Demystifying the IRS Form 5471 Part 4. Schedule J

By Anthony Diosdi

In order to provide the Internal Revenue Service (“IRS”) with the information necessary to ensure compliance with the subpart F rules and global intangible low-taxed income (“GILTI”) provisions, each year certain U.S. persons with interests in foreign corporations must file an IRS Form 5471 otherwise known as “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” This is the fourth of a series of articles designed to provide a basic overview of the Form 5471. This article will focus on Schedule J. Schedule J tracks the earnings and profits of a controlled foreign corporation (“CFC”). This article is designed to supplement the IRS instructions to Schedule J.

Schedule J has dramatically changed for the 2018 tax season. Schedule J now includes Part 1 entitled “Accumulated E&P of Controlled Foreign Corporation.” Schedule J also added Part II entitled “Nonpreviously Taxed E&P Subject to Recapture as Subpart F Income. Schedule J of Form 5471 has also added the following new columns:

1) Post-2017 E&P Not Previously Taxed (post-2017 Section 959(c)(3) balance.

2) Hovering Deficit and Deduction for Suspended Taxes.

3) PTI from Section 965(a) Inclusion (Section 959(c)(1)(A)).

4) PTI from Section 965(b)(4)(A) (Section 959(c)(1)(A)).

5) PTI from Section 951A Inclusion (Section 959(c)(1)(A)).

6) PTI from Section 965(a) Inclusion (Section 959(c)(2)).

7) PTI from Section 965(b)(4)(A) (Section 959(c)(2)), and

8) PTI from Section 965(b)(4)(A) (Section 959(c)(2)), and

9) PTI from Section 951A Inclusion (Section 959(c)(2)).

Who Must Complete the Form 5471 Schedule J

Category 1, 4, and 5 filers must attach a Schedule J to their Form 5471.

Lines a and b

Schedule J begins by asking the preparer to complete Lines a and b. Line specifically asks the preparer to determine the category of income and enter the applicable corresponding code. In order to answer the question on Line a, the preparer must reference the instructions to IRS Form 1118. IRS Form 1118 states that there are six categories of foreign source income to be reported on Schedule J and assigns codes to each category of income. The preparer may select from the applicable categories of income and codes listed below:

Code Category of Income

951A Section 951A Category Income

FB Foreign Branch Category Income

PAS Passive Category Income

901j Section 901(j) Income

RBT Income Re-Sourced by Treaty

GEN General Category Income

Below is a definition of each category of foreign source income:

Section 951A Category Income

Section 951A (GILTI inclusions) category income is any amount includible in gross income under Section 951A (other than passive category income).

Foreign Branch Category Income

Foreign branch income is defined under Internal Revenue Code Section 904(d)(2)(j)(i) as the business profits of a U.S. person which are attributable to one or more Qualified Business Units (“QBUs”).

Passive Category Income

Passive income is generally the following:

1. Any income received or accrued that would be foreign personal holding company income if the corporation were a CFC. This includes any gain on the sale or exchange of stock that is more than the amount treated as a dividend under Section 1248.
2. Any amount includible in gross income under Section 1293 (which relates to certain passive foreign investment companies (“PFICs”).

Section 901(j) Income

Section 901(j) income is income earned from a sanctioned country.

Income Re-Sourced by Treaty

If a sourcing rule in an applicable income tax treaty treats any U.S. source income as foreign source, and the corporation elects to apply the treaty, the income will be treated as foreign source.

General Category Income

This category includes all income not described above.

Line b

Line b states that if Code 901j is entered on Line a, the country code for the sanctioned country using the two-letter codes (from the list at IRS.gov/countrycodes) must be entered.

Part 1- Accumulated E&P of Controlled Foreign Corporation
U.S.

After completing Lines a and b, the preparer will move onto Part 1 of Schedule J. The first question asks the preparer to “check the box if [the] person filing [the] return does not have all U.S. Shareholders’ information to complete columns (e)(ii)-(e)(iv) and (e)(vii)-(ix).”

According to the instructions to Schedule J, the box at the top of Part 1 may be checked if the person filing Form 5471 does not have all U.S. shareholders’ information necessary to complete any one of the previously taxed E&P amounts required to be included in column (e). If the person filing Form 5471 is unable to determine whether amounts should be reported as previously taxed E&P, those amounts should be included in column (a), Post-2017 E&P Not Previously Taxed, Section 959(c)(3) balance.

