The IRS published final regulations (T.D. 10026) on Jan. 14 addressing the application of the dual consolidated loss (DCL) rules, expanding their reach to disregarded payment losses (DPLs).
The final regulations generally retain the basic approach and structure of the proposed DPL rules from 2024 proposed regulations (REG-105128-23), which introduced a new system of rules addressing certain disregarded payments that give rise to losses for foreign tax purposes. The final regulations also announce additional transition relief further delaying the application of the DCL rules to foreign taxes that are based on the global anti-base erosion (GloBE) model rules.
However, other provisions from the proposed regulations, such as those addressing the interaction with intercompany transaction regulations and changes to stock ownership rules, were not finalized in these final regulations. See our prior coverage of the 2024 proposed regulations here.
The final regulations generally apply the DPL rules to taxable years of disregarded payment entity (DPE) owners beginning on or after Jan. 1, 2026.
DPL rules
The DPL rules aim to address concerns regarding the avoidance of the DCL rules through certain arrangements involving disregarded entity classification allowed under the entity classification regulations.
Specifically, the DPL rules:
- Track whether certain types of payments involving a disregarded entity and its owner give rise to potential double-deduction outcomes
- Neutralize any resulting double-deduction outcome through an income inclusion similar to the one that the owner would have had with respect to the payments had the payments been regarded for U.S. tax purposes
- Treat the income inclusion as giving rise to a suspended deduction, which is treated as if it were reconstituted net operating loss that becomes deductible only to the extent of disregarded payment income (DPI) derived in the taxable year in which the suspended deduction is established, or in subsequent taxable years
The final regulations generally adopt the proposed scope of DPL rules, applying them only to items that:
- Give rise to deductions of the DPE under a foreign tax law
- Are disregarded for U.S. tax purposes but would be interest, structured payments, or royalties if the items were regarded
The final regulations further narrow the scope of the DPL rules by introducing a de minimis exception and excluding royalties paid under license agreements executed before the release of the 2024 proposed regulations. Additionally, they revise the definition of a DPE to exclude entities unrelated to a DPE owner and clarify that a foreign branch owned by a domestic corporation through one or more partnerships can qualify as a DPE.
Similar to the DCL rules, a DPL inclusion is triggered by a defined triggering event (i.e., a foreign use or failure to comply with certification requirements) occurring during the DPL certification period. Regarding foreign use, the final regulations narrow the definition of a foreign use for DPL purposes by excluding the deemed foreign use that may occur under the mirror legislation rule.
Upon a triggering event, any positive balance in the DPL cumulative register, which is generally derived from the DPI of the entity, would be applied to the DPL and, accordingly, would reduce the amount that the DPE owner must include in income with respect to the DPE under the DPL rules. The final regulations modify the determination of a DPL cumulative register so that a DPL does not decrease the register and terminate the certification period with respect to a DPL as a result of a DPL inclusion.
Anti-avoidance rule
The final regulations adopt the anti-avoidance rule from the 2024 proposed regulations, which requires appropriate adjustments with respect to a transaction, series of transactions, plan, or arrangement that is engaged with a view to avoid the purposes of Section 1503(d) and the regulations thereunder.
Grant Thornton Insight
The final regulations retain the “with a view” standard, which has been less commonly applied compared to other anti-avoidance standards in the code or regulations, such as the “principal purpose” standard. This development signals an increased emphasis on the “with a view” standard, and taxpayers should remain cautious regarding the potentially broad application of this anti-avoidance rule while awaiting further guidance.
The anti-avoidance rule is modified to clarify that the purpose of Section 1503(d) and the regulations thereunder is to prevent double deduction and similar outcomes for both DCLs and DPLs. The final regulations also add certain exceptions to the application of the anti-avoidance rule, as it applies to DCLs, for transactions or interpretations that would be addressed by rules in the 2024 proposed regulations.
Rulemaking authority
The IRS provided detailed explanation in the preamble to the final regulations to support their authority to issue the DPL rules. The IRS asserted that revising the regulations to prevent abuse, misuse or unintended consequences that only arise due to the classification rules under the check-the-box regime is a proper exercise of the authority under the regulations, including the express delegation of authority under Section 7805(a).
Additionally, the IRS emphasized that the DPL rules represent a reasonable response to significant policy concerns arising from the check-the-box election. The IRS also indicated that these rules align with other special provisions in the check-the-box regulations that treat an entity as regarded for limited tax purposes (e.g., certain banking rules, federal tax liabilities, and employment and excise taxes) while generally preserving the entity’s disregarded classification.
Applicability dates
The final regulations generally apply the DPL rules to taxable years of DPE owners beginning on or after Jan. 1, 2026. However, the anti-avoidance rule applies to DCLs incurred in taxable years ending on or after Aug. 6, 2024. Additionally, the final regulations allow an entity that would become a DPE as of Aug. 6, 2024, to change its classification to an association without regard to the 60-month limitations under the check-the-box regulations.
Additional transition relief with respect to the GloBE model rules
The final regulations further extend the transition relief announced in Notice 2023-80 such that the DCL rules (including the DPL rules) would generally apply without taking into account qualified domestic minimum top-up taxes (QDMTTs) or taxes collected under an income inclusion rule (IIR) or undertaxed profits rule (UTPR) with respect to losses incurred in taxable years beginning before Aug. 31, 2025. Taxpayer may rely on the guidance described in the preamble until final regulations are published in the Federal Register.
The additional transition relief allows additional time to consider future OECD guidance and legislation enacted by foreign jurisdictions that implements the GloBE Model Rules. However, the transition relief is limited to an additional year to minimize the double deduction outcomes that may result.
Next steps
Taxpayers should evaluate their existing structure to assess the impact of the final regulations on their current arrangements between domestic corporations and disregarded entities. Taxpayers who may be owners of DPEs should consider restructuring strategies in anticipation of the DPL rules taking effect.
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