, led to questions about how the distributions were to be treated, especially if the eight-year period had not yet run.
Further complicating the situation, individuals who owned a CFC were treated differently in the taxation of E & P earned in years after 2017 than corporations that owned a CFC. There were also concerns that an individual might not have the same resources to pay the tax over the eight-year period. Therefore, an election under Section 962 was available to individuals where they were treated like a corporation and allowed to claim a foreign tax credit( FTC) on the taxes paid by the CFC on this deferred income( something not normally allowed).
So how were PTEP distributions taxed to the individual who made this election? In the complex world of international taxation, the U. S. Internal Revenue Code( IRC) provides a framework for how foreign earnings are taxed. Two important components of this framework include the Section 965 priority rule and the Section 962 ordering rules. These rules play a crucial role in determining how PTEP is treated, especially in the context of distributions and inclusions under the U. S. tax system.
The following reviews these two areas of importance, especially to individuals who own CFCs.
Section 965 Priority Rule
The Section 965 priority rule is a specific guideline within the broader context of the U. S. tax code that deals with how PTEP is treated. This rule was introduced as part of the TCJA, which imposed a one-time transition tax on the untaxed foreign earnings of certain specified foreign corporations.
VIEWPOINTS: ISSUE 1 2025 | 05