Can the Transition Tax and GILTI Regulations be Challenged Under the RFA?

Recently, in the case of Monte Silver, et Al v. Internal Revenue, et al, Monte Silver and his law firm, Monte Silver, Ltd, challenged the Internal Revenue Service’s (“IRS’s”) failure to conduct a small business impact analysis under the Regulatory Flexibility Act (“RFA”) when implementing regulations for the transition tax. Monte Silver, Ltd challenged the implementation of regulations promulgated for the taxation of the global intangible low-taxed income (“GILTI”) under the same theory. This article discusses if the regulations for the transition tax and GILTI are subject to attack under a theory that the IRS and Department of Treasury failed to comply with the RFA.

What is the RFA?

Congress enacted the Regulatory Flexibility Act or RFA, 5 U.S.C. §§ 601–612,  in 1980 to require federal agencies to consider the effects of their regulations on small businesses and other small entities. “Small entity” means a “small business,” “small organization,” or “small government jurisdiction” (non-federal government with a population less than 50,000. As a general matter, a small business or organization is one which is “independently owned and operated” and “not dominant in its field” of operation. If a regulation is expected to have a “significant economic impact on a substantial number of small entities,” the RFA requires the issuing agency to consider alternatives, with the goal of minimizing significant impacts on small entities. The RFA “arose from the concern that small businesses may be forced to bear an unnecessary or disproportionate burden when the federal government issues regulations.” Nat’l Ass’n for Home Care v. Shalala, 135 F. Supp. 2d 161, 163 (D.D.C. 2001).

The RFA does not alter the substantive mission of federal agencies under their own statutes. However, the RFA “is a procedural statute setting out precise steps a federal agency must take to ensure that its rules “tak[e] into account the size and nature of the regulated businesses.” Mid-Tex Elec. Coop., Inc. v. FERC, 773 F.2d 327, 342 (D.C. Cir. 1985). Specifically, the RFA provides that whenever a federal agency is required to publish a notice of proposed rulemaking, it must first determine whether the rules under consideration would “have a significant economic impact on a substantial number of small entities.” 5 U.S.C. § 605(b).

In making its determination, the federal agency must prepare an initial regulatory flexibility analysis (“IRFA”). 5 U.S.C. § 603. The agency must publish the IRFA in the Federal Register, invite public comments, and transmit the IRFA to the Chief Counsel for Advocacy of the Small Business Administration (‘SBA”). When the federal agency issues the final rules, it must prepare a final regulatory flexibility analysis (“FRFA”) also to be published in the Federal Register. 5 U.S.C. § 604. The RFA requires both the IRFA and FRFA to generally “describe the effect of the proposed rule on small businesses and discuss alternatives that might minimize adverse economic consequences.” Nat’l Women, Infants, & Child Grocers Ass’n v. Food & Nutrition Serv, 416 F. Supp. 2d 92, 108 (D.D.C. 2006). In particular, the FRFA must contain “a description of the steps the agency has taken to minimize the significant economic impact on small entities,” including “a statement of the factual, policy, and legal reasons for selecting the alternative adopted in the final rule and why each one of the other significant alternatives to the rule considered by the agency . . . was rejected.” 5 U.S.C. § 604(a)(6). However, no such description is necessary if “the head of the agency certifies that the rule will not . . . have a significant economic impact on a substantial number of small entities.” 5 U.S.C. § 605(b).

The Section 965 Transition Tax

The RFA dispute in this case arises from the enactment of the TCJA in 2017, the most significant change to the Internal Revenue Code since 1986. Section 965, as amended by the TCJA, serves as a transition from a worldwide tax system to a more territorial based tax system. Prior to the TCJA, a U.S. corporation could defer foreign income from taxation by retaining earnings indefinitely through a foreign subsidiary. The U.S. corporation would be subject to U.S. income tax only when the foreign earnings were distributed to it by the foreign subsidiary. As a result, the pre-TCJA rules incentivized U.S. corporations to accumulate substantial earnings outside the U.S. The TCJA is an attempt to encourage repatriation of such accumulated earnings. Under the TCJA, domestic corporations are in most circumstances entitled to a 100-percent deduction for any dividends received from their foreign subsidiaries, which eliminates any U.S. tax liability on the dividend. See I.R.C. § 245A. However, in order to prevent a U.S. corporation from taking undue advantage of Section 245A, the TCJA amended Section 965 to treat earnings that had been accumulated in a foreign subsidiary prior to the TCJA as being repatriated to the U.S. before the new rules took effect.

