On April 11, 2023, a notice of proposed rulemaking (REG-121709-19) relating to supervisory approval of certain penalties under section 6751(b) was published in the Federal Register (88 FR 21564). See the Background and the Explanation of Provisions sections of the preamble to REG-121709-19 for a discussion of the proposed regulations, which are incorporated in this document to the extent not inconsistent with the Summary of Comments and Explanation of Revisions section of this preamble.

Eight comments responding to the notice of proposed rulemaking were received and are available at https://www.regulations.gov or upon request. A public hearing was held on September 11, 2023, and four speakers provided testimony. After careful consideration of all of the written comments and testimony, the proposed regulations are adopted by this Treasury decision with minor modification. The public comments are summarized and discussed in the Summary of Comments and Explanation of Revisions.

Many of the comments addressed similar issues and expressed similar points of view. The comments largely opposed the proposed timing rules and many of the proposed definitions. Comments expressed concern that the proposed regulations would not implement what the comments viewed as the purpose of section 6751(b). The Treasury Department and the IRS disagree with these comments’ characterization of the text and effect of the proposed regulations, as well as their characterization of the statute’s text and scope, its legislative history, and the caselaw interpreting it.

As explained in the preamble to the proposed regulations, the purpose of these rules is to clarify application of section 6751(b) in a manner that is consistent with the statutory text and that promotes nationwide uniformity, administrability for the IRS, and ease of understanding by taxpayers. Several comments suggested alternative rules that would impose extra-statutory formalities on IRS employees that would increase the probability of appropriate penalties being avoided if IRS employees do not satisfy those formalities. By contrast, the adopted rules faithfully interpret the statutory text, ensure penalties are imposed where appropriate, and guard against inappropriate use of penalties.

1. Comments on Proposed Timing Rules

The proposed regulations included three rules regarding the timing of supervisory approval of penalties under section 6751(b). Proposed §301.6751(b)-1(c) provided that, for penalties that are included in a pre-assessment notice issued to a taxpayer that provides the basis for jurisdiction in the United States Tax Court (Tax Court) upon timely petition, supervisory approval must be obtained at any time before the notice is mailed by the IRS. Proposed §301.6751(b)-1(d) provided that, for penalties raised in the Tax Court after a petition, supervisory approval may be obtained at any time prior to the Commissioner requesting that the court determine the penalty. Finally, proposed §301.6751(b)-1(b) provided that supervisory approval for penalties that are not subject to pre-assessment review in the Tax Court may be obtained at any time prior to assessment.

Comments argued that the proposed timing rules should be rejected in favor of earlier deadlines for supervisory approval of penalties, which the comments asserted would more effectively prevent bargaining by the IRS. The comments’ suggested deadlines, however, lack any basis in the statutory text, and are supported by reasoning that has been rejected by three United States Circuit Courts of Appeals (circuit courts). Moreover, the suggested earlier deadlines would not do anything to prevent bargaining, as the preamble to the proposed regulations explained. Despite the comments’ stated concerns about the existence of bargaining, no comment identified a specific example of bargaining, and no court has ever found that an IRS employee attempted to use a penalty as a bargaining chip.

Some comments suggested that the timing rule should require supervisory approval before issuance of a 30-day letter¹ (or substantive equivalent). As support for this suggestion, one comment stated that caselaw supported the assertion that the statute is ambiguous regarding when approval must occur. This comment misinterprets the existing caselaw, which has focused on an ambiguity as to what the “initial determination” is that must be approved, not on when the approval must occur. On the question of when approval must occur, the circuit courts that have considered the issue have uniformly held that a supervisor can approve a penalty at any point before losing discretion over whether to approve imposition of the penalty. The comments advocating for requiring approval before issuance of a 30-day letter (or substantive equivalent) rest heavily on a misunderstanding of a supervisor’s authority and on policy reasons that are not in fact served by the suggested deadline. The comments also fail to address the circuit courts’ opinions that are contrary to their recommendations on this issue.

As multiple circuit courts have explained, the statute lacks an “express timing requirement,” and the Tax Court’s “formal communication” rule has no basis in the text of the statute. Kroner v. Commissioner, 48 F.4th 1272, 1276 (11th Cir. 2022); Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 29 F.4th 1066, 1072 (9th Cir. 2022), reh’g en banc denied, No. 20-73420 (9th Cir. July 14, 2022); Minemyer v. Commissioner, Nos. 21-9006 & 21-9007, 2023 WL 314832 (10th Cir. January 19, 2023). As explained in the preamble to the proposed regulations, the lack of any deadline in the statute other than assessment indicates that the provision did not intend an earlier deadline.

Despite this, the Tax Court has continued to apply its own precedent in cases appealable to circuits other than the Ninth, Tenth, and Eleventh. See Aldridge v. Commissioner, T.C. Memo. 2024-24 (appealable to the Eighth Circuit); Swift v. Commissioner, T.C. Memo. 2024-13 (appealable to the Fifth Circuit); Bachner v. Commissioner, T.C. Memo. 2023-148; Robinson v. Commissioner, T.C. Memo. 2023-147 (appealable to the Fourth Circuit); Jadhav v. Commissioner, T.C. Memo. 2023-140; Conrad v. Commissioner, T.C. Memo. 2023-100; Braen v. Commissioner, T.C. Memo 2023-85 (appealable to the Third Circuit). For cases appealable to the Ninth Circuit, the Tax Court has held that it will follow the timing rule of Laidlaw’s, which the Tax Court interpreted to require a case-by-case analysis of whether a particular supervisor retained the discretion to approve penalties when they did so. See Kraske v. Commissioner, 161 T.C. 104 (2023). In Kraske and Pangelina v. Commissioner, T.C. Memo. 2024-5, the Tax Court suggested that an IRS Examination Division (Exam) supervisor’s discretion may be lost when a case is transferred to the Independent Office of Appeals (Appeals), but this is factually incorrect. As the Ninth Circuit recognized in Laidlaw’s, it is only “once the notice is sent” that “the Commissioner begins to lose discretion over whether the penalty is assessed.” Laidlaw’s, 29 F.4th at 1071 n.4. Even when a case is transferred from Exam to Appeals, the Exam supervisor still has discretion to provide the required approval because the penalty is still before the IRS as a whole. As the preamble to the proposed regulations noted, a supervisor’s discretion is lost only after the IRS issues a pre-assessment notice subject to Tax Court review to a taxpayer. Because a supervisor retains discretion to approve a penalty until that point, issuance of the pre-assessment notice subject to Tax Court review remains the appropriate deadline for obtaining supervisory approval of penalties included in such a notice.

The earlier deadlines that comments recommended and that the Tax Court continues to impose do not serve the legislative purpose that penalties be imposed where appropriate. By contrast, the proposed timing rules serve the legislative purpose of imposing penalties where appropriate while ensuring the requirement for supervisory approval can prevent bargaining. The proposed timing rules are consistent with all of the circuit-level authority interpreting the statute and provide a bright-line rule that is administrable for the IRS and fair to taxpayers. Accordingly, this Treasury decision adopts the proposed timing rules without modification.

2. Comments on Proposed Definitions

A. Individual who first proposed the penalty

The proposed regulations provided that the individual who first proposes a penalty is the individual who section 6751(b)(1) references as the individual making the initial determination of a penalty assessment. A proposal can be made either to a taxpayer (or the taxpayer’s representative) or to the individual’s supervisor or a designated higher level official. One comment agreed with the proposed definition of “individual who first proposed the penalty,” while two others disagreed.

The proposed regulations illustrated the effect of this definition in an example in which a Revenue Agent proposes a penalty to her immediate supervisor, but the supervisor does not approve the penalty and it does not appear in the statutory notice of deficiency; the penalty is then raised by an IRS Office of Chief Counsel (Counsel) Attorney in a Tax Court Answer and that attorney is considered the “individual who first proposed the penalty.” Those disagreeing with the proposed definition argued that, in that example, it was the Revenue Agent and not the Counsel attorney that made the initial determination of the penalty. Such a view is at odds with the statutory text, which references (with respect to the penalty) the “initial determination of . . . assessment”, and caselaw. See North Donald LA Property, LLC v. Commissioner, T.C. Memo. 2023-50 (citing multiple cases before concluding that “[w]e have never held that the exam team’s decision not to assert a penalty has any bearing on Chief Counsel’s ability to assert that penalty later”). As the preamble to the proposed regulations explained, an initial determination that does not ultimately result in an assessment of a penalty is not an “initial determination of . . . assessment.” In addition, adopting the comments’ suggested interpretation would render section 6214, which allows Counsel to raise a penalty in an answer, amended answer, or other pleading, meaningless because it would remove Counsel’s ability to make an independent evaluation of whether a penalty is appropriate.

By contrast, the proposed definition harmonizes the statutory scheme and allows the IRS the flexibility to pursue penalties when appropriate. The IRS should not be prevented from asserting a penalty solely because an individual IRS employee involved earlier in the process did not determine that the penalty was appropriate at the time such employee considered it, a result that would follow from adopting the comments’ suggestions. Instead, the IRS should be permitted to assert penalties that both a Counsel attorney and the attorney’s supervisor believe are warranted.

Comments’ concerns about the proposed definition of “individual who first proposed the penalty” have led the Treasury Department and the IRS to conclude that language is needed to clarify that, for purposes of determining which individual first proposed a penalty, the individual must have proposed the penalty either to a taxpayer (or the taxpayer’s representative) or to the individual’s supervisor or designated higher level official. This requirement is to preclude informal suggestions of coworkers or supervisors as being treated as the initial determination of a penalty assessment when those individuals had no official responsibility with respect to a penalty determination or the responsibility was a supervisory one. This interpretation also allows supervisors to do their job of reviewing and directing a subordinate’s work, which may include suggesting that their subordinates propose a penalty. It also eliminates those who are not assigned responsibility for making an initial penalty determination from being treated as having done so by virtue of having made an informal comment about a penalty to a coworker. An example is added to these final regulations to illustrate the effect of the definition. Specifically, the new example highlights that an individual who did not make a proposal to a taxpayer, supervisor, or designated higher level official is not the individual who made the initial determination of a penalty assessment.

B. Immediate supervisor and designated higher level officials

The proposed regulations defined the term “immediate supervisor” as any individual with responsibility to review another individual’s proposal of penalties without the proposal being subject to an intermediary’s approval.

Some comments argued that the proposed definition of “immediate supervisor” was too vague, and that it could allow non-managerial, non-supervisory personnel to approve penalties. Some argued that the definition should be revised to mean any individual who “directly supervises the substantive work” of an individual, while others recommended that it be limited to a single individual that meets the definition of a “supervisor” or “manager” under other provisions of Federal law related to labor and employment matters.

These alternative suggestions focus on substantive work generally, rather than penalty review specifically. Because supervisory approval in this context relates only to penalties, this broader focus is not appropriate. By looking to an individual’s assigned job duties rather than their title, the proposed definition takes a functional approach that is consistent with the statutory purpose of ensuring that a person that is familiar with the penalty aspects of a case be the one to give approval to assert penalties. See Sand Inv. Co. v. Commissioner, 157 T.C. 136, 142 (2021) (holding that the legislative history supports the conclusion that the person with the greatest familiarity with the facts and legal issues presented by the case is the “immediate supervisor” for purposes of section 6751(b)). Moreover, unlike some of the suggested alternatives, the proposed definition recognizes that IRS employees often have multiple supervisors with different roles for different parts of an examination.

After consideration of the comments, the final regulations adopt the proposed definition with one modification. Rather than defining “immediate supervisor” as “any individual with responsibility to approve another individual’s proposal of penalties,” the adopted definition defines it as “any individual with responsibility to review another individual’s proposal of penalties.” This definition recognizes that a person assigned to review a penalty proposal has the responsibility to make a judgment call about the appropriateness of the penalty. Responsibility to review another’s work is the hallmark of being a supervisor. The definition adopted in the final regulations takes a practical approach that is consistent with the statute’s focus on supervision of the penalty proposal.

Pursuant to the grant of authority in section 6751(b)(1) to designate which higher level officials may approve the initial determination, in addition to the general grant of authority in section 7805(a), the proposed regulations defined a “higher level official” as any person who has been directed via the Internal Revenue Manual or other assigned job duties to approve another individual’s proposal of penalties before they are included in a notice that is a prerequisite to Tax Court jurisdiction, an answer to a Tax Court petition, or are assessed without the need for such inclusion.

Some comments disagreed with this definition, arguing that it is too vague and should be narrowed to only a small group of upper-level management. But these comments’ suggested alternatives reject a functional approach in favor of unnecessary formalities that could result in appropriate penalties being eliminated. They are also inconsistent with section 6751(b)’s provision of discretion to designate which higher level officials may designate a penalty. Accordingly, the final regulations adopt the proposed definition without change.

C. Personally approved (in writing)

The proposed regulations define “personally approved (in writing)” to mean any writing, including in electronic form, that is made by the writer to signify the writer’s assent and that reflects that it was intended as approval.

Comments argued that the definition of “personally approved (in writing)” should be revised to require that the approval, if made electronically, be made through a digital signature that includes a software-generated timestamp indicating when the document was signed and who signed it. One comment also argued that, alternatively, the IRS should require that a statement of signing accompany the request for a supervisor’s approval of a penalty.

After consideration of the comments, the proposed definition is adopted without change. Adopting the comments’ suggestions would impose formalities that frustrate imposition of appropriate penalties. The statute does not mandate the use of a particular type of signature, only that the approval be in writing. While it may be a best practice to use digital signatures with software-generated timestamps, mandating their use would go beyond the scope of the statute and these regulations. Nor does the statute require the immediate supervisor to use any particular format when approving the penalty, such as with a statement of signing. The functional approach adopted in these final regulations ensures that written approval, which is all the statute requires, is obtained. See PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 213 (5th Cir. 2018) (rejecting an argument that section 6751(b)(1) was not satisfied because the penalty was not on the same page as the signature); Deyo v. Commissioner, 296 F. App’x 157 (2d Cir. 2008) (rejecting an argument that section 6751(b)(1) was not satisfied because the approval was provided by a stamp rather than a manual signature); Thompson v. Commissioner, T.C. Memo. 2022-80 (rejecting the argument that cross-examination of a revenue agent and his supervisor was needed because it “would be immaterial and wholly irrelevant” where there was written approval in the record); Raifman v. Commissioner, T.C. Memo. 2018-101 (same).

