Proposed OBBBA Foreign Tax Rules

On Aug. 3, the U.S. Department of the Treasury and the IRS published proposed regulations implementing the One Big Beautiful Bill Act’s (OBBBA’s) repeal of the Section 898(c)(2) one-month deferral election and the new Section 960(d)(4) foreign tax credit (FTC) disallowance on certain Section 951A PTEP distributions. The proposed regulations generally follow Notice 2025-72 and Notice 2025-77 but add an elective framework under Section 898. There is a short, 45-day comment period, and the regulations are expected to be finalized by Jan. 4, 2027. In the meantime, taxpayers can rely on the proposed rules prior to final regulations being issued provided that the proposed regulations are applied in their entirety and consistently.

Background

Section 898 generally requires a specified foreign corporation to use the tax year of its majority U.S. shareholder. Before the OBBBA, a corporation could elect to begin its tax year one month earlier than the tax year of its majority U.S. shareholder (deferral election). The OBBBA repealed the one-month deferral election for taxable years beginning after Nov. 30, 2025. A corporation that previously made the now-repealed election will have a one-month short taxable year (the first required year), followed by a conforming taxable year (the succeeding taxable year) as it moves to the conforming year. For a calendar-year majority U.S. shareholder, the short year is Dec. 1 through Dec. 31, 2025.

A foreign net income tax accrues at the close of a full foreign taxable year, but after the repeal that tax can fall into the short year. The accrual of the entire tax in the short year could turn an income group into a loss group and prevent foreign taxes from being deemed paid under Section 960. Notice 2025-72 previewed interim tax allocation rules to reduce the impact of the change.

The OBBBA also increased the deemed-paid percentage under Section 960(d)(1) for Section 951A net controlled foreign corporation tested income inclusions from 80% to 90% and added Section 960(d)(4), which disallows a credit for 10% of foreign taxes associated with distributions of PTEP attributable to certain Section 951A inclusions for tax years ending after June 28, 2025. Notice 2025-77 addressed uncertainty over the cutoff on June 28, 2025.

Highlights of the proposed regulations

Section 898(c)

The proposed regulations provide a default method to allocate the tax but also allow taxpayers to make certain elections that add flexibility.

The rules generally cover foreign net income taxes accrued by an affected corporation in its first required year when it is treated as paying or accruing the tax for FTC purposes. The covered taxes are specified foreign income taxes. Withholding taxes generally are excluded, and cash-method corporations are outside the regime.

After assigning a specified foreign income tax to relevant income groups, such as subpart F income groups, tested income groups, and residual income groups, the default method under the FTC rules allocates the tax between the first required and succeeding taxable years using a single allocation percentage based on foreign-law taxable income. The numerator is income attributable to the one-month short year under Treasury Regulation Section 1.1502-76(b) principles, and the denominator is total foreign-law taxable income for the foreign taxable year. For most federal income tax purposes, the allocated amounts accrue in their respective first required and succeeding years, which affects subpart F income, tested income, the high-tax exception and high-tax exclusion determinations, earnings and profits, and deemed-paid credits for each assigned year. For purposes of Section 905(c) foreign tax redeterminations and Section 986(a) foreign tax determinations, however, the allocation does not change the tax’s original accrual year.

The proposed regulation’s most notable change from Notice 2025-72 is the elective framework. Taxpayers can elect to treat all of an affected corporation’s distributive shares of creditable foreign tax expenditures (CFTEs) from an affected partnership as specified foreign income taxes allocable between the first required and succeeding years. Taxpayers also can elect an income-group-specific allocation method instead of using the default single allocation percentage, or they can make an irrevocable election to allocate certain succeeding-year taxes if the foreign tax year straddles the short year and the following U.S. tax year. Alternatively, taxpayers can elect to leave specified foreign income taxes in the first required year, but that election prevents allocation of succeeding-year taxes.

The election can be made by controlling domestic shareholders and, once made, the election binds all U.S. shareholders for the first required year and the succeeding year. Election statements generally must be attached to the relevant Form 5471 for the first required and succeeding taxable years. The CFTE election, the income-group-specific election, and revocation of any election other than the irrevocable succeeding-year election must be made on an amended return within 24 months of the original, unextended due date of the return for the first required year.

Crowe observation

Affected corporations and income groups should model the impact of available elections. In some cases, elections can preserve credits, although additional foreign tax information and coordinated filings might be required.

Section 960(d)(4)

The proposed regulations under Section 960(d)(4) divide Section 951A PTEP into pre-June 29, 2025, and post-June 28, 2025 (pre- and post-cutoff) groups, with parallel groups for reclassified Section 951A PTEP. The controlling date is the end of the U.S. shareholder’s taxable year in which the inclusion occurs rather than the PTEP distribution date. The proposed regulations provide that Section 960(d)(4):

• Does not apply to taxes on distributions of pre-June 29 PTEP
• Disallows 10% of foreign taxes on distributions of post-June 28 PTEP, including withholding taxes and taxes deemed paid under Section 960(b)(1) through an upper-tier controlled foreign corporation (CFC)

The preamble to the proposed regulations also provides that the PTEP regulations proposed in December 2024 will be modified to be consistent with the rules.

Crowe observation

Taxpayers will need to separately track pre- and post-cutoff Section 951A PTEP groups and the related taxes to ensure the 10% disallowance is applied correctly.

Looking ahead

Taxpayers should identify all specified foreign corporations still using the one-month deferral election, map foreign tax years that do not align with U.S. taxable years, and consult their tax adviser to model the default allocation and applicable elections. They also should consult their tax adviser to update PTEP and FTC processes to bifurcate Section 951A PTEP into pre- and post-cutoff groups.