13 January 2026 United States | Forthcoming proposed regulations would address the pre-OBBBA transition rule for IRC Section 951(a)(2)(B) and the GILTI and FDDEI changes made by OBBBA
In three notices released on December 4, 2025, the Treasury Department (Treasury) and the Internal Revenue Service (IRS) announced their intent to issue proposed regulations on changes made to certain international provisions under the "One Big Beautiful Bill Act" (OBBBA):
For tax years of a foreign corporation beginning before January 1, 2026, IRC Section 951(a) requires a United States shareholder (US shareholder) owning stock of a controlled foreign corporation (CFC) on the last day of the corporation's tax year on which the corporation is a CFC (the last relevant day) to include in gross income its "pro rata share" of the CFC's subpart F income. For this purpose, the US shareholder's pro rata share is determined by first proportionally allocating subpart F income to the US shareholder, based on the shareholder's share of a hypothetical distribution treated as made by the CFC on the last relevant day. To the extent that the foreign corporation is not a CFC during all of its tax year, the allocation is reduced ratably based on the non-CFC period. For mid-year acquisitions of the CFC stock, IRC Section 951(a)(2)(B) reduces the US shareholder's pro rata share by distributions received by any other person as a dividend on that stock (including any gain treated as a dividend under IRC Section 1248), subject to a limitation based on the period during which the US shareholder did not own the stock. Similar rules apply in determining a US shareholder's pro rata share of a CFC's tested income under IRC Section 951A. The OBBBA eliminated the last-relevant-day component of IRC Section 951(a)(1)(A) and provides new rules for determining pro rata shares of subpart F income (by introducing the "attributable to" concept). Thus, for tax years of a foreign corporation beginning after December 31, 2025, a US shareholder owning CFC stock on any day of the CFC's tax year must include in gross income its pro rata share (as determined under the new rules) of the CFC's subpart F income. The OBBBA also includes a special transition rule for purposes of applying IRC Section 951(a)(2)(B) (transition rule) during pre-OBBBA periods. Specifically, the transition rule treats a "dividend paid (or deemed paid)" by a CFC as not a dividend for purposes of applying IRC Section 951(a)(2)(B) if the dividend "does not increase the taxable income of a [US] person subject to Federal income tax … (including by reason of a dividends received deduction, an exclusion from gross income, or an exclusion from subpart F income)." The transition rule applies to dividends (i) paid or deemed paid on or before June 28, 2025 during a CFC's tax year including that date, if the US shareholder does not own the stock of the CFC during the portion of the tax year on or before June 28, 2025 or (ii) paid or deemed paid after June 28, 2025 and before the CFC's first tax year beginning after December 31, 2025. Before Notice 2025-75, the transition rule left some uncertainties as to its application and its interaction with other IRC Sections and Treasury regulations. Notice 2025-75 announces that Treasury and the IRS intend to issue proposed regulations on the transition rule. These proposed regulations would address the meaning of certain terms used in the transition rule, the treatment of structures involving partnerships and S corporations by applying a look-through rule, the ordering of the transition rule and Treas. Reg. Section 1.245A-5, and reporting requirements, as described next. A dividend paid (or deemed paid) would be any amount that is treated as a distribution and received by any other person as a dividend under IRC Section 951(a)(2)(B), as in effect before the OBBBA amendments. Thus, the term would include gain treated as a dividend under IRC Section 1248 but not a distribution excluded from gross income under IRC Section 959(a) as PTEP. A US person subject to federal income tax would be any US person as defined in IRC Section 7701(a)(30) (including a nonresident alien who elects US residency), irrespective of whether that person has any federal income tax liability for any tax year. However, domestic grantor trusts, and bona fide residents of Guam, the Northern Mariana Islands, or the US Virgin Islands would be excluded from this definition. Domestic partnerships and S corporations would also be excluded; these entities would be subject to look-through treatment. A look-through rule would apply to (i) dividends paid by a CFC and received by a partnership or an S corporation and (ii) amounts includible in an S corporation's gross income under IRC Section 951(a)(1)(A) or 951A(a). Thus, in these cases, the determination of an increase to taxable income would be made at the partner or shareholder level (as applicable). In tiered structures, the look-through rule would apply successively up the ownership chain until reaching an owner that is neither a partnership nor an S corporation. However, to the extent a dividend paid by a CFC would be allocated under the look-through rule to a "de minimis owner" of a publicly traded domestic partnership (determined based on a 5% ownership test), the dividend would be treated as increasing the taxable income of a US person subject to federal income tax. This rule would not apply, however, if the domestic partnership has actual knowledge that the de minimis owner is not a US person subject to federal income tax or that the dividend does not increase such owner's taxable income. Taxable income as referenced in the transition rule would