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Proposed Regulations to PTEP Accounts of US Shareholders in CFCs Recently Issued By U.S. Treasury And the IRS

By: Jerald David August, August Tax Law, P.C.

The IRS has published proposed regulations (REG-105479-18) on previously taxed earnings and profits (PTEP) of foreign corporations and resulting basis adjustments. The proposed rulemaking was issued on November 29, 2024. Comments and public hearing requests are due by March 3, 2025. The main operative provisions involved in the proposed rulemaking are Sections 959 (PTEP inclusion) and Section 961 (basis adjustments). These rules are intended to operate in tandem to prevent double taxation of PTEP, which are earnings and profits of a foreign corporation described in Sections 959(c)(1) or (c)(2). Section 959 designates amounts of E&P as PTEP based on amounts included, or treated as included, in gross income regarding the foreign corporation under Section 951(a). The complex (342 pages) of proposed regulations provides rules on core aspects of the PTEP system, including rules that address long-standing issues under Sections 959 and 961, account for new provisions and amendments under the Tax Cuts and Jobs Act of 2017 and implement prior guidance issued by the Service issued both before and after the TCJA 2017. But the proposed rule-making, despite its complexity and length, does not cover all required subjects. In this regard the government announced that more thought and reflection is required in order to issue final regulations which fully integrate the PTEP rules with rules governing the corporate taxation of US corporations and their shareholders, foreign and domestic partners and partnerships, members of a US consolidated group of corporations, tax-free reorganizations and liquidations of corporations, application to S corporations and their shareholders, just to name a few. Yes, in-bound reorganizations under Section 367(b) and out-bound transfers described in Section 367(a) are also impacted as well.

This required integration of the deemed income inclusion regimes with the rest of the Code easily takes on the appearance of a multi-headed monster. There are numerous PTEP accounts to track, foreign tax credit accounts to take into account and gross-up amount under Section 78 where applicable, dollar-basis accounting for determining foreign currency gain or loss, stock basis and ownership unit basis tracking. All of this PTEP tracking must be reflected on CFC informational and US shareholder tax returns in characterizing distributions and gain from the sale of shares of stock in a foreign corporation.

An article on the Proposed Regulations to the PTEP and basis adjustment rules in Section 959 and 961 authored by Jerald August, Editor in Chief of Corporate Taxation, will be published in the next issue of Corporate Taxation, Thomson Reuters Checkpoint Edge and WESTLAW.

Previously Taxed Income for Controlled Foreign Corporations: Enactment of Subpart F In the Revenue Act of 1962

The controlled foreign corporation rules have been in the Internal Revenue Code for over 60 years and were enacted in the Revenue Act of 1962. Congress' intent at that time was to prevent US shareholders owning 10% or more of the voting stock of a controlled foreign corporation, owned more than 50% by US shareholders, from deferring US income inclusion of foreign source income generated from certain "passive sources" as well as income, gain or loss from related affiliate sales, services and manufacturing operations. Categories of passive income include foreign source interest, dividends, royalties, capital gains, as well as foreign based sales income as defined, which are collectively referred to as subpart F income. The major category of subpart F income is foreign base company income defined in Section 954. Again, subpart F was enacted to remove the "deferral privilege" enjoyed by US shareholders for subpart F income.

Under Section 951(a)(1), US shareholders of a CFC owning stock in the CFC on the last day of its taxable year must include their allocable share of subpart F income in gross income. Subpart F income inclusions result in a corresponding increase to stock basis of the US shareholder determined on a share-by-share basis under Section 961. Congress did not want "double taxation" of the US shareholder who reported an income inclusion of offshored profits from subpart F income. Therefore, distributions from previously taxed item (PTEP) would not be taxed as dividends to the extent of the adjusted stock basis of the US shareholder distributee. But what may seem simple from a conceptual standpoint of tracking subpart F income inclusions and matching PTEP distributions prior to the Tax Cuts and Jobs Act of 2017, the required integration of the PTEP with the rest of the Code generated a fair degree of complexity and attendant uncertainty. A major reason for the resulting complexity was the manner in which the subpart F, income inclusion rule, distribution and basis adjustment rules were interface with other rules in the Code, including but not limited to rules recharacterizing gain from the sale of CFC stock under Section 1248, otherwise non-taxable corporate restructurings, repatriation of foreign earnings and profits under Section 367(b) and treatment under the consolidated return regulations. There were also foreign tax credit accounts to maintain on foreign income taxes imposed on subpart F income.

The Avalanche of New Deemed Income Inclusions Under the Tax Cuts and Jobs Act of 2017: Enactment of the PTEP Monster!

