The Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) issued Notice 2025-72 to announce their intent to issue forthcoming proposed regulations addressing two key areas impacted by recent legislation. Specifically, the notice details plans for proposed regulations under Section 70352 of Public Law 119-21, 139 Stat. 72 (July 4, 2025), commonly known as the One, Big, Beautiful Bill Act (OBBBA), which repealed Section 898(c)(2) of the Internal Revenue Code (Code). The OBBBA directed the Treasury Department and the IRS to issue guidance on allocating foreign taxes for foreign corporations affected by this repeal (the forthcoming proposed Section 898 regulations). Additionally, the notice addresses forthcoming proposed regulations under Section 987 that will modify the election concerning the recognition of pretransition Section 987 gain or loss ratably over the transition period pursuant to §1.987-10(e)(5)(ii)(A).

Repeal of the One-Month Deferral Election

Prior Law and Provisions

Section 898 provides rules for determining the required taxable year for a “specified foreign corporation” (SFC). An SFC is defined as a foreign corporation treated as a controlled foreign corporation (CFC) for Subpart F purposes where a United States shareholder (U.S. shareholder, as defined in Section 951(b)) owns over 50 percent of the stock by vote or value on each testing day (a majority U.S. shareholder).

Section 898(c)(1) generally required an SFC to adopt the same taxable year as its majority U.S. shareholder (the majority U.S. shareholder year). However, prior to the OBBBA’s enactment, Section 898(c)(2) permitted the one-month deferral election, allowing an SFC to elect a taxable year beginning one month earlier than the majority U.S. shareholder year.

New Provisions and Statutory Transition Rule

Section 70352 of the OBBBA repealed the one-month deferral election for taxable years of SFCs beginning after November 30, 2025.

To manage the transition, Section 70352(c) of the OBBBA provides a statutory transition rule. If a corporation is an SFC as of November 30, 2025, its first taxable year beginning after November 30, 2025, must end at the same time as the first required year (within the meaning of Section 898(c)(1)) ending after that date. Consequently, an SFC that utilized the one-month deferral election will have a one-month short taxable year as its first required year. This change in taxable year is treated as initiated by the corporation and made with the consent of the Secretary.

Critically, the transition rule directs the Secretary to issue guidance for allocating foreign taxes paid or accrued in the specified foreign corporation’s first required year and its succeeding taxable year.

Guidance on Allocation of Foreign Income Taxes

The repeal of the deferral election creates a potential mismatch because a specified foreign corporation’s foreign taxable year may close with or within its first required year. In such cases, the foreign net income tax (a tax determined on the basis of income, gain, deduction, and loss arising in a foreign taxable year) accrues in the first required year, even though only one month of income accrues for Federal income tax purposes. This mismatch could cause the SFC to have a loss in an income group, which in turn could prevent a U.S. shareholder from having an inclusion under Section 951(a)(1) or tested income under Section 951A, thereby precluding a deemed paid credit under Section 960(a) or (d).

The forthcoming proposed Section 898 regulations (described in Section 3 of Notice 2025-72) address this issue. These rules apply only to an "affected corporation," which is an SFC that takes foreign income taxes into account under the accrual method of accounting and is required to change its first taxable year beginning after November 30, 2025, pursuant to Section 70352(c) of the OBBBA.

Specified Foreign Income Taxes

The allocation rules apply only to a "specified foreign income tax" (SFIT), defined as a foreign net income tax that accrued in the affected corporation’s first required year for which the affected corporation is the section 901 taxpayer.

The rules do not apply to other foreign taxes, such as an affected corporation’s distributive share of foreign income taxes paid or accrued by a partnership, withholding taxes described in Section 901(k)(1)(B), or foreign income taxes accrued in the succeeding taxable year. Foreign net income tax accrued in the succeeding taxable year is excluded primarily due to the expectation that the administrative burden of allocation would exceed the benefits, as such an allocation would be difficult to perform before the due date of the majority U.S. shareholder’s income tax return for the taxable year with which the first required year ends. Furthermore, specified foreign corporations using the cash method of accounting are excluded from these allocation rules.

Ordering Rule for SFIT Allocation

The notice establishes a four-step ordering rule for allocating SFITs between the first required year and the succeeding taxable year:

Determination: The SFITs are determined.
Apportionment to Groups: The SFIT is allocated and apportioned in the first required year to income groups (§1.960-1(d)(2)) and PTEP groups (§1.960-1(d)(3)(ii)(B)) by applying §1.861-20 (as modified by §1.960-1(d)(3)(ii)(B)). For this purpose, the tentative gross tested income items described in §1.951A-2(c)(7)(ii) are treated as income groups.
Allocation: The allocation rule detailed in Section 3.05 of the notice is applied to determine the amount of SFIT in each income group allocated to the first required year and the succeeding taxable year.
Accrual Treatment: The amounts allocated to the first required year and the succeeding taxable year are treated as accruing in the respective year for all purposes of the Code (with exceptions below). This includes computing Subpart F income, tested income (including whether the high-tax exception or high-tax exclusion applies), earnings and profits, and taxes deemed paid under Section 960(a), (b), or (d).