D. Automatically calculated through electronic means

The proposed regulations provide that a penalty is “automatically calculated through electronic means” if it is proposed by an IRS computer program without human involvement. A penalty is no longer considered “automatically calculated through electronic means” if a taxpayer responds to a computer-generated notice proposing a penalty and challenges the penalty or the amount of tax to which the penalty is attributable, and an IRS employee works the case.

Some comments argued that the proposed definition of “automatically calculated through electronic means” is too broad and encompasses penalties that, in the comments’ view, should never be exempt from supervisory approval for various reasons. As explained in the preamble to the proposed regulations, the scope of this definition is limited to identifying when a penalty should be considered exempt from the supervisory approval requirements of section 6751(b)(1) by operation of section 6751(b)(2)(B). Comments sought to narrow the proposed definition and impose additional requirements on the IRS that are divorced from the statutory requirements. The comments were directed to whether proposal and assessment of certain penalties should ever be automated, as opposed to whether a specific penalty was in fact “automatically calculated through electronic means” within the meaning of section 6751(b)(2)(B). As such, the comments go beyond the scope of the regulations.

One comment recommended that the proposed definition be revised to eliminate the requirement that an IRS employee consider a taxpayer’s response to an automatically-generated notice in order to remove the penalty from the automatically-calculated exception. In this comment’s view, this requirement could lead to situations where the IRS ignores correspondence and asserts penalties without proper consideration of the taxpayer’s response to an automatically-generated penalty notice. The Treasury Department and the IRS are sensitive to the comment’s concerns but consider this a matter outside of the scope of these regulations. The stated concerns are policy considerations about how the IRS should handle correspondence. They are not within the scope of these regulations, which seek only to interpret and define the statutory text of section 6751(b). As stated in the preamble to the proposed regulations, it is the policy of the IRS to give “full and fair consideration to evidence in favor of not imposing [a] penalty, even after the [IRS’]s initial consideration supports imposition of a penalty . . . .” This policy should prohibit the type of conduct with which the comment is concerned. Finally, even if the IRS did fail to consider a taxpayer’s response to an automatically-generated penalty notice, there would be no bargaining nor would there be an individual who made an initial determination with respect to the penalty at issue. Accordingly, it would be impossible for the IRS to obtain supervisory approval from the (non-existent) individual’s supervisor. As the preamble to the proposed regulations explains, requiring supervisory approval in that situation would disrupt the automated process and would not square with the statutory text. For these reasons, the proposed definition is adopted without modification.

3. Other Comments

Comments made a number of other recommendations that went beyond the scope of the proposed regulations. These recommendations related to the types of forms the IRS should use in documenting supervisory approval and how those forms should be provided to taxpayers, the internal practices the IRS should follow to ensure compliance with section 6751(b) among its employees, and the types of employees that should be permitted to approve certain penalties over a certain dollar threshold. Other comments also criticized the existing penalty approval process as ineffective and stated that pending legislation would soon obviate the need for these regulations. Finally, one comment was submitted that did not relate to section 6751(b).

Aside from being outside of the scope of these regulations, adopting these recommendations would impose laborious formalities that are not required by section 6751(b) and that would give taxpayers and their representatives more opportunities to avoid the penalties that Congress intended be asserted against them. The final regulations therefore do not adopt these recommendations.

The principal author of these regulations is William Prater of the Office of the Associate Chief Counsel (Procedure and Administration). However, other personnel from the Treasury Department and the IRS participated in their development.

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 301 is amended as follows:

Paragraph 1. The authority citation for part 301 is amended by adding an entry for §301.6751(b)-1(a)(4) in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805

* * * * *

Section 301.6751(b)-1(a)(4) also issued under 26 U.S.C. 6751(b)(1).

* * * * *

Par. 2. Section 301.6751(b)-1 is added to read as follows:

(a) Approval requirement—(1) In general. Except as provided in paragraph (a)(2) of this section, section 6751(b) of the Internal Revenue Code (Code) generally bars the assessment of a penalty unless the initial determination of the assessment of the penalty is personally approved (in writing) by the immediate supervisor of the individual making the initial determination or such higher level official as the Secretary of the Treasury or her delegate may designate. Paragraph (a)(2) of this section lists penalties not subject to section 6751(b)(1) and this paragraph (a)(1). Paragraph (a)(3) of this section provides definitions of terms used in section 6751(b) and this section. Paragraph (a)(4) of this section designates the higher level officials described in this paragraph (a)(1). Paragraphs (b) through (d) of this section apply section 6751(b)(1) and this paragraph (a)(1) to penalties not subject to pre-assessment review in the United States Tax Court (Tax Court), penalties that are subject to pre-assessment review in the Tax Court, and penalties raised in the Tax Court after a petition is filed, respectively. Paragraph (e) of this section provides examples illustrating the application of section 6751(b) and this section. Paragraph (f) of this section provides dates of applicability of this section.

(2) Exceptions. Under section 6751(b)(2), section 6751(b)(1) and this section do not apply to:

(i) Any penalty under section 6651, 6654, 6655, 6673, 6662(b)(9), or 6662(b)(10) of the Code; or

(ii) Any other penalty automatically calculated through electronic means.

(3) Definitions. For purposes of section 6751(b) and this section, the following definitions apply—

(i) Penalty. The term penalty means any penalty, addition to tax, or additional amount under the Code.

(ii) Individual who first proposed the penalty. Except as otherwise provided in this paragraph (a)(3)(ii), the individual who first proposed the penalty is the individual who section 6751(b)(1) and paragraph (a)(1) of this section reference as the individual making the initial determination of a penalty assessment. For purposes of this section, a proposal of a penalty can be made only to either a taxpayer (or the taxpayer’s representative) or to the individual’s supervisor or designated higher level official. A proposal of a penalty, as defined in paragraph (a)(3)(i) of this section, to a taxpayer does not include mere requests for information relating to a possible penalty or inquiries of whether a taxpayer wants to participate in a general settlement initiative for which the taxpayer may be eligible, but does include offering the taxpayer an opportunity to agree to a particular penalty in a particular amount other than a penalty under a settlement initiative offered to a class of taxpayers. An individual who first proposed the penalty is not the individual whom section 6751(b)(1) and paragraph (a)(1) of this section reference as the individual making the initial determination of a penalty assessment if the assessment of the penalty is attributable to an independent proposal made by a different individual.

(iii) Immediate supervisor. The term immediate supervisor means any individual with responsibility to review another individual’s proposal of penalties, as defined in paragraph (a)(3)(i) of this section, without the proposal being subject to an intermediary’s approval.

(iv) Higher level official. The term higher level official means any person designated under paragraph (a)(4) of this section as a higher level official authorized to approve a penalty for purposes of section 6751(b)(1).

(v) Personally approved (in writing). The term personally approved (in writing) means any writing, including in electronic form, made by the writer to signify the writer’s assent. No signature or particular words are required so long as the circumstances of the writing reflect that it was intended as approval.

(vi) Automatically calculated through electronic means. A penalty, as defined in paragraph (a)(3)(i) of this section, is automatically calculated through electronic means if an IRS computer program automatically generates a notice to the taxpayer that proposes the penalty. If a taxpayer responds in writing or otherwise to the automatically-generated notice and challenges the proposed penalty, or the amount of tax to which the proposed penalty is attributable, and an IRS employee considers the response prior to assessment (or the issuance of a notice of deficiency that includes the penalty), then the penalty is no longer considered “automatically calculated through electronic means.”

(4) Higher level official. Any person who has been directed by the Internal Revenue Manual or other assigned job duties to approve another individual’s proposal of penalties before they are included in a pre-assessment notice prerequisite to Tax Court jurisdiction, an answer, amended answer, or amendment to the answer to a Tax Court petition, or are assessed without need for such inclusion, is designated as a higher level official authorized to approve the penalty for purposes of section 6751(b)(1).

(b) Penalties not subject to pre-assessment review in the Tax Court. The requirements of section 6751(b)(1) and paragraph (a)(1) of this section are satisfied for a penalty that is not subject to pre-assessment review in the Tax Court if the immediate supervisor of the individual who first proposed the penalty personally approves the penalty in writing before the penalty is assessed. Alternatively, a person designated as a higher level official as described in paragraph (a)(4) of this section may provide the approval otherwise required by the immediate supervisor.

(c) Penalties subject to pre-assessment review in the Tax Court. The requirements of section 6751(b)(1) and paragraph (a)(1) of this section are satisfied for a penalty that is included in a pre-assessment notice that provides a basis for Tax Court jurisdiction upon timely petition if the immediate supervisor of the individual who first proposed the penalty personally approves the penalty in writing on or before the date the notice is mailed. Alternatively, a person designated as a higher level official as described in paragraph (a)(4) of this section may provide the approval otherwise required by the immediate supervisor. Examples of a pre-assessment notice described in this paragraph (c) include a statutory notice of deficiency under section 6212 of the Code, a notice of final partnership administrative adjustment under former section 6223 of the Code, and a notice of final partnership adjustment under section 6231 of the Code.

(d) Penalties raised in the Tax Court after a petition. The requirements of section 6751(b)(1) and paragraph (a)(1) of this section are satisfied for a penalty that the Commissioner raises in the Tax Court after a petition (see section 6214(a) of the Code) if the immediate supervisor of the individual who first proposed the penalty personally approves the penalty in writing no later than the date on which the Commissioner requests that the court determine the penalty. Alternatively, a person designated as a higher level official as described in paragraph (a)(4) of this section may provide the approval otherwise required by the immediate supervisor.

(e) Examples. The following examples illustrate the rules of this section.

(1) Example 1. In the course of an audit regarding a penalty not subject to pre-assessment review in the Tax Court, Revenue Agent A concludes that Taxpayer T should be subject to the penalty under section 6707A of the Code for failure to disclose a reportable transaction. Revenue Agent A sends T a letter giving T the option to agree to the penalty; submit additional information to A about why the penalty should not apply; or request within 30 days that the matter be sent to the Independent Office of Appeals (Appeals) for consideration. After T requests that Appeals consider the case, A prepares the file for transmission, and B (who is A’s immediate supervisor, as defined in paragraph (a)(3)(iii) of this section) signs a cover memorandum informing Appeals of the proposed penalty and asks Appeals to consider it. The Appeals Officer upholds the penalty, and it is assessed. The requirements of section 6751(b)(1) are satisfied because B’s signature on the cover memorandum is B’s personal written assent to the penalty proposed by A and was given before the penalty was assessed.

(2) Example 2. In the course of an audit, Revenue Agent A concludes that Taxpayer T should be subject to an accuracy-related penalty for substantial understatement of income tax under section 6662(b)(2). Revenue Agent A sends T a Letter 915, Examination Report Transmittal, along with an examination report that includes the penalty. The Letter 915 gives T the option to agree to the examination report; provide additional information to be considered; discuss the report with A or B (who is A’s immediate supervisor, as defined in paragraph (a)(3)(iii) of this section); or request a conference with an Appeals Officer. T agrees to assessment of the penalty and signs the examination report to consent to the immediate assessment and collection of the amounts shown on the report. B provides written supervisory approval of the penalty after T signs the examination report, but before the penalty is assessed. Paragraph (b) of this section applies because T’s agreement to assessment of the penalty excepts it from pre-assessment review in the Tax Court. Because B provided written supervisory approval before assessment of the penalty, the requirements of section 6751(b)(1) are satisfied.

(3) Example 3. In the course of an audit of Taxpayer T by a team of revenue agents, Revenue Agent A concludes that T should be subject to an accuracy-related penalty for negligence under section 6662(b)(1) and (c). Supervisor B is the issue manager and is assigned the duty to review the Notice of Proposed Adjustment for any penalty A would propose. Revenue Agent A reports to B, but B is not responsible for the overall management of the audit of T. C is the case manager of the team auditing T and is responsible for the overall management of the audit of T. C may assign tasks to A and other team members, and has responsibility for approving any examination report presented to T.

(i) Alternative Outcome 1: Only B approves the penalty in writing before the mailing to T of a notice of deficiency that includes the penalty. Under paragraph (a)(3)(iii) of this section, B qualifies as the immediate supervisor of A with respect to A’s penalty proposal, and the requirements of section 6751(b)(1) are met.

(ii) Alternative Outcome 2: Only C approves the penalty in writing before the mailing to T of a notice of deficiency that includes the penalty. Because C has responsibility to approve A’s proposal of the penalty as part of approving the examination report, C qualifies as a higher level official designated under paragraph (a)(4) of this section to approve the penalty proposed by A, and the requirements of section 6751(b)(1) are met.

(4) Example 4. In the course of an audit, Revenue Agent A concludes that Taxpayer T should be subject to a penalty for negligence under section 6662(c). Revenue Agent A recommends the penalty to her immediate supervisor B, who thinks more factual development is needed to support the penalty but must close the audit immediately due to the limitations period on assessment expiring soon. The IRS issues a statutory notice of deficiency without the penalty and T files a petition in the Tax Court. In reviewing the case file and conducting discovery, IRS Chief Counsel Attorney C concludes that the facts support imposing a negligence penalty under section 6662(c). Attorney C proposes to her immediate supervisor, D, that the penalty should apply and should be raised in an Answer pursuant to section 6214(a). D agrees and signs the Answer that includes the penalty before it is filed. The section 6662(c) penalty at issue is subject to pre-assessment review in the Tax Court and was raised in the Tax Court after a petition was filed under paragraph (d) of this section. Therefore, written supervisory approval under paragraph (d) of this section was required prior to filing the written pleading that includes the penalty. Attorney C is the individual who first proposed the penalty for purposes of section 6751(b)(1) and paragraphs (d) and (a)(3)(ii) of this section, and she secured timely written supervisory approval from D, the immediate supervisor, as defined in paragraph (a)(3)(iii) of this section. As a result, the requirements of section 6751(b)(1) are met. Revenue Agent A did not make the initial determination of the penalty assessment because any assessment would not be attributable to A’s proposal but would be based on the independent proposal of Attorney C raised pursuant to section 6214(a).

