Pro Rata Share of Subpart F Income, Tested Income, or Tested Loss, REG-115646-25, 91 Fed. Reg. _____ (proposed Aug. 26, 2026)

The Department of the Treasury and the Internal Revenue Service have released a comprehensive set of proposed regulations under REG-115646-25 to address the sweeping statutory changes enacted by the One, Big, Beautiful Bill Act (OBBBA), Public Law 119-21. Designed for tax professionals advising clients with international holdings, this article analyzes the statutory impetus for these regulations, details key additions, revisions, and deletions to existing Treasury regulations, and evaluates the policy rationales and technical justifications provided by the Internal Revenue Service. Finally, we review applicability dates and the terms under which taxpayers may rely on these proposed rules pending finalization.

Statutory Impetus and Regulatory Purpose

The OBBBA, enacted on July 4, 2025, fundamentally reformed the mechanisms of subpart F and Global Intangible Low-Taxed Income (GILTI) taxation for taxable years of foreign corporations beginning after December 31, 2025. Under pre-OBBBA law, former Internal Revenue Code (IRC) Section 951(a)(1)(A) operated under a “last day of the year” ownership test. Inclusions of subpart F income were restricted to United States shareholders who owned stock, directly or indirectly under Section 958(a), on the “last day of the taxable year on which the corporation was a CFC.” This rule allowed taxpayers to shift significant tax liabilities through mid-year stock transfers, requiring complex rules like the Section 245A extraordinary reduction rules to prevent tax avoidance.

The OBBBA replaced this historic framework with a period-based ownership model. Under revised Section 951(a)(1)(A), a U.S. shareholder must include in gross income their pro rata share of subpart F income if the foreign corporation is a controlled foreign corporation (CFC) “at any time during the foreign corporation’s taxable year” and the shareholder owns stock of the foreign corporation “on any day during the CFC year.”

To implement this daily proration model, revised Section 951(a)(2) states that a shareholder’s pro rata share is the portion of subpart F income attributable to the stock owned and the “any period of the CFC year during which (i) the shareholder owned such stock, (ii) the shareholder was a U.S. shareholder of the corporation, and (iii) the corporation was a CFC.” Additionally, the OBBBA amended Section 951A(a) to replace the GILTI inclusion amount with a “net CFC tested income” inclusion model, requiring pro rata share determinations of tested income and tested loss to be calculated under the same Section 951(a)(2) period-based rules. Under Section 951(a)(4), Congress explicitly delegated authority to the Secretary of the Treasury to prescribe regulations necessary to carry out these provisions, including rules allowing or requiring taxpayers to close the taxable year of a CFC upon a disposition of stock.

Key Additions and Revisions to Current Regulations

The proposed regulations introduce several fundamental additions and modifications to Title 26 of the Code of Federal Regulations (C.F.R.) to align existing administrative rules with the new statutory mandate.

General Income Inclusion Rules

Proposed §1.951-1(b)(1) implements the daily proration approach by requiring any U.S. shareholder who owned stock in a CFC on “any day during a CFC year” to include their pro rata share of subpart F income. Crucially, the taxable year of the inclusion is accelerated relative to prior law; the pro rata share must be included in the shareholder’s taxable year “that includes the last day on which the shareholder owns stock in the foreign corporation during the CFC year.”

Proposed §1.951-1(b)(2) applies a parallel rule for Section 956 inclusions of investments in U.S. property. Although the OBBBA retained the “last day” ownership rule for Section 956 under Section 951(a)(1)(B), the proposed regulations synchronize the inclusion year, requiring Section 956 amounts to be included in the shareholder’s taxable year that includes the last day of stock ownership during the CFC year.

Mandatory Closing of the Taxable Year

Under Proposed §1.951-1(d)(1)(i), a foreign corporation must close its taxable year “for all purposes of the Internal Revenue Code (and, therefore, as to all shareholders of the foreign corporation)” upon the occurrence of a “status change event.” Proposed §1.951-1(d)(1)(ii) defines a status change event as occurring when a foreign corporation “becomes or ceases to be a controlled foreign corporation.”

