Treasury and IRS issue proposed regulations providing guidance on Subpart F Income and NCTI Pro Rata Share Rules

The One Big Beautiful Bill Act (OBBBA)² made substantial changes to the longstanding rules in section 951, governing when and how a U.S. shareholder must include in gross income its pro rata share of a CFC’s subpart F income, and in section 951A, governing when and how a U.S. shareholder must take into account its pro rata share of its CFCs’ tested income and tested losses to compute net CFC tested income (NCTI) included in gross income.³

In particular, the OBBBA replaced the prior regime’s so-called “hot potato” rule, which looked solely to stock owned on the last day of the CFC’s taxable year, with a new framework under which a U.S. shareholder’s pro rata share of a CFC’s subpart F income and tested income and tested loss is determined based on a U.S. shareholder’s ownership at any point during the CFC’s taxable year. The prior approach required a U.S. shareholder to take such items into account in computing gross income only if such shareholder owned stock in a CFC on the last day of the taxable year on which it was a CFC—an approach that often resulted in a loss of revenue to the government and unexpected results in certain M&A transactions. 

The Proposed Regulations provide comprehensive rules for determining a U.S. shareholder’s pro rata share through a daily proration approach, mandatory and elective closings of a CFC’s taxable year, and rules addressing foreign income tax allocation.

Taxpayers acquiring and disposing of CFCs will need to review closely the Proposed Regulations, as the approach taken for purposes of allocating subpart F income and NCTI, in addition to any actions taken by the other party, could have a meaningful impact on the tax consequences of such acquisition or disposition. 

Background

Pre-OBBBA law: the “hot potato” rule

Prior to the OBBBA, former section 951(a)(1)(A) required a U.S. shareholder to include its pro rata share of the subpart F income of a CFC only if the U.S. shareholder owned directly or indirectly (applying the principles in section 958(a)) stock of the CFC on the last day of the taxable year of the CFC on which the CFC was treated as a CFC (the “last relevant day”).⁴ A U.S. shareholder’s pro rata share of subpart F income was determined based on a hypothetical distribution of the CFC’s subpart F income on the last relevant day reduced by dividends (or deemed dividends, including under section 1248) received by prior U.S. shareholders during the taxable year, but only to the extent of the subpart F income attributable to the portion of the year during which the current U.S. shareholder did not own the CFC’s stock.⁵ 

The pre-OBBBA “global intangible low-taxed income” (GILTI) rules under former section 951A similarly required a CFC’s tested items to be taken into account and included in the computation of a U.S. shareholder’s GILTI inclusion only if such U.S. shareholder owned directly or indirectly (applying the principles in section 958(a)) the CFC stock on the last relevant day.⁶

This rule was commonly referred to as the “hot potato” rule because it generally allowed a U.S. shareholder to avoid subpart F and GILTI inclusions simply by disposing of CFC stock to another U.S. shareholder before the last relevant day—essentially passing the inclusions for the whole year like a hot potato to such successive U.S. shareholder.⁷ The last relevant day requirement was a longstanding fixture of the subpart F anti-deferral regime since its original enactment in 1962.

• In the context of purchases and sales of shares of CFCs, where the taxable year of the CFC could not otherwise be closed (e.g., through an entity classification election to cause the CFC to be a disregarded entity or partnership, a section 338(g) election or a closing of the books election under section 1.245A-5(e) of the Treasury regulations), the “hot potato” rule resulted in substantial negotiations between buyers and sellers in respect of (i) indemnities for subpart F income or GILTI attributable to the seller’s ownership period and (ii) covenants regarding a party’s ability to generate subpart F income or GILTI before or after a transaction (which, particularly in light of the pre-OBBBA downward ownership attribution rules under section 958(b), was relevant even where a buyer or seller was not a U.S. person).