Section 965 imposes a one-time transition tax on a U.S. shareholder’s share of the  accumulated post-1986 deferred foreign income (“ADFI”) of certain foreign corporations. For this purpose, a U.S. person is considered a “U.S. shareholder” of a foreign corporation if the person owns directly, indirectly, or constructively at least 10% of the total combined voting power or total value of the foreign corporation’s stock. Section 965 generally accomplishes the transition tax by increasing the subpart F income of each specified foreign corporation (“SFC”) owned by the U.S. shareholder by an amount equal to the SFC’s ADFI as of November 2, 2017 or December 31, 2017, whichever is greater. Each SFC’s ADFI equals its post-1986 earnings and profits (“E&P”) (as measured in the SFC’s functional currency), excluding any E&P that constitute income effectively connected with the conduct of a U.S. trade or business or that, if distributed, would be treated as previously taxed E&P under Section 959. ADFI is determined without reduction for any dividends that the SFC may have distributed during its last taxable year that began before January 1, 2018, unless such dividends were distributed to another SFC.

An SFC that has positive post-1986 E&P first determines its subpart F income for the year, without regard to any Section 965 inclusion. The SFC takes that subpart F income into account by increasing its Section 959(c)(2) E&P by the amount of subpart F income that the SFC’s U.S. shareholder included. Second, the SFC determines the proper treatment of any distribution it made to another SFC before January 1, 2018. As a result, a distributee SFC excludes, from the E&P that it uses to measure ADFI, any portion of the distribution that the distributing SFC included in its own ADFI. Third, the SFC determines its Section 965(a) inclusion amount, which the U.S. shareholder includes in its income under Section 951(a)(1)(A). As a result, if, in the inclusion year or any subsequent year, the SFC distributes an amount that the U.S. shareholder included in income under Section 965, the distribution would be from the SFC’s Section 959(c)(2) E&P (i.e., previously-taxed subpart F income). Fourth, the SFC takes into account its distributions, other than those it made to another SFC. To the extent any such distribution is a Section 301(c)(1) dividend, the SFC treats the amount of the dividend as a reduction, first of Section 959(c)(1) E&P, second of Section 959(c)(2) E&P, and third of Section 959(c)(3) E&P. Fifth, the SFC determines the amount, if any, of the Section 956 inclusion, which the U.S. shareholder includes in income under Section 951(a)(1)(A). This five-step process applies separately to each E&P measurement.

Section 965 effectively taxes a corporate U.S. shareholder’s share of the SFCs’ ADFI at 15.5% and an individual U.S. shareholder’s share of the SFCs’ ADFI at 17.54%, but only to the extent the U.S. shareholder held the ADFI in cash, cash equivalents, or certain other short-term assets. The remaining ADFI is taxed at 8% and 9.05% for corporate and individual shareholders, respectively.

Section 965(o) directs the Secretary of the Treasury to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [Section 965].” On August 9, 2018, the respondent issued proposed regulations to Section 965. Such regulations were finalized on February 5, 2019. Before issuing those regulations, the respondent released a series of notices describing the regulations it intended to issue. These regulations are the subject of this case before this Court.

The Implementation of the Section 965 Regulations

On August 9, 2018, the Department of Treasury and the IRS published, in the Federal Register, a Notice of Proposed Rulemaking under Section 965 (“Proposed Notice”). See 83 Fed. Reg. 39,514 (Aug. 9, 2018). The Proposed Notice contained a certification that the information collection requirements stemming from the proposed regulations would not “have a significant economic impact on a substantial number of small entities” and, thus, an IRFA was “not required” and was not performed. See Id. at 39,540–41. The respondent based its certification on the following “facts”: (1) the IRS estimated the average burden of complying with the information collection requirements to be five hours, which was “minimal, particularly in comparison to other regulatory requirements related to owning stock in [an SFC]”; (2) the information collection requirements applied only if a taxpayer chose to make an election or rely on a favorable rule; (3) the information collection requirements applied to the owners of SFCs, rather than the SFCs themselves, and SFCs in any event would “infrequently be small entities”; and (4) the information collection requirements applied primarily to U.S. shareholders of SFCs and, if such U.S. shareholders were businesses, they were “generally not small businesses” given the significant resources and investment required. Id. at 39,541. The certification noted that the Proposed Notice had been submitted to the Chief Counsel for Advocacy of the SBA for comment on its impact on small businesses.

