Some foreign subsidiaries now have a taxable year one month long, and Treasury has proposed how to split a year of foreign taxes across it
Some controlled foreign corporations have just lived through a taxable year that lasted a month.
That is the mechanical consequence of section 70352 of Public Law 119-21, which repealed the one-month deferral election in section 898(c)(2) for taxable years of specified foreign corporations beginning after 30 November 2025. A specified foreign corporation must otherwise use the taxable year of the United States shareholder that owns more than half of it. The repealed election let it run a year that opened a month earlier. Strip that away and the first required year is the stub between the old year end and the new one, which for a corporation that had elected is exactly one month long, and the statute treats the change as initiated by the corporation and consented to by the Secretary.
On Friday morning the Treasury Department and the Internal Revenue Service filed proposed regulations saying what happens to the foreign taxes that land in that month.
One method, not a reasonable one
A foreign tax does not divide itself.
The proposed rules set an allocation percentage for each specified foreign income tax. It is the portion of the corporation's taxable income under foreign law attributable to the first required year under the principles of section 1.1502-76(b), over total taxable income under foreign law for the foreign taxable year the tax is imposed on. A commenter asked for permission to use any reasonable method that matched taxes to the income they relate to, including allocation back into the preceding year. Treasury and the IRS declined, and the preamble gives the statutory reason as well as the practical one: section 70352(c) directs allocation between the first taxable year and the one that succeeds it, and not to an earlier year.
Two escapes survive. Proposed section 1.898(c)-1(e)(3) would let a taxpayer elect a separate percentage for each income group, which the preamble accepts is sometimes the better match and generally the more burdensome analysis. Proposed section 1.898(c)-1(e)(4) would let a taxpayer elect not to allocate at all, in which case the whole specified foreign income tax is taken into account in the one-month year.
The other half is a straight disallowance
The same document carries a second set of rules that has nothing to do with stub years.
Section 70312(a)(1) of the same Act raised the figure in section 960(d)(1) from 80 percent to 90 percent, cutting the reduction in deemed paid foreign taxes on a section 951A inclusion from 20 percent to 10. Section 70312(b) then added section 960(d)(4), which disallows a credit for 10 percent of the foreign income taxes paid, accrued or deemed paid on a distribution of previously taxed earnings and profits that came from such an inclusion. To make that operable the proposed regulations would split the existing section 951A PTEP group in section 1.960-3(c)(2)(viii) in two, at inclusions in shareholder years ending after 28 June 2025. Notice 2025-77 described those rules last year and drew no comments, so they are proposed as they stood.
Dates
Comments and any request for a hearing are due 45 days after publication, under REG-115145-25 at regulations.gov.
The Treasury Department and the IRS say they expect to finalise by 4 January 2027. Reliance is available before then on each half separately, provided the half relied on is applied in its entirety and in a consistent manner. The preamble also says the PTEP proposed regulations published on 2 December 2024 will be conformed to this one, and that a separate proposal on pretransition section 987 gain or loss is still to come.
