globaltaxnews.ey.comSign up for tax alert emailsPrintDownload | ||||||
28 August 2026 United States | Proposed regulations would implement OBBBA's overhaul of CFC pro-rata share rules
On August 25, 2026, the US Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued proposed regulations (REG-115646-25) that would implement revisions to the pro-rata share rules, which were enacted under the One Big Beautiful Bill Act (OBBBA). First, the proposed regulations would set forth new rules for determining US shareholders' pro-rata shares of a CFC's subpart F income and tested income or tested loss, including new allocation methodologies and new requirements or elections to close tax years. Additionally, they would extend those rules to IRC Section 951B and terminate regulations that become unnecessary. The proposed regulations would also address the transition rule for certain pre-OBBBA dividends by adopting the framework in Notice 2025-75. Further, the proposed regulations would modify information reporting requirements under IRC Section 6038. The proposed regulations would affect US shareholders of CFCs, including US shareholders or CFCs undertaking mergers, acquisitions, or other restructurings. Similarly, they would affect foreign-controlled US shareholders of foreign-controlled CFCs that are subject to IRC Section 951B. If a foreign corporation is a CFC, IRC Sections 951(a) and 951A(a) generally require a US shareholder of the corporation to take into account the shareholder's pro-rata share of the corporation's subpart F income and tested income or tested loss. For tax years of a foreign corporation beginning before January 1, 2026, pro-rata shares arose only for US shareholders that owned stock of the corporation on the last day of the corporation's tax year on which the corporation was a CFC (the last relevant day). In addition, a US shareholder's pro-rata share was reduced in certain respects, including to reflect certain dividends made by the foreign corporation before (or after) the shareholder's ownership period (dividend-to-another-person reduction). Allocating CFC income based on last-relevant-day ownership gave rise to potential issues (including perceived under-taxation) in certain cases. The OBBBA significantly revised these rules, first by eliminating the last-relevant-day component and next by setting forth a new, more flexible standard for allocating CFC income to US shareholders. Under this new standard, a US shareholder's pro-rata share of a foreign corporation's subpart F income or tested income is the portion of such income that is attributable to the shareholder's stock in the corporation and any part of the corporation's tax year during which (i) the shareholder owned the stock, (ii) the shareholder was a US shareholder of the corporation; and (iii) the corporation was a CFC. These revisions apply to foreign corporations' tax years beginning after December 31, 2025. The OBBBA also added a special transition rule for purposes of applying the dividend-to-another-person reduction during certain pre-OBBBA periods (transition rule). Under the transition rule, a dividend made by a foreign corporation may reduce a US shareholder's pro-rata share only to the extent the dividend increases a US person's taxable income. The transition rule applies to certain dividends paid (including deemed paid) by a foreign corporation in certain tax years beginning before December 31, 2025. Further, the OBBBA's enactment of IRC Section 951B effectively extended IRC Sections 951(a) and 951A(a) to "foreign controlled United States shareholders" (FCUSS) of "foreign controlled foreign corporations" (FCFCs). An FCUSS is any US person that would be a US shareholder of a foreign corporation if the ownership threshold in IRC Section 951(b) were raised from 10% to more than 50%, and the constructive ownership rules of IRC Section 958(b) were applied without regard to IRC Section 958(b)(4) (regarding the limitation on downward attribution). An FCFC is any foreign corporation, other than a CFC, that would be a CFC if IRC Section 957(a) looked to ownership by FCUSSs, also determined by applying the constructive ownership rules of IRC Section 958(b) without regard to IRC Section 958(b)(4). The proposed regulations would provide a daily proration approach for purposes of IRC Sections 951(a) and 951A. Thus, a US shareholder's pro-rata share of a CFC's subpart F income, tested income or tested loss would be based on the stock the shareholder owns and the number of days it owns the stock during the CFC tax year (determined on a block-by-block basis and then aggregated where the shareholder acquires or disposes of shares of stock at different times). Accordingly, a US shareholder's pro-rata share would not necessarily consist of only items of gross income or deduction incurred by the CFC during the shareholder's ownership period. Additional rules would apply where a CFC has multiple classes of stock. In these cases, the CFC's income would first be allocated among classes under a hypothetical distribution generally mirroring the one under existing Treas. Reg. Section 1.951-1(e). The income allocated to each class would then be further allocated under the daily proration approach discussed previously. To address changes in a CFC's equity capital, share averaging would apply. Thus, if a CFC were to issue or redeem shares of its stock, a weighted average share count would apply for purposes of the daily proration approach and, if applicable, the hypothetical distribution. Together, these components (daily proration, hypothetical distribution, and share averaging) would generally parallel the methodology under IRC Section 1248 for determining E&P attributable to stock of a foreign corporation. Additionally, the Preamble to the regulations indicates that Treasury Department and the IRS believe alternative approaches, such as specially allocating extraordinary items of a CFC, could be unduly complex or burdensome or give rise to inappropriate results. The proposed regulations would introduce two new rules for closing a foreign corporation's tax year before its normal