In the case of a corporation becoming a CFC, the taxable year closes on “the last day that the foreign corporation is not a controlled foreign corporation,” and in the case of a corporation ceasing to be a CFC, the year closes on “the last day that the foreign corporation is a controlled foreign corporation.” To prevent technical circumvention, Proposed §1.951-1(d)(1)(iii) provides that the partnership attribution rules under §1.958-1(d)(1) and option attribution under Section 318(a)(4) are disregarded solely for the purpose of identifying a status change event.

Elective Closing of the Taxable Year

Where a CFC does not experience a status change event but undergoes a substantial shift in ownership, Proposed §1.951-1(d)(2)(i) permits the “controlling section 958(a) U.S. shareholders” to elect to close the CFC’s taxable year for all purposes of the Code. This election is available only if a “significant ownership variance” occurs.

Proposed §1.951-1(d)(2)(ii)(A) defines a significant ownership variance as a decrease, in the aggregate, of “more than 50 percentage points (by vote or value)” in the ownership of one or more Section 958(a) U.S. shareholders, taking into account all “specified transfers” occurring “pursuant to the same plan during the same taxable year of a controlled foreign corporation.” A specified transfer includes direct or indirect sales, redemptions, issuances of stock, or transfers of partnership interests holding CFC stock.

To execute the election, Proposed §1.951-1(d)(2)(iv) requires all controlling Section 958(a) U.S. shareholders and all other Section 958(a) U.S. shareholders who owned stock on any day of the CFC’s taxable year up to and including the closing date to enter into a written, binding agreement. Each electing shareholder must attach an “Elective Section 951 Year-Closing Statement” to their timely filed original Federal income tax return. Proposed §1.951-1(d)(2)(vi) establishes a consistency requirement, mandating that if significant ownership variances occur with respect to multiple CFCs pursuant to a single plan, the election must be made for all such CFCs.

Daily Proration and Weighted Average Share Mechanics

If the foreign corporation’s year does not close, Proposed §1.951-1(e)(2) applies a daily proration approach to allocate subpart F income, tested income, and tested loss. If a CFC has a single class of stock and a constant share count, a U.S. shareholder’s pro rata share is determined under Proposed §1.951-1(e)(2)(i)(A) by multiplying the subpart F income by:

A fraction representing the shareholder’s proportionate ownership of outstanding shares, and
A fraction representing the number of days the shareholder owned the shares while the corporation was a CFC and the shareholder was a U.S. shareholder, divided by the total days in the CFC year.

For shareholders who vary their holdings, Proposed §1.951-1(e)(2)(i)(B) requires these calculations to be performed separately for each “CFC year block,” defined as “a group of shares within a class of stock of a controlled foreign corporation that a United States shareholder owns for the same period during a CFC year.”

If a CFC has multiple classes of stock, Proposed §1.951-1(e)(2)(ii) adopts the economic hypothetical distribution analysis of existing regulations, allocating the subpart F income to classes based on the relative distribution rights of the classes if all “allocable earnings and profits” were distributed on the last day of the CFC year. Where the outstanding share count changes mid-year (such as via issuance or redemption), Proposed §1.951-1(e)(2)(iii)(A) requires the substitution of a “weighted average share count,” calculated as the sum of the shares outstanding on each day of the CFC year divided by the total number of days in the CFC year.

Foreign Income Tax Allocations

Because mandatory or elective year-closings can result in a foreign taxable year spanning multiple short U.S. taxable years, Proposed §1.951-1(d)(3)(i) requires a portion of the foreign income taxes that accrue in the post-closing U.S. taxable year to be allocated back to the short U.S. taxable year ending on the closing date. This allocation must be made based on “the portion of the taxable income of the foreign corporation (as determined under foreign law) for the foreign taxable year that is attributable under the principles of §1.1502-76(b) (without regard to §1.1502-76(b)(2)(ii)) to the period of the foreign taxable year ending with the closing date.” Once allocated, these taxes are treated as accrued as of the close of the short taxable year for all purposes of the Code (except Section 986(a)).