OBBBA revisions to Sections 951 and 951A

The OBBBA fundamentally changed this longstanding approach, signifying a major shift from the “hot potato” rule that had been in place for over sixty years. Under amended section 951(a)(1)(A), a U.S. shareholder must include in gross income its pro rata share of the subpart F income of a CFC if the U.S. shareholder owns (applying the principles in section 958(a)) stock of the CFC on any day during the CFC’s taxable year during which the foreign corporation is a CFC.⁸

The pro rata share rule under amended section 951(a)(2) is no longer determined through a hypothetical distribution of the CFC’s subpart F income on the last relevant day. Instead, the pro rata share is based on the subpart F income attributable to the stock of the foreign corporation owned by the shareholder and any period of the CFC year during which:

• the shareholder owned such stock 
• the shareholder was a U.S. shareholder of the corporation, and 
• the corporation was a CFC.⁹

Furthermore, section 951(a)(3), as amended by the OBBBA, requires that a subpart F inclusion for a CFC year be included in a U.S. shareholder’s gross income for the U.S. shareholder’s taxable year that includes the last day during the CFC’s year on which the U.S. shareholder owned the stock of the CFC.

The OBBBA similarly revised section 951A. In addition to removing the “net deemed tangible income return” from the computation (hence, the change in acronyms from GILTI to NCTI), under the revised provision, a U.S. shareholder’s inclusion under section 951A in respect of a CFC now arises if such U.S. shareholder owns (applying the principles in section 958(a)) stock of the CFC on any day during the CFC’s taxable year during which the foreign corporation is a CFC.¹⁰ A U.S. shareholder’s pro rata share of the tested income or tested loss of each CFC is determined for this purpose under the rules of amended section 951(a)(2).¹¹

Accordingly, any person that was a U.S. shareholder at any period during the CFC year (rather than on only the last relevant day) will need to report and pay tax on its share of any subpart F income and NCTI attributable to the CFC for such year.

Proposed regulations under Sections 951 and 951A

1. Daily proration approach

The Proposed Regulations generally adopt a daily proration approach for allocating subpart F income, tested income, and tested loss to U.S. shareholders based on their respective ownership periods during the CFC’s taxable year. Under this approach, a U.S. shareholder’s pro rata share is determined based on the percentage of applicable stock owned by such shareholder multiplied by the percentage of the CFC’s taxable year during which the U.S. shareholder held such stock.¹² 

Treasury and the IRS considered, and ultimately rejected, alternative approaches—including an interim closing of the books method and an extraordinary item exception¹³—as unnecessarily complex, administratively burdensome, or potentially leading to inappropriate results. The daily proration approach was viewed as providing a clear, administrable, and equitable rule for allocating income among shareholders that own stock for different periods during the CFC’s taxable year. Furthermore, Treasury and the IRS stated that such approach is consistent with the language in section 951(a)(1)(A), which focuses on the U.S. shareholder’s pro rata share of all items of subpart F income for the CFC year (and not the pro rata share of specific items that comprise subpart F income).

• In the context of purchases and sales of CFCs, this rule will require more covenants addressing sharing of information between buyers and sellers of CFCs and coordination to ensure that each party (i) has the information that is needed to prepare Forms 5471 and (ii) is consistently reporting its share of the subpart F and NCTI inclusions on its Form 5471. 
• Furthermore, where a CFC is acquired and its taxable year does not end as a result of the acquisition (e.g., as a result of an entity classification election, a section 338(g) election, or under the rules described below), in light of the absence of an extraordinary item rule, buyers and sellers of CFCs will need to consider representations, covenants, and potentially indemnities with respect to extraordinary items of income or gain that are recognized by a party either before or after the closing and that are allocated to the other party under the daily proration approach.
• Moreover, despite the daily proration approach for CFC income items, surprisingly, the Proposed Regulations do not provide that foreign income taxes accrued only at the end of the CFC’s foreign taxable year may be similarly pro-rated between the seller’s and buyer’s respective ownership periods. This is a material difference between the general proration rule and the narrower mandatory or elective closing-of-the-books rules described below, which do allow for the proration of foreign income taxes between periods, and it is expected to give rise to subpart F and NCTI inclusions for sellers without a corresponding foreign tax credit. Aside from contractual points to address this potential mismatch, sellers that do not satisfy the narrow requirements to make the closing-of-the-books election described below may consider alternative structures to match income to foreign income taxes.¹⁴

