Proposed Regulations Address CFC Taxable Year And Partial FTC Disallowance On PTEP Distributions

On July 31, 2026, the U.S. Treasury Department (“Treasury”) and the Internal Revenue Service (IRS) issued proposed regulations (REG-115145-25) (the “Proposed Regulations”), published in the Federal Register on August 3, 2026, addressing two changes to the Internal Revenue Code of 1986, as amended (the “Code”),¹ that were made under the One Big Beautiful Bill Act (OBBBA): 

• the allocation of foreign income taxes of specified foreign corporations whose taxable years change as a result of the repeal of the one-month deferral election that was previously permitted under former section 898(c)(2) (Prop. Reg. §1.898(c)-1) 
• the new section 960(d)(4) foreign tax credit (FTC) partial disallowance applicable to certain previously taxed earnings and profits (PTEP) distributions attributable to section 951A inclusions (Prop. Reg. §1.960-3).

The Proposed Regulations largely follow the roadmap set out in IRS Notice 2025-72 (issued November 25, 2025, addressing section 898(c) allocation) and IRS Notice 2025-77 (issued December 4, 2025, addressing section 960(d)(4)).

However, the Proposed Regulations also expand upon the guidance in those notices in several important respects. Most notably, as discussed below, the Proposed Regulations add four new elections under Prop. Reg. § 1.898(c)-1 that provide taxpayers more flexibility to manage their FTC profile between a short first required year and the following full succeeding taxable year.

This alert summarizes the key provisions of the Proposed Regulations, compares them to the prior notices and provides illustrative examples.

Background

Repeal of Section 898(c)(2) and one-month deferral

Prior to its repeal by section 70352 of the OBBBA, section 898(c)(2) permitted “specified foreign corporations” to elect a taxable year ending one month earlier than the majority U.S. shareholder’s taxable year (the “one-month deferral election”). For a calendar-year majority U.S. shareholder of a controlled foreign corporation (a CFC), this meant that the CFC could elect to use a November 30 year-end, which effectively resulted in a one-year deferral of U.S. shareholder taxes in respect of inclusions under section 951 and section 951A.

The repeal requires these CFCs to change to a taxable year conforming with their majority U.S. shareholder’s year (e.g., a December 31 year-end for CFCs with calendar year majority U.S. shareholders).

This change creates a short “first required year” (e.g., December 1–31, 2025 for a CFC that previously used a November 30 year-end) followed by the first full “succeeding taxable year” (e.g., January 1–December 31, 2026). The Proposed Regulations address how foreign income taxes that relate to a foreign tax year straddling the short first required year and the succeeding taxable year are to be allocated.

Section 960(d)(4) FTC disallowance

Section 70312(b) of the OBBBA added new section 960(d)(4), which disallows a foreign tax credit for 10% of the foreign income taxes paid (or deemed paid under section 960(b)(1)) or accrued with respect to amounts excluded from gross income under section 959(a) by reason of a prior section 951A inclusion.

Section 960(d)(4) matches the 10% haircut that is imposed on the deemed paid FTCs available in respect of the section 951A inclusions themselves under section 960(d)(1). New section 960(d)(4) applies to foreign income taxes paid (or deemed paid) or accrued with respect to any PTEP relating to inclusions under section 951A in taxable years of U.S. shareholders ending after June 28, 2025.

The notices

Notice 2025-72 announced forthcoming proposed regulations under section 898(c) and described the intended rules for allocating specified foreign income taxes between the first required year and succeeding taxable year. Taxpayers were permitted to rely on the notice’s rules for taxes paid or accrued in taxable years beginning after November 30, 2025, and ending before the proposed regulations were published in the Federal Register.

Notice 2025-77 announced forthcoming proposed regulations under section 960(d)(4) and described the PTEP group bifurcation mechanism. Taxpayers were permitted to rely on its rules for taxable years of U.S. shareholders beginning before the date that the Proposed Regulations were published in the Federal Register.

Prop. Reg. §1.898(c)-1 (Section 898(c))

Prop. Reg. §1.898(c)-1 follows many of the core elements contained in Notice 2025-72 for purposes of allocating an “affected corporation’s”² “specified foreign income taxes”³ between the “first required year”⁴ and the “succeeding taxable year.”⁵

The affected corporation’s specified foreign income taxes are first allocated to each income group under Treas. Reg. §1.960-1(d)(2) and the PTEP groups treated as income groups under Treas. Reg. §1.960-1(d)(3)(ii)(B) (e.g., subpart F income group, tested income group, residual income group).

