Today, Treasury and the IRS issued proposed regulations under section 965, including for purposes of the excise tax on the net investment income of private foundations.

The 2017 tax legislation, P.L. 115-97, popularly known as the Tax Cuts and Jobs Act, enacted the section 965 transition tax as part of its overall reform of the international tax provisions of the Code. In general, section 965 requires US shareholders (generally US persons who directly, indirectly, or constructively own 10% or more of the stock of a foreign corporation) to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations by treating those earnings as included in the income of the US shareholder (the “section 965 inclusion”). Section 965(c) sets forth a participation exemption that allows deductions to impose lower effective rates on the section 965 inclusion, depending on whether the foreign earnings are held in cash.

The proposed regulations (including the preamble) provide the following guidance with respect to private foundations that are US shareholders of specified foreign corporations:

  • Any section 965 inclusion generally is included in the calculation of gross investment income of a private foundation for purposes of determining the excise tax imposed under section 4940 (generally two percent of net investment income)
  • The section 965(c) deduction is not treated as an ordinary and necessary expense paid or incurred for the production or collection of gross investment income for purposes of section 4940(c)(3)(A) (and, accordingly, the full amount of any inclusion generally is subject to the excise tax on net investment income)
  • Private foundations are not permitted to make an election—generally available to other taxpayers—to pay any section 965 tax liability in eight annual installments with respect to any excise tax imposed under section 4940

Practitioners have asked Treasury and the IRS to confirm that section 965 inclusions generally will be excluded from the unrelated business taxable income of exempt organizations, but the proposed regulations do not address this issue.