On August 3, 2026, the US Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) published proposed regulations in the Federal Register (REG-115145-25) that would implement two provisions of the One Big Beautiful Bill Act (OBBBA).

The proposed regulations first address the transition rule associated with the OBBBA's repeal of the one-month deferral election under IRC Section 898(c)(2). The proposed regulations follow the framework previously announced in Notice 2025-72 for allocating certain foreign income taxes that accrue during the mandatory, one-month "short year" caused by the repeal of the election (see Tax Alert 2025-2608), but provide certain modifications. Most notably, the proposed regulations introduce elective relief for specified distributive shares of partnership creditable foreign tax expenditures (CFTEs), certain succeeding-year taxes, income-group-specific allocation percentages, and an election not to allocate specified foreign income taxes.

The proposed regulations under IRC Section 960(d)(4) would adopt the guidance in Notice 2025-77 (see Tax Alert 2026-0178) on IRC Section 960(d)(4)'s foreign tax credit disallowance rule for distributions of previously taxed earnings and profits resulting from IRC Section 951A inclusions (IRC Section 951A PTEP).

Proposed regulations under IRC Section 898(c)

Background

Before the OBBBA, a specified foreign corporation (SFC)¹ could elect under IRC Section 898(c)(2) to begin its tax year one month earlier than its majority United States (US) shareholder (the one-month deferral election). The OBBBA repealed that election for tax years of SFCs beginning after November 30, 2025. As a result, an SFC that previously made the one-month deferral election was required to have a mandatory one-month short tax year (the first required year). In many cases, an SFC would accrue 12 months of taxes within that one-month short tax year, with only one month of corresponding income. To address this mismatch, the OBBBA included a transition rule that instructed Treasury to issue regulations for allocating foreign taxes that are paid or accrued in that one-month short tax year between that short tax year and the succeeding tax year. Treasury and the IRS issued Notice 2025-72 to address this issue by establishing a framework for allocating "specified foreign income taxes" between the first required year and the succeeding tax year.

The proposed regulations' allocation rules would apply only to an SFC that takes foreign income taxes into account under the accrual method of accounting and must change its first tax year beginning after November 30, 2025, due to the repeal of the one-month deferral election (an affected corporation).

Foreign taxes subject to allocation

Specified foreign income taxes

Specified foreign income taxes are defined as foreign net income taxes (i) that accrue during an affected corporation's one-month short tax year caused by the repeal of the one-month deferral election and (ii) for which the affected corporation is the IRC Section 901 taxpayer. As under Notice 2025-72, the proposed regulations would not apply to taxes that are likely to accrue close in time to the associated income, such as withholding taxes and taxes paid by cash-basis SFCs.

Election to treat CFTEs as specified foreign income taxes

By default, the proposed regulations would exclude an affected corporation's distributive share of partnership CFTEs from the definition of specified foreign income taxes. However, when a partnership is required to change its tax year because an affected corporation partner changes its year under the OBBBA (an affected partnership), the proposed regulations provide an election to treat an affected corporation's distributive share of certain CFTEs of the affected partnership (specified distributive share of CFTEs) as specified foreign income taxes subject to allocation.

The election would apply only where the partnership's transition to the required tax year aligns with the affected corporation's transition, thereby extending the allocation rules to partnership-level foreign taxes that may present the same timing mismatch as foreign taxes accrued directly by the affected corporation.

Irrevocable election to allocate relevant succeeding year taxes

The proposed regulations would retain Notice 2025-72's treatment of foreign income taxes accruing during the succeeding tax year by generally excluding those taxes from the allocation framework, so they would not be treated as specified foreign income taxes for allocation and remain entirely in the succeeding tax year. However, a limited election would apply to foreign income taxes that accrue in a succeeding tax year. Specifically, when the affected corporation's foreign tax year (for instance, March 31 year-end) does not align with its US tax year (for instance, December 31 year-end), the proposed regulations provide an irrevocable election to allocate certain taxes that accrue in a succeeding tax year (relevant succeeding year taxes) between the first required year and the succeeding tax year. Taxpayers electing to allocate relevant succeeding year taxes would have to use the income-group-specific allocation methodology described later.

Ordering rules

Under the proposed regulations, specified foreign income taxes would first be allocated and apportioned to the appropriate income groups (e.g., tested income and subpart F income groups) under the existing foreign tax allocation and apportionment rules. The specified foreign income taxes assigned to each income group would then be allocated between the first required year and the succeeding tax year under the allocation methodology described next. The foreign income taxes allocated to each tax year would subsequently be taken into account under the applicable provisions of the Code (e.g., for determining subpart F income, tested income, earnings and profits, and IRC Section 960 deemed paid taxes).

Allocation methodology and elections

A specified foreign income tax in each income group would be allocated to the first required year and the succeeding tax year by applying a single allocation percentage uniformly across all income groups. An allocation percentage would be generally determined by dividing the affected corporation's foreign taxable income that is attributable to the ?rst required year under the principles of Treas. Reg. Section 1.1502-76(b) by the total foreign taxable income for the foreign tax year to which the speci?ed foreign income tax relates. The proposed regulations introduce two elections that would modify the application of this default allocation methodology.

