The Pennsylvania Department of Revenue (the Department) published an Information Notice (available here) setting forth its position as to how the repatriation income and deduction under Section 965 of the Internal Revenue Code (the Code) (the Repatriation Tax) should be treated for Pennsylvania corporate net income tax (CNIT) and personal income tax (PIT) purposes.
Repatriation Tax Background
The Repatriation Tax is part of what is known as the Tax Cuts and Jobs Act of 2017 and is imposed on previously untaxed earnings and profits (E&P) of certain foreign corporations accumulated after 1986 and prior to 2018. The provision requires most taxpayers to include in taxable income for the last taxable year that began before January 1, 2018, an amount equal to the untaxed E&P of foreign corporations in which they own an interest (the Repatriation Amount).
The Repatriation Tax also includes a deduction (the Repatriation Deduction) designed to reduce the effective tax rate on the Repatriation Amount to (i) 15.5% in the case of cash or cash equivalents and (ii) 8% in the case of illiquid assets. Taxpayers must recognize the Repatriation Amount, less the Repatriation Deduction (the Net Repatriation Amount) as income in the year of the deemed repatriation. Taxpayers other than real estate investment trusts (REITs) may elect to defer their payments of the Repatriation Tax over an eight-year period to mitigate the one-time tax hit. Unlike other corporations, REITs are not required to recognize the entire Net Repatriation Amount as income in the first year, but instead recognize it over eight years.
CNIT Treatment of the Repatriation Amount
For CNIT purposes, CNIT income begins with a corporation’s taxable income before net operating losses (NOLs) and "special deductions" (i.e., the deductions listed in Part VIII—Sections 241 through 250—of the Code) as reported by the corporation to the federal government. The CNIT Regulations specifically refer to the amount reported on Line 28 of IRS Form 1120 as the starting point for CNIT income.
For federal income tax purposes, there is a new Schedule J to IRS Form 1120 on which a taxpayer reports its Repatriation Amount and its Repatriation Deduction and determines its Repatriation Tax liability. The Net Repatriation Amount is not reported on Line 28 of IRS Form 1120; instead, the Repatriation Tax is added to a corporation's federal tax liability.
Because the Repatriation Amount is included in its Subpart F income and, therefore, is part of a corporation's federal taxable income, notwithstanding that the Repatriation Amount and Repatriation Deduction are not included on Line 28 of IRS Form 1120, the Department explained that the Repatriation Amount is included in a taxpayer's CNIT income. The Department also concluded that a taxpayer may reduce its CNIT income by the amount of its Repatriation Deduction. Based on the foregoing, a CNIT taxpayer must include the Net Repatriation Amount in CNIT income.
For CNIT purposes, a taxpayer is entitled to a deduction for dividends received from a foreign corporation (the Dividends Received Deduction). The Pennsylvania Dividends Received Deduction with respect to both foreign and domestic corporations is the same percentage as the federal dividends received deduction for dividends received from a domestic subsidiary.
In the Notice, the Department concluded that the Net Repatriation Amount, as opposed to the Repatriation Amount, is treated as a deemed dividend from the foreign corporations from which the Repatriation Amount is derived. The Department thus determined that the Net Repatriation Amount, not the Repatriation Amount, is eligible for the Dividends Received Deduction. Additionally, because the Pennsylvania apportionment rules provide that dividends are not taken into account when calculating the sales factor, the Net Repatriation Amount is not included in either the numerator or the denominator of a corporation’s sales factor.
In addition to the above, the Notice explains:
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No election will be available to spread the Repatriation Tax liability out over time, as is available for federal tax;
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REITs will recognize the Net Repatriation Amount at the same time as it is recognized for federal tax purposes (i.e., over an eight-year period); and
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A corporation that already filed a return for the year that included the Repatriation Tax but did not take into account the Net Repatriation Amount should file an amended CNIT return following the guidance in the Notice. For a corporation that files such an amended return prior to November 15, 2018, (i) no interest or penalty will be due with respect to any additional CNIT owed by the corporation, and (ii) if the inclusion of the Net Repatriation Amount is the only change on an amended return, the statute of limitations will be increased to three years from the date the amended return is filed, but only with respect to the Net Repatriation Amount, not any other item reported on the return.
PIT is not imposed on federal taxable income; instead, PIT is imposed on eight specifically enumerated categories of income, including dividends paid "in cash or property." Because the Net Repatriation Amount is not paid in cash or property, the Department explained that the Net Repatriation Amount is not required to be included in the PIT base.
PIT taxpayers are advised that they must include any actual dividends they receive that are paid in cash or property in their CNIT base, even if they do not receive a federal Form 1099-DIV reporting the payment. Additionally, pass-through entities that are required by the IRS to report the Net Repatriation Amount on IRS Form 1065, Schedule K or IRS Form 1120-S are instructed to use Schedule M to Pennsylvania Form PA-20S/PA-65 to (i) report the Net Repatriation Amount as business income, and (ii) then back out the income with a statement explaining the adjustment. If and when an actual distribution of cash out of E&P is made to the pass-through entity, it should be reported on Schedule B of the PA-20S/PA-65.
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Pennsylvania, like many other states, continues to grapple with how federal tax reform affects state taxation and whether/how it should change its tax rules in light of the significant overhaul in federal tax law. We will continue to monitor these changes.
Ballard Spahr's Tax Group can assist with any questions about Pennsylvania taxes and other state and local tax issues. For more information, please contact Wendi L. Kotzen, co-leader of the Tax Group, at (215) 864-8305, or Chris Jones at (215) 864-8424.
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