Columns (a), (b), and (c)

Columns (a), (b), and (c) asks the preparer to report Internal Revenue Code Section 959(c)(3) balances “Post-2017 E&P Not Previously Taxed,” “Post-1986 Undistributed Earnings,” and “Pre-1987 E&P Not Previously Taxed.”

Column (a)

Column (a) asks for a CFC’s opening balance, current year additions and subtractions, and the closing balance in the foreign corporation’s E&P described in Section 959(c)(3) must be disclosed. In general, this is E&P of the foreign corporation which has not been included in gross income of a U.S. person under Section 951(a)(1). The instructions issued by the IRS for Column (a) specifically state:

“In column (a), report E&P described in section 959(c)(3) and earned after the repeal of section 902, that is, post-2017 E&P not previously taxed (post-2017 section 959(c)(3) balance). The repeal of section 902 is effective for tax years of foreign corporations beginning after December 2017, and to tax tears of U.S. shareholders in which or with which such tax years of foreign corporations end.”

Column (a) is particularly designed to report the high tax exception of subpart F income and GILTI. In order to understand what needs to be disclosed on Column (a), it is important to understand the high tax exception rules of subpart F and GILTI. Internal Revenue Code Section 954(b)(4) provides that foreign base company income shall not include any “item of income” of a CFC that the taxpayer establishes that has been subject to an effective rate of income tax of at least 90 percent of the U.S. corporate rate (i.e., 18.9 percent). GILTI provides an exception from “tested income” (discussed below) for income excluded from foreign base company income under the high-taxed exception. See IRC Section 951A(c)(2)(2)(A)(i)(III).

In identifying income that is high-taxed, Section 954 regulations look to the now-repealed Internal Revenue Code Section 902 E&P and tax pools that would be associated with subpart F income inclusion. Special rules promulgated under Internal Revenue Code Sections 902 and 904 provided for passive basket foreign personal holding company income. Proposed Regulations to Internal Revenue Code Section 960 has adopted an annual tax approach that groups subpart F income according to a number of categories stated in Treasury Regulation 1.954-1(c)(1)(iii). Each type of foreign base company income or foreign personal holding company income must be treated as its own subpart F income. Under this approach, different types of subpart F income are segregated for purposes of the high-tax exception.

An example how this tax regime operates can be summarized as follows:

Assume that CFC owns two DREs that each generate $100x foreign base company income. One DRE is taxed by its home country at 25 percent and the other DRE is taxed at 15 percent. The CFC as a whole has a combined $160 of net foreign base company income in the general basket and pays $40 of foreign tax for a combined tax rate of 20 percent. Under the proposed regulations, the treatment would depend on whether the DREs earn the same type of subpart F income; if both DREs earned base company sales income, averaging would be permitted; by contrast, in one earned foreign base company sales and the other foreign base company services income, only the 25 percent rate item would be eligible to be excluded. See The High-Tax Exception and E&P Limitation to Subpart F Income, by William Skinner, International Tax Journal, November-December, 2018.

For purposes of reporting the above mentioned example on Column (a), the CFC would report the $160 of net foreign base income. Reporting the “Post 2017 E&P Not Previously Taxed” depends on Section 959(c)(3) which is discussed below. With that said, under the Tax Cuts and Jobs Act, only the 25 percent rate would be eligible for the high tax exclusion.

Column (b)

Column (b) asks for a CFC to report post-1986 undistributed earnings. The instructions issued by the IRS for Column (a) specifically state:

“In column (b), report post-1986 undistributed earnings, as defined under section 902(c)(1), and as in effect prior to the repeal of section 902.”

Column (b) is designed to report the high tax exception of only subpart F income (since GILTI did not exist prior to 2018). In order to properly report what needs to be disclosed on Column (b), it is important to understand the high tax exception rules of subpart F prior to the enactment of the 2017 Tax Cuts and Jobs Act. Prior to 2018, for purposes of the high-taxed exception, Internal Revenue Code Sections 902 and 904 created nine separate baskets. Of these, three pertained to special kinds of export companies that were usually not subject to heavy foreign taxation, and two baskets applied to income from specific industries- financial services and shipping. Of the four remaining baskets, three pertained to various types of passive income, and the fourth was the overall or residual basket which applied to business income.