First, taxpayers could elect to compute a separate allocation percentage for each income group, using a closing-of-the-books method applied separately to each income group to which foreign taxable income is assigned under Treas. Reg. Section 1.861-20. This election was added in response to comments noting that the use of a single allocation percentage could result in a mismatch between income and taxes where the income types differ between the first required year and the succeeding tax year.

Second, taxpayers could elect to forgo an allocation entirely, keeping all specified foreign income taxes in the first required year under existing accrual rules. This election would give controlling domestic shareholders the flexibility to retain the existing accrual treatment in lieu of applying the allocation regime.

Procedural rules for elections

The proposed regulations' elections would be made by the affected corporation's controlling domestic shareholders. Under a consistency rule, an election would apply to all of the US shareholders of an SFC. However, there is no consistency requirement for different SFCs of a US shareholder, so different elections could be made (or not made) for each of that US shareholder's SFCs. The elections relating to specified distributive shares of CFTEs and separate-income-group-allocation percentages could be made or revoked on an amended return filed within a prescribed 24-month period. The election relating to relevant succeeding year taxes would be irrevocable and would have to be filed on an original return. The election to forgo the allocation regime would have to be filed on an original return and could be revoked on an amended return within a 24-month window.

Interaction with IRC Sections 905(c) and 986(a)

Any foreign tax redetermination under IRC Section 905(c) and any translation of foreign income taxes into US dollars under IRC Section 986(a) would be determined for the entire specified foreign income tax before applying the allocation rules. The allocation between the first required year and the succeeding tax year would then be applied to the adjusted specified foreign income tax liability, thereby preserving the operation of the existing rules while implementing the allocation regime.

Applicability date

The proposed regulations under IRC Section 898(c) would apply to tax years of SFCs beginning after November 30, 2025. Taxpayers may rely on the proposed regulations before they are finalized, provided they apply the rules consistently and in their entirety for the SFC's first required year and succeeding tax years.

Implications

The proposed regulations would give taxpayers additional flexibility through several new elections. Taxpayers affected by the repeal of the one-month deferral election should evaluate whether these elections better align foreign income taxes with the related income and lessen the potential for uncreditable foreign taxes.

Proposed regulations under IRC Section 960(d)(4)

Background

Subject to certain limitations, a taxpayer may generally claim a credit for the foreign income taxes it pays or accrues. For a domestic corporation, the credit extends to foreign income taxes that the corporation is deemed to have paid under IRC Section 960, which addresses certain foreign income taxes attributable to amounts included in income under subpartF of the Code.

Before the OBBBA, IRC Section 960(d)(1) effectively reduced by 20% the foreign income taxes deemed paid on an income inclusion under IRC Section 951A. No similar reduction applied to foreign income taxes associated with distributions of IRC Section 951A PTEP.

The OBBBA reduced the IRC Section 960(d)(1) disallowance from 20% to 10%. At the same time, the OBBBA enacted IRC Section 960(d)(4), which disallows a foreign tax credit for 10% of certain foreign income taxes paid or accrued (or deemed paid under IRC Section 960(b)(1)) for distributions of IRC Section 951A PTEP that are excluded from gross income under IRC Section 959(a).

The 10% disallowance under IRC Section 960(d)(4) applies to foreign income taxes paid or accrued (or deemed paid) on "any amount excluded from gross income under section 959(a) of [the IRC] by reason of an inclusion in gross income under section 951A(a) of such Code after June 28, 2025." Notice 2025-77 clarified this effective date and addressed related issues, as discussed next.

Effective date and tracking rules

Consistent with Notice 2025-77, application of the 10% disallowance under IRC Section 960(d)(4) to a distribution of IRC Section 951A PTEP would depend on when the PTEP arose (determined by reference to a US shareholder's tax year), not when it is distributed. Thus, the disallowance could apply to any IRC Section 951A PTEP excluded from gross income under IRC Section 959(a), provided the PTEP resulted from an amount included in a tax year of a US shareholder ending after June 28, 2025.

Also consistent with the Notice, the proposed regulations would require tracking IRC Section 951A PTEP in new groups — a "pre-06/29/25 section 951A PTEP" group, for PTEP not subject to the IRC Section 960(d)(4) disallowance, and a "post-06/28/25 section 951A PTEP" group, for PTEP that is subject to the disallowance. This tracking would also apply to IRC Section 951A PTEP described in IRC Section 959(c)(1) (reclassified IRC Section 951A PTEP).

Applicability date

The proposed regulations under IRC Section 960(d)(4) would apply to foreign income taxes paid or accrued (or deemed paid under IRC Section 960(b)(1)) on amounts excluded from gross income under IRC Section 959(a) by reason of an IRC Section 951A inclusion, to the extent the inclusion arises in a US shareholder's tax year ending after June 28, 2025. Taxpayers may rely on the proposed regulations before they are finalized, provided they apply the rules consistently and in their entirety for all applicable tax years.

Implications

By adopting the guidance in Notice 2025-77, the proposed regulations provide taxpayers with greater certainty around IRC Section 960(d)(4)'s effective date while also increasing information that must be tracked with respect to IRC Section 951A PTEP.