This week, House Ways and Means Committee Chairman Kevin Brady (R-TX) released legislative text of technical corrections to the Tax Cuts and Jobs Act (TCJA) that would allow companies to receive refunds with respect to overpayments of “transition tax” liability – a key provision for which manufacturers have advocated.
The TCJA moved the United States away from its decades-old “worldwide” system for taxing international income. Under the old system, all earnings of a U.S. company were subject to U.S. tax, irrespective of the country in which it was earned. While a deferral regime sometimes delayed the imposition of tax until earnings were brought back to the United States, our high federal income tax rates served as a disincentive to repatriation. This resulted in what has been referred to as the “lockout” effect. The TCJA addressed this issue by reducing statutory tax rates and adopting a dividend exemption system, which allows businesses to repatriate foreign earnings without an additional layer of U.S. tax.
As part of the transition to this new system, the TCJA imposed a one-time “transition tax” on previously unrepatriated foreign earnings. The rate at which the tax is imposed depends on the form in which the foreign earnings are held, and the amount subject to tax is determined by reference to foreign earnings and profits as of two measurement dates.
Once a taxpayer determines their amount of transition tax liability, they may elect to pay the amount in installments over eight years. Guidance from the IRS states that taxpayers who elect to pay their transition liability in installments, and who overpay their total federal income taxes for a particular year, are not be eligible for a refund. In a legal memorandum explaining its decision, the IRS argued that the right to a refund cannot exist until the entire transition liability is paid in full.
[R]ecent IRS guidance provides that overpayments of corporate income tax (including excess payments of estimated tax) will not be refunded to taxpayers but will be applied to the taxpayer’s [transition tax] liability until that liability is completely extinguished. This policy has the effect of negating the legislative intent of spreading the cash impact of [the transition tax] evidenced by the installment payment provision of the law. This policy should be reversed. A taxpayer should be allowed a refund of any overpayment of estimated tax that remains after applying the payment to the taxpayer’s income tax liability. . . continuing the policy of denying refunds would frustrate the intent of the Congress when it allowed payment of the transition tax liability in installments.
Chairman Brady’s proposal is expected to serve as a starting point for House and Senate negotiators as they develop a year-end government funding bill. Reversing the IRS policy would help ensure that the TCJA has the intended effect of spurring economic growth by providing certainty to taxpayers, and manufacturers urge Congress to adopt this provision.
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