(5) Example 5. In the course of an audit, Revenue Agent A concludes that Taxpayer T should be subject to a penalty for negligence under section 6662(c). Revenue Agent A includes the penalty in a draft report that she sends for review to her immediate supervisor B. B reviews A’s recommendation and notices that A did not consider whether a penalty for a substantial understatement of income tax under section 6662(d) should apply in the alternative. B sends an email to A telling her to “add a section 6662(d) penalty if the math checks out.” Revenue Agent A reviews the facts, determines that the imposition of the section 6662(d) penalty is warranted, and adds the penalty to a report she issues to the taxpayer. Revenue Agent A is the individual who first proposed both of the penalties for purposes of section 6751(b)(1) and paragraphs (d) and (a)(3)(ii) of this section because she is the individual who first proposed the penalty to the taxpayer. Supervisor B did not make the initial determination of the section 6662(d) penalty because, even though she first thought of and suggested it, she did not propose it to the taxpayer or her supervisor (or designated higher level official).

(6) Example 6. The IRS’s Automated Underreporter (AUR) computer program detects a discrepancy between the information received from a third party and the information contained on Taxpayer T’s return. AUR automatically generates a CP2000, Notice of Underreported Income, that includes an adjustment based on the unreported income and a proposed penalty under section 6662(d) that is mailed to T. The CP2000 gives T 30 days to respond to contest the proposed adjustments and the penalty. T submits a response to the CP2000, asking only for more time to respond. More time is granted but no further response is received from T, and a statutory notice of deficiency that includes the adjustments and the penalty is automatically generated and issued to T. The section 6662(d) penalty at issue is automatically calculated through electronic means under paragraphs (a)(2)(ii) and (a)(3)(vi) of this section. The penalty was proposed by the AUR computer program, which generated a notice to T that proposed the penalty. Although T submitted a response to the CP2000, the response did not challenge the proposed penalty, or the amount of tax to which the proposed penalty is attributable. Therefore, the penalty was automatically calculated through electronic means and written supervisory approval was not required.

(f) Applicability date. The rules of this section apply to penalties assessed on or after December 23, 2024.

Douglas W. O’Donnell, Deputy Commissioner.

Approved: December 2, 2024.

Aviva R. Aron-Dine, Deputy Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register December 20, 2024, 4:15 p.m., and published in the issue of the Federal Register for December 23, 2024, 89 FR 104419)

¹ Typically a 30-day letter proposes penalties and gives the taxpayer an opportunity to request an administrative appeal.

FTS began as a pilot program in 2001 with the goal of successfully using dispute resolution techniques to promote issue resolution at earlier stages. See Notice 2001-67, 2001-2 C.B. 544 (December 3, 2001). In 2003, the IRS formally established FTS for taxpayers under the jurisdiction of the Large and Mid-Size Business division, a predecessor to LB&I. The IRS also allowed the use of Appeals’ alternative dispute resolution (ADR) settlement authority in certain cases under the jurisdiction of SB/SE. See Rev. Proc. 2003-40, 2003-25 I.R.B. 1044 (June 23, 2003). In 2012, the IRS permanently established the FTS program for taxpayers under the jurisdiction of TE/GE. See Announcement 2012-34, 2012-36 I.R.B. 334 (September 4, 2012). Thereafter, Rev. Proc. 2017-25, 2017-14 I.R.B. 1039 (April 3, 2017), formally established the SB/SE FTS program.

The PAM program allows a taxpayer and Appeals to resolve disputes through mediation while a taxpayer’s case is still under consideration by Appeals. Both the taxpayer and Appeals must agree to mediation, which is not binding. The PAM procedures are described in Rev. Proc. 2014-63, 2014-53 I.R.B. 1014 (December 29, 2014). See also section 7123(b)(1) of the Internal Revenue Code (Code). Both FTS and PAM operate in accordance with these authorities as well as applicable portions of the Internal Revenue Manual (IRM).

FTS AND PAM PILOT PROGRAM CHANGES

The changes being piloted under FTS and PAM incorporate and rely upon all existing FTS and PAM guidance except for that which is the subject of specific pilot revisions. All existing procedures for commencing and conducting FTS and PAM not specifically modified by this announcement remain in place and continue in operation.

Under the pilot program, FTS can be applied to one or more issues in a case. Previously, if a taxpayer had one issue that was ineligible for FTS, the entire case was ineligible. In addition, participation in FTS will not disqualify a taxpayer from PAM. Requests to participate in FTS and PAM will not be denied without the approval of a first-line executive. These first line executives include but are not limited to:

When requests for FTS or PAM are formally denied, taxpayers will receive an explanation for the denial. Finally, the pilot program removes the pre-FTS managerial conference requirements for SB/SE and TE/GE taxpayers. See IRM 8.26.2.5(1) (06-23-2017); IRM 8.26.7.2.1(1) (03-28-2014).

These changes are intended to extend the provisions of the current FTS and PAM programs to a wider range of cases and to increase usage and oversight of ADR within the IRS. These piloted changes will be evaluated after a two-year test period to determine the degree to which they should be discontinued, adjusted, or made permanent. Among other factors, this evaluation will be based on usage data, experiences of IRS personnel, and taxpayer satisfaction. The FTS pilot will be available to any taxpayer under the jurisdiction of Exam. The PAM pilot will likewise be available to taxpayers nationwide who have non-docketed cases before Appeals.

LAST CHANCE FTS PILOT PROGRAM

The IRS will also undertake a limited-scope Last Chance FTS pilot program. Under this program, when a taxpayer submits a protest in response to a 30-day or equivalent letter issued at the conclusion of an examination under SB/SE’s jurisdiction, the SB/SE Group Manager overseeing the case will ask Appeals to contact the taxpayer to inform the taxpayer of the FTS option. The designated Appeals point-of-contact will act as a neutral resource independent of the SB/SE examination staff proposing the adjustment or enforcement action and will provide the taxpayer with information regarding FTS. If the taxpayer requests FTS and the SB/SE examination team consents to participate, the rules of traditional FTS, as modified by the FTS pilot described in this announcement, will apply. If the taxpayer chooses not to request FTS, the case will be transferred by SB/SE to Appeals using currently existing procedures.

The Last Chance FTS pilot program, which is intended to further publicize availability of FTS, will initially be limited to select cases under examination by SB/SE revenue agents and tax compliance officers. The Last Chance FTS pilot program will not impact a taxpayer’s eligibility for FTS. Instead, the IRS’s objective is to determine whether participation in FTS increases when taxpayers are reminded of their FTS options immediately prior to the case entering Appeals’ jurisdiction.

The FTS and PAM pilot program changes described in this announcement are effective for all requests for FTS made on or after January 15, 2025 and expire on January 15, 2027. The Last Chance FTS pilot program is effective beginning on January 15, 2025 and expires on January 15, 2027.

The IRS encourages taxpayers to submit written comments on the changes being piloted, including suggested improvements to make FTS and PAM more useful and effective. Comments may be submitted electronically via the Federal eRulemaking Portal at https://www.regulations.gov (type “IRS Announcement 2025-6” in the search field on the Regulations.gov home page to find this notice and submit comments). Alternatively, comments may be submitted by mail to: Internal Revenue Service, Attn: CC:PA:LPD:PR (Announcement 2025-6), Room 5203, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044. Comments may be submitted at any point during the pilot period.

The principal author of this announcement is Robin Ferguson of the Office of the Associate Chief Counsel (Procedure and Administration). For further information regarding this announcement, contact Robin Ferguson at (202) 317-5217 (not a toll-free number).

Before the proposed regulations are adopted as final regulations, consideration will be given to comments that are submitted timely to the IRS as prescribed in the preamble under the “ADDRESSES” section. In addition to the comments specifically requested in the Explanation of Provisions, the Treasury Department and the IRS request comments on all aspects of the proposed regulations. Any comments submitted will be made available at www.regulations.gov or upon request.

A public hearing will be scheduled if requested in writing by any person who timely submits written comments. Requests for a public hearing are encouraged to be made electronically. If a public hearing is scheduled, notice of the date and time for the public hearing will be published in the Federal Register.

Any IRS Revenue Procedures, Revenue Rulings, Notices, or other guidance cited in this document are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at www.irs.gov.

The principal authors of these regulations are Karen R. Li, Elena M. Madaj and Chadwick Rowland, Office of Associate Chief Counsel (International). However, other personnel from the IRS and the Treasury Department participated in their development.

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, the Treasury Department and the IRS propose to amend 26 CFR part 1 as follows:

Paragraph 1. The authority citation for part 1 is amended by revising the entry for §1.951-1, adding entries in numerical order for §§1.951-2, 1.959-1 through 1.959-12, and 1.961-1 through 1.961-13, revising the entry for §1.986(c)-1, and adding an entry in numerical order for §1.1502-59 to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

* * * * *

Sections 1.951-1 and 1.951-2 also issued under 26 U.S.C. 951, 959, and 961.

* * * * *

Sections 1.959-1 through 1.959-12 also issued under 26 U.S.C. 245A(g), 904(d)(7), 951A(f)(1)(B), 959, 960(f), 962, 965(o), 986, 986(c)(2), 989(c), and 1373.

* * * * *

Sections 1.961-1 through 1.961-13 also issued under 26 U.S.C. 743(b), 959, 961 and 961(a), (b), and (c), 965(o), and 1373.

* * * * *

Section 1.986(c)-1 also issued under 26 U.S.C. 962, 965(o), 986 and 986(c)(2), and 989(c).

* * * * *

Section 1.1502-59 also issued under 26 U.S.C. 959, 960, 961, 986, and 1502.

* * * * *

Par. 2. Section 1.163(j)-7 is amended by:

The revision and addition read as follows:

* * * * *

(g) * * *

(2) Treatment of certain dividends and previously taxed earnings and profits. For purposes of computing the ATI of a relevant foreign corporation for a taxable year, the following amounts are (without duplication) subtracted from tentative taxable income—

(i) Any dividend included in gross income that is received from a related person, within the meaning of section 954(d)(3), with respect to the distributee; and

(ii) Any previously taxed earnings and profits that are distributed to the foreign corporation in a covered distribution (determined under §1.959-4) or that result from the application of section 961(c) basis to covered gain recognized by the foreign corporation (determined under §1.961-9).

* * * * *

(m) * * *

(2) * * * Paragraph (g)(2)(ii) of this section applies to a taxable year of a foreign corporation that begins on or after [date of publication of final regulations in the Federal Register] or is an early application year (as described in §1.959-12(d)) and to a taxable year of a person for which such taxable year of that foreign corporation is relevant.

* * * * *

Par. 3. Section 1.245A(d)-1 is amended by:

The revision reads as follows:

* * * * *

(c) * * *

(22) * * * The term section 245A(d) PTEP means previously taxed earnings and profits assigned to a section 245A(d) PTEP group or a reclassified section 245A(d) PTEP group (each as defined in §1.959-1(b)). * * *

* * * * *

Par. 4. Section 1.312-6 is amended by adding paragraph (f) to read as follows:

* * * * *

(f) An amount included in a corporation’s gross income under section 951(a) or 951A(a) for a particular period is taken into account in computing the corporation’s earnings and profits for that period. See also §1.312-8(c) (domestic corporation’s receipt of previously taxed earnings and profits does not increase earnings and profits). This paragraph (f) applies to a taxable year of a corporation beginning on or after [date of publication of final regulations in the Federal Register]. This paragraph (f) also applies to a taxable year of a domestic corporation that is a shareholder in a foreign corporation, if a taxable year of the foreign corporation that is an early application year (as described in §1.959-12(d)) ends with or within the taxable year of the domestic corporation.

Par. 5. Section 1.312-8 is amended by adding paragraph (c) to read as follows:

* * * * *

(c) Previously taxed earnings and profits that are distributed to a domestic corporation in a covered distribution (determined under §1.959-4) do not increase the corporation’s earnings and profits. See §§1.959-4 and 1.961-4 for rules excluding distributed previously taxed earnings and profits from gross income and reducing basis. See also §1.312-6(f) (sections 951(a) and 951A(a) inclusions increase earnings and profits). This paragraph (c) applies to a taxable year of a domestic corporation beginning on or after [date of publication of final regulations in the Federal Register]. This paragraph (c) also applies to a taxable year of a domestic corporation that is a shareholder in a foreign corporation, if a taxable year of the foreign corporation that is an early application year (as described in §1.959-12(d)) ends with or within the taxable year of the domestic corporation.

Par. 6. Section 1.743-1 is amended by adding paragraphs (d)(4) and (j)(7) to read as follows:

* * * * *

(d) * * *

(4) Coordination with derived basis. See §1.961-5(d) for a rule coordinating the application of this paragraph (d) with derived basis that transfers to a transferee.

* * * * *

(j) * * *

(7) Covered distributions treated as previously taxed earnings and profits. See §1.961-4(c)(2)(iii) for rules regarding the use of a positive basis adjustment under section 743(b) upon the receipt of a covered distribution that is treated as previously taxed earnings and profits with respect to certain direct or indirect partners of the partnership.

* * * * *

Par. 7. Section 1.861-20 is amended by:

Par. 8. Section 1.904-6 is amended by:

Par. 9. Section 1.905-3 is amended by:

§1.905-4 [Amended]

Par. 10. Section 1.905-4 is amended by, in paragraph (c)(6), removing the language “PTEP group taxes (as defined in §1.960-3(d)(1))” and adding the language “a tax pool described in §1.959-2(b)(4) or (d)(2)” in its place.

Par. 11. Section 1.951-1 is amended by:

The revisions and additions read as follows:

(a) * * *

(1) Section 951(a) inclusions. If a foreign corporation is a controlled foreign corporation (within the meaning of section 957 or, if applicable, section 953(c)(1)(B)) at any time during a taxable year of the foreign corporation, every person who is a United States shareholder (as defined in section 951(b) and paragraph (g) of this section) of the foreign corporation at any time during such taxable year and owns (within the meaning of section 958(a)) stock in the foreign corporation on the last day in such taxable year on which the foreign corporation is a controlled foreign corporation shall, for the United States shareholder’s taxable year in which or with which such taxable year of the foreign corporation ends, include in gross income the sum of—

(i) The United States shareholder’s pro rata share (determined under paragraph (b) of this section) of the foreign corporation’s subpart F income (as defined in section 952) for the taxable year of the foreign corporation; and

(ii) The amount determined under section 956 with respect to the United States shareholder for the taxable year of the foreign corporation, but only to the extent not excluded from gross income under section 959(a)(2) and §1.959-5.

