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Final and Proposed Rules for Cloud Computing Transactions

The IRS has release final and proposed regulations on transfers of digital content and could transactions.

Final Regulations Under Section 861

The IRS released final regulations under Section 861 to modify rules set forth in the 2019 proposed regulations regarding the classification of transactions involving computer programs. The final regulations also extended the rules to transfers of digital content and expanded existing guidance surrounding classification of cloud transactions.

The final regulations differ from the 2019 proposed regulations in the following ways:

  • Replace a de minimis rule with respect to digital content and cloud transactions with a predominant character rule to classify transactions consisting of multiple elements. In general, predominant character is determined by the primary benefit or value received by a customer.
  • Incorporate content unprotected by copyright law solely because the creator dedicated the content to the public domain into the definition of digital content.
  • Treat all cloud transactions as provision of services and remove other factors listed in the proposed regulations.

The final regulations are effective for tax years beginning on or after January 14, 2025, however taxpayers may elect to apply all rules in the final regulations to taxable years beginning on or after August 14, 2019, and all subsequent taxable years, with certain stipulations.

Other Related Guidance Released

The IRS also released proposed regulations on sourcing of income from cloud transactions under the international provisions of the Internal Revenue Code (IRC). The proposed regulations provide that gross income from a cloud transaction is sourced as service income according to where the service is performed. The location of services performed is calculated through a formula comprised of an intangible property factor, a personnel factor, and a tangible property factor.

Finally, in Notice 2025-6, the IRS requested commentary if the characterization rules in the final regulations under §861 were to apply to all provisions of the IRC and explore whether further IRS guidance would be needed on this topic.

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