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September 8, 2021

IRS allows taxpayer to reverse "gap period" transaction through late check-the-box election

In a private letter ruling (PLR 202135006, released September 3, 2021), the US Internal Revenue Service (IRS) permitted a taxpayer effectively to undo planning undertaken during a so-called gap period (described later).

After many taxpayers implemented gap period strategies in 2018, the U.S. Department of the Treasury (Treasury) and the IRS in 2019 issued regulations (the extraordinary disposition regulations) under Sections 245A and 954(c)(6) of the US Internal Revenue Code that retroactively neutralized, and in some cases penalized, gap period strategies. In the newly released PLR, the IRS granted the taxpayer's request to make a late entity-classification election (familiarly, a check-the-box election) that would cause the relevant transaction to become disregarded. The PLR is unique insofar as the taxpayer's stated motivation for requesting relief was to mitigate the "negative tax consequences" attributable to the extraordinary disposition regulations.


A "gap period" is relevant for a controlled foreign corporation (CFC) that has a fiscal (US) tax year and a corporate United States shareholder (a Section 245A shareholder). The term refers to the period (i) beginning after December 31, 2017 (the second E&P measurement date for purposes of the IRC Section 965 transition tax), and (ii) ending on the last day of the CFC's last tax year beginning before January 1, 2018 (the last year to which the GILTI regime did not apply).

Before the extraordinary disposition and other regulations were issued, certain taxable transactions executed during a CFC's gap period were expected to have favorable tax consequences. US federal income tax generally did not apply to gain that the CFC recognized in its gap period (and the corresponding earnings and profits) if the gain did not constitute subpart F income or income effectively connected with a US trade or business. (It would not be taken into account under IRC Section 965 or the GILTI regime, and it could fund a dividend to the Section 245A shareholder for which the shareholder might be allowed an offsetting deduction under IRC Section 245A.) Additionally, the increased basis attributable to the transaction might give rise to depreciation or amortization deductions or QBAI that would reduce the Section 245A shareholder's overall GILTI inclusion amount. Many Section 245A shareholders caused their fiscal-year CFCs to engage in gap period transactions, which necessarily occurred during 2018.

In October 2018, Treasury and the IRS proposed regulations under the GILTI regime with retroactive effect (the disqualified basis regulations, now found in final form at Treas. Reg. Sections 1.951A-2(c)(5) and -3(h)). Among other things, the regulations generally precluded taxpayers from taking into account basis increases resulting from gap period transactions (disqualified basis) when computing their GILTI inclusion amount. The disqualified basis regulations thus generally muted the benefits of gap period transactions. They did not, however, trigger negative tax consequences for taxpayers that had already executed gap period transactions.

That changed when Treasury and the IRS issued the extraordinary disposition regulations — initially in temporary form (Temp. Treas. Reg. Section 1.245A-5T) in June 2019 and later as a final regulation (Treas. Reg. Section 1.245A-5) in August 2020. The extraordinary disposition regulations generally apply retroactively to certain transactions occurring during a CFC's gap period in 2018 (extraordinary dispositions). The extraordinary disposition regulations affect dividends distributed by a foreign corporation that has undertaken an extraordinary disposition. Depending on whether the distributee is a Section 245A shareholder or a CFC, the extraordinary disposition regulations render the dividend (in whole or in part) ineligible for a dividends-received deduction under IRC Section 245A or for the exception to foreign personal holding company income in IRC Section 954(c)(6). Accordingly, the extraordinary disposition regulations can cause a dividend to give rise to net taxable income (in case of a CFC distributee, subpart F income). Absent the extraordinary disposition regulations, this result would not occur. Additionally, a 21% rate now applied to the gain from the extraordinary disposition, rather than the reduced rate for GILTI inclusions (presently 10.5%) that might have applied if the gain had been recognized after the gap period.

Responding to complaints from taxpayers and tax practitioners that the simultaneous application of the disqualified basis regulations and extraordinary disposition regulations resulted in double taxation, Treasury and the IRS issued new regulations (the coordination regulations). The coordination regulations effectively subjected gain to one of the two sets of regulations, but not both. The coordination regulations are extremely complex, however, and complying with them requires significant time and expense.


In PLR 202135006, US Parent, a publicly traded corporation, owned the stock of non-US subsidiaries. Parent's CFC, FSub, owned all the outstanding equity interests of a foreign corporation (Taxpayer).

On an unspecified date (presumably during FSub's gap period), FSub contributed assets to Taxpayer in exchange for Taxpayer's stock (the Contribution). Taxpayer represented that the Contribution did not qualify as a tax-free transaction under IRC Section 351(a). Accordingly, FSub recognized gain in the contributed assets, and Taxpayer's aggregate basis in the assets increased by the amount of gain that FSub recognized.

After FSub executed the Contribution, Treasury and the IRS issued the extraordinary disposition regulations. Because the Contribution constituted an extraordinary disposition, the regulations could cause future dividends from FSub to be wholly or partially taxable.

If Taxpayer had been classified as a disregarded entity for US federal tax purposes at the time of the Contribution rather than a corporation, the Contribution would have been disregarded. FSub would have recognized no gain, the basis of the contributed assets would not have increased, and the extraordinary disposition regulations would not apply.

Having missed the deadline for making a check-the-box election to be classified as a disregarded entity as of the Contribution, Taxpayer requested a ruling from the IRS allowing it to make the election and "unwind" the Contribution.


To obtain the requested relief, Taxpayer had to demonstrate under Treas. Reg. Section 301.9100-3 that it acted reasonably and in good faith, and that granting the relief would not prejudice the government's interests. Based on Taxpayer's representations, the IRS ruled that Taxpayer could elect disregarded-entity status effective as of an unspecified date (presumably a date preceding the date of the Contribution). In support of its ruling, the IRS noted that (i) Taxpayer had exercised reasonable diligence but was unaware that the extraordinary disposition regulations could cause "negative tax consequences" if the election were not made; (ii) Taxpayer's advisors did not inform Taxpayer that the negative tax consequences could be mitigated by making the election; and (iii) granting the relief would produce the same result as if the election had been timely. The IRS did not mention the disqualified basis regulations or the coordination regulations.


Before PLR 202135006 was issued, it was not clear whether the IRS would permit taxpayers to "unwind" gap period transactions. In the PLR, the IRS allowed a taxpayer to achieve that result, albeit by granting Taxpayer relief to make a late check-the-box election that would cause the transaction to be disregarded.

Many taxpayers undertook gap period transactions in 2018. Many of those transactions (like the one in the PLR) would become disregarded if a late check-the-box election could be made. Taxpayers that undertook such a transaction may want to evaluate whether they too might be eligible for relief, enabling them to cause their transaction to be disregarded. Disregarding the transaction, at minimum, would relieve taxpayers from the burden of complying with the complex coordination regulations. It remains to be seen whether the PLR reflects a broader willingness on the part of the IRS to allow other types of relief in response to retroactive regulations.


Contact Information
For additional information concerning this Alert, please contact:
International Tax and Transaction Services
   • Colleen O’Neill, Washington, DC (
   • Allen Stenger, Washington, DC (
   • Jane Vukmer, Washington DC (