(2) Currency translation. See section 989(b) for translating an amount included in income under this section into U.S. dollars.

(3) Characterization of inclusion in determining a personal holding company. * * *

(4) Certain stock ownership rules. * * *

* * * * *

(c) Pro rata share of subpart F income—(1) In general. For purposes of paragraph (b) of this section, a United States shareholder’s pro rata share of the foreign corporation’s subpart F income for the taxable year of the foreign corporation is the sum of all subpart F income allocated to the United States shareholder in accordance with the rules described in paragraph (c)(2) of this section. Under those rules, subpart F income attributable to covered items (that is, subpart F income attributable to certain distributions and certain gain with respect to stock) is separately allocated, in each case consistently with how the covered item is assigned at the foreign corporation-level under §1.951-2 as part of determining the extent to which attributes specific to the United States shareholder (that is, previously taxed earnings and profits or section 961(c) basis) are applied to exclude the covered item from the foreign corporation’s subpart F income under section 959(b) or 961(c). Then, subpart F income not attributable to covered items is allocated based on the United States shareholder’s share of the foreign corporation’s allocable earnings and profits (as determined under paragraph (e) of this section). See paragraphs (c)(3) and (h) of this section for definitions and examples, respectively.

(2) Rules for allocating subpart F income—(i) Determine subpart F income attributable to each covered item. First, determine the subpart F income of the foreign corporation attributable to each covered item, computed as the portion of the covered item that is included in foreign base company income (as defined in §1.954-1(a)(5)) or insurance income (as defined in §1.954-1(a)(6)). See §1.951-2(b) for the definition of a covered item.

(ii) Allocate subpart F income attributable to each covered item. Second, allocate to the United States shareholder a pro rata portion of the subpart F income attributable to each covered item, determined by multiplying such subpart F income by a fraction. The numerator of the fraction is the portion of the covered item that is both assigned to the United States shareholder under §1.951-2 and included in adjusted gross foreign base company income (as defined in §1.954-1(a)(3)) or adjusted gross insurance company income (as defined in §1.954-1(a)(6)), and the denominator of the fraction is the portion of the covered item that is included in adjusted gross foreign base company income or adjusted gross insurance company income. However, if the denominator of the fraction would be zero, then the fraction is considered to be zero.

(iii) Allocate subpart F income not attributable to covered items. Third, allocate to the United States shareholder a pro rata portion of all subpart F income of the foreign corporation not attributable to covered items, determined by multiplying all such subpart F income by a fraction. The numerator of the fraction is the portion of the foreign corporation’s hypothetical distribution described in paragraph (e) of this section that would be distributed with respect to the stock of the corporation that the United States shareholder owns (within the meaning of section 958(a)), and the denominator of the fraction is the amount of such hypothetical distribution.

(3) Definitions. For purposes of this paragraph (c), the term covered item has the meaning provided in §1.951-2(b).

* * * * *

(e) Hypothetical distribution—(1) * * *

(i) Hypothetical distribution and hypothetical distribution date. For a taxable year of a controlled foreign corporation, the hypothetical distribution described in this paragraph (e) (hypothetical distribution) is a distribution treated as made by the corporation with respect to stock of the corporation owned by all shareholders of the corporation in an amount equal to the corporation’s allocable earnings and profits for the taxable year, on the last day of the taxable year on which the corporation is a controlled foreign corporation (hypothetical distribution date).

* * * * *

(h) Examples—(1) Examples not involving covered items. The following examples illustrate the application of paragraphs (c) and (e) of this section in cases not involving covered items.

* * * * *

(2) Examples involving covered items. The following examples illustrate the application of paragraphs (c) and (e) of this section in cases involving covered items.

(i) Assumed facts. For purposes of the examples in this paragraph (h)(2), unless otherwise indicated, the following facts are assumed:

(A) US1 and US2 are unrelated domestic corporations that are covered shareholders. Neither US1 nor US2 is a member of a consolidated group (as defined in §1.1502-1(h)).

(B) F1, F2, and F3 are foreign corporations, each of which is a controlled foreign corporation and uses the British pound (£) as its functional currency.

(C) Each entity uses the calendar year as its taxable year, and no entity has a short taxable year.

(D) To the extent a covered item received or recognized by a foreign corporation is previously taxed earnings and profits, the covered item is excluded in determining the foreign corporation’s subpart F income and tested income or tested loss under section 959(b) and §1.959-4 or section 961(c) and §1.961-9, as applicable.

(E) To the extent a covered item received or recognized by a foreign corporation is not previously taxed earnings and profits, the covered item is—

(1) In the case of a covered distribution, excluded in determining the foreign corporation’s subpart F income and tested income or tested loss under sections 954(c)(6) and 951A(c)(2)(A)(i)(IV); and

(2) In the case of covered gain, included in the foreign corporation’s foreign personal holding company income (as defined in section 954(c)) and then its adjusted gross foreign base company income (as defined in §1.954-1(a)(3)) either because section 964(e)(1) does not apply or because section 964(e)(4) applies.

(F) The only reductions to adjusted gross foreign base company income (as defined in §1.954-1(a)(3)) are for deductions under §1.954-1(a)(4). Thus, there are no reductions by reason of section 952(c) (subpart F income limited to current earnings and profits) or section 954(b)(4) (exception for certain income subject to high foreign taxes).

(G) To the extent a covered item received or recognized by a foreign corporation is excluded in determining the foreign corporation’s subpart F income and tested income or tested loss as described in this paragraph (h)(2)(i), the listed exclusion is not necessarily the only applicable exclusion.

(ii) Example 1: Subpart F income attributable to covered items—(A) Facts—(1) In general. US1 and US2 each directly own 50% of the single class of outstanding stock of F1. F1 directly owns all the outstanding stock of each of F2 and F3. For F1’s taxable year ending on December 31 of year 3, F1’s gross income consists of two covered items, which are a £60x covered distribution received from F2 and £40x of covered gain recognized with respect to stock of F3. US1 and US2 are assigned equal portions of each covered item under §1.951-2. The entirety of US1’s assigned portion of each covered item is previously taxed earnings and profits (because, in the case of the covered distribution, £30x of F2’s previously taxed earnings and profits with respect to US1 is applied to US1’s assigned portion and, in the case of the covered gain, £20x of F1’s section 961(c) basis with respect to US1 is applied to US1’s assigned portion). None of US2’s assigned portion of either covered item is previously taxed earnings and profits (because F2 has no previously taxed earnings and profits with respect to US2 and F1 has no section 961(c) basis with respect to US2). F1 has no deductions for the taxable year.

(2) Subpart F income. For F1’s taxable year ending on December 31 of year 3, F1 has £20x of subpart F income consisting of foreign base company income (adjusted net foreign base company income as defined in §1.954-1(a)(5)), which in turn consists of foreign personal holding company income (as defined in section 954(c)). Table 1 in this paragraph (h)(2)(ii)(A)(2) provides the treatment of F1’s gross income in computing its adjusted net foreign base company income.

(B) Analysis. Under paragraph (c) of this section, F1’s subpart F income attributable to each covered item is separately allocated to US1 and US2. F1 has £0 of subpart F income attributable to the covered distribution and £20x of subpart F income attributable to the covered gain because in each case that is the portion of the covered item that is included in F1’s adjusted net foreign base company income. See paragraph (c)(2)(i) of this section. The £20x of subpart F income attributable to the covered gain is allocated to each of US1 and US2 by multiplying the amount of such subpart F income by a fraction, the numerator of which is the portion of the covered gain that is both assigned to the United States shareholder under §1.951-2 and included in F1’s adjusted gross foreign base company income (£0 in the case of US1, and £20x in the case of US2), and the denominator of which is the portion of the covered gain that is included in F1’s adjusted gross foreign base company income (£20x). See paragraph (c)(2)(ii) of this section. Thus, US2 is allocated all £20x of the subpart F income attributable to the covered gain. Accordingly, for purposes of paragraph (b) of this section, US1 has a £0 pro rata share, and US2 has a £20x pro rata share, of F1’s £20x of subpart F income. See paragraph (c)(1) of this section.

(C) Alternative facts: expenses—(1) Facts. The facts are the same as in paragraph (h)(2)(ii)(A) of this section, except as follows. Only £10x of US1’s assigned portion of the covered gain is previously taxed earnings and profits (because there is only £10x of section 961(c) basis with respect to US1 available to be applied to US1’s assigned portion). In addition, F1 has £5x of deductions, which are not foreign income taxes, that are definitely related to the covered gain. The deductions reduce F1’s adjusted gross foreign base company income by £5x in computing net foreign base company income under §1.954-1(a)(4). Thus, F1 has £25x of subpart F income, all of which is attributable to the covered gain.

(2) Analysis. As summarized in Table 1 in this paragraph (h)(2)(ii)(C)(2), the £25x of subpart F income attributable to the covered gain is allocated to each of US1 and US2 by multiplying the amount of such subpart F income by a fraction, the numerator of which is the portion of the covered gain that is both assigned to the United States shareholder under §1.951-2 and included in F1’s adjusted gross foreign base company income (£10x in the case of US1, and £20x in the case of US2), and the denominator of which is the portion of the covered gain that is included in F1’s adjusted gross foreign base company income (£30x). See paragraph (c)(2)(ii) of this section. Accordingly, for purposes of paragraph (b) of this section, US1 has a £8.3x pro rata share, and US2 has a £16.7x pro rata share, of F1’s £25x of subpart F income.

(iii) Example 2: Subpart F income attributable and not attributable to covered items—(A) Facts—(1) In general. US1 and US2 each directly own 50% of the single class of outstanding stock of F1. F1 directly owns all the outstanding stock of each of F2 and F3. For F1’s taxable year ending on December 31 of year 3, F1 has £500x of allocable earnings and profits for purposes of the hypothetical distribution described in paragraph (e) of this section. F1’s gross income for the taxable year consists of a £60x covered distribution received from F2, £40x of covered gain recognized with respect to stock of F3, £295x of royalty income received from an unrelated person, and £125x of foreign oil and gas extraction income (as defined in section 907(c)(1)). US1 and US2 are assigned equal portions of each covered item under §1.951-2, and the entirety of US1’s assigned portion of each covered item, but none of US2’s assigned portion of either covered item, is previously taxed earnings and profits (because, in the case of the covered distribution, there are sufficient previously taxed earnings and profits with respect to US1 to be applied to US1’s assigned portion and there are no previously taxed earnings and profits with respect to US2 to be applied to US2’s assigned portion, and, in the case of the covered gain, there is sufficient section 961(c) basis with respect to US1 to be applied to US1’s assigned portion and there is no section 961(c) basis with respect to US2 to be applied to US2’s assigned portion). F1 has £20x of deductions for the taxable year, consisting of £15x of foreign withholding taxes imposed on the covered distribution and £5x of expenses, which are not foreign income taxes, that are definitely related to the covered gain. The £5x of expenses reduce F1’s adjusted gross foreign base company income by £5x in computing net foreign base company income under §1.954-1(a)(4).

(2) Subpart F income. For F1’s taxable year ending on December 31 of year 3, F1 has £310x of subpart F income consisting of foreign base company income (adjusted net foreign base company income as defined in §1.954-1(a)(5)). Table 1 in this paragraph (h)(2)(iii)(A)(2) provides the treatment of F1’s items of gross income in computing its adjusted net foreign base company income.

(B) Analysis—(1) In general. Under paragraph (c) of this section, F1’s subpart F income attributable to each covered item is separately allocated to US1 and US2, and then F1’s remaining subpart F income is allocated to the United States shareholders. As described in paragraphs (h)(2)(iii)(B)(2) and (3) of this section and summarized in Table 1 in this paragraph (h)(2)(iii)(B)(1), US1 is allocated a total of £147.5x, and US2 is allocated a total of £162.5x, of subpart F income. Accordingly, for purposes of paragraph (b) of this section, US1 has a £147.5x pro rata share, and US2 has a £162.5x pro rata share, of F1’s £310x of subpart F income. See paragraph (c)(1) of this section.

(2) Allocation of subpart F income attributable to covered items. F1 has £0 of subpart F income attributable to the covered distribution and £15x of subpart F income attributable to the covered gain because in each case that is the portion of the covered item that is included in F1’s adjusted net foreign base company income. See paragraph (c)(2)(i) of this section. The £15x of subpart F income attributable to the covered gain is allocated to each of US1 and US2 by multiplying the amount of such subpart F income by a fraction, the numerator of which is the portion of the covered gain that is both assigned to the United States shareholder under §1.951-2 and included in F1’s adjusted gross foreign base company income (£0 in the case of US1, and £20x in the case of US2), and the denominator of which is the portion of the covered gain that is included in F1’s adjusted gross foreign base company income (£20x). See paragraph (c)(2)(ii) of this section. Thus, US2 is allocated all £15x of the subpart F income attributable to the covered gain.

(3) Allocation of subpart F income not attributable to covered items. F1 has £295x of subpart F income not attributable to covered items (£310x × £15x). This subpart F income is allocated to each of US1 and US2 by multiplying the amount of the subpart F income by a fraction, the numerator of which is portion of F1’s £500x hypothetical distribution described in paragraph (e) of this section that would be distributed with respect to stock of F1 that the United States shareholder owns (£250x in the case of each of US1 and US2), and the denominator of which is the amount of the hypothetical distribution (£500x). See paragraph (c)(2)(iii) of this section. Thus, each of US1 and US2 is allocated £147.5x of the subpart F income not attributable to covered items.

(C) Alternative facts: tested income—(1) Facts. The facts are the same as in paragraph (h)(2)(iii)(A) of this section, except that F1’s £125x item of foreign oil and gas extraction income is instead gross tested income. Because there are no allowable deductions properly allocable to the gross tested income, F1 thus has £125x of tested income.