end. Under the first, a foreign corporation's tax year would be required to close upon a "status change event," which would occur when the corporation becomes or ceases to be a CFC. For this purpose, CFC status would be determined by treating a domestic partnership in the same manner as a foreign partnership and by disregarding constructive ownership through options. Under the second, US shareholders undergoing a "significant ownership variance" with respect to a CFC (referred to as "controlling IRC Section 958(a) US shareholders") could elect to close the CFC's tax year at the end of the variance date. A significant ownership variance would arise when certain dispositions or issuances (referred to as "specified transfers") occurring under the same plan reduce, by more than 50 percentage points in the aggregate (by vote or value), the percentage of CFC stock owned directly or indirectly by one or more US shareholders. For this purpose, certain transactions involving related persons or occurring under F-reorganizations would be disregarded. The election would require a binding agreement among all US shareholders that directly or indirectly own stock in the CFC on any day of the CFC's tax year on or before the variance date. If a foreign corporation's US tax year closes under the proposed regulations but its foreign tax year remains open, the regulations would allocate foreign income tax for which the corporation is the taxpayer (other than withholding tax) among the resulting short US tax years. The allocation would be based on the foreign-law taxable income attributable to each period under closing-of-the-books principles. This rule would generally align those taxes with the income to which they relate, rather than treating them as accruing entirely in the later short US tax year in which the foreign tax year ends. The proposed regulations would apply the same pro-rata share rules to FCUSSs and FCFCs under IRC Section 951B. Thus, for IRC Section 951B purposes, a daily proration approach would apply in determining an FCUSS's pro-rata share of an FCFC's subpart F income, tested income or tested loss. Additionally, a foreign corporation's tax year would close when the corporation becomes or ceases to be an FCFC. Because the new pro-rata share rules allocate CFC income based on the periods during which each US shareholder owns CFC stock, Treasury and the IRS took the view that regulations addressing potential issues under the former last-relevant-day framework are no longer necessary. Accordingly, Treas. Reg. Section 1.245A-5(e) and (f), along with Treas. Reg. Section 1.1502-80(j), would not apply to foreign corporations' tax years beginning after December 31, 2025. Those regulations had been intended to address potential reductions to pro-rata shares in scenarios involving dividends eligible for a deduction under IRC Section 245A or dividends eligible for an exclusion under IRC Section 954(c)(6) or 959(b). The proposed regulations would implement the OBBBA's transition rule, which limits the extent to which certain dividends reduce a pro-rata share. They would do so by adopting the rules (including reporting requirements) in Notice 2025-75. For a fuller discussion of the transition rule and Notice 2025-75, see EY Tax Alert 2026-0178. To reflect the new pro-rata share rules, the proposed regulations would modify the information required to be reported under Treas. Reg. Section 1.6038-2(f) about a foreign corporation. Thus, new information would be required to be reported on Form 5471 regarding dispositions and issuances of stock and US shareholders' daily ownership of stock. The portions of the proposed regulations on the new pro-rata share rules (including information reporting) would apply to tax years of foreign corporations beginning after December 31, 2025, and to relevant US shareholder tax years. The portion of the proposed regulations on the transition rule would apply to foreign corporations' tax years that either (i) include June 28, 2025, or (ii) begin after June 28, 2025, and before the corporation's first tax year beginning after December 31, 2025. Treasury and the IRS expect to finalize the proposed regulations by January 4, 2027. Taxpayers may rely on all aspects of the regulations before their finalization, provided they and their related parties apply them in their entirety and consistently. Written or electronic comments and requests for a public hearing must be received by October 26, 2026. The proposed regulations provide important guidance on issues arising under the OBBBA's revisions to IRC Sections 951 and 951A. In general, the regulations seek to balance precision around the determination of a US shareholder's pro-rata share with administrability and consistency with IRC Section 1248. Accordingly, where ownership of CFC stock changes during the CFC's tax year, an early closing of the tax year (under the new rules or through liquidations or other transactions) may provide the exclusive means for limiting a US shareholder's pro-rata share to items incurred by the CFC during the shareholder's ownership period. In turn, this can affect deemed-paid foreign tax credits. In recent guidance, Treasury and the IRS have adopted commentators' recommendations for additional elections that would increase complexity but mitigate potentially arbitrary, adverse results (see Tax Alert 2026-1687). Taxpayers that could be subject to such results should consider providing comments on elections or other mechanisms that would address these issues. Because of the applicability date of the proposed regulations, the new pro-rata share rules could apply not only to future transactions but also to dispositions and acquisitions (including in connection with M&A deals) that have already occurred. Similarly, the proposed regulations could give rise to new reporting obligations for both prior and future transactions (including issuances, redemptions and dispositions). Thus, generally all taxpayers that are US shareholders of CFCs should carefully review and familiarize themselves with the proposed regulations.
Document ID: 2026-1865 | ||||||