2. Mandatory closing of taxable year

The Proposed Regulations provide that a CFC’s taxable year closes mandatorily at the end of the day on the date that a “status change event” occurs—that is, if the foreign corporation becomes or ceases to be a CFC. The mandatory closing applies to all shareholders for all purposes of the Code, regardless of any individual shareholder’s changes in ownership. The Proposed Regulations include special rules addressing the treatment of domestic partnerships and options in the context of mandatory closings, which are keyed off the Proposed Regulations’ general approach of focusing only on U.S. persons that are treated as owning (within the meaning of section 958(a)) stock of a CFC.¹⁵

Unlike the consolidated return regulations, the Proposed Regulations do not contain an equivalent “next day” rule¹⁶ that treats items of income, loss, gain or deduction of the CFC arising on the date that the status change event occurs but that are properly allocable to the post-status change period as arising in the post-status change period. Accordingly, sellers of CFCs will need to consider negotiating covenants that prevent a buyer from taking actions outside of the ordinary course of business on the closing date, but after the closing, that would increase a seller’s subpart F or NCTI inclusions.

When a mandatory (or an elective closing, as described below) of the taxable year causes a CFC’s U.S. taxable year to end mid-way through its foreign taxable year, foreign income taxes will be allocated between the resulting short taxable years using a closing-of-the-books method as of the end of the day on which the status change event occurs.¹⁷ This is similar to the allocation of foreign income taxes permitted in other contexts where a CFC’s U.S. taxable year closes but its foreign taxable year does not (for example, as a result of an election under section 338(g)).¹⁸

• Under this allocation method, a portion of the foreign income tax that accrues in the CFC’s second short U.S. taxable year will be allocated back to the first short U.S. taxable year ending on the closing date. The amount of foreign income taxes allocated to the first short U.S. taxable year is equal to the product of (i) the full amount of foreign income taxes accrued in the CFC’s entire foreign taxable year and (ii) the ratio of (A) the taxable income of the CFC (as determined under foreign law) that is attributable to the first short U.S. taxable year under the principles of section 1.1502-76(b) of the Treasury regulations (without regard to section 1.1502-76(b)(2)(ii) of the Treasury regulations) to (B) the full amount of the CFC’s taxable income for its entire foreign taxable year (as determined under foreign law).

Foreign taxes allocated to the first short year under this rule are treated as accrued by the CFC at the close of that taxable year for all purposes of the Code (except section 986(a)).¹⁹

3. Elective closing of taxable year

In addition to the mandatory closing of the taxable year rule, the Proposed Regulations also provide an election to close the CFC’s taxable year as of the end of the day on which the “significant ownership variance” occurs.

However, the scope of this election is notably limited.²⁰ The election is available only upon a “significant ownership variance,” which occurs where, taking into account all “specified transfers” that occur pursuant to the same plan during the same taxable year, the percentage of the stock of the CFC owned by one or more U.S. shareholders decreases by more than 50 percentage points (by either vote or value) in the aggregate percentage of stock owned by U.S. shareholders (as determined before the first of the transfers).

For this purpose, a “specified transfer” means a change in the ownership of the stock of a CFC resulting from a sale, exchange, or other disposition of stock of a foreign corporation or a partnership interest, as well as an issuance of stock or a partnership interest.²¹ The significant ownership variance occurs on the day the last specified transfer taken into account in the significant ownership variance occurs.²²

• The date of the significant ownership variance is notable because, if multiple transfers occur on different dates pursuant to the same plan, the CFC’s taxable year ends at the end of the day on the day of the last of the transfers (even if the percentage of the CFC stock owned by U.S. shareholders decreases by more than 50 percentage points on a prior date). Therefore, where possible, U.S. shareholders selling shares of a CFC pursuant to a plan should consider coordinating to ensure that all transfers occur on the same day.

In order for the election to be made, all “controlling section 958(a) shareholders”²³ of the CFC must file an “Elective Section 951 Year-Closing Statement” with its timely filed original U.S. federal income tax return for the taxable year that includes the day that the CFC’s taxable year would close as a result of the election.²⁴

Furthermore, all of the controlling U.S. shareholders and all other U.S. shareholders of the CFC that own stock of the CFC on any day of the CFC’s taxable year up to and including the day that the significant ownership variance occurs must enter into a written binding agreement that requires the controlling U.S. shareholders to make the election, and the notice described in section 1.964-1(c)(3)(iii) of the Treasury regulations must be provided to all United States persons that own stock of the CFC during the taxable year that ends on the day on which the CFC’s taxable year closes.

