Before the Tax Cuts and Jobs Act, the United States was one of the few developed countries that taxed corporate income on a worldwide basis. Coupled with relatively high statutory corporate tax rates, this approach made the U.S. a less competitive place for multinational companies. Because U.S. corporations had little incentive to repatriate foreign earnings, many left profits offshore to avoid U.S. tax on repatriated income.
The 2017 tax reform shifted the United States toward a modified territorial system beginning in 2018. Under the new rules, certain dividends received by a U.S. corporate shareholder that owns at least 10 percent of a foreign corporation are 100 percent exempt from U.S. corporate income tax. That change was intended to encourage U.S. companies to bring foreign earnings home and to spur domestic investment and job creation.
To ease the transition from a worldwide system to this modified territorial regime, the law imposed a mandatory repatriation tax—commonly called a “toll tax”—on accumulated, previously untaxed earnings and profits (E&P) of foreign corporations that were earned before Jan. 1, 2018. Every U.S. shareholder owning at least 10 percent of a foreign corporation with positive pre-2018 accumulated E&P must include its share of that E&P in taxable income. The included amount is subject to U.S. tax at reduced rates established by the reform.
The toll tax can be paid over an eight-year period if the taxpayer elects to use the installment option. Unlike the 100 percent dividend exemption—which applies only to qualifying U.S. corporate shareholders—the mandatory repatriation tax applies to all U.S. shareholders, including individuals, trusts, and other pass-through owners.
S corporation shareholders have a special rule that allows them to defer recognition of the toll tax until a triggering event occurs. For foreign corporations that use a calendar tax year, the toll tax (or the first installment if the taxpayer chooses the eight-year payment schedule) must be paid with the U.S. shareholder’s 2017 tax return, and that payment deadline applies even if the taxpayer has an extension for filing.
Once the pre-2018 E&P subject to the toll tax are actually distributed to U.S. shareholders in 2018 or later years, those distributions are not taxable again at the U.S. level. In this way, the repatriation tax functions as a one-time transition measure to bring previously untaxed foreign earnings into the U.S. tax base while moving forward under a system that generally exempts certain future foreign-source dividends from U.S. corporate tax.