Special rules provided for passive basket foreign personal holding company income. In other cases, the high-taxed status of foreign base company income was determined by a hypothetical indirect credit that would apply under Internal Revenue Code Section 960. Averaging was built into the pools, the high-taxed exception prior the 2018 could be satisfied with respect to low-taxed subpart F income, so long as the CFC’s average pool rate was sufficiently high-taxed.

An example how this tax regime operates can be summarized as follows:

Assume that CFC owns two DREs that each generate $100x foreign base company income. One DRE is taxed by its home country at 25 percent and the other DRE is taxed at 15 percent. The CFC as a whole has a combined $160 of net foreign base company income in the general basket and pays $40 of foreign tax for a combined tax rate of 20 percent. Under the law prior to 2018, the two DREs’ income would be averaged for purposes of the high-taxed exception. Reporting the “Post E&P pre-2018 undistributed earnings” depends on Section 959(c)(3) which is discussed below. 

Column (c)

Column (c) is used to report the aggregate amount of the foreign corporation’s pre-1987 Section 964(a) E&P accumulated since 1962 and not previously distributed or deemed distributed.

The application of this rule is beyond the scope of this article.

Column (d)

Use column (d) to report hovering deficits and suspended taxes. See Internal Revenue Code Section 381(c)(2)(B) and Regulation Section 1.367(b)-7 and suspended taxes.

In order to complete column (d) it is important to understand the concept of hovering deficits. We will therefore provide an overview of this complex rule. Hovering deficits and suspended taxes typically deal with tax consequences of certain foreign-to-foreign and inbound corporate transactions. In order to understand the hovering deficit and suspended tax rules for purposes of Schedule J.

In general, Section 367 governs corporate restructurings under Sections 332, 351, 354, 355, 356, and 361 (Subpart C nonrecogntion transactions) in which the status of a foreign corporation as a “corporation” is necessary for the application of relevant Subchapter C nonrecognition provisions. Other provisions in Subchapter C (Subchapter C carryover provisions) apply to such transactions in conjunction with the enumerated provisions and detail additional consequences that occur in connection with the transaction. For example, Sections 362 and 381 govern the carryover of basis and E&P from the transferor corporation to the transferee corporation in applicable transactions.

The Subchapter C carryover provisions generally have been drafted to apply to domestic corporations and shareholders. As a result, those provisions often do not fully take into account the cross-border aspects of U.S. taxation. For example, Section 381 does not specifically take into account source and foreign tax credit issues that arise when earnings and profits move from one corporation to another.

The Treasury has enacted regulations to deal with these perceived problems. For example, Treasury Regulation Section 1.367(b)-7 applies to an acquisition by a foreign corporation (foreign acquiring corporation) of the assets of another foreign corporation (foreign target corporation) in a transaction described in Internal Revenue Code Section 381 (foreign Section 381 transaction) and addresses the manner in which earnings and profits and foreign income taxes of the foreign acquiring corporation and foreign target carry over to the surviving foreign corporation (foreign surviving corporation). These rules typically apply to reorganizations or Section 332 liquidations between two foreign corporations.

The principle Code Sections implicated by the carryover of earnings and profits and foreign income taxes in a foreign Section 381 transaction are Sections 381, 902, 904, and 959. Section 381 generally permits earnings and profits (or deficit in earnings and profits) to carry over to a surviving corporation, thus enabling “the successor corporation to step into the ‘tax shoes’ of its predecessor. * * * [and] represents the economic integration of two or more separate businesses into a unified business enterprise.” See H. Rep. No. 1337, 83rd Cong., 2nd Sess. 41 (1954). However, a deficit in earnings and profits of either the transferee or transferor corporation can only be used to offset earnings and profits accumulated after the date of transfer. See IRC Section 381(c)(2)(B). This is commonly known as the “hovering deficit rule.” The hovering deficit rule is a legislative mechanism designed to designed to deter the trafficking in favorable tax attributes that the IRS and courts had repeatedly encountered.