The specified foreign income taxes in an income group are then further allocated to the first required year under the general rule using a single, entity-wide allocation percentage applied to all specified foreign income taxes. The allocation percentage for the first required year is an amount, expressed as a percentage, equal to (i) the affected corporation’s taxable income (for the relevant foreign taxable year) attributable to the first required year (determined based on the principles of Treas. Reg. §1.1502-76(b))⁶ pided by (ii) the affected corporation’s total taxable income for the relevant foreign taxable year.⁷

The portion of any specified foreign income taxes in an income group that are not allocated to the first required year based on the allocation percentage are allocated to the succeeding taxable year.

The most significant departure in the Proposed Regulations from Notice 2025-72 is the four new elections that are available under the Proposed Regulations.

1. New election: specified distributive shares of CFTEs

What changed

Notice 2025-72 expressly excluded an affected corporation’s distributive share of creditable foreign tax expenditures (CFTEs) from an affected partnership from the definition of “specified foreign income tax,” meaning those taxes would never be allocated.

In response to comments, the Proposed Regulations introduce an election that permits an affected corporation to treat its “specified distributive shares of CFTEs”—its distributive share of CFTEs from an “affected partnership” (a partnership that takes into account foreign income taxes under an accrual method and that is required to change its taxable year because of the section 898(c)(2) repeal)—as specified foreign income taxes subject to allocation.

The election reaches a distributive share of CFTEs only if the CFTEs are foreign net income taxes, the affected corporation takes the share into account in its first required year, and the affected partnership’s first required year ends on the same date as the affected corporation’s first required year. If the election is not made, the exclusion continues and these CFTEs are taken into account entirely in the first required year.

Example

CFCX owns interests in Partnership W (not required to change its year—not an “affected partnership”) and Partnership Y (required to change its year—an “affected partnership”). CFCX has a 4,000u distributive share of Partnership W’s tax and a 6,000u distributive share of Partnership Y’s tax.

Without the election

Neither share is allocated. Both are taken into account entirely in the first required year.

With the election

The 6,000u Partnership Y share is allocated between the first required year and succeeding taxable year (using the applicable allocation percentage). The 4,000u Partnership W share is still not allocated.

2. New election: income group specific allocation percentage

What changed

Notice 2025-72 provided a single, entity-wide allocation percentage as the only methodology.

The Proposed Regulations introduce an election to apply an income-group-specific allocation percentage computed separately for each income group, using the closing-of-the-books method described in Treas. Reg. §1.1502-76(b)(2)(i) rather than the ratable allocation alternative that is available under the general rule. This election recognizes that income in different categories (e.g., tested income referred to as “CFC income” or foreign base company services income referred to as “FBC services income”) may not accrue ratably across groups.

Example

CFCX accrues 7,200u of Country X tax, allocated: 5,400u to the CFC income group and 1,800u to the FBC services income group. Total Country X taxable income is 45,000u, with 33,750u considered CFC income and 11,250u considered FBC services income.

Single allocation percentage

Assuming 3,750u of total taxable income is considered to arise in the first required year, the general allocation percentage would be 8.33% (3,750u/45,000u). The first-required-year allocation of taxes would thus be: 450u of CFC income taxes (5,400u × 8.33%) and 150u of FBC services income taxes (1,800u × 8.33%).

Income-group-specific election

Assuming that, of the first-required year income, 2,250u is CFC income (out of a total of 33,750u) and 1,125u is FBC services income (out of a total of 11,250u), the allocation percentages would be: 6.66% (2,250u/33,750u) for CFC income and 10% (1,125u/11,250u) for FBC services income.

Accordingly, if the election were made, 360u of CFC income taxes (5,400u × 6.66%) and 180u of FBC services income taxes (1,800u × 10%) would be allocated to the first required year, and the remaining 5,040u and 1,620u, respectively, would be allocated to the succeeding taxable year.

Note

The election produces different allocations when income in different groups arises in different periods. Here, the FBC services income was more concentrated in December 2025, resulting in a higher group-specific allocation percentage for FBC services income taxes to the first required year, while more CFC income taxes were pushed into the succeeding taxable year.

3. New election: relevant succeeding year taxes

What changed

Notice 2025-72 provided that taxes accrued in the succeeding taxable year would never be allocated. Rather, they would fall entirely into the succeeding taxable year under normal accrual rules.