Finally, the election is subject to a consistency requirement, which requires that, if the election is made with respect to one CFC, it must be made with respect to all CFCs affected by the same plan or arrangement.

• Taxpayers that are seeking to utilize the elective closing of the CFC’s taxable year will need to include specific covenants or agreements in the relevant transaction documents requiring all relevant parties to enter into the binding agreement, make the elections and provide the requisite notice.²⁵

4. Transition rule

For CFC taxable years that include or begin after June 28, 2025, but before the first taxable year beginning after December 31, 2025, the Proposed Regulations provide guidance on the transition rule set forth in the OBBBA.²⁶ Under this transition rule, certain dividends (and deemed dividends, such as those under section 1248) for certain pre-effective-date taxable years are not treated as dividends for purposes of the former section 951(a)(2)(B) reduction rule, except to the extent that the dividend increases the taxable income of a United States person after application of all relevant provisions of the Code and Treasury regulations, including the extraordinary reduction rules in section 1.245A-5(e) of the Treasury regulations.

The transition rule targets the gap period before the OBBBA’s new pro rata share rules take effect. As described above, a dividend paid to a prior U.S. shareholder would reduce the new U.S. shareholder’s pro rata inclusion of the CFC’s subpart F income (and/or its GILTI inclusion) through the reduction rule in former section 951(a)(2)(B).

However, if the prior U.S. shareholder offset a dividend paid or its section 1248 deemed dividend (the portion of the gain on the disposition of the CFC stock recharacterized as a dividend) by means of the section 245A DRD, the portion of subpart F income and/or attributable GILTI inclusion of the CFC swept up as an actual or deemed dividend would effectively escape U.S. taxation in the hands of both the transferor and transferee. The transition rule prevents that result by disregarding the portion of dividends that did not increase the taxable income of a U.S. shareholder for purposes of the reduction under former section 951(a)(2)(B).

The Proposed Regulations include a substantiation requirement, under which taxpayers must identify the relevant dividends and demonstrate that the conditions of the transition rule have been satisfied.

5. Anti-abuse rule

The Proposed Regulations also include an anti-abuse rule, which disregards the effect of any transaction or arrangement entered into as part of a plan a principal purpose of which is the avoidance of federal income tax by changing the amount of allocable E&P distributed in the hypothetical distribution with respect to any share of stock.²⁷

6. Other changes²⁸

• With respect to section 951B, the rules governing pro rata share determinations apply to foreign-controlled United States shareholders and foreign-controlled foreign corporations in the same manner as they apply to U.S. shareholders in CFCs.²⁹ However, the elective closing of the CFC’s taxable year is not available to foreign-controlled U.S. shareholders with respect to a foreign-controlled foreign corporation (as defined in section 951B(c)) because such shareholders cannot own the requisite percentage of stock (more than 50%) for a significant ownership variance to occur.
• The Proposed Regulations phase out the extraordinary reduction rule in sections 1.245A-5(e) and 1.245A-5(f) of the Treasury regulations for taxable years of CFCs beginning after December 31, 2025.
• Similarly, section 1.1502-80(j) is phased out for consolidated return years that include the last day of a taxable year of a CFC beginning on or after January 1, 2026.
• Treasury and the IRS also note that they are continuing to study issues relating to the coordination of section 1248 with the revised pro rata share rules. In addition, Treasury and the IRS intend to modify the 2024 proposed regulations under sections 959 and 961 regarding previously taxed earnings and profits to reflect the OBBBA amendments in a separate guidance project.
• As a result of the new daily proration rules, the information that is required to be reported on the IRS Form 5471 has been expanded to include a detailed description of each class of stock, the outstanding shares on the first day of the year, as well as the date and description of any issuances, redemptions or other changes.

7. Examples

Example 1: Daily proration—single class of stock, no change in ownership

• Facts: FC, a CFC, has 100 shares of a single class of stock outstanding. USP1, a domestic corporation, owns 60 shares. USP2, a domestic corporation, owns 40 shares. Both are U.S. shareholders of FC for the entirety of Year 1 (365 days). For Year 1, FC has $100x of subpart F income.
• Result: USP1’s pro rata share of FC’s subpart F income is $60x ($100x × (60/100) × (365/365)). USP2’s pro rata share is $40x ($100x × (40/100) × (365/365)).