Special rules are built into the Internal Revenue Code and its regulations for the “hovering deficit rule.” For example, Internal Revenue Code Section 902 provides that a deemed paid foreign tax credit is available to a domestic corporation that receives a dividend from a foreign corporation in which it owns 10 percent or more of the voting stock. The Internal Revenue Code provides for the computation of deemed-paid taxes with regard to dividends from the relevant foreign corporations first out of multi-year pools of earnings and profits accumulated (and related foreign income taxes paid or deemed paid) in taxable years beginning after December 31, 1986, or beginning with the first year in which the domestic corporation owns 10 percent or more of the voting stock of a foreign corporation, whichever is later. (The Internal Revenue Code and regulations refer to pooled earnings and profits and foreign income taxes as post-1986 undistributed earnings and post-1986 foreign income taxes).

Congress enacted the pooling rules because it believed that blending foreign income taxes and earnings and profits into “pools” from which distributions are made was fairer and more appropriate than computing deemed-paid taxes with reference to annual layers of earnings and profits (and foreign income taxes). See Joint Committee on Taxation, 99th Cong., 2nd sess., General Explanation of the Tax Reform Act of 1986 (JCS-10-87) (1986 Bluebook), at 870 (May 4, 1987).

Below, please see Illustration 1 which provides a simple illustration how a foreign acquisition transaction may result in a hovering deficit and how such a transaction would be reported be broken down for U.S. reporting requirements of Schedule J. See Office of Chief Counsel Internal Revenue Service Memorandum, June 9, 2006, Final Regulations Relating to Stock Transfer Rules: Carryover of Earnings and Taxes.

Illustration 1.

Foreign Corporation A

Separate Corporation A

Separate Category	E&P	Foreign Taxes
General	200u	$30
Passive	(100u)	$10
	100u	$40

Foreign Corporation B

Separate Category	E&P	Foreign Taxes
General	300u	$60
Passive	100u	$30
	400u	$80

On January 1, 2017, foreign corporation B acquires the assets of foreign corporation A in a reorganization described in Section 368(a)(1)(C). Immediately following the foreign Section 381 transaction, foreign surviving corporation is a CFC.

Result

The foreign surviving corporation has the following post-1986 undistributed earnings and post-1986 foreign income taxes:

During the 2017 tax year, foreign surviving corporation does not accumulate any earnings and profits or pay any foreign income taxes. On December 31, 2017, foreign surviving corporation distributes 300u to its shareholders. This distribution reduces its post-1986 undistributed earnings and post-1986 foreign income taxes on a pro rata basis as follows:

Separate Category	E&P	Foreign Taxes
General	250u	$45
Passive	50u	$15
	300u	$60

Immediately after the distribution, foreign surviving corporation has the following post-1986 undistributed earnings and post-1986 foreign income taxes:

Post-transaction earnings– In its taxable year ending on December 31, 2018, foreign surviving corporation accumulates earnings and profits and pays related foreign income taxes as follows:

Separate Category	E&P	Foreign Taxes
General	100u	$20
Passive	50u	$10
	150u	$40

The hovering deficit in the passive category will offset the post-transaction earnings in that category and a proportionate amount of the foreign taxes related to the hovering deficit will be added to the post-1986 foreign income taxes pool. Because the post-transaction earnings in the passive category are half of the amount of the hovering deficit, half of the related taxes are added to the post-1986 foreign taxes pool. According, foreign surviving corporation has the following post-1986 undistributed earnings and post-1986 foreign income taxes on January 1, 2019:

Column (e)

Use column (e) of Schedule J is used to report the running balance of a foreign corporation’s previously taxed earnings and profits (“PTEP”). For Column (e) reporting purposes, the term PTEP refers to E&P of a foreign corporation attributable to amounts which are, or have been, included in the gross income of a United States shareholder. An understanding of Internal Revenue Code Section 959 is important in order to complete column (e) of Schedule J.

Overview of Section 959

Under Section 959(a)(1), distributions of PTEP are excluded from the U.S. shareholder’s gross income, or the gross income of any other U.S. person who acquires the U.S. shareholder’s interest (or a portion thereof) in the foreign corporation (such U.S. person, a “successor in interest”). Section 959(a)(2) further excludes PTEP from a U.S. shareholder’s gross income if such E&P would be included in the gross income of the U.S. shareholder or successor in interest under Section 951(a)(1)(B) as an amount determined under Section 956. Distributions are not treated as dividends except that such distributions immediately reduce the E&P of the CFC.