be generally defined by reference to IRC Section 63. For regulated investment companies (RICs), real estate investment trusts (REITs), and organizations exempt from taxation by reason of IRC Section 501(a), taxable income would mean investment company taxable income, real estate investment trust taxable income, and unrelated business taxable income, respectively. The determination of whether a dividend increases the taxable income of a US person would be made after applying any exclusions from income or any dividends-received deduction (DRD) to the dividend. Notice 2025-75 lists, as examples, the following types of dividends where there is no increase in taxable income: (i) dividends excluded from gross income under IRC Section 931 or 933, (ii) dividends eligible for an IRC Section 245A DRD, including by reason of IRC Section 1248(j) or 964(e)(4), and (iii) dividends that are paid to a CFC and do not give rise to subpart F income or tested income because of IRC Section 954(c)(6)'s look-through exception or IRC Section 959(b)'s exclusion for PTEP distributions. Similarly, IRC Section 954(c)(3)'s same country exception might result in a dividend not increasing taxable income. In making these determinations, any general deductions that are not specifically related to the dividend, such as depreciation deductions and net operating losses, are not taken into account. Further, dividends received by an upper-tier CFC would be treated as increasing the taxable income of a US person to the extent taken into account in determining a US shareholder's inclusion under IRC Section 951(a)(1)(A) or 951A(a) (but not to the extent allocable to a non-IRC Section 951(a) shareholder). This determination is made without regard to (i) properly allocable deductions of the upper-tier CFC, (ii) IRC Section 952(c)(1)'s rules regarding the earnings and profits limitation, qualified deficits, and chain deficits (in the case of subpart F income), and (iii) tested losses of any other CFCs and the net deemed tangible income return of the US shareholder (in the case of IRC Section 951A(a) inclusions). Nonetheless, dividends that are excluded from subpart F income or tested income under the high-tax exception in IRC Section 954(b)(4) or the high-tax exclusion in Treas. Reg. Section 1.951A-2(c)(1)(iii), respectively, would not be treated as increasing taxable income of a US person. To the extent that a dividend increases the taxable income of a US person by less than the full dividend, the portion that does not increase taxable income would not be treated as a dividend for purposes of IRC Section 951(a)(2)(B). Finally, the determination of whether a dividend increases the taxable income of a US person is made on a share-by-share basis. Treas. Reg. Section 1.245A-5 limits the IRC Section 245A DRD or IRC Section 954(c)(6) exclusion for certain dividends received from a CFC. In relevant part, this regulation applies when a controlling IRC Section 245A shareholder's ownership in a CFC is reduced during a tax year in a manner that lowers or eliminates the shareholder's subpart F income or GILTI inclusion (the extraordinary reduction limitation). The regulation addresses a concern that a dividend that is both received by the shareholder from the CFC and attributable to current-year subpart F or tested income could be eligible for an IRC Section 245A DRD and, in certain cases, also give rise to an IRC Section 951(a)(2)(B) reduction. To address this concern, the extraordinary reduction limitation disallows the IRC Section 245A DRD, with the result that the dividend is generally included in taxable income. For a dividend received by an upper-tier CFC, the extraordinary reduction limitation provides similar rules for the exclusion under IRC Section 954(c)(6). In both cases, the regulation permits the payor CFC's tax year to be closed as of the date of the extraordinary reduction, so that the shareholder would have subpart F income or GILTI inclusions with respect to the CFC for the short year (these inclusions would, together with IRC Section 959, generally displace IRC Section 245A or 954(c)(6)). For US persons determining whether a dividend paid by a CFC increases their taxable income, the notice provides that all applicable IRC Sections and Treasury regulations would apply before any limitation the transition rule may impose on the IRC Section 951(a)(2)(B) reduction. Under this approach, the notice clarifies that the extraordinary reduction limitation in Treas. Reg. Section 1.245A-5 applies before the transition rule, and the election to close a CFC's tax year remains available. A US shareholder that reduces its pro rata share of subpart F income or tested income under IRC Section 951(a)(2)(B), as a result of a dividend subject to the transition rule, would be required to attach a statement to Form 5471 (Information Return of US Persons with Respect To Certain Foreign Corporations) identifying those dividends and describing why and how the shareholder is entitled to the IRC Section 951(a)(2)(B) reduction after applying the transition rule. Notice 2025-75 anticipates that the forthcoming proposed regulations would apply to CFC tax years that either (i) include June 28, 2025, or (ii) begin after June 28, 2025, but before the CFC's first tax year beginning after December 31, 2025. Additionally, taxpayers may rely on the guidance in the notice until proposed regulations are published, provided that the taxpayer and its related parties follow the rules in their entirety and consistently for all dividends paid before the publication of the proposed regulations. Notice 2025-75 offers welcome guidance regarding the application of the transition