Example 2: Daily proration—mid-year share transfer

• Facts: The facts are the same as in Example 1 above, except that on June 30 of Year 1, USP2 sells 20 of its 40 shares of FC to Individual A, a nonresident alien individual. Also assume that $75x of the $100x of subpart F income is attributable to FC’s disposition of an asset on December 31 of Year 1.
• Result: USP1’s pro rata share remains $60x. USP2 has two CFC year blocks: 40 shares owned from January 1 through June 30 (181 days) and 20 shares owned from July 1 through December 31 (184 days). USP2’s pro rata share with respect to the first block is $19.84x ($100x × (40/100) × (181/365)). USP2’s pro rata share with respect to the second block is $10.08x ($100x × (20/100) × (184/365)). USP2’s total pro rata share for Year 1 is $29.92x ($19.84x + $10.08x). Due to the lack of an extraordinary item exception in the Proposed Regulations, USP2’s pro rata share is determined based on the full $100x of subpart F income, even though $75x of the subpart F income was generated after it sold its first block to Individual A.

Example 3: Mandatory closing of taxable year (status change event)

• Facts: FC is a foreign corporation with a calendar taxable year. USP, a domestic corporation, owns 100% of FC stock as of January 1 of Year 1. On June 30 of Year 1, USP sells all its stock in FC to Individual A, a nonresident alien individual.
• Result: USP owns the stock of FC through June 30, and Individual A owns the stock beginning July 1. FC ceases to be a CFC on July 1. A status change event occurs on June 30 (the last day FC is a CFC), and the taxable year of FC closes for all purposes of the Code as of the end of June 30.
• Alternative: If Individual A were instead a United States citizen (and unrelated to USP), FC would remain a CFC after the sale, and the mandatory closing rule would not apply. However, because USP’s ownership decreased by more than 50 percentage points, a significant ownership variance occurred, and USP may therefore elect to close the taxable year of FC as of the end of June 30.³⁰

Example 4: Elective closing—transfer between related persons

• Facts: The facts are the same as in Example 3, except that Individual A is a United States citizen and USP and Individual A are related persons.
• Result: Because FC remains a CFC after the sale, the mandatory closing rule does not apply. Although USP’s ownership decreased by 100 percentage points, the total percentage of FC stock owned by U.S. shareholders is not treated as decreasing because Individual A is a related person whose increase in ownership entirely offsets USP’s decrease. The sale does not give rise to a significant ownership variance, and USP may not elect to close the taxable year of FC.

Example 5: Elective closing—multiple sellers pursuant to same plan

• Facts: US1 and US2, both domestic corporations, own 60% and 40% of the stock of CFC, respectively. CFC uses a calendar taxable year. On June 30, US1 sells all its CFC stock (60%) to US3, a domestic corporation unrelated to US1 or US2. Pursuant to the same plan, US2 sells all its CFC stock (40%) to US3 on September 1.
• Result: The significant ownership variance occurs on September 1 (the date of the last specified transfer pursuant to the same plan) regardless of the day on which the more-than-50-percentage-point decrease first occurred (June 30). If the election is made, the taxable year of CFC closes on September 1.

Example 6: Allocation of foreign income taxes between short taxable years

• Facts: A foreign corporation uses a calendar taxable year for both U.S. and foreign income tax purposes. The foreign corporation’s U.S. taxable year closes on June 30 as a result of a mandatory or elective closing. The foreign corporation earned 50% of its foreign taxable income from January 1 to June 30.
• Result: Under the closing-of-the-books method, 50% of the foreign income tax that accrues on December 31 (at the end of the foreign taxable year) is allocated to the U.S. taxable year ending with the closing (January 1 to June 30). Foreign income taxes so allocated are treated as accrued by the CFC at the close of that taxable year for all purposes of the Code (except section 986(a)).