Allocation Between Taxable Years

The allocation percentage is calculated to determine the SFIT allocated to the first required year.

General Allocation Percentage: The allocation percentage for each SFIT generally equals the portion of taxable income, as determined under foreign law, that is attributable to the first required year (numerator) divided by the total taxable income, as determined under foreign law, for the foreign taxable year to which the SFIT relates (denominator).
Methodology: The principles of §1.1502-76(b) are used to attribute the foreign tax base, allowing for either a closing of the books method or a ratable allocation method. This approach aims to match the accrued SFIT in the short year to the associated income.
PTEP Group Exception: If an SFIT is assigned to a PTEP group under the ordering rules (Section 3.04(2)), the entire amount of that tax is allocated to the first required year. The corresponding foreign law taxable income is excluded from the calculation of the allocation percentage under Section 3.05(1)(a).
Succeeding Taxable Year Allocation: Any amount of the SFIT assigned to an income group remaining after the allocation to the first required year is allocated to the succeeding taxable year.

Application of Sections 905(c) and 986(a)

For purposes of Sections 905(c) (redetermination of U.S. tax liability due to change in foreign tax liability) and Section 986(a) (translation of foreign income taxes), an SFIT is treated as accruing in the first required year, regardless of whether a portion is allocated to the succeeding taxable year. Thus, the first required year is the year to which the specified foreign income tax relates for Sections 905(c)(1)(B) and 986(a) purposes.

Any subsequent change in the liability for an SFIT requires three steps: first, adjusting the amount of SFIT accrued in the first required year; second, reapplying the allocation rules (Sections 3.04(1), 3.04(2), and 3.04(3)) based on the adjusted amount; and third, adjusting the amounts of SFIT treated as accruing in the first required year and the succeeding taxable year.

Guidance on Recognition of Pretransition Gain or Loss under Section 987

Section 987 applies to taxpayers, including CFCs, that own a qualified business unit (QBU) with a functional currency other than the dollar. Under Section 987(3), foreign currency gain or loss (Section 987 gain or loss) is recognized when the QBU makes a remittance.

The existing Section 987 regulations (§1.987-10) include transition rules for pretransition gain or loss that arose before the regulations became applicable. Specifically, §1.987-10(e)(5)(ii)(A) permits taxpayers to elect to recognize pretransition gain or loss ratably over the transition period, which is ten taxable years. Under this "amortization election," a taxpayer recognizes one-tenth of its pretransition gain or loss in each taxable year of the transition period.

The forthcoming proposed Section 987 regulations (described in Section 4 of Notice 2025-72) will modify the effect of the amortization election to appropriately account for pretransition gain or loss during short taxable years, including those resulting from the Section 898(c)(2) repeal.

If the amortization election is made, pretransition gain or loss is recognized ratably over 120 months (rather than ten taxable years) beginning with the first day of the first taxable year in which the Section 987 regulations apply.

If an owner recognized a ratable portion of pretransition gain or loss under §1.987-10(e)(5)(ii)(A) in any taxable year ending before November 25, 2025, and before the application of the new rules, each such prior taxable year is deemed to contain twelve months for purposes of the 120-month amortization period. For instance, if the first applicable short taxable year ended before November 25, 2025, and the owner recognized one-tenth of the gain/loss, the remaining pretransition gain or loss would be recognized ratably over the subsequent 108 months.

IRS Expectations for Future Regulations and Reliance

Forthcoming Proposed Section 898 Regulations

The forthcoming proposed Section 898 regulations are intended to apply to taxable years of specified foreign corporations beginning after November 30, 2025.

Tax professionals should note that taxpayers may rely on the rules described in Section 3 of Notice 2025-72 for foreign taxes paid or accrued in SFC taxable years beginning after November 30, 2025, and ending before the regulations are formally published in the Federal Register. However, this reliance is conditioned upon the taxpayer applying the Section 3 rules in their entirety and consistently for both the first required year and the succeeding taxable year of the SFC.

Forthcoming Proposed Section 987 Regulations

The forthcoming proposed Section 987 regulations are intended to apply to taxable years beginning after December 31, 2024, and ending on or after November 25, 2025.

Taxpayers may rely on the rules described in Section 4 of this notice before the proposed regulations are published, provided the rules are applied in their entirety and consistently with respect to each Section 987 QBU, original deferral QBU, and outbound loss QBU for that taxable year and each subsequent taxable year.

Request for Comments

The Treasury Department and the IRS specifically request comments on several points that may shape the final regulations. They seek input on whether the allocation rule provided in Section 3.05 of the notice should extend to foreign taxes other than SFITs, such as an affected corporation’s distributive share of foreign income taxes paid or accrued by a partnership that is forced to change its taxable year due to the CFC’s change. Furthermore, they request comments on other multi-year rules that may require guidance due to the short taxable years resulting from the Section 898(c)(2) repeal. Comments must be submitted by January 24, 2026.

Prepared with assistance from NotebookLM.