However, shareholders must account for PTEP with respect to their stock in a CFC, and CFCs must account for the aggregate amount of PTEP of all shareholders. Under provisions of the 2017 Tax Cuts and Jobs Act, the portion of a U.S. shareholder’s GILTI included in gross income under Section 951A(a) that is allocated to a CFC is treated as an amount included in the gross income of a shareholder for purposes of Internal Revenue Code Section 959. Likewise, amounts determined under Section 959(a) with respect to certain increases of subpart F income and a shareholder’s inclusions of such income. Also, amounts of a U.S. shareholder’s inclusions under Section 965(a) that are reduced by deficits attributable to stock of another CFC under Section 965(b) are treated as amounts included in the shareholder’s gross income under Section 951(a) for purposes of Section 959. In addition, Section 959 must take into consideration subpart F income inclusions from hybrid dividends as defined under Section 245A(e)(2) and the gains on the disposition of the sale of CFC stock.

Accordingly, Section 959(c)(2) PTEP may arise from income inclusions under Section 951(a)(1)(A), Section 951A(f)(1), Section 959(e), Section 964(e)(4), or Section 965(a) by the reason of Section 965(b)(4)(A). Section 965 and proposed regulations under that section provide special foreign tax credit and deduction rules, and proposed regulations under Section 986 provide special foreign currency gain or loss rules, for distributions of PTEP attributable to income inclusions arising from the application of Section 965(a) and PTEP attributable to income inclusions arising from the application of Section 965(a) and PTEP attributable to the application of Section 965(b)(4)(A).

Order of Earnings and Profits upon Distribution

Under Internal Revenue Code Section 316, distributions are considered first as distributions from current E&P, to the extent thereof, and then as distributions from the most recently accumulated E&P, to the extent thereof. PTEP will be maintained in annual PTEP accounts. To facilitate the rule in Section 959(c), which incorporates the ordering rule of Section 316, requires a “last in, first out” approach to sourcing of distributions from annual PTEP accounts, subject to the special priority rule for PTEP arising by reason of the application of Section 965. Thus, in general, Section 959(c)(1) PTEP in the most recent annual PTEP account will be distributed first (with the exception for Section 965 PTEP), followed by the next most recent annual PTEP account, and so on, after which the same approach will to Section 959(c)(2) PTEP. Within each annual PTEP account, the PTEP attributable to each group of PTEP earned in that year. Once the PTEP groups relating to Section 959(c)(1) PTEP are exhausted, distributions will be sourced from Section 959(c)(2) PTEP. Once those two PTEP groups are exhausted, under the last-in, first-out approach, distributions are sourced pro rata from the remaining Section 959(c)(2) groups in each annual PTEP account, starting from the most recent annual PTEP account. Finally, once all the PTEP groups have been exhausted, the remaining amount of any distributions will be sourced from Section 959(c)(3) E&P, to the extent thereof.

Adjustments Due to an Income Inclusion in Excess of Current Earnings and Profits

A U.S. shareholder’s income inclusion under Section 951A is not subject to a limitation based on the E&P of its CFCs for the taxable year. Consequently, in a year in which the portion of a U.S. shareholder’s GILTI inclusion amount allocated to a CFC exceeds the CFC’s current E&P, the PTEP resulting by reason of Section 951A(f)(1) will exceed the CFC’s current E&P and, in some cases, may exceed the CFC’s accumulated E&P as well. A U.S. shareholder’s GILTI for a taxable year is the excess, if any, of the U.S. shareholder’s “net tested income” for the taxable year over that shareholder’s “net deemed tangible income return” for the taxable year. Net CFC Tested Income with respect to any U.S. shareholder is the excess (if any) of the aggregate of the shareholder’s pro rata of the “tested income” of each CFC with respect to which the shareholder is a U.S. shareholder the shareholder’s taxable year over the aggregate of that shareholder’s pro rata share of “tested loss” of each CFC with respect to which the shareholder is a U.S. shareholder for the taxable year of the U.S. shareholder. See IRC Section 951A(c). The tested income of a CFC is the excess (if any) of the gross income of the CFC determined without regard to certain items (listed below) over deductions (including taxes) properly allocable to that gross income. The items excluded from gross income are:

1) Any items of income described in Section 952(b) (Any U.S. source income effectively connected with the conduct by such corporation);

2) Any gross income taken into account in determining subpart F income;

3) Any gross income excluded from the foregn base company income;

4) Any dividend received from a related person.