Example 7: Transition rule—interaction with Section 1.245A-5(e)

• Facts: US1, a domestic corporation, owns all the stock of CFC, which uses a calendar taxable year. On March 1, 2025, CFC pays a $100x dividend to US1, which, without the application of section 1.245A-5(e) of the Treasury regulations, qualifies for the section 245A DRD. On July 1, 2025, US1 sells all its CFC stock to US2, a domestic corporation, resulting in an extraordinary reduction within the meaning of section 1.245A-5(e) of the Treasury regulations. If section 1.245A-5(e) of the Treasury regulations was applied before and without regard to the transition rule, US1’s pre-reduction pro rata share would be $100x; the entire $100x dividend would be an extraordinary reduction amount, and the ineligible amount with respect to US1 would be $100x. 
• Result: Under the transition rule, the determination of whether the $100x dividend increases the taxable income of a United States person is made after the application of all relevant provisions—including the extraordinary reduction rules—applied before and without regard to the transition rule. Because the ineligible amount is $100x, none of the dividend is eligible for the section 245A deduction after applying the extraordinary reduction rules. Accordingly, the entire $100x dividend increases the taxable income of US1 and is, therefore, treated as a dividend for purposes of former section 951(a)(2)(B). US2’s pro rata share of CFC’s subpart F income is reduced by the $100x dividend under former section 951(a)(2)(B).
• Alternative: If, instead, the dividend had been fully offset by the section 245A deduction (i.e., the extraordinary reduction rules did not disallow the deduction), the dividend would not have increased the taxable income of a United States person. In that case, the transition rule would disregard the dividend for purposes of former section 951(a)(2)(B), and US2’s pro rata share of CFC’s subpart F income would not be reduced—preventing the subpart F income from escaping U.S. taxation in the hands of both US1 and US2.

Applicability dates

The Proposed Regulations generally apply to taxable years of foreign corporations beginning after December 31, 2025.

The transition rule applies to taxable years that include June 28, 2025, or that begin after June 28, 2025, but before the first taxable year of the foreign corporation beginning after December 31, 2025.

Taxpayers may rely on the rules set forth in the Proposed Regulations before they are published as final regulations, provided the taxpayers and their related parties 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, and certain issues identified above may be clarified or otherwise addressed in the final regulations. Comments on the Proposed Regulations, and requests for a public hearing, are due 60 days after publication in the Federal Register. 

Footnotes

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

2. Pub. L. 119-21.

3. Section 951(b) defines “U.S. shareholder” as a United States person who owns, or is considered as owning (under the direct, indirect, and constructive ownership rules of sections 958(a) and 958(b)), 10 percent or more of the total combined voting power or 10 percent or more of the total value of all classes of stock of a foreign corporation. This definition applies for both subpart F and NCTI inclusions.

4. Former section 951(a)(1)(A).

5. Former section 951(a)(2)(A), (B). Furthermore, if the CFC was not treated as a CFC for its entire taxable year, the U.S. shareholder would only be required to include in income an amount equal to the product of (i) the CFC’s subpart F income and (ii) the percentage of the year that the CFC was treated as a CFC. Former section 951(a)(2)(A).

6. Former section 951A(e)(2) (providing that “[a] person shall be treated as a United States shareholder of a [CFC] for any taxable year of such person only if such person owns (within the meaning of section 958(a)) stock in such foreign corporation on the last day in the taxable year of such foreign corporation on which such foreign corporation is a [CFC]”).

7. The “last relevant day” was defined as the last day during the taxable year of a foreign corporation on which both (i) such foreign corporation was a CFC and (ii) the U.S. shareholder owned (within the meaning of section 958(a)) stock of such corporation. See former section 951(a)(1) (flush language).
Section 1248 served as a partial backstop against the “hot potato” strategy of disposing of CFC stock before the last relevant day, particularly before the addition of the section 245A dividends received deduction (“DRD”) under the Tax Cuts and Jobs Act of 2017 (“TCJA”). Under section 1248(a), the gain on the disposition of stock in a CFC is recharacterized as a dividend to the extent of earnings and profits (“E&P”) accumulated during the holding period while the foreign corporation was a CFC. A U.S. shareholder who sold its CFC stock before the last relevant day (regardless of whether the disposition was an attempt to avoid a subpart F or GILTI inclusion) would have the stock gain recharacterized as a dividend to the extent of post-1962 E&P attributable to that stock. Prior to TCJA, the deemed dividend under section 1248 would be taxable as ordinary income, but that tax could potentially have been reduced or offset by indirect foreign tax credits available under former section 902. See former Treas. Reg. §1.902-1(a)(11). After the TCJA, section 1248(j) was added to allow the deemed dividend to be deducted from the U.S. shareholder’s gross income by means of the section 245A DRD; however, the extraordinary reduction rules in Treas. Reg. §1.245A-5(e) would potentially disallow a portion of the DRD (or the DRD in its entirety) to ensure that earnings that in the absence of the section 1248 deemed dividend would be subpart F income or give rise to a GILTI inclusion did not escape taxation because of the interaction between the “hot potato” rule and the application of the section 245A DRD.

