The U.S. Department of the Treasury and the IRS have issued proposed regulations (REG-115646-25) implementing the One Big Beautiful Bill Act’s (OB3) changes to the rules for determining a U.S. shareholder’s1 pro rata share of a controlled foreign corporation’s (CFC) Subpart F income, tested income, and tested loss. The proposed rules provide guidance on how those amounts are allocated when CFC ownership changes during the year, when a foreign corporation’s tax year closes, and how certain transition rule dividends are treated.
The proposed regulations generally apply to taxable years beginning after December 31, 2025. Taxpayers may rely on the proposed regulations before they are finalized if they apply them consistently and in their entirety.
New IRC §951 & §951A Rules for Allocating Subpart F & Tested Income
Before the OB3, a U.S. shareholder generally was required to include its pro rata share of a CFC’s Subpart F income only if it owned stock in the CFC on the last day of the taxable year that the corporation was a CFC. The OB3 replaced that approach by requiring a U.S. shareholder to take into account its share of Subpart F income if it owns CFC stock at any time during the CFC year. As a result, Treasury and the IRS needed to establish rules for determining how Subpart F income, tested income, and tested loss are allocated when ownership of a CFC changes during the year.
IRS Proposes Daily Proration Method for CFC Income Allocations
One of the most significant aspects of the proposed regulations is the allocation of Subpart F income, tested income, and tested losses using a daily proration method when ownership of a CFC changes during the year. Under this approach, a U.S. shareholder’s pro rata share is based on both its ownership percentage and the portion of the year during which it owned the CFC stock.
The regulations also provide detailed rules for situations involving multiple classes of stock and changes in the number of shares outstanding during the year, including stock issuances and redemptions. These rules are intended to ensure that Subpart F income, tested income, and tested losses are allocated in a manner that reflects both ownership interest and ownership periods.
New Rules for CFC Tax Year Closings
The proposed regulations provide both mandatory and elective tax year closing rules for foreign corporations. A foreign corporation generally must close its taxable year when it becomes or ceases to be a CFC. The IRS explained that the mandatory closing rule is intended to prevent income, gain, deduction, or loss from periods when the foreign corporation was not subject to the CFC regime from affecting the determination of a shareholder’s Subpart F income, tested income, or tested loss.
The regulations also permit an elective tax year closing when a significant ownership variance occurs. In general, a significant ownership variance exists when specified transfers result in a decrease of more than 50% in ownership by IRC §958(a) U.S. shareholders. However, transfers between related parties generally are not taken into account for this purpose.
For this purpose, transfers involving partnerships may need to be analyzed by looking through the partnership to determine whether there has been the requisite reduction in ownership by IRC §958(a) U.S. shareholders. Thus, a transfer of a partnership interest can be relevant if it changes the indirect ownership of CFC stock held through the partnership, but the CFC year does not close merely because a partnership interest is transferred; the significant ownership variance threshold and related transfer rules must be satisfied.
If the election is made, the CFC’s taxable year closes for all U.S. shareholders and for all purposes of the IRC. The IRS stated that this election is intended to provide greater certainty in transactions involving substantial ownership shifts while limiting opportunities for abuse in cases involving smaller or related party transfers.
Transition Rule Guidance for Certain Dividends
In addition to implementing the new IRC §951 and §951A rules, the proposed regulations provide guidance on the transition rule enacted as part of the OB3. The transition rule generally addresses how certain dividends paid before the new pro rata share regime becomes fully effective are treated when applying the former IRC §951(a)(2)(B) rules. The proposed regulations largely incorporate guidance previously provided in Notice 2025-75 and clarify when a dividend will be disregarded for purposes of reducing a shareholder’s pro rata share of Subpart F income or tested income.
The regulations also retain documentation requirements for taxpayers relying on the transition rule. The IRS declined requests for broader safe harbors and generally continues to require taxpayers to substantiate that a dividend increased the taxable income of a U.S. person subject to federal income tax.
Implications of the Proposed IRC §951 & §951A Allocation Rules
The proposed rules may create new planning and compliance considerations. The timing of stock acquisitions, dispositions, redemptions, and other ownership changes may directly affect a U.S. shareholder’s pro rata share of Subpart F income and tested income. Taxpayers also should evaluate the interaction of the new allocation rules with foreign tax credit calculations, information reporting requirements, and transactions involving multiple classes of CFC stock.
How Forvis Mazars Can Help
Professionals at Forvis Mazars can help taxpayers evaluate the impact of the proposed regulations on existing structures and planned transactions, model potential effects on Subpart F and IRC §951A inclusions, assess foreign tax credit implications, and address reporting considerations. Contact us to learn more.
- 1Internal Revenue Code (IRC) §951(b) states that a U.S. shareholder is defined as a U.S. person who owns, under IRC §958(a), or is considered to own under IRC §958(b), 10% or more of the total combined voting power of all classes of voting stock or 10% or more of the total value of shares of all classes of stock.