In this video, I explain the transition tax for deemed repatriation earnings as covered on the tax compliance and planning of of the CPA exam TCP.
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The Tax Cuts and Jobs Act introduced a significant shift in the tax system for certain U.S. corporations with foreign operations. Under this new system, U.S. corporations can now fully deduct dividends received from their controlled foreign corporations (CFCs), effectively moving towards a territorial tax system. This means that U.S. corporations are taxed only on their domestic income, not on their foreign income.

To transition to this system, there's a one-time requirement for U.S. shareholders, who own at least 10% of a CFC, to pay taxes on the foreign earnings that have not been previously taxed by the U.S. This is known as the one-time deemed repatriation tax. This tax applies to the last tax year that begins before January 1, 2018, and it targets the accumulated untaxed earnings of the CFCs.

However, there's an exception for S corporations, a special type of corporation in the U.S. that meets specific Internal Revenue Code requirements. S corporations can defer this one-time transition tax until certain triggering events occur, such as the liquidation of the S corporation, the cessation of its business, or a transfer of its stock. This deferral provides some flexibility for S corporations in managing their tax obligations during the transition to the new tax system.

he untaxed earnings of Controlled Foreign Corporations (CFCs) are categorized into two distinct types for tax purposes:

Cash or Cash Equivalents: This category includes liquid assets that are easily convertible into cash. Earnings falling under this category are subject to a higher tax rate of 15.5%. The rationale behind the higher rate is that cash and similar assets are more readily accessible and can be repatriated more easily, hence they are taxed more heavily.

Non-Cash Earnings: This category encompasses all other forms of earnings that are not in the form of cash or cash equivalents. These could include reinvested earnings in business operations, real estate, equipment, and other forms of non-liquid assets. Earnings in this category are taxed at a lower rate of 8.0%, reflecting the recognition that these types of earnings are not as readily accessible as cash and may require significant effort or expense to convert into cash.

This two-tiered approach to taxing untaxed earnings aims to balance the tax burden on U.S. shareholders of CFCs, taking into account the different levels of liquidity and accessibility of the foreign earnings.


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