Treasury and the IRS have issued proposed regulations (REG-115145-25) under Internal Revenue Code (IRC) Sections 898(c) and 960(d)(4) addressing two international tax changes enacted under the One Big Beautiful Bill Act (OB3). The guidance provides rules for allocating certain foreign taxes following the repeal of the one-month deferral election for specified foreign corporations (SFCs) and implements the foreign tax credit limitation applicable to certain distributions of previously taxed earnings and profits (PTEP) associated with net controlled foreign corporation tested income (NCTI).
Foreign Tax Allocation Rules Following Repeal of the One-Month Deferral Election
Prior to the enactment of the OB3, an SFC generally could elect a taxable year beginning one month earlier than the taxable year of its majority U.S. shareholder. The legislation repealed this election for taxable years beginning after November 30, 2025. As a result, many SFCs were required to transition to a new taxable year, often resulting in a one-month short taxable year as part of the change. Furthermore, this one-month short taxable year would be included in a U.S. shareholder’s 2025 taxable year.
This transition created a practical concern for taxpayers claiming foreign tax credits. In many cases, a foreign income tax imposed on a full foreign taxable year may accrue during the SFC’s short taxable year for U.S. tax purposes. Without a transition rule, foreign taxes and the income to which those taxes related could be recognized in different taxable years, potentially affecting the amount of foreign taxes available for foreign tax credit purposes. The proposed regulations address this issue by providing rules to allocate certain foreign income taxes between the SFC’s short transition year and the succeeding taxable year.
Section 898 Proposed Regulations Provide Multiple Foreign Tax Allocation Elections
Consistent with prior Notice 2025-72, the proposed regulations generally require certain foreign net income taxes accrued during an affected corporation’s short transition year to be allocated between the transition year and the succeeding taxable year. Rather than allowing taxpayers to adopt any reasonable allocation method, Treasury and the IRS provided prescribed methodologies through various elections that a taxpayer may choose from.
- Election for Partnership Foreign Taxes: An affected SFC generally considers its share of creditable foreign tax expenditures (CFTEs) paid by a partnership. If a partnership also experiences a short taxable year because of the SFC’s required year-end change, taxpayers may elect to include certain partnership-level foreign taxes in the allocation. This election is intended to address situations where the same timing issues that affect an SFC’s direct foreign taxes also arise through partnership investments.
- Election for Income Group Specific Allocation: Rather than applying a single allocation percentage across all income groups, taxpayers may elect to calculate separate allocation percentages for each income group. This approach may better align foreign taxes with the categories of income to which those taxes relate, particularly when income patterns vary significantly throughout the year.
- Election to Not Allocate: Taxpayers may also elect not to allocate specified foreign income taxes between the transition year and the succeeding taxable year. Instead, the taxes remain fully in the short transition year. For some taxpayers, this may provide a simpler administrative result and could produce a more favorable foreign tax credit outcome.
- Election to Allocate Relevant Succeeding Year Taxes: Taxpayers may make an election to allocate certain foreign taxes accrued in the succeeding taxable year when the related foreign taxable year began the start of that year. This election may help preserve the connection between income recognized during the short transition year and the foreign taxes imposed on that income.
Forvis Mazars Insight:The availability of multiple elections means taxpayers should carefully evaluate their facts and circumstances and model the potential impact of each alternative before filing returns for affected years. Different elections could produce significantly different foreign tax credit results. Time is of the essence as this evaluation must be done before the filing of a taxpayer’s 2025 tax return (which would be October 15, 2026, for a calendar year taxpayer that requested an extension for filing).
Section 960(d)(4) Requires Separate PTEP Tracking for Foreign Tax Credit Purposes
In addition to the IRC §898 guidance, the proposed regulations implement IRC §960(d)(4), which was enacted as part of the OB3 and limits the foreign tax credits available with respect to certain distributions of 951A PTEP. The guidance largely follows the framework previously described in Notice 2025-77 and provides additional detail regarding how taxpayers should track and apply the foreign tax credit limitation.
A key aspect of the guidance is the creation of separate 951A PTEP groups for inclusions occurring before and after June 28, 2025. Under the proposed regulations, taxpayers must distinguish between PTEP arising from IRC §951A inclusions in taxable years ending on or before June 28, 2025, and PTEP arising from IRC §951A inclusions in taxable years ending after that date.
This distinction is important because the 10% foreign tax credit disallowance under IRC §960(d)(4) applies only to foreign taxes associated with 951A PTEP distributions post June 28, 2025. Foreign taxes attributable to pre-June 29, 2025, 951A PTEP generally are not subject to the limitation.
Forvis Mazars Insight: As a result, taxpayers will need to maintain additional PTEP tracking and records to properly determine the foreign tax credit consequences of future distributions.1
How Forvis Mazars Can Help
Taxpayers affected by the repeal of the one-month deferral election should evaluate which IRC §898 elections best align with their foreign income and foreign tax profile. In addition, taxpayers should review their PTEP tracking processes to ensure that 951A PTEP (attributable to periods before and after June 28, 2025) is properly segregated for foreign tax credit purposes. The proposed regulations do permit taxpayers to rely on the rules prior to finalization if applied consistently and in their entirety. Our international tax professionals can help assess the impact of these rules, model available elections, and evaluate tax credit and PTEP reporting considerations. Contact us to learn more.
- 1 Schedule P of IRS Form 5471 is used to track a U.S. shareholder’s PTEP with respect to a foreign corporation. A draft of the form reflecting post-OB3 PTEP categories has been released by the IRS.