Information Reporting on Form 5471

To enable the IRS to verify compliance under the new daily proration rules, Proposed §1.6038-2(f)(8) expands the information required to be reported on Form 5471. United States persons must now provide a detailed description of each class of stock, the outstanding shares on the first day of the year, the exact date and description of any issuance, redemption, or other change in outstanding shares, and the post-change balance of outstanding stock. Furthermore, direct and indirect owners must report the exact date, description, and balance of any stock acquired, received, disposed of, or redeemed during the annual accounting period.

Revisions to GILTI under Section 951A

To coordinate with the OBBBA’s transition to a net tested income model, Proposed §1.951A-1(b) and (c) replace the GILTI inclusion rules with the “net CFC tested income inclusion amount.” Under Proposed §1.951A-1(d)(1), pro rata shares of tested income and tested loss are determined under Section 951(a)(2) period-based rules in the same manner as subpart F income. The proposed regulations retain the complex Tested Loss allocation rules under Proposed §1.951A-1(d)(3) (allocating tested loss to cumulative preferred stock with dividend arrearages or to junior classes of equity when common stock has a zero liquidation value), but modify them to operate within the hypothetical distribution framework.

Transition Rules for Pre-OBBBA Dividends

Proposed §1.951-4 provides guidance on the application of the statutory transition rule under Section 70354(c)(2) of the OBBBA. Under Proposed §1.951-4(b), for purposes of applying former Section 951(a)(2)(B), a dividend paid or deemed paid by a CFC is not treated as a dividend to the extent that:

The dividend was paid on or before June 28, 2025, and the shareholder did not own the stock during the portion of the taxable year ending on June 28, 2025, or the dividend was paid after June 28, 2025, and before the CFC’s first taxable year beginning after December 31, 2025, and
The dividend does not increase the taxable income of a United States person subject to Federal income tax.

To prevent tax-indifferent parties from absorbing these dividends, Proposed §1.951-4(h) enforces a strict substantiation requirement. U.S. shareholders claiming a reduction under former Section 951(a)(2)(B) must attach a “Pro Rata Share Transition Rule Statement” to Form 5471. This statement must detail the dividend amounts, establish the taxpayer’s entitlement to dividend treatment, and describe exactly how the taxpayer determined that the dividend increased the taxable income of a United States person subject to Federal income tax.

Key Deletions, Phaseouts, and Conforming Amendments

The proposed regulations systematically delete or phase out regulatory provisions that have been rendered obsolete by the OBBBA’s period-based allocation model.

Phaseout of the Section 245A Extraordinary Reduction Rules

The extraordinary reduction rules of §1.245A-5(e) and (f) were originally promulgated to prevent U.S. corporate shareholders from avoiding subpart F and GILTI inclusions by transferring CFC stock mid-year and subsequently claiming a 100-percent dividends received deduction under Section 245A. Because the OBBBA’s daily proration rules ensure that a transferor corporation remains liable for subpart F and tested income accrued during its period of ownership, the extraordinary reduction rules are no longer necessary.

Consequently, Proposed §1.245A-5(k)(3) provides a phaseout rule: “Paragraphs (b)(2)(ii), (e), and (f) of this section do not apply to taxable periods of foreign corporations beginning after December 31, 2025.” For periods beginning on or before December 31, 2025, the existing extraordinary reduction rules remain fully active.

Phaseout of Section 1.1502-80(j) Consolidated Group Rules

Under existing §1.1502-80(j), members of a consolidated group are treated as a single U.S. shareholder for purposes of calculating the Section 951(a)(2)(B) reduction for dividends distributed within the group. Because Section 951(a)(2)(B) is entirely inapplicable for taxable years of foreign corporations beginning after December 31, 2025, §1.1502-80(j) is rendered obsolete. Proposed §1.1502-80(j)(3) restricts the applicability date of the regulation, confirming that the paragraph applies only to consolidated return years “that include the last day of a taxable year beginning before January 1, 2026, of a controlled foreign corporation owned by a member of the consolidated group.”