5) Any foreign oil and gas extraction income.

The tested loss of a CFC is the excess (if any) of associated deductions that exceed tested income.

The aggregate of the amounts of Section 959(c)(1) PTEP, Section 959(c)(2) PTEP, and Section 959(c)(3) E&P of a CFC must equal the E&P of the foreign corporation.

Similarly, an income inclusion under Section 951(a)(1)(A) by reason of Section 965 is not subject to an E&P limitation. Further, while

Below, please find Illustration 2 which (based on the example stated in IRS Notice 2019-01) provides how to report “Previously Taxed E&P” in accordance with Internal Revenue Code Section 959(c)(1)(A).

Illustration 2.

USP, a domestic corporation, wholly owns FC, a foreign corporation that has the U.S. dollar as its functional currency. Both USP and FC use the calendar year as their taxable year. Before 2018, the PTEP of FC was maintained in annual accounts. As of December 31, 2018, FC’s $300x of E&P (before taking into account distributions made or inclusions under Section 951(a)(1)(B) in 2018) applicable to USP’s interest in FC are classified under Notice 2019-01 as Section 3.01 as follows:

Section 959(c)(1)				Section 959(c)(2)
Year	965(a)	965(b)	951(a)(1)(B)	965(a)	965(b)	951A	951(a)(1)(A)	959(c)(3)
2018						50x	30x
2017				100x	50x			20x
2016			25x				25x
Total		25x				255x		20x

In 2018, FC has an amount described in Section 956(a) (“section 956(a) amount”) of $125x, without considering the application of Section 959(a)(2). In 2019, FC earns $25x of current E&P, and the amount of USP’s income inclusion under Section 951A(a) that is allocated to FC under Section 951A(f)(2) and proposed Treasury Regulation Section 1.951A-6(b)(2) is $20x. FC also makes a distribution of $195x in 2019. In 2020, FC earns no current E&P, but FC makes a distribution of $60x. For all years, the PTEP of FC in each PTEP group is described in a single 904 category, and all Section 959(c)(3) E&P of FC are described in a single Section 904 category.

Analysis 2018

As of december 31, 2018, before considering FC’s Section 9569a) amount, FC has total Section 959(c)(2) PTEP of $255x. Under Section 959(a)(2) and (f)(1), because FC’s Section 959(c)(2) PTEP exceeds its Section 956(a) amount, USP does not include any amount in income under Section 951(a)(1)(B). However, under Section 959(c)(1)(A), $125x of FC’s Section 959(c)(2) earnings must be reclassified as Section 959(c)(1) PTEP. The reclassified PTEP remains in the 2017 annual PTEP account. Thus, in FC’s 2017 annual PTEP account, FC’s reclassified Section 965(a) PTEP is increased by $100x and its Section 965(a) PTEP is decreased by $100x. Additionally, FC’s reclassified Section 965(b) PTEP is increased by $25x and its Section 965(b) PTEP is decreased by $25x. Accordingly, as of December 31, 2018, FC’s E&P applicable to USP’s interest in FC.

Section 959(c)(1)				Section 959(c)(2)
Year	965(a)	965(b)	951(a)(1)(B)	965(a)	965(b)	951A	951(a)(1)(A)	959(c)(3)
2018						50x	30x
2017	100x	25x			25x			20x
2016			25x				25x
Total		150x				130x		20x