rule. Importantly, the notice coordinates the transition rule with Treas. Reg. Section 1.245A-5 and confirms the continued availability of the closing-of-the-year-election. The notice also provides useful clarity on look-through treatment for partnerships and S corporations and income inclusions of entities such as RICs and REITs. Still, the notice brings with it an extra layer of compliance of which taxpayers must be mindful when applying the transition rule. Under IRC Section 960(d)(1), a corporate United States (US) shareholder that has an inclusion under IRC Section 951A (a Section 951A inclusion) is deemed to have paid an amount of foreign income taxes that were paid or accrued by a CFC whose income gave rise to the inclusion. The US shareholder may then claim a foreign tax credit for these "deemed paid taxes," subject to certain limitations. Before the OBBBA, foreign tax credits with respect to 20% of these "deemed paid taxes" were disallowed; the OBBBA reduced this disallowance percentage to 10%. When the CFC's earnings are distributed to the US shareholder that previously recognized the Section 951A inclusion (Section 951A PTEP), any withholding taxes were potentially creditable against Section 951A inclusions. For tiered CFCs, any withholding taxes or upper-tier CFC income taxes may be deemed paid by the US shareholder under IRC Section 960(b). Before the OBBBA, the 20% disallowance percentage applicable to taxes deemed paid on the original inclusions did not apply either to withholding taxes paid or upper-tier CFC income taxes deemed paid under IRC Section 960(b). For example, a US shareholder that received a distribution of Section 951A PTEP and paid withholding tax on that distribution could claim a foreign tax credit for the entire withholding tax, subject to applicable limitations. Similarly, the disallowance percentage did not apply to foreign income taxes deemed paid under IRC Section 960(b) on Section 951A PTEP distributions, although IRC Section 78 treated these deemed paid taxes as a dividend. The OBBBA added IRC Section 960(d)(4), which disallows a foreign tax credit for 10% of any foreign income taxes paid or accrued, or deemed paid under IRC Section 960(b)(1), on a distribution of Section 951A PTEP. Accordingly, the OBBBA coordinates the treatment of foreign income taxes related to Section 951A PTEP distributions with those on Section 951A inclusions. The OBBBA states that the 10% disallowance applies to foreign income taxes paid or accrued (or deemed paid or accrued) with respect to "any amount excluded from gross income under Section 959(a) of such Code by reason of an inclusion in gross income under section 951A(a) of such Code after June 28, 2025." Following the enactment of OBBBA, questions arose as to the precise meaning of this effective date. According to a section-by-section summary of the OBBBA released by the Senate Finance Committee, the disallowance percentage applies to any foreign income tax on Section 951A PTEP distributed after June 28, 2025.1 Alternatively, the effective date could be read to apply the disallowance percentage to Section 951A distributions related to Section 951A inclusions occurring after June 28, 2025. Notice 2025-77 was issued to address this question. Notice 2025-77 announces that Treasury and the IRS intend to issue proposed regulations under IRC Section 960(d)(4), as introduced in the OBBBA, on the 10% disallowance on creditable foreign taxes related to distributions of PTEP arising from IRC Section 951A inclusions. In addition, they also intend to modify the proposed PTEP regulations, originally published on December 2, 2024, to align with the guidance in the notice. Under the forthcoming regulations, IRC Section 960(d)(4) would apply the 10% disallowance percentage to foreign income taxes on Section 951A PTEP distributions only if the PTEP arose from a Section 951A inclusion of a US shareholder for a tax year ended after June 28, 2025. Accordingly, the disallowance percentage would apply based on the US shareholder's tax year for which it had the relevant Section 951A inclusion that gave rise to the Section 951A PTEP. In certain circumstances, this could mean that foreign income taxes on a Section 951A PTEP distribution paid before June 28, 2025, are subject to the 10% disallowance percentage. Notice 2025-77 permits taxpayers to rely on its guidance until proposed regulations are published, provided they follow the guidance in its entirety and consistently for all applicable tax years. Notice 2025-77 resolves uncertainty about the effective date of IRC Section 960(d)(4), confirming that foreign income taxes on Section 951A PTEP distributions (whether occurring before or after June 28, 2025) are subject to the 10% disallowance percentage if the PTEP arose from a US shareholder's IRC Section 951A inclusion in a tax year ended after June 28, 2025. Notice 2025-78 on the exclusion from DEI and FDDEI for sales or dispositions of IP and other excluded property IRC Section 250(a)(1), as amended by the OBBBA, allows a domestic corporation to deduct a percentage of its FDDEI, effectively reducing the US federal income tax rate on that income. Generally, a corporation's FDDEI is its deduction-eligible income (DEI) derived from either (i) property sold or licensed to a non-US person for a foreign use; or (2) services performed for a person, or with respect to property, located outside the United States. Certain categories of income are excluded from DEI and, in turn, are not eligible for the FDDEI deduction. IRC Section 250(b)(3)(A)(i)(VII, as amended by the OBBBA, now excludes from DEI any income and gain from the sale or other disposition of (i) intangible