Deletions of GILTI Deemed Tangible Return Calculations

The OBBBA repealed the calculation of a net deemed tangible income return (the 10-percent routine yield on physical business assets) at the shareholder level, shifting GILTI to a pure net tested income inclusion model. Accordingly, the proposed regulations delete paragraph (f) of §1.951A-1, which contained definitions for several GILTI-specific variables. Additionally, Proposed §1.951A-1(c) removes the regulatory rules for determining a U.S. shareholder’s pro rata share of qualified business asset investment (QBAI), tested interest expense, and tested interest income.

Internal Revenue Service Legal Analysis and Policy Rationales

The preamble to the proposed regulations provides critical insights into the IRS’s legal analysis and the policy rationales that guided their technical drafting choices.

Rejection of the Interim Closing of the Books Approach

During the pre-drafting comment period, several tax practitioners recommended that Treasury allow an unrestricted elective “interim closing of the books” or a special allocation of extraordinary items to handle mid-year ownership changes, similar to the rules under Section 706 for partnerships or Section 1377 for S corporations. The IRS flatly rejected these suggestions. The IRS explained that an interim closing of the foreign corporation’s books or a special allocation of extraordinary items “may, in certain cases, be complex, administratively burdensome, or lead to inappropriate results (for example, when the earnings and profits (E&P) limitation under section 952(c) applies).”

The IRS’s statutory justification rests on the fundamental nature of subpart F and tested income as corporate-level net amounts rather than itemized pass-through items. The IRS noted:

“Rules in other contexts that adopt such approaches in allocating various items of income, gain, deduction, loss, and credit attributable to a taxpayer’s ownership period differ from the pro rata share rules in that sections 951 and 951A require the allocation of subpart F income, tested income, or tested loss, each of which is a single, net amount determined at the foreign corporation level with respect to its taxable year.”

The IRS further observed that the statutory language of Section 951(a)(1)(A) “requires this result by referring to the pro rata share of ‘the corporation’s subpart F income for the CFC year,’ which, in using the term defined in section 952, means the pro rata share of the sum of the amounts described in section 952(a) and not the pro rata share of specific items that comprise subpart F income.” The same logic applies to Section 951A, where tested income and tested loss are defined as net amounts for the CFC’s taxable year under Section 951A(b)(2). Accordingly, a daily proration of the final net annual amount, rather than an item-by-item interim closing, is legally mandated by the statutory text and prevents the administrative distortion of allocating gross income items without regard to annual net limitations.

Confining Mandatory Closings to Status Change Events

The IRS determined that a mandatory closing of the taxable year is appropriate only when a foreign corporation becomes or ceases to be a CFC (a status change event). In these situations, the IRS reasoned that “confining the analysis to the period in which the relevant earnings of the foreign corporation are subject to U.S. taxation under sections 951 through 965” is necessary to carry out the statute’s intent.

By closing the taxable year on the day of the status change, the regulations ensure that “items of income, gain, deduction, or loss incurred while the foreign corporation’s earnings are not subject to the subpart F provisions of the Code” are prevented from “affecting the determination of a U.S. shareholder’s pro rata share under section 951 or 951A.” Additionally, the IRS noted that mandatory closing in these circumstances “may mitigate potential compliance burdens associated with obtaining information relating to the foreign corporation while it is owned and controlled by foreign persons.”

Setting the Elective Closing Threshold at Fifty Percentage Points

In designing the elective year-closing mechanism under Proposed §1.951-1(d)(2), the IRS rejected practitioner recommendations to allow elective closings for minor ownership shifts (such as 10 percent). The IRS concluded that an elective closing must be restricted to a significant ownership variance exceeding 50 percentage points. The IRS’s rationale is twofold:

Economic and Control Realities: A shift of more than 50 percentage points “generally indicates that a seller or selling group has relinquished control of the CFC and therefore has a heightened interest in closing the CFC’s taxable year so as to avoid the effect of the new controlling shareholder or shareholders’ actions on the determination of their pro rata share.” At this threshold, the seller “typically does not remain involved in the CFC’s activities after relinquishing control,” making a clean taxable year-end essential to prevent post-transaction actions by the buyer from retroactively altering the seller’s tax liability.
Burden and Abuse Mitigation: The IRS asserted that “the potential benefit afforded by a closing of the CFC’s taxable year in cases of less significant changes in ownership would likely be outweighed by the resulting compliance and administrative burden.” Furthermore, “the additional flexibility to close the taxable year of a CFC could lead to improper manipulation or abuse if it was available for minor changes in ownership or transfers involving related persons.”