8. Section 951(a)(1)(A) (as amended by the OBBBA). However, this change does not extend to subpart F inclusions under section 956, namely a U.S. shareholder’s pro rata share of a CFC’s investment of earnings in U.S. property. The “hot potato” rule still governs these types of inclusions.

9. Section 951(a)(2) (as amended by the OBBBA).

10. Section 951A(c)(2) (as amended by the OBBBA).

11. Section 951A(c)(1) (as amended by the OBBBA). 

12. The Proposed Regulations generally adopt the hypothetical distribution analysis under current section 1.951-1(e) of the Treasury regulations for purposes of determining the subpart F income that is allocated among the classes of stock of a CFC. Section 1.951-1(e)(2) of the Treasury regulations makes the pro rata share determination on a class-by-class basis, allocating income among different classes of stock (e.g., based on relative economic rights to distributions and liquidation proceeds). Accordingly, the daily proration methodology applies separately to each class of stock, with a U.S. shareholder’s pro rata share of the CFC’s subpart F income or tested income being determined by reference to the U.S. shareholder’s ownership percentage within each class and the portion of the CFC’s taxable year during which the U.S. shareholder held stock of that class. Where the number of shares of a class of CFC stock changes during the CFC year (e.g., due to a redemption or issuance), the Proposed Regulations substitute a weighted average share count for the fixed denominator in the daily proration formula.

13. Treas. Reg. §1.706-4 and Treas. Reg. §1.1502-76(b) each contain extraordinary item rules that require certain non-ordinary course items of income, loss or deduction to be allocated to the day on which they are properly taken into account, including gain or loss from the sale or other disposition of an asset, a net operating loss carryforward, any item from the retirement or discharge of indebtedness, any item from the settlement of a tort or similar third-party liability, compensation-related deductions arising in connection with a target’s change in status and dividend income.

14. For example, for a partnership seller to a corporate buyer that would not otherwise qualify for the mandatory closing discussed below, a section 338(g) election may be considered, though this election comes with other material differences (including character and, likely, gain differences) that would need to be weighed and evaluated.

15. Under these rules, a mandatory closing of a foreign corporation’s taxable year may be triggered where a domestic partnership acquires or sells CFC stock, because for purposes of determining whether a status change event occurs, CFC status is determined on an aggregate basis by reference to the individual partners of the partnership. For example, if a domestic corporation sells all the stock of a CFC to a domestic partnership whose partners do not individually own sufficient stock to satisfy the requirements of sections 951(b) and 957(a), the foreign corporation would be considered to cease to be a CFC for these purposes and a status change event would occur, mandating the closing of the foreign corporation’s taxable year. See Prop. Treas. Reg. §1.951-1(d)(1)(iii)(A) (stating that Treas. Reg. §1.958-1(d)(1) is applied without regard to the exceptions in Treas. Reg. §1.958-1(d)(2)(i) and (ii)). 
Alternatively, if a domestic partnership whose partners do not individually own sufficient stock to satisfy the requirements of sections 951(b) and 957(a) sells all of the stock of a foreign corporation to a domestic corporation, the foreign corporation would be considered to become a CFC for these purposes and a status change event would occur, mandating the closing of the foreign corporation’s taxable year. Id. Notably, this rule would not give rise to a mandatory closing of the books if a domestic partnership whose partners do not individually own sufficient stock to satisfy the requirements of sections 951(b) and 957(a) sells all of the stock of a foreign corporation to a foreign corporation or another domestic partnership whose owners would not satisfy such ownership requirements on a look-through basis. In addition, the Proposed Regulations provide that constructive ownership of stock through options under section 318(a)(4) and section 1.958-2(e) of the Treasury regulations is disregarded solely for purposes of determining whether a status change event occurs.

