The IRS has issued proposed regulations relating to the allocation of foreign taxes for corporations affected by the repeal of the one-month deferral election and the disallowance of foreign tax credits on certain distributions of previously taxed earnings. (Preamble to Prop Reg REG-115145-25, 8/3/2026)
Comments on the proposed regulations are due September 17, 2026, and taxpayers are “strongly encouraged” to provide feedback to the IRS electronically through the rulemaking portal, along with requests for a public hearing. Paper submissions are also accepted by mail.
Tax year mismatch from deferral election repeal
The One Big Beautiful Bill Act (OBBB), P.L. 119-21, repealed the one-month deferral election under IRC § 898(c)(2) for tax years of specified foreign corporations beginning after November 30, 2025. This election had allowed a specified foreign corporation to use a tax year beginning one month earlier than the tax year of its majority U.S. shareholder.
As a result of the repeal, an affected foreign corporation must change its tax year to conform with its shareholder, resulting in a one-month short tax year for its first required year. This change creates a potential mismatch where a foreign net income tax imposed with respect to a full foreign tax year accrues for U.S. tax purposes in the short, one-month required year. This could result in a U.S. shareholder having insufficient foreign source income in the short year to utilize the associated foreign tax credits.
Allocation rules for foreign taxes
To address the potential mismatch, the proposed regulations provide rules to allocate a “specified foreign income tax” between an affected corporation’s first required year and its succeeding tax year. A specified foreign income tax is defined as a foreign net income tax that is accrued by an affected corporation in its first required year. These rules generally do not apply to withholding taxes or taxes of cash-basis taxpayers.
The amount allocated to the first required year is determined by multiplying the specified foreign income tax by an allocation percentage. The numerator of the allocation percentage is the portion of the corporation’s foreign taxable income that is attributable to the first required year, and the denominator is the total foreign taxable income for the foreign tax year.
To determine the income attributable to the short period, taxpayers can use the principles of Reg. § 1.1502-76(b), which permit either a closing-of-the-books or a ratable allocation method.
New elections provide flexibility
The proposed regulations incorporate several elections to provide taxpayers with flexibility and reduce compliance burdens. Taxpayers may elect to treat certain distributive shares of creditable foreign tax expenditures from partnerships as specified foreign income taxes subject to the allocation rules. Another election permits taxpayers to use a separate, income-group specific allocation percentage rather than a single allocation percentage for all income groups.
To address situations where a corporation’s foreign and U.S. tax years do not align, the regulations provide an irrevocable election to allocate certain succeeding year taxes between the first required year and the succeeding year. These elections are generally made by a corporation’s controlling domestic shareholders.
Finally, taxpayers can elect to forgo the allocation rules entirely. If this election is made, the corporation would instead apply the normal accrual rules, taking all specified foreign income taxes into account in the first required year.
New FTC disallowance on PTEP distributions
The OBBB also increased the percentage for the deemed paid credit for global intangible low-taxed income, or GILTI, from 80% to 90%. Concurrently, the act added IRC § 960(d)(4), which disallows a foreign tax credit for 10% of the foreign income taxes paid or accrued with respect to a distribution of previously taxed earnings and profits (PTEP) that results from a § 951A inclusion.
To implement this change, the proposed rules clarify that the disallowance applies to distributions from § 951A inclusions that occur in a U.S. shareholder’s tax year ending after June 28, 2025. The regulations establish a mechanism to track the PTEP subject to the new disallowance by dividing the existing “section 951A PTEP” group into two new groups: one for PTEP from inclusions in shareholder years ending on or before June 28, 2025, and another for PTEP from inclusions in shareholder years ending after that date.
Applicability and reliance
The regulations under IRC § 898(c) concerning the allocation of foreign taxes are proposed to apply to tax years of specified foreign corporations beginning after November 30, 2025. Taxpayers may rely on these proposed regulations before they are finalized, provided they apply the rules in their entirety and in a consistent manner.
The rules under IRC § 960(d)(4) relating to the foreign tax credit disallowance are proposed to apply to foreign income taxes paid or accrued with respect to a distribution of PTEP from a § 951A inclusion in a U.S. shareholder’s tax year ending after June 28, 2025. Taxpayers may also rely on these rules before they are published as final.
For more on the allocation of foreign taxes and transition rule for specified foreign corporations, see Checkpoint’s Federal Tax Coordinator 2d ¶ O-2308.
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