(2) Analysis. The results are the same as in paragraph (h)(2)(iii)(B) of this section. In addition, each of US1 and US2 has a £62.5x pro rata share of F1’s £125x of tested income, determined by multiplying the amount of the tested income by the fraction used in allocating F1’s subpart F income not attributable to covered items to the United States shareholder (£250x/£500x, as described in paragraph (h)(2)(iii)(B)(3) of this section). See §1.951A-1(d)(2).

(i) Applicability date. This section applies to taxable years of foreign corporations that begin on or after [date of publication of final regulations in the Federal Register] or are early application years (as described in described in §1.959-12(d)) and to taxable years of persons for which such taxable years of those foreign corporations are relevant. See §1.951-1 as contained in 26 CFR part 1 revised as of April 1, 2024, for a version of this section applicable to prior taxable years.

Par. 12. Add section 1.951-2 to read as follows:

(a) Scope. This section sets forth the rules for assigning a foreign corporation’s covered items to covered shareholders. Under §§1.959-4 and 1.961-9, these assignments determine the extent to which shareholder-specific attributes (previously taxed earnings and profits or section 961(c) basis) are applied to the covered items. Paragraph (b) of this section defines a covered item. Paragraph (c) of this section describes the rules for assigning covered items. Paragraph (d) of this section describes a fraction determining assignments under the general assignment rule. Paragraph (e) of this section adjusts assignments to account for general successor transactions. Paragraph (f) of this section provides a currency translation rule. Paragraph (g) of this section provides definitions and rules of general applicability for purposes of this section. Paragraph (h) of this section provides examples illustrating the application of this section. Paragraph (i) of this section provides the applicability date of this section.

(b) Covered items. A covered item is gross income of a foreign corporation that consists of either the portion of a covered distribution received by the foreign corporation (determined under §1.959-4) or a covered gain recognized by the foreign corporation (determined under §1.961-9). Covered shareholders that own stock of a foreign corporation during a taxable year of the foreign corporation in which the foreign corporation receives or recognizes a covered item are assigned portions of the covered item in accordance with the rules described in paragraph (c) of this section. See also paragraph (g) of this section, incorporating §1.959-1(b) for the definition of covered shareholder, §1.959-4(c) for the definition of covered distribution, and §1.961-9(c) for the definition of covered gain.

(c) Rules for assigning a covered item—(1) Determine assignments based on stock ownership on the last relevant day. First, assign a pro rata portion of the covered item to each covered shareholder that owns stock of the foreign corporation on the last relevant day of the foreign corporation’s taxable year (defined in §1.959-1(b) as the last day of the taxable year on which the foreign corporation is a controlled foreign corporation), determined by multiplying the amount of the covered item by the fraction computed in accordance with paragraph (d) of this section. If there is no day during the taxable year on which the foreign corporation is a controlled foreign corporation, then treat the last day of the taxable year as the last relevant day.

(2) Adjust assignments for general successor transactions. Second, if the foreign corporation is an acquired foreign corporation in one or more general successor transactions that occur during the foreign corporation’s taxable year, then, for each such general successor transaction (starting with the earliest transaction), adjust covered shareholders’ assigned portions of the covered item in accordance with paragraph (e) of this section. See also paragraph (g) of this section, incorporating §1.959-7(b) for the definitions of acquired foreign corporation and general successor transaction.

(d) Fraction in determining assignments—(1) In general. In determining a covered shareholder’s assigned portion of a covered item of a foreign corporation under paragraph (c)(1) of this section, the fraction described in that paragraph is computed as follows. The numerator of the fraction is the amount that would be the covered shareholder’s share of the hypothetical distribution described in §1.951-1(e) for the foreign corporation’s taxable year if, for purposes of this paragraph (d), §1.951-1(e) were applied with the modifications described in paragraph (d)(2) of this section. The denominator of the fraction is the amount that would be the hypothetical distribution described in §1.951-1(e) for the foreign corporation’s taxable year if, for purposes of this paragraph (d), §1.951-1(e) were applied with the modifications described in paragraph (d)(2) of this section.

(2) Modifications—(i) Allocable earnings and profits. For purposes of this paragraph (d), the foreign corporation’s allocable earnings and profits (as defined in §1.951-1(e)(1)(ii)) are treated as the amount that is the greater of—

(A) The earnings and profits of the foreign corporation for the taxable year, determined under section 964 and not reduced by distributions during the taxable year; and

(B) The sum of all covered items of the foreign corporation for the taxable year.

(ii) Controlled foreign corporation status. For purposes of this paragraph (d), §1.951-1(e) applies without regard to whether the foreign corporation is a controlled foreign corporation. In addition, if there is no day during the taxable year on which the foreign corporation is a controlled foreign corporation, then the hypothetical distribution date (as defined in §1.951-1(e)(1)(i)) is treated as the last day of the taxable year.

(e) Rules for general successor transactions—(1) In general. In adjusting covered shareholders’ assignments of a covered item for a general successor transaction under paragraph (c)(2) of this section, increase an assignment in accordance with paragraph (e)(2) of this section, and then decrease assignments in accordance with paragraphs (e)(3) and (4) of this section. Generally, under these rules (together with §§1.959-4 and 1.961-9), previously taxed earnings and profits or section 961(c) basis with respect to the transferor covered shareholder (if the general successor transaction occurs before the last relevant day) or successor covered shareholder (if the general successor transaction occurs on or after the last relevant day) are applied to a covered item to the same extent such previously taxed earnings and profits or section 961(c) basis would have been applied if the general successor transaction had not occurred.

(2) Increase—(i) General successor transaction occurring before the last relevant day. If the general successor transaction occurs before the last relevant day of the taxable year but after the covered item is received or recognized, then, subject to the limitation in paragraph (e)(2)(iii) of this section, increase the transferor covered shareholder’s assignment of the covered item as follows. Increase the assignment by the additional portion of the covered item that would have been assigned to the transferor covered shareholder under paragraph (c)(1) of this section if the day on which the covered item is received or recognized were the last relevant day and the hypothetical distribution described in paragraph (d)(1) of this section were treated as made immediately before the covered item is received or recognized.

(ii) General successor transaction occurring on or after the last relevant day. If the general successor transaction occurs on or after the last relevant day of the taxable year but before the covered item is received or recognized, then, subject to the limitation in paragraph (e)(2)(iii) of this section, increase the successor covered shareholder’s assignment of the covered item as follows. Increase the assignment by the additional portion of the covered item that would have been assigned to the successor covered shareholder under paragraph (c)(1) of this section if the day on which the covered item is received or recognized were the last relevant day and the hypothetical distribution described in paragraph (d)(1) of this section were treated as made immediately before the covered item is received or recognized.

(iii) Limitations. The increase pursuant to paragraph (e)(2)(i) or (ii) of this section applies only to the extent it results in an additional portion of the covered item being previously taxed earnings and profits that are both with respect to the covered shareholder described in that paragraph and excluded from the foreign corporation’s gross income under section 959(b) and §1.959-4 or section 961(c) and §1.961-9. Further, the increase cannot exceed the aggregate of each connected covered shareholder’s assigned portion of the covered item under paragraph (c)(1) of this section.

(3) Decreases for connected covered shareholders owning acquired stock. For each connected covered shareholder that owns acquired stock of the foreign corporation on the last relevant day of the taxable year, decrease the connected covered shareholder’s assignment (but not below zero) by the product of the increase pursuant to paragraph (e)(2) of this section and a fraction. The numerator of the fraction is the connected covered shareholder’s assigned portion of the covered item under paragraph (c)(1) of this section, and the denominator of the fraction is the aggregate of the assigned portion of the covered item under paragraph (c)(1) of this section of each connected covered shareholder described in the preceding sentence.

(4) Decreases for connected covered shareholders not owning acquired stock. For each connected covered shareholder that does not own acquired stock of the foreign corporation on the last relevant day of the taxable year, decrease the connected covered shareholder’s assignment by the product of the increase pursuant to paragraph (e)(2) of this section, reduced by the decreases pursuant to paragraph (e)(3) of this section, and a fraction. The numerator of the fraction is the connected covered shareholder’s assigned portion of the covered item under paragraph (c)(1) of this section, and the denominator of the fraction is the aggregate of the assigned portion of the covered item under paragraph (c)(1) of this section of each connected covered shareholder described in the preceding sentence.

(f) Currency rule. For purposes of this section, if a covered item of a foreign corporation is denominated in a currency other than the foreign corporation’s functional currency, then the covered item is translated into the foreign corporation’s functional currency at the spot rate on the day on which the covered item is received or recognized.

(g) Definitions and rules of general applicability. The definitions in §§1.959-1(b) and 1.961-(b), and the rules of general applicability in §§1.959-1(c) and (d) and 1.961-1(c) and (d), apply for purposes of this section, with the following additions.

Acquired stock. The term acquired stock means, in a general successor transaction, stock of an acquired foreign corporation the ownership of which is acquired by the successor covered shareholder.

Connected covered shareholder. The term connected covered shareholder means, in a general successor transaction, a covered shareholder that owns acquired stock of an acquired foreign corporation on the last relevant day of the acquired foreign corporation’s taxable year in which the general successor transaction occurs, or any covered shareholder bearing a relationship described in section 267(b) (determined without regard to section 267(c)(3)) or 707(b) to a covered shareholder first described in this sentence.

Covered item. The term covered item has the meaning provided in paragraph (b) of this section.

(h) Examples—(1) In general. This paragraph (h) provides examples illustrating the application of this section.

(2) Assumed facts. For purposes of the examples in this paragraph (h), unless otherwise indicated, the following facts are assumed:

(i) US1 and US2 are unrelated domestic corporations that are covered shareholders. Neither US1 nor US2 is a member of a consolidated group (as defined in §1.1502-1(h)).

(ii) F1, F2, and F3 are foreign corporations, each of which is a controlled foreign corporation and uses the British pound (£) as its functional currency.

(iii) Each entity uses the calendar year as its taxable year, and no entity has a short taxable year.

(3) Examples—(i) Example 1: General assignment rule and single class of stock—(A) Facts. US1 and US2 each directly own 50% of the single class of outstanding stock of F1. F1 directly owns all the outstanding stock of each of F2 and F3. For F1’s taxable year ending on December 31 of year 3, the last relevant day is December 31, and F1 has £500x of earnings and profits and two covered items. The covered items are a £60x covered distribution received from F2 and £40x of covered gain recognized with respect to stock of F3.

(B) Analysis. The portion of each covered item assigned to each of US1 and US2 is determined by multiplying the amount of the covered item by a fraction, the numerator of which is the portion of a £500x hypothetical distribution treated as made by F1 on the last relevant day that would be distributed with respect to stock of F1 that the covered shareholder owns (£250x in the case of each US1 and US2), and the denominator of which is the amount of the hypothetical distribution (£500x). See paragraphs (c)(1) and (d)(1) of this section; see also paragraph (d)(2) of this section (treating F1’s hypothetical distribution as equal to the greater of £500x, F1’s earnings and profits for the taxable year, and £100x, the sum of F1’s covered items for the taxable year). Thus, US1 and US2 are each assigned £30x of the covered distribution (£60x × £250x/£500x) and £20x of the covered gain (£40x × £250x/£500x).

(C) Alternative facts: common stock and preferred stock—(1) Facts. The facts are the same as in paragraph (h)(3)(i)(A) of this section (Example 1), except as follows. The stock of F1 owned by US1 is an 8% nonparticipating, voting preferred share of stock with a par value of £1,000x, and the stock of F1 owned by US2 is common stock. There are no accrued but unpaid dividends with respect to the preferred stock.

(2) Analysis. The portion of each covered item assigned to each of US1 and US2 is determined by multiplying the amount of the covered item by a fraction, the numerator of which is the portion of a £500x hypothetical distribution treated as made by F1 on the last relevant day that would be distributed with respect to stock of F1 that the covered shareholder owns (£80x in the case of US1, computed as 0.08 × £1,000x, and £420x in the case of US2, computed as £500x × £80x), and the denominator of which is the amount of the hypothetical distribution (£500x). See paragraphs (c)(1) and (d) of this section. Thus, US1 is assigned £9.6x of the covered distribution (£60x × £80x/£500x) and £6.4x of the covered gain (£40x × £80x/£500x), and US2 is assigned £50.4x of the covered distribution (£60x × £420x/£500x) and £33.6x of the covered gain (£40x × £420x/£500x).

(ii) Example 2: General successor transaction occurs before the last relevant day and after a covered distribution—(A) Facts. US1 directly owns all the shares of the single class of outstanding stock of F1, and F1 directly owns all the outstanding stock of F2. On June 30 of year 3, US1 sells all the stock of F1 to US2 for money equal to the fair market value of the stock in a general successor transaction. For F1’s taxable year ending on December 31 of year 3, the last relevant day is December 31, and F1 has £500x of earnings and profits and one covered item. The covered item is a £100x covered distribution received by F1 from F2 on March 31. Immediately before the covered distribution, F2 has £100x of previously taxed earnings and profits with respect to US1.

(B) Analysis—(1) In general. Without regard to paragraphs (c)(2) and (e) of this section (adjustments for general successor transactions), US2 would be assigned all £100x (and thus US1 would be assigned none) of the covered item because US2 owns all the stock of F1 on the last relevant day and therefore US2 would have a 100% share of a £500x hypothetical distribution treated as made by F1 on that day. See paragraphs (c)(1) and (d) of this section. However, because the sale is a general successor transaction occurring before the last relevant day but after F1 receives the covered item, the assignments to US1 (the transferor covered shareholder) and US2 (a connected covered shareholder by reason of owning acquired stock of F1 on the last relevant day) are adjusted. See paragraphs (c)(2) and (e)(1) of this section. The specific adjustments are described in paragraph (h)(3)(ii)(B)(2) of this section. As a result of these adjustments, the entirety of the covered item is a distribution to F1 of F2’s previously taxed earnings and profits with respect to US1 under §1.959-4. Moreover, the previously taxed earnings and profits could be distributed by F1 to US1 before the sale and, to the extent not so distributed, are previously taxed earnings and profits of F1 that transfer from US1 to US2 in the sale under §1.959-7.

