April 18, 2018 Connecticut Department of Revenue Services issues guidance on state's treatment of and reporting requirement for IRC Section 965 transition tax The Connecticut Department of Revenue Services (DRS) has issued Office of the Commissioner Guidance, OGC-4, detailing the state's treatment of the federal transition tax under Internal Revenue Code (IRC) Section 965, and reporting requirements for Corporation Business Tax, Pass-Through Entity Tax, Personal Income Tax and Fiduciary Tax returns. General Taxpayers must report Section 965 income, in its entirety, on their 2017 Connecticut returns. The guidance reinforces that Connecticut treats Subpart F income as dividend income, and will follow the federal dividend treatment of Section 965 income. Unlike federal law, however, Connecticut will not allow taxpayers to elect to defer payment of any portion of the tax associated with Section 965 income. Corporation Business Tax Returns Corporations must include the full amount of Section 965 income (i.e., before deductions provided to achieve the special federal effective tax rates) on their 2017 Connecticut Form 1120, Schedule D, Line 9. In general, the Section 965 income that must be reported is found on Line 1 of the federal IRC 965 Transition Tax Statement. This amount also must be reported as dividend income on Form CT-1120 ATT, Schedule I, Column A. Connecticut then allows a dividends received deduction for 100% of the IRC Section 965 income, which is reported on Form CT-1120 ATT, Schedule I, Column C. Any expenses related to the Section 965 income must then be added back on Form CT-1120 ATT, Schedule I, Column D. Under legislation (SB 11) pending in the Connecticut legislature, such expenses would equal 10% of the Section 965 income. Although the legislation is pending, DRS recommends that corporations follow the proposed legislation, as 10% would be accepted by DRS as the appropriate expense addback amount upon audit. Pass-Through Entity Returns For Connecticut income tax purposes, the Section 965 amount is reported similarly to how it is reported on the federal Form 1120S. The Section 965(a) amount is reported on Form CT-1065/CT-1120SI, Part I, Schedule C, Line 11, and the Section 965(c) deduction is reported on Line 13. The Connecticut-sourced portion of any IRC Section 965 amount also must be reported on Part VI, Line 11 and Line 13, respectively. Personal Income Tax The starting point in determining a taxpayer's Connecticut income tax liability is federal adjusted gross income, Line 37 on federal Form 1040. Since the net Section 965 amount will already be included in the taxpayer's federal adjusted gross income, a resident taxpayer is not required to report such amount separately on Form CT-1040. Nonresident taxpayers, however, must report the income on Schedule CT-SI if the taxpayer receives a Schedule CT-K1 from a pass-through entity reporting Connecticut-sourced Section 965 income, or receives other information or documentation directly from a specified foreign corporation reporting income relating to Connecticut-sourced Section 965 income. Fiduciary Income Tax The starting point in determining a fiduciary's Connecticut income tax liability is the federal taxable income of the trust or estate, Line 22 of federal Form 1041. Because the net Section 965 amount will already be included in the federal taxable income of the trust or estate, the fiduciary is not required to report the amount separately on its Connecticut fiduciary return. If the net Section 965 income is not distributed to beneficiaries, the fiduciary must complete and include a statement similar to the IRC 965 Transition Tax Statement reporting the amount required to be included in Connecticut income. Implications OGC-4 provides clarity around how the IRC Section 965 amount should be reported on Connecticut income tax returns. For corporate income tax purposes, while a full dividends received deduction is allowed against Section 965 amounts, many taxpayers may be surprised by the DRS's administrative position that disallowed expenses are presumed to be 10% of any Section 965 amount. Although the DRS position is in accordance with proposed legislation, there are two important considerations. First, the legislation has not been enacted and therefore carries no authority at present. Second, even if enacted, the bill would allow taxpayers to petition for an alternative computation of the expense addback if they can show that the default 10% addback is not representative of associated expenses. For personal income tax purposes, OGC-4 clarifies that Connecticut income tax will be based on the net Section 965 amount reported on a taxpayer's federal tax return. ———————————————
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