The Proposed Regulations add a new irrevocable election to allocate “relevant succeeding year taxes”—foreign net income taxes accrued by the affected corporation in the succeeding taxable year that relate to a foreign taxable year beginning before the succeeding taxable year (e.g., a non-calendar foreign tax year such as an April 1–March 31 year-end). This election was added in response to a comment noting that absent allocation, affected corporations with mismatched foreign tax years could permanently lose FTC capacity.

Note

Unlike the other three elections, which may be revoked, the election to allocate succeeding year taxes is irrevocable once made.

Example

CFCX wholly owns DEZ, a disregarded entity in Country Z with a non-calendar (April 1–March 31) foreign tax year. DEZ accrues 5,000u of Country Z tax in CFCX’s succeeding taxable year (2026) for the Country Z taxable year ending March 31, 2026—a foreign taxable year that began (April 1, 2025) before the succeeding taxable year.

Without the election

The entire 5,000u falls into the succeeding taxable year (2026). No allocation.

With the election

The 5,000u is allocated between the first required year and succeeding taxable year using the applicable allocation percentage.

4. New election: opt out of allocation entirely

What changed

Notice 2025-72 did not contemplate any option to forgo allocation. The methodology applied mandatorily.

The Proposed Regulations add a non-allocation election permitting an affected corporation to have all specified foreign income taxes taken into account entirely in the first required year, applying current-law accrual rules without allocation. This responds to a comment from practitioners who preferred simplicity or obtained a better FTC result by not splitting taxes. The election applies to all specified foreign income taxes of the affected corporation, and if it is made, the affected corporation’s relevant succeeding year taxes may not be allocated.

Example

If CFCX makes the non-allocation election, the entire 7,200u of Country X tax is taken into account in full in the first required year (December 1–31, 2025). No allocation percentage is computed. This may be advantageous where the affected corporation expects sufficient section 904 limitation in the short first required year.

Countervailing considerations also apply, however. Calendar-year taxpayers weighing this election should also consider that a December 1–31, 2025 first required year begins before, and the succeeding taxable year begins after, December 31, 2025. As a result, the OBBBA amendments to sections 951, 951A and 960(d)(1)—including the increase in the section 960(d)(1) deemed-paid percentage from 80% to 90%—would generally apply to the succeeding taxable year but not to the first required year.

Making the elections—new procedural rules

The Proposed Regulations provide detailed procedural rules for making these new elections.

The elections are made for the affected corporation’s first required year by “controlling domestic shareholders” as defined in Treas. Reg. §1.964-1(c)(5)—i.e., U.S. shareholders collectively possessing more than 50% of the CFC’s total combined voting power.

Once an election is made (or not made) by the controlling domestic shareholders, it applies to all U.S. shareholders of the affected corporation.

Each election is made by attaching a statement to Form 5471 with a specified title:

– “Section 898 Specified Distributive Shares of CFTEs Election Statement”

– “Section 898 Income Group Specific Election Statement”

– “Section 898 Non-Allocation Election Statement”

– “Section 898 Relevant Succeeding Year Tax Election Statement”

Elections on an original return: attached to Form 5471 filed with the original income tax return for the relevant taxable year. Elections via amended return: only the CFTE and income-group-specific elections may be made on an amended return. Any such election, and any available revocation, must be filed within 24 months of the original return’s due date (determined without regard to extensions).

Three of the four elections (CFTE, income-group-specific, and non-allocation) may be revoked by attaching a revocation statement to Form 5471. The relevant succeeding year tax election is irrevocable once made.

Prop. Reg. §1.960-3 (Section 960(d)(4))

The section 960(d)(4) rules and the PTEP group bifurcation mechanism were adopted without substantive change from Notice 2025-77, as Treasury and the IRS noted that no comments were received on those provisions.

Specifically, the existing “section 951A PTEP” group under Treas. Reg. §1.960-3(c)(2)(viii) is bifurcated into two sub-groups:

– A “pre-06/29/25 section 951A PTEP” group (for section 951A inclusions in U.S. shareholder taxable years ending on or before June 28, 2025)

– A “post-06/28/25 section 951A PTEP” group (for inclusions in U.S. shareholder taxable years ending after June 28, 2025)

New section 960(d)(4) applies to disallow 10% of the FTCs otherwise allowable with respect to taxes allocated to the post-06/28/25 section 951A PTEP group. The disallowance applies both to foreign income taxes attributable to the distribution and to foreign income taxes deemed paid under section 960(b)(1) with respect to the distribution, and so can apply in tiered CFC structures.