The Department of Treasury and the IRS issued a number of notices in response to comment letters received on the Proposed Notice and various published guidelines. On February 5, 2019, the Department of Treasury and IRS published the final regulations in the Federal Register. See 84 Fed. Reg. 1838 (Feb. 5, 2019). The final regulations adopted the regulations in the Proposed Notice, with certain changes. The RFA certification in the final regulations restated the first two “facts” set out in the Proposed Notice’s certification. In response to “a number of comments asserting that a substantial number of small entities would be affected by the proposed regulations,” the final regulations countered that these comments were “principally concerned with U.S. citizens living abroad.” Id. at 1873. The final regulations offered some very rough in-house estimates to the effect that 10,000 or so small multinational corporations (i.e., corporations with less than $25 million in gross receipts) were potentially impacted, explaining that “comprehensive counts of all types of small businesses affected by section 965 and these regulations [were] not readily available” at the time. Id. This absence of any “comprehensive counts” is hardly surprising, as no IRFA (much less an FRFA) had been prepared at all, the Proposed Notice having deemed an IRFA to be unnecessary at the outset. See 83 Fed. Reg. at 39,541. The final regulations also provided some additional data on small multinational businesses that were taken from estimates in the Conference Report accompanying the TCJA and from the Bureau of Economic Analysis. Presented in tabular format, the data included a footnote stating that “Small Multinational Businesses are not necessarily small entities as defined by the Regulatory Flexibility Act.” 84 Fed. Reg. at 1874. Finally, the final regulations indicated that the Chief Counsel for Advocacy of the SBA provided no comments on the Proposed Notice.

Monte Silver’s Case Against the Section 965 Regulations

Monte Silver is a U.S. citizen residing in Israel. Monte Silver reports his income through Silver Limited, an Israeli corporation that is taxed as a controlled foreign corporation (“CFC”) for U.S. tax purposes.

In early January 2018, Silver learned about the recently passed Tax Cuts and Jobs Act (“TCJA”) and transition tax applied to him. Over the following month, he spoke to owners of other small businesses abroad as well as tax professionals about the complexities and implications of the transition tax. In early March 2018, Monte Silver launched a “campaign through which small business owners could email senior officials of the Department of Treasury and the IRS to advise them of their problems and to seek relief.”  After the proposed regulations implementing Section 965 were released for public comment in August 2018, Monte Silver noticed the language in the regulations concerning the RFA. On January 30, 2019, Monte Silver filed this action alleging that the Department of Treasury and IRS violated the RFA and the Administrative Procedure Act (“APA”) in promulgating the final regulations implementing for Section 965 of the Internal Revenue Code. Monte Silver argued that he was injured with the cost associated with complying with the TCJA’s transition tax regulations, which included certain ‘collection of information’ and ‘recordkeeping obligations.” Monte Silver also claimed that he will be forced to expend money on Transition tax-related compliance for years to come through a so-called 962 election.

The court ultimately dismissed Monte Silver’s 965 case against the Department of Treasury and the IRS based on standing for the following reasons.

The 962 Standing Issue

Before Article III limits the constitutional role of the federal judiciary to resolving cases and controversies…a showing of standing is an essential element to the exercise of a federal court’s jurisdiction. In order to satisfy the “irreducible constitutional minimum of standing,” a litigant must demonstrate that (1) they have suffered an injury in fact — the invasion of a legally protected interest; (2) the injury is fairly traceable to the defendants’ challenged conduct (a causal connection); and (3) a favorable decision on the merits likely will redress the injury. See Lujan, 504 U.S. at 560–61. The alleged injury must be concrete and particularized and actual or imminent, not conjectural, hypothetical or speculative. See Spokeo, Inc. v. Robins, 578 U.S. ___, ___, 136 S. Ct. 1540, 1548 (2016). “This set of criteria implements Article III by limiting judicial intervention to only those disputes between adverse parties that are ‘in a form . . . capable of judicial resolution.’” Fla. Audubon Soc’y, 94 F.3d at 663 (quoting Schlesinger v. Reservists Comm. to Stop the War, 418 U.S. 208, 2018 (1974)).

Monte Silver claimed a 962 election in connection with transition related tax for Monte Silver, Ltd. Monte Silver alleged that he will suffer future injury to comply with the requirements of Section 962 in connection with his transition tax filing. By making a 962 election, Monte Silver can apply foreign tax credits to offset his transition tax liability. The statute giving rise to this ability resides in a separate portion of the Internal Revenue Code that predates TCJA. Monte Siliver argued that the only way he could enjoy the benefit of 10 years credits for Israeli corporate taxes paid by Silver Ltd was by making an election under Section 962 of the Internal Revenue Code. The court determined that these arguments were not factual averments which the court could rely upon to establish standing.