(2) Adjustments. US1’s assigned portion of the covered item is increased by £100x, which is the additional portion of the covered item that would have been assigned to US1 under paragraph (c)(1) of this section if March 31 were the last relevant day (and, thus, F1’s £500x hypothetical distribution were treated as made when US1 owned all the stock of F1 and would therefore have a 100% share of the hypothetical distribution). See paragraph (e)(2)(i) of this section. In determining this increase, the first limitation in paragraph (e)(2)(iii) of this section does not apply because a £100x increase does not exceed the amount of F2’s previously taxed earnings and profits with respect to US1 that could be applied to exclude such additional portion of the covered item from F1’s gross income under section 959(b). In addition, the second limitation in paragraph (e)(2)(iii) of this section does not apply because a £100x increase does not exceed the amount of the covered item assigned to US2 under paragraph (c)(1) of this section. The £100x increase to US1’s assigned portion of the covered item decreases US2’s assigned portion of the covered item from £100x to £0. See paragraph (e)(3) of this section.

(C) Alternative facts: limitation on increase and multiple connected covered shareholders—(1) Facts. The facts are the same as in paragraph (h)(3)(ii)(A) of this section (Example 2), except as follows. Immediately before the £100x covered distribution on March 31, F2 has £90x (rather than £100x) of previously taxed earnings and profits with respect to US1. On September 30 of year 3, F1 issues shares of its single class of outstanding stock to US3, a corporate covered shareholder related to US2 within the meaning of section 267(b), with the result that US2 and US3 each own half of the stock of F1 on the last relevant day.

(2) Analysis—(i) In general. Without regard to paragraphs (c)(2) and (e) of this section (adjustments for general successor transactions), US2 and US3 would each be assigned £50x (and thus US1 would be assigned none) of the covered item because US2 and US3 each own half of the stock of F1 on the last relevant day and therefore would each have a 50% share of a £500x hypothetical distribution treated as made by F1 on that day. See paragraphs (c)(1) and (d) of this section. However, because the sale is a general successor transaction occurring before the last relevant day but after F1 receives the covered item, the assignments to US1 (the transferor covered shareholder), US2 (a connected covered shareholder by reason of owning acquired stock of F1 on the last relevant day), and US3 (a connected covered shareholder by reason of bearing a relationship described in section 267(b) to US2) are adjusted. See paragraphs (c)(2) and (e)(1) of this section. The specific adjustments are described in paragraph (h)(3)(ii)(C)(2)(ii) of this section. As a result of these adjustments, £90x of the covered item is a distribution to F1 of F2’s previously taxed earnings and profits with respect to US1 under §1.959-4. Moreover, the previously taxed earnings and profits could be distributed by F1 to US1 before the sale and, to the extent not so distributed, are previously taxed earnings and profits of F1 that transfer from US1 to US2 in the sale under §1.959-7.

(ii) Adjustments. US1’s assigned portion of the covered item is increased by £90x, which is the lesser of the additional portion of the covered item that would have been assigned to US1 if March 31 were the last relevant day (£100x) and the amount of F2’s previously taxed earnings and profits with respect to US1 that could be applied to exclude such additional portion of the covered item from F1’s gross income under section 959(b) (£90x). See paragraphs (e)(2)(i) and (iii) of this section. Because US2 owns acquired stock of F1 on the last relevant day, the £90x increase to US1’s assigned portion of the covered item first decreases US2’s assigned portion of the covered item, from £50x to £0. See paragraph (e)(3) of this section. Then, the remaining £40x increase to US1’s assigned portion of the covered item decreases US3’s assigned portion of the covered item, from £50x to £10x. See paragraph (e)(4) of this section.

(iii) Example 3: General successor transaction occurs after the last relevant day—(A) Facts. US1 directly owns all 100 shares of the single class of outstanding stock of F1. F1 directly owns all the outstanding stock of F2. On March 31 of year 3, F1 issues 100 shares of its single class of outstanding stock to a nonresident alien individual and, consequently, F1 ceases to be a controlled foreign corporation. On June 30 of year 3, US1 sells its 100 shares of stock of F1 to US2 for money equal to the stock’s fair market value in a general successor transaction. For F1’s taxable year ending on December 31 of year 3, the last relevant day is March 31 and F1 has £500x of earnings and profits and one covered item. The covered item is a £100x covered distribution received by F1 from F2 on September 30. Immediately before the covered distribution, F2 has £50x of previously taxed earnings and profits with respect to US2 (all of which transferred from US1 to US2 in the Sale).

(B) Analysis—(1) In general. Without regard to paragraphs (c)(2) and (e) of this section (adjustments for general successor transactions), US2 would be assigned none of the covered item because US2 owns none of the stock of F1 on the last relevant day and therefore US2 would have a 0% share of a £500x hypothetical distribution treated as made by F1 on that day. See paragraphs (c)(1) and (d) of this section. However, because the sale is a general successor transaction occurring on or after the last relevant day but before F1 receives the covered item, the assignments to US2 (the successor covered shareholder) and US1 (a connected covered shareholder by reason of owning acquired stock of F1 on the last relevant day) are adjusted. See paragraphs (c)(2) and (e)(1) of this section. The specific adjustments are described in paragraph (h)(3)(iii)(B)(2) of this section. As a result of these adjustments, £50x of the covered item is a distribution to F1 of F2’s previously taxed earnings and profits with respect to US2 under §1.959-4.

(2) Adjustments. US2’s assigned portion of the covered item is increased by £50x, which is the additional portion of the covered item that would have been assigned to US2 under paragraph (c)(1) of this section if September 30 were the last relevant day (and, thus, F1’s £500x hypothetical distribution were treated as made when US2 owned half of the stock of F1 and would therefore have a 50% share of the hypothetical distribution). See paragraph (e)(2)(ii) of this section. In determining this increase, the first limitation in paragraph (e)(2)(iii) of this section does not apply because a £50x increase does not exceed the amount of F2’s previously taxed earnings and profits with respect to US2 that could be applied to exclude such additional portion of the covered item from F1’s gross income under section 959(b). In addition, the second limitation in paragraph (e)(2)(iii) of this section does not apply because a £50x increase does not exceed the amount of the covered item assigned to US1 under paragraph (c)(1) of this section. The £50x increase to US2’s assigned portion of the covered item decreases US1’s assigned portion of the covered item by £50x. See paragraph (e)(3) of this section.

(i) Applicability date. This section applies to taxable years of foreign corporations that begin on or after [date of publication of final regulations in the Federal Register] or are early application years (as described in §1.959-12(d)) and to taxable years of persons for which such taxable years of those foreign corporations are relevant.

Par. 13. Section 1.951A-1 is amended by, for each paragraph listed in the following table, removing the language in the ‘‘Remove’’ column wherever it appears and adding in its place the language in the ‘‘Add’’ column:

Par. 14. Section 1.951A-2 is amended by:

The addition reads as follows:

* * * * *

(c) * * *

(1) * * *

(vi) Previously taxed earnings and profits excluded from the corporation’s gross income under section 959(b) and §1.959-4 or section 961(c) and §1.961-9.

* * * * *

Par. 15. Section 1.951A-7 is amended by adding paragraph (f) to read as follows:

* * * * *

(f) Pro rata share determinations and exclusions under sections 959(b) and 961(c). Sections 1.951A-1(d) and 1.951A-2(c)(1)(vi) apply to taxable years of foreign corporations that begin on or after [date of publication of final regulations in the Federal Register] or are early application years (as described in §1.959-12(d)) and to taxable years of persons for which such taxable years of those foreign corporations are relevant. See §1.951A-1(d) as contained in 26 CFR part 1 revised as of April 1, 2024, for a version of §1.951A-1(d) applicable to prior taxable years.

Par. 16. Section 1.952-1 is amended by adding paragraphs (c)(4), (c)(5), and (h) to read as follows:

* * * * *

(c) * * *

(4) Coordination of earnings and profits limitation with sections 959(b) and 961(c)—(i) In general. Distributions of previously taxed earnings and profits received by a controlled foreign corporation, and previously taxed earnings and profits resulting from the application of a controlled foreign corporation’s section 961(c) basis to gain recognized by the controlled foreign corporation, are not included in the controlled foreign corporation’s earnings and profits for the taxable year for purposes of the limitation in section 952(c)(1)(A). See paragraph (h) of this section (regarding excluding previously taxed earnings and profits from a controlled foreign corporation’s gross income for purposes of determining its subpart F income).

(ii) Applicability date. Paragraph (c)(4)(i) of this section applies to taxable years of foreign corporations that begin on or after [date of publication of final regulations in the Federal Register] or are early application years (as described in §1.959-12(d)) and to taxable years of persons for which such taxable years of those foreign corporations are relevant.

(5) Transition rule for deficits of a domestic partnership that was an inclusion shareholder with respect to a controlled foreign corporation—(i) In general. For purposes of applying section 952(c)(1)(B) to any taxable year of a controlled foreign corporation, a United States shareholder that owns (within the meaning of section 958(a)) stock of the controlled foreign corporation by reason of an interest in a domestic partnership on the last day of the first taxable year of the controlled foreign corporation during which §1.958-1(d) applies to the domestic partnership (or, if earlier, the last day of such taxable year on which the foreign corporation is a controlled foreign corporation) (transition date) takes into account its assigned portion of any prior year deficit (determined under paragraph (c)(5)(ii) of this section) for any taxable year of the controlled foreign corporation ending before the application of §1.958-1(d) in determining the United States shareholder’s pro rata share of a prior year deficit under section 952(c)(1)(B)(iv)(II), and the domestic partnership ceases to take into account such prior year deficit.

(ii) Assigned portion of prior year deficit. A United States shareholder’s assigned portion of a prior year deficit is determined on the transition date by multiplying a domestic partnership’s pro rata share of the prior year deficit (determined under section 952(c)(1)(B)(iv)(II) as of the close of the taxable year in which the deficit arose) by a fraction, the numerator of which is the liquidation value of the United States shareholder’s interest in the partnership and the denominator of which is the aggregate liquidation value of all partners’ interests in the partnership. For purposes of this fraction, the liquidation value of a partner’s interest in the partnership is the amount of cash the partner would receive with respect to the interest if, on the transition date, the partnership (and any partnership through which the partner indirectly owns an interest in the partnership) sold all of its property for an amount of cash equal to the fair market value of the property (taking into account section 7701(g)), satisfied all of its liabilities (other than those described in §1.752-7), paid an unrelated third party to assume all of its §1.752-7 liabilities in a fully taxable transaction, and then the partnership (and any partnership through which the partner indirectly owns an interest in the partnership) liquidated.

(iii) Applicability date. This paragraph (c)(5) applies to taxable years of foreign corporations beginning on or after [date of publication of final regulations in the Federal Register], and to taxable years of United States shareholders in which or with which such taxable years of foreign corporation end. A United States shareholder may apply this paragraph (c)(5) to a taxable year of a foreign corporation that precedes the taxable years described in the preceding sentence if each of the following conditions is satisfied—

(A) Consistent application condition. This paragraph (c)(5) is applied in its entirety to the taxable year and all succeeding taxable years of the foreign corporation, to all taxable years of United States shareholders to which such a taxable year of the foreign corporation is relevant, and to all taxable years of related foreign corporations that end on or after the later of the last day of the first taxable year of the foreign corporation to which this paragraph (c)(5) applies and the first day on which the foreign corporations are related. For purposes of the preceding sentence, foreign corporations are related if the foreign corporations bear a relationship to each other described in section 267(b).

(B) Open period of limitations condition. The period of limitations on assessment for each taxable year described in paragraph (c)(5)(iii)(A) of this section is open under section 6501.

(C) Written consent condition. Each United States shareholder described in paragraph (c)(5)(iii)(A) of this section provides to the foreign corporation a written statement in which the United States shareholder consents to apply the rules described in this paragraph (c)(5) to the taxable years of the United States shareholder described in paragraph (c)(5)(iii)(A) of this section and affirms that the period of limitations on assessment for each such taxable year is open under section 6501.

* * * * *

(h) Exclusions from gross income under sections 959(b) and 961(c). See §§1.959-4 and 1.961-9 for rules excluding previously taxed earnings and profits from a controlled foreign corporation’s gross income for purposes of determining its subpart F income.

Par. 17. Section 1.954-1 is amended by:

The additions read as follows:

* * * * *

(c) * * *

(1) * * *

(iii) * * *

(C) Covered items. A single item of income is the portion of a covered item (as defined in §1.951-2(b)) that—

(1) Falls within a single category of foreign base company income described in paragraph (c)(1)(iii)(A)(1) or (2) of this section;

(2) Falls within a separate category (as defined in §1.904-5(a)(4)(v)); and

(3) In the case of any amount which constitutes passive foreign personal holding company income, falls within a single group of passive income under the grouping rules of §1.904-4(c)(3), (4), or (5).

* * * * *

(h) * * *

(4) Paragraph (c)(1)(iii)(C) of this section. Paragraph (c)(1)(iii)(C) of this section applies to taxable years of a foreign corporation that begin on or after [date of publication of final regulations in the Federal Register] or are early application years (as described in §1.959-12(d)), and to taxable years of a United States shareholder of the foreign corporation in which or with which such taxable year of such foreign corporation ends.

Par. 18. Section 1.959-1 is revised to read as follows:

(a) Overview—(1) In general. The section 959 regulations provide rules regarding previously taxed earnings and profits. This section sets forth definitions and rules of general applicability. Section 1.959-2 sets forth rules for shareholder-level and foreign corporation-level accounting of a foreign corporation’s previously taxed earnings and profits. Section 1.959-3 provides the adjustments under section 959 to shareholder-level accounts with respect to a foreign corporation. Section 1.959-4 provides rules for excluding previously taxed earnings and profits received in a distribution from gross income of a covered shareholder or controlled foreign corporation. Section 1.959-5 provides rules for excluding the portion of a section 956 amount that is allocated to previously taxed earnings and profits from gross income of a covered shareholder. Section 1.959-6 provides rules for allocating and apportioning current year taxes paid or accrued by a foreign corporation to its previously taxed earnings and profits. Section 1.959-7 provides rules for transferring previously taxed earnings and profits in a general successor transaction. Sections 1.959-8 through 1.959-9 are reserved. Section 1.959-10 provides examples illustrating the application of the section 959 regulations. Section 1.959-11 sets forth transition rules. Section 1.959-12 sets forth applicability dates. See §1.1502-59 for additional rules for a consolidated group.