For purposes of applying section 960(d)(4), taxes on PTEP distributions are allocated between the pre- and post-groups proportionately based on the amount distributed from each group, with the ordering of distributions following section 959(c) and Treas. Reg. §1.959-3(b), treating distributions as first paid from the section 951A PTEP group for the current year and then the section 951A PTEP group for the most recent prior taxable years.

Example (Section 960(d)(4)/PTEP bifurcation)

USP, a domestic corporation, wholly owns FC1, a CFC. FC1 has $100x of tested income (and a corresponding section 951A inclusion for USP) in each of calendar years 2024 and 2025. On January 1, 2026, FC1 distributes $150x to USP as a section 959(a) distribution. Country X imposes a $30x withholding tax.

Of the $150x distribution, $100x is treated as distributed from post-06/28/25 section 951A PTEP (from the 2025 inclusion year) and $50x as pre-06/29/25 section 951A PTEP (from the 2024 inclusion year). The $30x withholding tax is allocated proportionately: (i) $20x to the post-06/28/25 group and (ii) $10x to the pre-06/29/25 group.

Of the $20x of FTCs otherwise allowable with respect to the post-06/28/25 PTEP group, $2x (10%) is disallowed under section 960(d)(4). The $10x on the pre-06/29/25 group is fully allowable (subject to other limitations). Because the operative test is the U.S. shareholder’s inclusion year rather than the date of distribution, the result would be the same if the $150x distribution had instead occurred on February 1, 2025.

Applicability dates

The Proposed Regulations under section 898(c) apply to taxable years of specified foreign corporations beginning after November 30, 2025.

The Proposed Regulations implementing section 960(d)(4) generally apply to section 951A inclusions in taxable years of U.S. shareholders ending after June 28, 2025.

Taxpayers may rely on the rules set forth in the Proposed Regulations before they are published as final regulations provided the taxpayers follow them in their entirety and in a consistent manner for the relevant taxable years.

Treasury and the IRS expect to finalize the Proposed Regulations by January 4, 2027. Comments on the Proposed Regulations, and requests for a public hearing, are due 45 days after publication in the Federal Register (i.e., September 17, 2026).

Footnotes

1.. Unless otherwise indicated, all “section” references contained herein are to sections of the Code.

2. An “affected corporation” is defined as a specified foreign corporation that uses the accrual method of accounting for foreign income taxes and whose first taxable year beginning after November 30, 2025, ends, pursuant to section 70352(c) of the OBBBA, on the date prescribed by that section (i.e., a CFC that was using the one-month deferral election and must change its taxable year).

3. A “specified foreign income tax” is defined as a foreign net income tax that (i) is accrued (without regard to Prop. Reg. §1.898(c)-1) by the affected corporation in its first required year and (ii) is a tax for which the affected corporation is the taxpayer under Treas. Reg. §1.901-2(f). Because the definition is limited to foreign net income taxes for which the affected corporation is the section 901 taxpayer and that are accrued in its first required year, it does not reach withholding taxes, a CFTE (as defined below) distributive share (absent the new election discussed below), or a tax accrued in the succeeding taxable year.

4. The “first required year” is defined as the affected corporation’s or affected partnership’s first taxable year beginning after November 30, 2025 (e.g., December 1–31, 2025).

5. The “succeeding taxable year” is defined as the first full taxable year following the first required year (e.g., January 1–December 31, 2026).

6. Very generally, Treas. Reg. §1.1502-76(b) governs how a corporation’s items of income, gain, deduction, loss, and credit are allocated between consolidated and separate returns when the corporation joins or leaves a consolidated group during a tax year. The regulation generally applies an “end of the day rule,” that treats the applicable corporation as becoming, or ceasing to be, a member of the relevant consolidated group at the end of the day that its status changes, as determined on a closing-of-the-books basis. The regulation also allows, in certain instances, for a ratable allocation election to prorate non-extraordinary items between the periods before and after the change in group membership, with extraordinary items being allocated to the period in which they arose on a closing-of-the-books basis.

7. The allocation has effects beyond the timing of the foreign tax credit. Because the amounts allocated to the first required year and the succeeding taxable year are treated as accruing in each respective year for all purposes of the Code other than sections 905(c) and 986(a), the allocation feeds directly into the computation of the affected corporation's subpart F income and tested income for each year. Among other things, it determines whether an item satisfies the high-tax exception to foreign base company income under Treas. Reg. §1.954-1(d) or the high-tax exclusion from tested income under Treas. Reg. §1.951A-2(c)(7) in either year.