On November 29, 2024, the U.S. Department of the Treasury and the IRS issued proposed regulations for previously taxed earnings and profits (PTEP) under Section 959. Included in the PTEP regulations are regulations that address Subpart F calculations under §951 and foreign currency gain or loss under §986.
Background
Section 951 regulations provide rules for allocating Subpart F income to shareholders. Such allocations result in the creation of PTEP. In 2017, §965 treated untaxed earnings and profits of foreign corporations as Subpart F income, which resulted in §965 PTEP. Current §986(c) regulations only provide rules for determining exchange gain or loss on distributions of §965 PTEP.
Section 951
The proposed regulations under §951 require a coordinated approach to PTEP accounting at the controlled foreign corporation (CFC) level and at the shareholder level with respect to a “covered item.” “Covered items” are a foreign corporation’s items of gross income that are either covered distributions1 or covered gain.2 The purpose is to help ensure that the CFC shareholder’s Subpart F income is allocated consistently with the assignment of covered items to shareholders at the foreign corporation level.
At the CFC level, the general assignment rule provides for the pro rata allocation of covered items to each covered shareholder that owns stock on the last day of the foreign corporation’s tax year. The proposed regulations modify this approach for successor transactions. To the extent that a transaction happens before the end of the year, the proposed regulations seek to treat the assignment of covered items consistently with what would have been its assignment if the change of ownership had not occurred.
Under current regulations, Subpart F income is allocated based on a shareholder’s pro rata share of the CFC’s earnings and profits. The proposed regulations modify this approach by requiring that a CFC’s Subpart F income attributable to covered items be separately allocated to U.S. shareholders consistently with how the covered item was assigned at the CFC level. This approach replaces the approach set forth in Revenue Ruling 82-16.3
Insight From Forvis Mazars: The shareholder-specific approach contemplated by the proposed regulations could impose reporting burdens on CFCs as well as their shareholders. It is likely that the consistent requirement could be most problematic when a U.S. shareholder has less than a controlling interest in the foreign corporation. Ownership of CFCs through partnership structures could also present additional reporting requirements.
Section 986(c)
Under the proposed regulations, a covered shareholder recognizes exchange gain or loss in two circumstances. The first is when PTEP is distributed to a covered shareholder and the second is when PTEP ceases to be with respect to the covered shareholder, e.g., a transfer to another covered shareholder in a general successor transaction or eliminated through a §338(g) election.
Foreign currency gain or loss is recognized concurrently with a transaction requiring recognition of gain or loss. The gain or loss is treated as ordinary income of loss from the same source and relating to same §904 category as the income inclusion that gave rise to the PTEP.
Note that foreign currency gain or loss is not recognized in two situations. The first is a distribution to a foreign corporation and the second is a transfer non-general successor transaction, e.g., a §351 transfer to a non-consolidated subsidiary.
Foreign currency gain or loss is calculated by translating PTEP into U.S. dollars at the spot rate on the date of the transaction and subtracting from that dollar amount the dollar basis of the PTEP determined as the time of the income inclusion. As a result, the foreign currency gain or loss is based on the movement of the exchange rate between the time of income inclusion giving rise to the PTEP and the date of transaction requiring gain or loss recognition.
Insight From Forvis Mazars: Taxpayers will not be required to recognize foreign exchange gain or loss on distributions of PTEP to foreign corporations. This simplifies taxpayer reporting for cash movement in corporate structures.
How Forvis Mazars Can Help
The proposed PTEP regulations create additional complexity for taxpayers as the rules can apply at both the shareholder and corporate level. Our tax professionals can help look over your situation so you can better understand your options. If you have questions or need assistance, please reach out to a professional at Forvis Mazars.
- 1A “covered distribution” is a dividend as defined in §316 and does not include a deemed dividend under §§ 78, 367(b), 964(e)(1), or 1248.
- 2A “covered gain” is gain recognized by a CFC on a sale or exchange of §961(c) ownership units that are shares of stock in a corporation.
- 3Internal Revenue Cumulative Bulletin, 1982-1, www.govinfo.com.