(2) Scope. This section sets forth definitions and rules of general applicability for purposes of the section 959 regulations. Paragraph (b) of this section provides definitions. Paragraph (c) of this section provides rules relating to S corporations. Paragraph (d) of this section provides an anti-avoidance rule.

(b) Definitions. The following definitions apply for purposes of the section 959 regulations.

2019 notice provisions. The term 2019 notice provisions has the meaning provided in §1.959-12(c)(2).

Acquired foreign corporation. The term acquired foreign corporation has the meaning provided in §1.959-7(b).

Adjusted applicable percentage. The term adjusted applicable percentage has the meaning provided in §1.959-2(b)(2)(iii)(A).

Annual PTEP account. The term annual PTEP account means an account that is described in §1.959-2(b)(1) and tracks previously taxed earnings and profits.

Character. The term character means, with respect to previously taxed earnings and profits, the taxable year, section 904 category, PTEP group and, if applicable, PTEP subgroup to which the previously taxed earnings and profits relate, as well as, if applicable, the adjusted applicable percentage and section 965(c) deduction percentage with respect to the previously taxed earnings and profits.

Controlled foreign corporation. The term controlled foreign corporation has the meaning provided in section 957(a) (or, if applicable, section 957(b) or 953(c)(1)(B)).

Corporate PTEP account. The term corporate PTEP account has the meaning provided in §1.959-2(d)(1).

Corporate PTEP tax pool. The term corporate PTEP tax pool has the meaning provided in §1.959-2(d)(2).

Covered distribution. The term covered distribution has the meaning provided in §1.959-4(c).

Covered gain. The term covered gain has the meaning provided in §1.961-9(c).

Covered shareholder. The term covered shareholder means a United States person (as described in section 7701(a)(30)), other than a domestic partnership.

Creditable PTEP tax group. The term creditable PTEP tax group has the meaning provided in §1.959-2(b)(4)(ii).

Current year taxes. The term current year taxes has the meaning provided in §1.960-1(b)(4) except that “foreign corporation” is substituted for “controlled foreign corporation” and “the foreign corporation’s taxable year” is substituted for “current taxable year”.

Deemed covered shareholder. The term deemed covered shareholder has the meaning provided in §1.959-7(g).

Dollar basis pool. The term dollar basis pool means an account that is described in §1.959-2(b)(1) and that tracks the basis in U.S. dollars of previously taxed earnings and profits.

Domestic partnership. The term domestic partnership has the meaning provided in section 7701(a)(2) and (4). See paragraph (c) of this section, providing that an S corporation is treated in the same manner as a domestic partnership.

Early application corporation. The term early application corporation has the meaning provided in §1.959-12(d)(1).

Early application years. The term early application years has the meaning provided in §1.959-12(d)(1).

Foreign income taxes. The term foreign income taxes has the meaning provided in §1.901-2(a).

General successor PTEP. The term general successor PTEP has the meaning provided in §1.959-7(c)(1).

General successor transaction. The term general successor transaction has the meaning provided in §1.959-7(b).

GILTI inclusion amount. The term GILTI inclusion amount has the meaning provided in §1.951A-1(c)(1) (or §1.1502-51(b) in the case of a member of a consolidated group, as defined in §1.1502-1(h)).

Last relevant day. The term last relevant day means the last day of a taxable year of a foreign corporation on which the foreign corporation is a controlled foreign corporation.

Multi-year dollar basis account. The term multi-year dollar basis account has the meaning provided in §1.959-11(b)(2)(ii)(B).

Multi-year PTEP account. The term multi-year PTEP account has the meaning provided in §1.959-11(b)(2)(ii)(A).

Own. The term own (or ownership or owned), when used with respect to stock of a foreign corporation, means to own the stock within the meaning of section 958(a) and §1.958-1(a) (thus determined by treating a domestic partnership in the same manner as a foreign partnership pursuant to §1.958-1(d)). When used with respect to interests in a partnership, own (or ownership or owned) means to own the interests within the meaning of the preceding sentence, determined by treating the interests as stock of a foreign corporation.

Previously taxed earnings and profits. The term previously taxed earnings and profits means earnings and profits of a foreign corporation that are described in section 959(c)(1) or (2). See §1.959-2(b) and (d) for covered shareholder-level and foreign corporation-level accounting of previously taxed earnings and profits.

Prior-law PTEP groups. The term prior-law PTEP groups has the meaning provided in §1.959-11(c)(2)(iii).

Prior-law PTEP group taxes. The term prior-law PTEP group taxes has the meaning provided in §1.959-11(c)(2)(iii).

PTEP group. The term PTEP group means any of the groups listed in §1.959-2(b)(2)(i).

PTEP realization event. The term PTEP realization event has the meaning provided in §1.959-6(b).

PTEP subgroup. The term PTEP subgroup means any of the groups listed in §1.959-2(b)(2)(ii).

PTEP tax pool. The term PTEP tax pool means an account that is described in §1.959-2(b)(1) and that tracks the U.S. dollar amount of foreign income taxes associated with previously taxed earnings and profits.

Relevant taxable year. The term relevant taxable year has the meaning provided in §1.959-3(b).

S corporation. The term S corporation has the meaning provided in section 1361(a)(1). See paragraph (c) of this section, providing that an S corporation is treated in the same manner as a domestic partnership.

Same priority PTEP. The term same priority PTEP has the meaning provided in §1.959-4(e)(5).

Section 904 category. The term section 904 category has the meaning provided in §1.960-1(b).

Section 956 amount. The term section 956 amount has the meaning provided in §1.959-5(c).

Section 959 regulations. The term section 959 regulations means the regulations in this part issued under section 959.

Section 965(c) deduction percentage. The term section 965(c) deduction percentage has the meaning provided in §1.959-2(b)(2)(iii)(B).

Spot rate. The term spot rate has the meaning provided in §1.988-1(d).

Substituted basis property. The term substituted basis property has the meaning provided in section 7701(a)(42).

Successor covered shareholder. The term successor covered shareholder has the meaning provided in §1.959-7(b).

Subpart F income. The term subpart F income has the meaning provided in section 952 and §1.952-1.

Taxable year. The term taxable year has the meaning provided in section 7701(a)(23), determined by treating a person (as described in section 7701(a)(1)) other than an individual that does not otherwise have a taxable year as computing taxable income on the basis of the calendar year.

Tested income. The term tested income has the meaning provided in section 951A(c)(2) and §1.951A-2(b)(1).

Tested loss. The term tested loss has the meaning provided in section 951A(c)(2) and §1.951A-2(b)(2).

Transferor covered shareholder. The term transferor covered shareholder has the meaning provided in §1.959-7(b).

United States shareholder. The term United States shareholder has the meaning provided in section 951(b) (or, if applicable, section 953(c)(1)(A)).

(c) Treatment of an S corporation—(1) In general. Except as provided in paragraph (c)(2) of this section, for purposes of the section 959 regulations, an S corporation is treated in the same manner as a domestic partnership, a reference to a domestic partnership includes an S corporation, and shareholders of an S corporation are treated as partners of such partnership. See section 1373(a). As applicable, the treatment of an S corporation and its shareholders under the preceding sentence is determined by replacing any partnership-specific provision with the equivalent provision for S corporations (for example, a reference to a partner’s distributive share of a partnership’s income refers to a shareholder’s pro rata share of an S corporation’s income).

(2) Treatment as a covered shareholder for taxable years for which elective entity treatment applies for §1.958-1(d)(1) purposes. See §1.959-11(d) for a rule treating an S corporation as a covered shareholder for any taxable year of the S corporation for which §1.958-1(d)(1) does not apply and §1.959-11(e) for a transition rule converting S corporation-level accounts (for example, annual PTEP accounts) to accounts of covered shareholders owning interests in the S corporation once the S corporation is no longer treated as a covered shareholder.

(d) Anti-avoidance rule. If a transaction, series of transactions, plan, or arrangement is engaged in with a principal purpose of avoiding the purposes of section 959 and the section 959 regulations, then appropriate adjustments are made, which may include adjustments to disregard the transaction, series of transactions, plan, or arrangement.

Par. 19. Section 1.959-2 is revised to read as follows:

(a) Scope. This section sets forth rules for shareholder-level and foreign corporation-level accounting of a foreign corporation’s previously taxed earnings and profits. Paragraph (b) of this section provides the shareholder-level accounting rules. Paragraph (c) of this section provides rules relating to combined pool elections for certain covered shareholder-level accounts. Paragraph (d) of this section provides the foreign corporation-level accounting rules.

(b) Shareholder-level accounting—(1) In general. A covered shareholder that owns stock of a foreign corporation must establish and maintain annual PTEP accounts, dollar basis pools, and PTEP tax pools with respect to the foreign corporation in accordance with this paragraph (b) and the adjustments prescribed in §1.959-3. The annual PTEP accounts track the foreign corporation’s previously taxed earnings and profits with respect to the covered shareholder, the dollar basis pools track the basis in U.S. dollars of the previously taxed earnings and profits, and the PTEP tax pools track the U.S. dollar amount of any foreign income taxes associated with the previously taxed earnings and profits. See also §1.1502-59(c)(2), treating members of a consolidated group as a single covered shareholder for purposes of section 959.

(2) Annual PTEP accounts—(i) In general. Each annual PTEP account must relate to a single taxable year of the foreign corporation and a single section 904 category. In addition, previously taxed earnings and profits within each annual PTEP account must be maintained in the foreign corporation’s functional currency and assigned to the PTEP groups identified in the following table.

(ii) Subgroups—(A) In general. To the extent required under §1.959-3(c), previously taxed earnings and profits assigned to a PTEP group within an annual PTEP account must be further assigned to the taxable section 962 PTEP subgroup or taxable section 1411 subgroup. These subgroups track previously taxed earnings and profits that will be includible in gross income under section 962(d) or includible in net investment income under section 1411(c) when distributed to the covered shareholder, as applicable.

(B) Coordination rule. A subgroup described in paragraph (b)(2)(ii)(A) of this section is not treated as a separate PTEP group for purposes of establishing and maintaining dollar basis pools and PTEP tax pools.

(iii) Percentages with respect to section 965 previously taxed earnings and profits—(A) Adjusted applicable percentage. An adjusted applicable percentage must be established and maintained with respect to all previously taxed earnings and profits assigned to the reclassified section 965(a) PTEP group, reclassified section 965(b) PTEP group, section 965(a) PTEP group, and section 965(b) PTEP group and relating to a single section 904 category (therefore without regard to the taxable years to which the previously taxed earnings and profits relate). The adjusted applicable percentage tracks the percentage of a credit or deduction for foreign income taxes associated with previously taxed earnings and profits that is disallowed under §1.965-5. See §1.959-11(c)(3) for the initial determination of the adjusted applicable percentage and §1.959-3(c)(3) for adjustments.

(B) Section 965(c) deduction percentage. A section 965(c) deduction percentage must be established and maintained with respect to all previously taxed earnings and profits assigned to the reclassified section 965(a) PTEP group and section 965(a) PTEP group and relating to a single section 904 category (therefore without regard to the taxable years to which the previously taxed earnings and profits relate). The section 965(c) deduction percentage tracks the percentage of foreign currency gain or loss with respect to previously taxed earnings and profits that is not recognized under §1.986(c)-1. See §1.959-11(c)(4) for the initial determination of the section 965(c) deduction percentage and §1.959-3(c)(3) for adjustments.

(iv) Deemed taxable years. If previously taxed earnings and profits are distributed to an upper-tier foreign corporation or result from the application of section 961(c) basis to gain recognized by an upper-tier corporation, and the previously taxed earnings and profits relate to a taxable year of a lower-tier foreign corporation that includes one or more days on which the upper-tier foreign corporation did not exist, then, solely for purposes of the establishment and maintenance of annual PTEP accounts, the upper-tier corporation is treated as having the taxable year or taxable years it would have had if it were to have existed on those days, determined based on the manner in which it computes its taxable income for its initial taxable year.

(3) Dollar basis pools. Each dollar basis pool must relate to previously taxed earnings and profits assigned to a single PTEP group within a single annual PTEP account or, if a combined pool election applies to the covered shareholder, previously taxed earnings and profits assigned to a single PTEP group and relating to a single section 904 category (therefore without regard to the taxable years to which the previously taxed earnings and profits relate). Basis within each dollar basis pool must be maintained in U.S. dollars.

(4) PTEP tax pools—(i) In general. Each PTEP tax pool must relate to previously taxed earnings and profits assigned to a single PTEP group within a single annual PTEP account or, if a combined pool election applies to the covered shareholder, previously taxed earnings and profits assigned to a single PTEP group and relating to a single section 904 category (therefore without regard to the taxable years to which the previously taxed earnings and profits relate). Foreign income taxes within each PTEP tax pool must be maintained in U.S. dollars.

(ii) Creditable PTEP tax group. To the extent required under §1.959-3(e), foreign income taxes within each PTEP tax pool must be assigned to the creditable PTEP tax group. This group tracks foreign income taxes that are eligible to be deemed paid under section 960(b).

(c) Combined pool elections—(1) In general. For purposes of paragraph (c) of this section, a combined pool election is made for a taxable year of a covered shareholder and, once made, remains in effect until revoked. The combined pool election applies with respect to each foreign corporation in which the covered shareholder owns stock, beginning as of the first day of the first taxable year of the foreign corporation that ends with or within the taxable year of the covered shareholder for which the combined pool election is made or, if later, the first day in which the covered shareholder owns stock of the foreign corporation.

(2) Revocation. A combined pool election may only be revoked with the consent of the Commissioner (and in the time and manner specified by the Commissioner), and such consent will be granted only in rare and unusual circumstances.

