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The IRS has provided guidance on allocating foreign income taxes and recognizing a Section 987 pretransition gain or loss under transition rules relating to the repeal of the one-month deferral election under Section 898(c)(2).
Notice 2025-72 (PDF - 191 KB), released on Nov. 25, creates an allocation regime for “affected corporations” that take into account foreign income taxes under an accrual method of accounting. Certain foreign net income taxes that arise in the first required year are treated as “specified foreign income taxes.” These taxes are first assigned to existing income groups under the foreign tax credit regulations (for example, Subpart F and tentative gross tested income), then split between the short first year and the succeeding year using a ratio of foreign-law taxable income for the short period to foreign-law taxable income for the full foreign year. The amounts of allocated tax are treated as accruing in each respective year for all purposes of the Internal Revenue Code.
The One Big Beautiful Bill Act (OBBBA) repealed the Section 898(c)(2) one-month deferral election for taxable years of specified foreign corporations (SFCs) beginning after Nov. 30, 2025. As a result, SFCs that have historically relied on the one-month deferral election must change their taxable year to align with the U.S. shareholder’s year-end. This results in a one-month “first required year” followed by a full calendar year, while foreign jurisdictions continue to impose foreign income tax based on their applicable foreign tax year.
Without special rules, changes to the tax year required by the repeal could unintentionally create mismatches between when income is recognized and when the associated foreign tax credits accrue. This could distort calculations for global intangible low-taxed income (GILTI), Subpart F, the high-tax exception/exclusion, and foreign tax credits (FTCs).
Grant Thornton insight:
The practical effect is to turn a one-month mismatch into a more mechanical allocation that better tracks underlying income and reduces the risk of artificial tested losses or stranded FTCs.
The notice also modifies the effect of the amortization election to appropriately take into account pretransition gain or loss for short taxable years resulting from the repeal of the one-month deferral election. Under the existing Section 987 transition rules, an electing owner recognizes one-tenth of its pretransition Section 987 gain or loss in each of 10 taxable years, beginning with the taxable year that begins on the transition date. The notice shifts this approach to a 120-month schedule beginning on the first day of the first taxable year in which the 2024 Section 987 regulations apply.
Taxpayers may rely on both the foreign tax allocation rules and the revised Section 987 rules before the proposed Section 898 and 987 regulations are published in the Federal Register, provided they apply the rules in their entirety and in a consistent manner.
Grant Thornton insight:
In the near term, taxpayers should identify which SFCs previously used the one-month deferral election and determine which of them are “affected corporations,” including confirming foreign year-ends and foreign income tax profiles. This includes modeling how specified foreign income taxes will allocate between the short first required year and the succeeding year and quantifying the resulting impacts on GILTI, Subpart F and foreign tax credit positions.
Taxpayers also should inventory Section 987 qualified business units, calculate pretransition gain or loss, and reforecast Section 987 income and loss on a 120-month schedule with special focus on any short years.
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