2019 Current Year Adjustment

During 2019, FC earns $25x of current E&P, and the amount of USP’s income inclusion under Section 951A(a) that is allocated to FC under Section 951A(f)(2) and proposed Treasury Regulation Section 1.951A-6(b)(2) is $20x. Thus, before taking into account USP’s income inclusion with respect to FC and any distributions by FC, FC’s Section 959(c)(3) E&P is initially increased by $25x. As a result of USP’s income inclusion under Section 951A. FC’s Section 951A PTEP increases by $20x and FC’s Section 959(c)(3) E&P is decreased by $20x. Accordingly, as of December 31, 2019, FC’s E&P (before taking into account distributions made in 2019) applicable to USP’s interest in FC are classified as follows:

Section 959(c)(1)				Section 959(c)(2)
Year	965(a)	965(b)	951(a)(1)(B)	965(a)	965(b)	951A	951(a)(1)(A)	959(c)(3)
2019						20x
2018						50x	30x	25x
2017	100x	25x			25x
2016			25x				25x
Total		150x				150x		25x

Distribution

FC’s distribution of $195x is from PTEP because the entire distribution would be a dividend under Section 316(a) without regard to Section 959 that is, for the purpose of Section 316, at the end of 2019, FC has $325x of E&P (without regard to this distribution), $25x of which is current E&P). Under Section 959(c), the distribution is first treated as attributable to Section 959(c)(1) PTEP.

Section 959(c)(2) PTEP

After the Section 959(c)(1) PTEP is exhausted, the remaining portion of the distribution ($45x) is treated as attributable to Section 959(c)(2) PTEP, to the extent thereof. The distributions are first sourced from Section 965(a) PTEP and then from Section 965(b) PTEP, and then pro rata from the remaining PTEP groups that contain Section 959(c)(2) PTEP under a LIFO approach. Thus, in FC’s 2017 annual PTEP account, FC’s Section 965(b) PTEP is decreased by $25x. In FC’s 2019 annual PTEP account, FC’s Section 951A PTEP is decreased by $20x. Because the entire distribution has been accounted for, the remaining PTEP groups that contain Section 959(c)(2) PTEP and FC’s Section 959(c)(3) E&P are not affected. Accordingly, as of December 31, 2019, FC’s E&P applicable to USP’s interest in FC are classified as follows:

Section 959(c)(1)				Section 959(c)(2)
Year	965(a)	965(b)	951(a)(1)(B)	965(a)	965(b)	951A	951(a)(1)(A)	959(c)(3)
2019
2018						50x	30x	25x
2017
2016							25x
Total						150x		25x

2020

FC’s distribution of $60x is from PTEP because the entire distribution would be divided under Section 316(a) without regard to Section 959 (that is, for purposes of Section 316, at the end of 2020, FC has $130x of E&P (without regard to the distribution), all which is accumulated E&P). Under Section 959(c), the distribution is first treated as attributable to Section 959(c)(1) PTEP; however, FC has no Section 959(c)(1) PTEP. Additionally, FC has no Section 965(a) PTEP or Section 965(b) PTEP. This distribution is sourced pro rata from the remaining PTEP groups that contain Section 959(c)(2) PTEP under a LIFO approach. Thus, in FC’s 2018 annual PTEP account, FC’s Section 951A PTEP is decreased by $37.5x ($60x x $50x/$80X) and its Section 951(a)(1)(A) PTEP is decreased by $22.5x ($60x x $30x/$80x). Because the entire distribution has been accounted for, the remaining PTEP groups that contain Section 959(c)(2) PTEP and FC’s Section 959(c)(3) E&P are not affected. Accordingly, as of December 31, 2010, FC’s E&P applicable to USP’s interest in FC are classified as follows:

Section 959(c)(1)				Section 959(c)(2)
Year	965(a)	965(b)	951(a)(1)(B)	965(a)	965(b)	951A	951(a)(1)(A)	959(c)(3)
2019
2018						12.5x	7.5x
2017								25x
2016							25x
Total						45x		25x

Column (f)

Use column (f) to report the opening and closing balance of the foreign corporation’s accumulated E&P. This amount is the sum of post-2017 E&P not previously taxed, post-1986 undistributed earnings, pre-1987 E&P not previously taxed, and PTI. Do not include column (d) amounts in the total reported in column (f).

Specific Instructions Related to Lines 1 Through 14

Line 1a

Line 1a asks the preparer to enter the balances for each column at the beginning of the tax year. These balances should equal the amounts reported as the ending balances in the prior year Schedule J.