16. Treas. Reg. §1.338-1(d) similarly provides that if a target corporation for which a section 338 election is made engages in a transaction outside the ordinary course of business on the acquisition date after the qualified stock purchase, the target and all related persons must treat the transaction as occurring at the beginning of the following day.

17. See Prop. Treas. Reg. §1.951-1(d)(3). The rule displaces the normal operation of section 1.905-1(d)(1)(i) of the Treasury regulations, which otherwise would cause the foreign income tax spanning multiple short U.S. tax years to accrue only in the U.S. taxable year in which the foreign taxable year ends. Without this override to the accrual principle in section 1.905-1(d)(1)(i) of the Treasury regulations, foreign tax credits with respect to the first short U.S. taxable year could be lost, as those underlying foreign taxes would not be associated with items of U.S. income in the first taxable year. The allocated foreign income taxes must then be allocated and apportioned to the proper foreign tax credit baskets under the mechanical rules of section 1.861-20 of the Treasury regulations.

18. See Treas. Reg. §1.338-9(d).

19. See Prop. Treas. Reg. §1.951-1(d)(3)(i).

20. The preamble specifically declined to allow an elective closing, in shifts of ownership of less than 50 percentage points: “Contrary to certain recommendations that an elective closing be available upon less substantial transfers of ownership, the proposed regulations would limit elective closings to these circumstances.” Pro Rata Share of Subpart F Income, Tested Income, or Tested Loss, 91 Fed. Reg. 55037, 55041 (proposed Aug. 26, 2026).

21. See Prop. Treas. Reg. §1.951-1(d)(2)(ii)(B).

22. In determining whether a significant ownership variance has occurred, the percentage of stock owned by a U.S. shareholder is not treated as decreasing to the extent a related United States person (within the meaning of section 267(b) or section 707(b)) increases its ownership of the CFC stock. Furthermore, the transferor and resulting corporations in reorganizations described in section 368(a)(1)(F) are treated as the same corporation.

23. The “controlling section 958(a) shareholders” are the U.S. shareholders (or, if applicable, single U.S. shareholder) whose percentage of ownership of stock of the CFC decreases as part of a significant ownership variance.

24. If the controlling U.S. shareholder is a member of a consolidated group, the “agent” of the consolidated group makes the election on behalf of the member.

25. Given the similarities between the two elections, the covenants might closely follow the covenants that have been used for purposes of making the closing of the books election under section 1.245A-5(e)(3) of the Treasury regulations. However, unlike elections under section 1.245A-5(e)(3) of the Treasury regulations, which have traditionally included binding agreements with buyers, under the Proposed Regulations it would appear that the sellers would not generally need the buyer to be a party to the binding agreement, unless the buyer is a U.S. person that already owns (applying the principles of section 958(a)) stock of the CFC on the date that the sale takes place. Notably, for this purpose, the Proposed Regulations clarify that the buyer will not be treated as “owning” on that date, the stock acquired on such date, as it is not considered to “own” such stock until the following day. See Prop. Treas. Reg. §1.951-1(f).

26. Notice 2025-75 provided preliminary guidance on the transition rule.

27. See Prop. Treas. Reg. §1.951-1(e)(3).

28. Treasury and the IRS have stated that the existing regulations under section 960 should continue to operate as designed to determine the foreign income taxes deemed paid by a domestic corporation with respect to inclusions under sections 951 and 951A. No changes to those regulations are currently proposed.

29. Notice 2025-75 provided preliminary guidance on the transition rule.

30. As noted above, because USP is the sole controlling section 958(a) U.S. shareholder and Individual A is not technically treated as “owning” stock on or before June 30 for this purpose under section 1.958-1(f) of the Proposed Regulations, it appears that USP may unilaterally elect to close the taxable year of FC and does not need to enter into a binding agreement with Individual A with respect to such election.