Treatment of Related-Party Transfers and Reorganizations

To prevent taxpayers from manufactured taxable-year closings, the IRS excluded related-party transfers from the significant ownership variance calculation. Under Proposed §1.951-1(d)(2)(ii)(C)(1), stock ownership is not treated as decreasing to the extent stock is transferred to a related United States person. The IRS justified this restriction because in related-party transactions, “the change in economic ownership of CFC stock is less meaningful or possibly absent,” and the availability of an election in such cases “may lead to inappropriate manipulation (for example, transactions may be undertaken solely for purposes of closing a CFC’s taxable year).”

Exclusion of Corporate Partners from Concurrent Partnership Closings

The IRS declined to provide for a concurrent closing of a partnership’s taxable year when a foreign corporate partner’s taxable year closes. Under general tax principles, a partnership’s taxable year does not close solely because a corporate partner’s year closes.

The IRS analyzed the compliance dynamic, noting that “a concurrent closing of the partnership’s taxable year would require the partnership’s items to be allocated between the foreign corporation’s short taxable year ending on the day of the status change event or significant ownership variance and the following short taxable year.” Because this concurrent closing “would require a seller to obtain information from a buyer to determine the foreign corporation’s distributive share of partnership items,” the IRS determined that the administrative and compliance hurdles outweighed the potential accuracy gains, thereby retaining the default rule that the partnership’s year does not close.

Applicability Dates, Transition Rules, and Taxpayer Reliance

The proposed regulations under Sections 951, 951A, and 6038 are generally proposed to apply to “taxable years of foreign corporations beginning after December 31, 2025, and to taxable years of United States shareholders for which such taxable years of those foreign corporations are relevant.” The IRS has indicated its intent to finalize these regulations by January 4, 2027.

Straddle Year Coordination Rules

The IRS identified a potential coordination conflict between the effective dates of the subpart F amendments and the GILTI amendments. Under Section 70354(c) of the OBBBA, the subpart F daily proration rules apply to “taxable years of foreign corporations beginning after December 31, 2025.” However, under Section 70323(c) of the OBBBA, the GILTI amendments requiring the inclusion of “net CFC tested income” apply to “taxable years beginning after December 31, 2025,” which the IRS interprets as referring to the taxable years of the U.S. shareholder.

This mismatch creates a “straddle year” when a foreign corporation’s taxable year begins after December 31, 2025, but ends within a U.S. shareholder’s taxable year that begins on or before December 31, 2025. Proposed §1.951A-7(c) resolves this by directing that the U.S. shareholder must apply the former version of §1.951A-1 (calculating a GILTI inclusion amount rather than net CFC tested income), but “must take into account the amendments to section 951(a)(2) made by the OBBBA in determining the United States shareholder’s pro rata share of any tested item” (such as tested income or tested loss) using the new daily proration rules.

Transition Rules for Pre-Effective Date Years

The transition rules governing dividends under Proposed §1.951-4 are proposed to apply to “taxable years of a foreign corporation that either include June 28, 2025, or begin after June 28, 2025, and before the foreign corporation’s first taxable year beginning after December 31, 2025.”

Interim Taxpayer Reliance Provisions

Importantly for active transactions, the IRS has authorized immediate reliance on these proposed rules. The preamble confirms:

“Taxpayers may rely on all aspects of the proposed regulations before the date the proposed regulations are finalized, provided a taxpayer and its related parties (within the meaning of sections 267(b) and 707(b)(1)) follow the rules in their entirety and in a consistent manner.”

For tax professionals, this reliance provision provides immediate procedural certainty. CPAs and EAs can advise clients to utilize the elective taxable year closing under Proposed §1.951-1(d)(2) for qualified transactions closing today, provided that the electing shareholders and their related parties consistently apply all provisions of the proposed regulations across their international corporate portfolios.

Prepared with assistance from Gemini Notebook.