According to the Court, Silver, Ltd is Not Subject to the 965 Regulations

As discussed above, Internal Revenue Code Section 965 imposes a one-time transition tax on U.S. taxpayers who are shareholders of certain foreign corporations. To that end, the final regulations implementing Section 965 explain, in summary, that they “affect United States persons with direct or indirect ownership interests in certain foreign corporations.” 84 Fed. Reg. 1,838 (emphasis added); A.R. at 3134 (emphasis added). For purposes of Section 965, a “United States person” is a citizen or resident of the United States, a domestic partnership or corporation, and certain estates and trusts. The court stated that there is no disputing that Monte Silver, as a U.S. person and sole shareholder of a controlled foreign corporation, is “subject to” the transition tax regulations.

The court found that as a corporation located in and organized under the laws of Israel, Silver Limited is not a citizen or resident of the United States, a domestic partnership or corporation, or a qualifying trust or estate. Accordingly, the court concludes that only Monte Silver is “subject to” the transition tax regulations.

Does Monte Silver Qualify as a “Small Entity” for Purposes of the RFA?

The RFA defines “small entities” as having the same meaning as the terms “small business,” “small organization,” and “small governmental jurisdiction,” as defined in the RFA. 5 U.S.C. § 601(6). Of those defined terms, the court determined that Monte Silver could conceivably fall only under the term “small business.” However, according to the court, Monte Silver’s attorneys into meeting the “small business concern” definition by virtue of his status as the sole proprietor of his real estate investing business. In this case, Monte Silver was not subject to the transition tax in his capacity as a real estate investor. Consequently, the court determined that Monte Silver is not a small entity for the purposes of the RFA and therefore has no standing to bring this case.

The Current Status of Monte Silver’s Litigation with the Department of Treasury and IRS

The district court dismissed Monte Silver’s lawsuit challenging the Section 965 regulations under the RFA. However, on February 5, 2025, the district court permitted Monte Silver’s motion to amend his complaint to allege that the IRS and the Department of the Treasury failed to comply with the RFA when promulgating regulations for the implementation of GILTI.

What Happens Next in Transition Tax and GILTI Tax Litigation?

Although the court ruled against Monte Silver in his challenge of the 965 regulations, the court’s opinion does not state that an aggrieved taxpayer is foreclosed from challenging the 965 regulations under a theory that the IRS and Department of Treasury failed to comply with the regulations. The court rejected Monte Silver’s attack on the 965 regulations based on his specific facts and circumstances. The court did not state that an aggrieved taxpayer subject to ill-conceived regulations promulgated under Section 965 does not have standing to litigate this matter. Thus, taxpayers that are harmed by improperly enacted Section 965 regulations can still bring suit in a federal court in appropriate circumstances.

Monte Silver’s lawsuit regarding the RFA and the GILTI regulations has just commenced. Although it is too early in litigation to determine arguments that will be raised in the RFA GILTI regulation challenge, it is unlikely to Monte Silver will mention Section 962 in this case and he will likely utilize his status as the sole proprietor of his real estate investing business to qualify as a “small entity” for purposes of the RFA.

A federal court has yet to weigh in on whether the IRS and Department of Treasury failed to comply with the RFA when the transition tax and GILTI regulations were promulgated.

Given the uncertainty in this area of administrative law, any litigant involved in litigation with the IRS regarding the transition Tax or GILTI should carefully review the contours of the transition tax or GILTI regulations to determine if they comply with the RFA. A careful assessment should also be made by the tax litigant to determine if the failure of the IRS and Department of Treasury to comply with the RFA when promulgating regulations has harmed them.

Anthony Diosdi is an  international tax attorney at Diosdi & Liu, LLP. Anthony focuses his practice on providing tax planning domestic and international tax planning for multinational companies, closely held businesses, and individuals. In addition to providing tax planning advice, Anthony Diosdi frequently represents taxpayers nationally in controversies before the Internal Revenue Service, United States Tax Court, United States Court of Federal Claims, Federal District Courts, and the Circuit Courts of Appeal. In addition, Anthony Diosdi has written numerous articles on international tax planning and frequently provides continuing educational programs to tax professionals. Anthony Diosdi is a member of the California and Florida bars. He can be reached at 415-318-3990 or [email protected].

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.