Repatriation of Post-1986 Foreign Accumulated Earnings and Profits Under the New Income Inclusion Regime in Section 965

The TCJA 2017 not only required the inclusion of previously offshored undistributed foreign accumulated earnings and profits under Section 965, but effectively ended the deferral of active business income by passage of the GILTI regime in Section 951A. Such major reforms layered additional amounts of distributed PTEP other than income inclusions under subpart F making it imperative that Section 959 and 961 catch-up with the additional income inclusions for which there were potentially billions of dollars of foreign earnings and profits that had not been repatriated. Congress first addressed offshored earnings and profits that were not treated as subpart F income by forcing US shareholders to include in gross income their pro rata shares of undistributed foreign accumulated earnings and profits going back to 1986 as a new 'monster-like" income inclusion for 2017 referred to as the "transition tax". The tax rate for the transition income inclusion for this entire amount would be set at favorable rates, i.e, 15% (for cash equivalents) or 8% (for all other non-cash assets) with respect to the US shareholder's share of the asset base of each particular CFC. These rules are set forth in Section 965 and regulations. The payment of the Section 965 tax may be deferred over an 8-year period with special rules for shareholders electing treatment with respect to S corporations owning controlled foreign corporation stock. The deferral period may be accelerated upon the occurrence of certain events. The resulting repatriation income inclusion rule created, large PTEP accounts since distributions of the PTEP were not required to be made as part of Section 965, simply the PTEP inclusions were to be tracked for later distribuiton. See August, "The Proposed GILTI Regulations Under Section 951A", Corporate Taxation (WG&L) (Mar/April 2019).

At this point, the repatriation tax set forth in TCJA 20107, Congress "on shored" the previous estimated $3 trillion offshored" accumulated earnings and profits of US shareholders of controlled foreign corporations for active business income that was not part of the subpart F regime. The "deferral privilege" had ended through 2017 although there will still be untaxed foreign earnings and profits that a foreign corporation may generate, and US shareholders and the foreign corporation must track. Congress was not finished by catching up with post-1986 foreign accumulated E&P, it also enacted the GILTI income inclusion regime to remove the deferral privilege for US shareholders of CFC for post-2017 tax years. While the 8-year deferred payment plan that was part of Section 965 expired, at least formally, with 2023 tax returns, there may be outstanding errors in tracking and reporting in this area. There are statute of limitations issues as well. In addition, there is case law that provides that the failure to include income under subpart F does not increase PTEP for purposes of Section 959. So, proving up transition income inclusions under Section 965 is still part of the tax reporting and compliance landscape.

Enactment of the Global Intangible Low-Taxed Income Inclusion Rules Under Section 951A

As mentioned, Congress further decided that the "deferral privilege" would be eliminated prospectively for tax years beginning after 2017. TCJA 2017 enacted the global intangible low-taxed income (“GILTI”) regime in new Section 951A. It is an anti-tax deferral regime like its much older income inclusion sibling, subpart F income, and further represents the counterweight to the favorable (yet narrower in scope and application) participation exemption system under Section 245A. I will defer reporting on the general rules and scope of Section 245A. The GILTI regime accelerates the required reporting of active business income derived from foreign sources even if such income is subject to taxation in one or more foreign jurisdictions. It is treated as gross income for purposes of Section 951(a)(1)(A) and for purposes of Section 959.

Incorporating Sections 965 and 951A with the existing structure of subpart F rules and application to intersecting provisions of the tax law presented the government with a challenge in setting forth guidance and eventually regulations. The government recognized this issue immediately with the passage of the TCJA 2017 and shortly thereafter issued Notice 2019-1, supra. Notice 2019 acknowledged the government’s awareness that there were difficult and complex rules and principles that needed to be addressed both in issuing its 2019 guidelines and in forthcoming regulations. The arduous task of setting forth a set of well-thought out rules and principles is confirmed by the interim period of over five years that it has taken by the U.S. Treasury and Internal Revenue Service to issue proposed regulations. The product of such effort is now reflected in the PTEP proposed regulations under Sections 959 and 961 issued on November 29, 2025, which may be otherwise referred to by this blogger as further guidance in “tracking the PTEP monster’s accounts”.

Required Integration of the PTEP "Monster's" PTEP Accounts, Distributions and Basis Adjustments: Proposed Regulations

The PTEP account rules under Section 959 as well as the stock basis adjustment rules in Section 961 are challenged by the expansion of deemed income inclusions that are included in gross income of US shareholders. How do you determine a non-taxable recovery of increased basis under Section 961 from a distribution of "other" earnings and profits or whether there is gain in excess of basis. How does Section 960 adjust to this expansion of the PTEP accounts which have to be tracked annually by the US shareholders and by each foreign corporation. The proposed regulations were issued on November 29, 2024, and comments are being received by the early March 2025 deadline before final regulations are issued. The proposed regulations are close to 350 pages long and admittedly do not cover all of the important issues that need to be addressed including, most notably, the application of the expanded income inclusion rules to corporate dividends, redemptions of stock, liquidations, formations and tax-free reorganizations.

Tax lawyers, accountants, tax return preparers and clients will all have to take into account the depth and width of the intersections of the TCJA 2017 in the cross-border context, in this case where US shareholders are shareholders, directly or indirectly, in controlled foreign corporations.

This blog post is intended only for informational purposes and was not intended and should not be construed to serve as advice on tax law.