PRIOR TO THE ENACTMENT of the Tax Cuts and Jobs Act, the United States was one of the few developed nations operating on a worldwide system of taxation. This tax regime, coupled with some of the highest statutory corporate tax rates in the world, created a far less attractive business environment for U.S. companies operating in an increasingly global economy. With little incentive to bring foreign earnings back to the United States for reinvestment, many American companies retained foreign earnings offshore to avoid paying U.S. taxes imposed upon repatriation. In an effort to incentivize U.S. companies to repatriate foreign earnings and increase U.S. investment and job growth, the new tax reform adopts a modified territorial tax regime, effective for the 2018 and subsequent tax years. This new system of taxation provides a 100 percent exemption from U.S. corporate taxation for dividends received by a 10 percent U.S. corporate shareholder from certain foreign corporations.

In preparation for this transition to a modified territorial tax regime, the new tax law provides for a mandatory repatriation tax (“toll tax”) imposed upon undistributed nonpreviously taxed foreign earnings and profits, effective for tax years of foreign corporations beginning before Jan. 1, 2018. All 10 percent U.S. shareholders of foreign corporations with positive pre-2018 accumulated E&P must include in income this E&P amount, subject to U.S. tax at reduced rates. The toll tax is payable over eight years at the taxpayer’s election. It is important to note that, in contrast to the 100 percent dividend exemption applicable only to U.S. corporate shareholders, the toll tax applies to all U.S. shareholders.

S corporation shareholders, however, may elect to defer the toll tax until a triggering event occurs. For calendar year foreign corporations, the toll tax (or first installment if eight-year payout is elected) must be paid with the 2017 tax return, without regard to extensions. When the E&P subject to the toll tax are actually distributed to the U.S. shareholders in 2018 and subsequent years, they will not be subject to U.S. tax a second time.