property as defined in IRC Section 367(d)(4) (IP), and (ii) any other property of a type that is subject to depreciation, amortization or depletion by the seller (other excluded property)) (OBBBA Excluded Income). For these purposes, sales or other dispositions include deemed sales or transactions subject to IRC Section 367(d), but do not include leases or licenses. Thus, income or gain from a sale or other disposition of IP (other than by license) or other excluded property is not eligible for the reduced FDDEI rate. The exclusion from DEI for sales or dispositions of IP and other excluded property applies to sales or other dispositions (including deemed sales or transactions subject to IRC Section 367(d)) occurring after June 16, 2025. Notice 2025-78 announces forthcoming regulations on the OBBBA's amendment to IRC Section 250, particularly the scope of OBBBA Excluded Income. A sale or other disposition of IP or other excluded property would be determined under general tax principles and would include deemed sales, other deemed dispositions, and transactions subject to IRC Section 367(d). A deemed sale or other deemed disposition would include any transaction or election treated as a sale or disposition of property for federal income tax purposes. However, a sale or other disposition does not include a lease or license as characterized for federal income tax purposes. Thus, for example, income from licensing IP to a foreign person continues to be included in DEI and, where applicable, eligible for the FDDEI deduction. An example in Notice 2025-78 illustrates the importance of properly characterizing a transaction involving IP as a sale or license. In the example, an arrangement labeled as a license involves the grant of an exclusive, irrevocable license for the remaining term of a copyright, which the example states, is characterized under general tax principles as a sale of IP. Consequently, any income or gain from the sale is excluded from DEI and FDDEI. If the arrangement were instead characterized as a license under general tax principles, the example notes, income or gain from the arrangement would be included in DEI and FDDEI. IP is defined by reference to IRC Section 367(d)(4). Notice 2025-78 explicitly provides that a copyrighted article (as defined in certain software regulations under Section 861) is not intangible property for this purpose. "Other excluded property" means property that is not IP and is, or has been, in the hands of the seller: (i) treated as property subject to an allowance for depreciation under IRC Section 167; (ii) subject to an allowance for amortization; or (iii) subject to the allowance for depletion under IRC Section 611. An example in Notice 2025-78 illustrates how the term "other excluded property" applies to sales of a type of property that a corporation both holds as inventory and uses in its trade or business. In the example, a domestic corporation both uses airplanes in its trade or business, depreciating those it uses under IRC Section 167, and holds other airplanes as inventory. The notice provides that any income from the sale of the airplanes that the taxpayer previously used in its trade or business (and depreciated) is treated as income from the sale of "other excluded property" and thus excluded from DEI. Conversely, it provides that income from the sale of airplanes held as inventory is not excluded from DEI and is thus potentially eligible for the FDDEI deduction. Notice 2025-78 also introduces a related-party anti-abuse rule that would apply where a group engages in an intra-group transaction with a principal purpose of avoiding the other excluded property rule. Applicability date and reliance The forthcoming proposed regulations would apply, when finalized, to sales or other dispositions (including deemed sales, deemed dispositions, or transactions subject to IRC Section 367(d)) occurring after June 16, 2025. Taxpayers may rely on the rules in Notice 2025-78 for sales or dispositions occurring before the proposed regulations are published in the Federal Register, provided they apply the rules consistently and in their entirety for all applicable tax years. Notice 2025-78 clarifies the scope of the new category of income that is excluded from DEI. Importantly, the notice confirms that licenses of IP, as determined under general US federal income tax principles, continue to qualify as DEI. Additionally, DEI includes property that a seller does not depreciate or amortize because, for example, it is held as inventory, even if the property is "of a type" that could be depreciated or amortized by the seller or another taxpayer. Taxpayers undertaking transactions (including deemed transactions) potentially involving IP or other excluded property should carefully review the federal income tax treatment of the property prior to the transaction, as well as the classification of the transaction itself, to determine whether income or gain from the transaction can be included in DEI and potentially eligible for the beneficial FDDEI rate. Treasury and the IRS's recent release of Notices 2025-75, 2025-77, and 2025-78 provides much-needed clarity and transitional guidance on the changes introduced by the OBBBA to key international tax provisions. Forthcoming proposed regulations announced by the notices, if finalized, are generally expected to apply retroactively. Taxpayers may rely on the guidance provided in specific sections of the notices until the proposed regulations are issued, subject to certain consistency requirements. Taxpayers, in general, should carefully review and familiarize themselves with the content of these notices.
Document ID: 2026-0178 | ||||||||
