Rodriquez v. Commissioner, No. 12-60533 (July 5, 2013), aff’g 137 T.C. 14 (2011) ruled recently on whether inclusion of income under sections 951 and 956 (951 Inclusions) of the Internal Revenue Code (IRC) may qualify for the preferential tax treatment afforded to qualified dividends, as defined by section 1(h)(11) of the IRC.
The Fifth Circuit agreed with the Tax Court and found that unlike qualified dividends, 951 Inclusions entail no actual transfer of property. In particular, the Fifth Circuit noted the “[s]ection 951 inclusions are calculated purely on the basis of CFC [controlled foreign corporation]-owned United Sates property and the CFC’s earnings, without any change of ownership” and that 951 Inclusions are “calculated solely on the basis of property owned by the CFC.” Because 951 Inclusions require no change in ownership of the property, they are not qualified dividends. As such, 951 Inclusions are taxed at the regular graduated rates up to 39.6% (in 2013), verses the preferential tax rate of up to 20% (in 2013) for qualified dividends. These new rates will almost double the tax liability for many taxpayers.
It should also be noted that the Fifth Circuit admitted that US taxpayer could have structured the transactions in question as a qualified dividend or it could have taken a myriad of other choices each of which “would have carried different tax implications, thereby altering our analysis.”
This acknowledgement by the Fifth Circuit is important to note forUS taxpayers with interests in controlled foreign corporations. This case serves as an important reminder that there are take-backs. If the transaction is not structured properly at the beginning, or is later determined to fall under section 951, the chance to treat the inclusion as a qualified dividend has passed and it will be taxed at regular, higher rates. It is important for taxpayers to understand the tax implications of this change, and structure their transactions accordingly.