Line 1b.

Line 1b states if there is a difference between last year’s ending balance on Schedule J and the amount which should be last year’s ending balance, include the difference for the difference. If there are multiple differences, include the explanation and amount of each such difference on the attachment. A preparer must not include adjustments required to be reported on line 6 or 12.

Line 2b.

Line 2b asks the preparer to list an “disallowed deduction for taxes suspended under the “anti-splitter rules.” This line is for unsuspended taxes under Section 909 as a result of related income taken into account by the foreign corporation, certain U.S. corporate owners of the foreign corporation, or a member of such U.S. corporate owner’s consolidated group. Report the unsuspended taxes in line 2a of column (a), (b), (c) , or (e), as applicable.

A preparer answering must understand Internal Revenue Code Section 901. Under Internal Revenue Code Section 901(b)(1), U.S. citizens and U.S. corporations are entitled to a foreign tax credit for “the amount of any income, war profits, and excess profits taxes paid or accrued during the tax year to any foreign country or to any possession of the United States. The taxpayer entitled to the credit is the taxpayer legally liable for the foreign tax under foreign law (the “technical taxpayer” rule). Under this “technical taxpayer” rule, the person who has legal liability for a foreign tax can be different than the person who realizes the underlying income under U.S. tax principles, resulting in a separation or “splitting” for the foreign income flowing up to the United States without associated income being subject to tax in the United States. Congress enacted Internal Revenue Code Section 909 to address this issue.

Under Internal Revenue Code Section 909, where there is a “foreign tax credit splitting event” with respect to foreign income tax is not taken into account for U.S. tax purposes before the tax year in which the related income is taken into account by the taxpayer. The definition of “foreign tax credit splitting event” is broad and could reach a variety of situations such as disregarded payments, or transfer pricing adjustments.

Any foreign tax credits reduced or suspended under a splitting event, must list that amount in line 2b.

Line 4

Report as a positive number E&P attributable to PTI distributions from lower-tier foreign corporations. The E&P of a CFC attributable to amounts which are, or have been, included in the gross income of a U.S. shareholder under Section 951(a), are not, when distributed through a chain of ownership described in Section 958(a), also included in the gross income of another CFC.

Any preparer must be understand Internal Revenue Code Section 958(a) in order to answer Line 4. Under Section 958(a), stock owned directly or indirectly by or for a foreign corporation, foreign partnership, foreign trust or foreign estate is considered as being owned proportionately by its shareholders, partners or beneficiaries. Stock so considered as owned is treated as actually owned for purposes of applying the direct and indirect ownership rules.

Line 5a.

Line 5a asks the preparer to enter earnings carried over to a surviving corporation after an acquisition by a foreign corporation of the assets by a foreign corporation described in Section 381. See Regulations 1.367(b)-7.

Line 5b.

Line 5b asks the preparer to list any deficit of a foreign surviving corporation. For more information, see the discussion above on hovering deficits.

Line 6.

Line 6 asks the preparer to attach a statement detailing the nature and amount of any adjustments not accounted for in the E&P determined before reduction for reductions for distributions.

Line 7.

Line 7 asks the preparer to enter on Line 7 E&P as of the close of the tax year before actual distributions or inclusions under Section 951(a)(1) or Section 951A during the year.

Line 8.

Line 8 asks the preparer to enter amounts included in gross income of the U.S. shareholder(s) under Section 951(a)(1)(A) or Section 951A with respect to the CFC.

Line 9.

Line 9 asks the preparer to report actual distributions as negative numbers.

Line 10.

Line 10 asks the preparer to use line 10 to report reclassifications of Section 959(c)(2) PTI.

Line 11.

Line 11 asks the preparer to use this line to report E&P not previously taxed, which is treated as earnings invested in U.S. property and therefore, reclassified as Section 959(c)(1) PTI (column (e)(i)).

Line 12.

Line 12 asks the preparer to attach a statement detailing the nature and amount of any adjustments in E&P not accounted for on lines 8 through 11.

Line 13.

Line 13 asks the preparer to list any hovering deficit offset included in column (d) is reported as a positive number. The same amount entered in column (d) is reported as a negative number in line 13 of column (a) or (b), as appropriate.

Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in international tax matters throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.