(3) Time and manner of making election—(i) In general. Except as otherwise provided by a form, instruction, publication, or other guidance, a covered shareholder makes a combined pool election by, for a transaction related to a timely filed (including extensions) original Federal income tax return of the covered shareholder, computing the dollar basis of, or foreign income taxes associated with, previously taxed earnings and profits consistent with a combined pool election.

(ii) Sixty-month limitation on a subsequent election. A covered shareholder is not permitted to make a combined pool election for any taxable year beginning less than 60 months after the last day that a previous combined pool election applied to the covered shareholder (or a predecessor).

(4) Converting to combined pools. As of the beginning of the first day that a covered shareholder’s combined pool election applies with respect to a foreign corporation, each of the covered shareholder’s dollar basis pools or PTEP tax pools with respect to the foreign corporation (a combined pool) is equal to the sum of all of the dollar basis pools or PTEP tax pools, as applicable, that, immediately before the combined pool election applies, related to the same PTEP group and section 904 category to which the combined pool relates.

(d) Foreign corporation-level accounting—(1) Corporate PTEP accounts. Corporate PTEP accounts must be established and maintained with respect to a foreign corporation. Each corporate PTEP account must relate to a single covered shareholder, and previously taxed earnings and profits within a corporate PTEP account must be assigned to section 904 categories and the PTEP groups identified in the table to paragraph (b)(2)(i) of this section. A corporate PTEP account for a covered shareholder is equal to the aggregate of all previously taxed earnings and profits that are within such covered shareholder’s annual PTEP accounts with respect to the foreign corporation. Thus, as a covered shareholder’s annual PTEP accounts with respect to the foreign corporation are adjusted under §1.959-3, the foreign corporation’s corporate PTEP account for the covered shareholder and the foreign corporation’s earnings and profits described in section 959(c)(1) or (c)(2) are also adjusted.

(2) Corporate PTEP tax pools. Corporate PTEP tax pools must be established and maintained by a foreign corporation. Each corporate PTEP tax pool must relate to a single covered shareholder, and foreign income taxes within a corporate PTEP tax pool must be assigned to section 904 categories and the PTEP groups identified in the table to paragraph (b)(2)(i) of this section. A corporate PTEP tax pool relating to a covered shareholder is equal to the aggregate of all foreign income taxes that are within that covered shareholder’s PTEP tax pools with respect to the foreign corporation. Thus, as a covered shareholder’s PTEP tax pools with respect to the foreign corporation are adjusted under §1.959-3, the foreign corporation’s corporate PTEP tax pool relating to the covered shareholder is also adjusted. Foreign income taxes within a corporate PTEP tax pool that are eligible to be deemed paid under section 960(b) are assigned to the creditable PTEP tax group within the covered shareholder’s PTEP tax pools.

(3) Earnings and profits determined independently of previously taxed earnings and profits. A foreign corporation’s earnings and profits are determined independently of the foreign corporation’s previously taxed earnings and profits. Thus, for example, the extent to which a distribution is made out of a foreign corporation’s earnings and profits is determined independently of the foreign corporation’s corporate PTEP accounts. See section 316. Similarly, a foreign corporation’s earnings and profits may be less than the foreign corporation’s previously taxed earning and profits (with the result that the foreign corporation has a deficit in earnings and profits described in section 959(c)(3)).

Par. 20. Section 1.959-3 is revised to read as follows:

(a) Scope. This section provides the adjustments under section 959 to shareholder-level accounts with respect to a foreign corporation. Paragraph (b) of this section provides the general rule, pursuant to which shareholder-level accounts (annual PTEP accounts, dollar basis pools, and PTEP tax pools) are adjusted with respect to a foreign corporation to reflect income inclusions relating to, and transactions occurring within, the foreign corporation’s taxable year. Paragraph (c) of this section describes adjustments to annual PTEP accounts. Paragraph (d) of this section describes adjustments to dollar basis pools. Paragraph (e) of this section describes adjustments to PTEP tax pools. Paragraph (f) of this section provides timing rules for when adjustments are treated as made. Paragraph (g) of this section provides an ordering rule for the application of this section to tiered foreign corporations. See also §1.959-2(d)(1) and (2), providing that as shareholder-level accounts are adjusted with respect to a foreign corporation under this section, the foreign corporation-level accounts are consequently also adjusted.

(b) In general. To reflect income inclusions and transactions related to a taxable year of a foreign corporation (such taxable year for which this section is being applied, the relevant taxable year), a covered shareholder’s annual PTEP accounts, dollar basis pools, and PTEP tax pools with respect to the foreign corporation must be adjusted in accordance with the rules in this section.

(c) Adjustments to annual PTEP accounts—(1) In general—(i) Increases for amounts included in gross income under section 951(a)(1)(A). If the foreign corporation is a controlled foreign corporation and the covered shareholder includes in gross income its pro rata share of the corporation’s subpart F income for the relevant taxable year under section 951(a)(1)(A) (including by reason of section 245A(e)(2) or 964(e)(4), but not including an amount described in section 959(e)), then, for each annual PTEP account that relates to the relevant taxable year and a section 904 category to which a portion of the inclusion is assigned (determined at the level of the covered shareholder, thus after the application of §1.904-4(c)), add an amount of previously taxed earnings and profits equal to such portion to the annual PTEP account. Assign such previously taxed earnings and profits to the section 951(a)(1)(A) PTEP group, except assign previously taxed earnings and profits to the section 245A(d) PTEP group to the extent section 245A(d) applies to the inclusion giving rise to the previously taxed earnings and profits (see sections 245A(e)(3) and 964(e)(4)). If applicable, further assign previously taxed earnings and profits to a PTEP subgroup in accordance with paragraph (c)(2) of this section.

(ii) Increases for amounts included in gross income under section 951A(a). If the foreign corporation is a controlled foreign corporation and the covered shareholder includes in gross income the portion of its GILTI inclusion amount that is treated as with respect to the corporation for the relevant taxable year under section 951A(a) and (f)(2), then, for each annual PTEP account that relates to the relevant taxable year and a section 904 category to which a portion of the inclusion is assigned (determined at the level of the covered shareholder, thus after the application of §1.904-4(c)), add an amount of previously taxed earnings and profits equal to such portion to the annual PTEP account. Assign such previously taxed earnings and profits to the section 951A PTEP group. If applicable, further assign previously taxed earnings and profits to a PTEP subgroup in accordance with paragraph (c)(2) of this section.

(iii) Increases for receipt of distributed previously taxed earnings and profits. If, during the relevant taxable year, previously taxed earnings and profits with respect to the covered shareholder are distributed to the foreign corporation in a covered distribution (determined under §1.959-4), then add such distributed previously taxed earnings and profits to the annual PTEP accounts in accordance with paragraph (c)(3) of this section.

(iv) Increases for previously taxed earnings and profits resulting from section 961(c) basis. If, during the relevant taxable year, previously taxed earnings and profits with respect to the covered shareholder result from the application of positive section 961(c) basis to covered gain recognized by the foreign corporation (determined under §1.961-9), then add such resulting previously taxed earnings and profits to the annual PTEP accounts in accordance with paragraph (c)(3) of this section.

(v) Decreases for current year taxes. If previously taxed earnings and profits are added to a PTEP group within an annual PTEP account pursuant to paragraph (c)(1)(iii) or (iv) of this section, then reduce the previously taxed earnings and profits in that PTEP group by the amount of the current year taxes allocated and apportioned under §1.959-6 to the corresponding PTEP group of the foreign corporation. The corresponding PTEP group of the foreign corporation is the PTEP group of the foreign corporation that is of the same type as the increased PTEP group and that is within a corporate PTEP account of the foreign corporation that is with respect to the covered shareholder. If the PTEP group of that type in multiple annual PTEP accounts increases pursuant to paragraph (c)(1)(iii) or (iv) of this section, apportion the amount of the current year taxes allocated and apportioned under §1.959-6 to the corresponding PTEP group of the foreign corporation among those increased PTEP groups under the principles of §1.861-20.

(vi) Decreases for distributed previously taxed earnings and profits. If, during the relevant taxable year, the foreign corporation distributes previously taxed earnings and profits with respect to the covered shareholder in a covered distribution (determined under §1.959-4), then remove such distributed previously taxed earnings and profits from the annual PTEP accounts.

(vii) Increases for amounts included in gross income as a dividend under section 1248(a) or (f). If, during the relevant taxable year, gain recognized by the covered shareholder is included in gross income as a dividend under section 1248(a) or (f) by reason of earnings and profits of the foreign corporation, then, for each annual PTEP account that relates to the relevant taxable year and a section 904 category to which a portion of the inclusion is assigned (determined at the level of the covered shareholder, thus after the application of §1.904-4(c)), add an amount of previously taxed earnings and profits equal to such portion to the annual PTEP account (see section 959(e)). Assign such previously taxed earnings and profits to the section 951(a)(1)(A) PTEP group, except assign previously taxed earnings and profits to the section 245A(d) PTEP group to the extent section 245A(d) applies to the inclusion giving rise to the previously taxed earnings and profits (including by reason of section 245A(e)(3)). If applicable, further assign previously taxed earnings and profits to a PTEP subgroup in accordance with paragraph (c)(2) of this section.

(viii) Decreases with respect to transferor covered shareholder for transferred previously taxed earnings and profits. If, during the relevant taxable year, previously taxed earnings and profits of the foreign corporation transfer from the covered shareholder in a general successor transaction (determined under §1.959-7), then remove such transferred previously taxed earnings and profits from the annual PTEP accounts.

(ix) Increases with respect to successor covered shareholder for transferred previously taxed earnings and profits. If, during the relevant taxable year, previously taxed earnings and profits of the foreign corporation transfer to the covered shareholder in a general successor transaction (determined under §1.959-7), then add such transferred previously taxed earnings and profits to the annual PTEP accounts in accordance with paragraph (c)(3) of this section.

(x) Reassignments for previously taxed earnings and profits to which a section 956 amount is allocated. If the foreign corporation is a controlled foreign corporation and a portion of the covered shareholder’s section 956 amount with respect to the corporation for the relevant taxable year is allocated to previously taxed earnings and profits (determined under §1.959-5), then reassign such previously taxed earnings and profits from a section 959(c)(2) PTEP group to the section 959(c)(1) PTEP group in the same row in the table in §1.959-2(b)(2)(i). If applicable, further assign previously taxed earnings and profits to the PTEP subgroup to which they relate. See paragraph (c)(4) of this section in the case of certain acquisitions of stock to which a section 956 amount of another shareholder is attributable.

(xi) Increases for amounts included in gross income under section 951(a)(1)(B). If the foreign corporation is a controlled foreign corporation and the covered shareholder includes in gross income a portion of its section 956 amount with respect to the corporation for the relevant taxable year under section 951(a)(1)(B), then, for each annual PTEP account that relates to the relevant taxable year and a section 904 category to which a portion of the inclusion is assigned (determined at the level of the covered shareholder, thus after the application of §1.904-4(c)), add an amount of previously taxed earnings and profits equal to such portion to the annual PTEP account. Assign such previously taxed earnings and profits to the general section 959(c)(1) PTEP group. If applicable, further assign previously taxed earnings and profits to a PTEP subgroup in accordance with paragraph (c)(2) of this section. See paragraph (c)(4) of this section in the case of certain acquisitions of stock to which a section 956 amount of another shareholder is attributable.

(2) Assignment to PTEP subgroups—(i) Taxable section 962 PTEP subgroup. If the covered shareholder is an individual and an election under §1.962-2 applies to the covered shareholder’s income inclusions under section 951(a) or 951A(a) for the relevant taxable year, then further assign a portion of previously taxed earnings and profits added pursuant to paragraph (c)(1)(i), (ii), or (xi) of this section (section 951(a) or 951A(a) inclusions) to the taxable section 962 PTEP subgroup. The portion of previously taxed earnings and profits assigned to the taxable section 962 PTEP subgroup is equal to the excess of the previously taxed earnings and profits over the income tax paid under this chapter on the income inclusions giving rise to the previously taxed earnings and profits (determined by translating such tax into the foreign corporation’s functional currency at the exchange rate at which the income inclusion is translated into U.S. dollars under section 989(b)).

(ii) Taxable section 1411 PTEP subgroup. If the covered shareholder is an individual, estate, or trust, then further assign previously taxed earnings and profits added pursuant to paragraph (c)(1)(i), (ii), (vii), and (xi) of this section (section 951(a), 951A(a), or 1248(a) or (f) inclusions) to the taxable section 1411 PTEP subgroup to the extent the income inclusion giving rise to the previously taxed earnings and profits is not taken into account in determining net investment income under §1.1411-4(a)(1)(i).

(3) Preserving the character of previously taxed earnings and profits—(i) In general. Add previously taxed earnings and profits that are described in paragraph (c)(1)(iii), (iv), or (ix) of this section (previously taxed earnings and profits received in a distribution, resulting from section 961(c) basis, or transferred to the covered shareholder) and that relate to a single section 904 category and single taxable year to the annual PTEP account that relates to such section 904 category and such taxable year or a taxable year (including a deemed taxable year) that ends with, or closest to, the last day of such taxable year, as applicable. Assign the previously taxed earnings and profits to the PTEP group, and if applicable PTEP subgroup, to which they relate. See §1.959-4, 1.959-7, or 1.961-9 for rules determining the character of previously taxed earnings and profits received, transferred, or resulting from section 961(c) basis, respectively.

(ii) Recalculate percentages with respect to section 965 previously taxed earnings and profits—(A) In general. If applicable in adding previously taxed earnings and profits described in paragraph (c)(1)(iii), (iv), or (ix) of this section (previously taxed earnings and profits received in a distribution, resulting from section 961(c) basis, or transferred to the covered shareholder) to annual PTEP accounts relating to the same section 904 category, recalculate an adjusted applicable percentage or section 965(c) deduction percentage with respect to relevant previously taxed earnings and profits within such annual PTEP accounts so that the percentage is a weighted average of—

(1) The adjusted applicable percentage or section 965(c) deduction percentage with respect to relevant previously taxed earnings and profits within the annual PTEP accounts immediately before the addition; and

(2) The adjusted applicable percentage or section 965(c) deduction percentage with respect to relevant previously taxed earnings and profits added to the annual PTEP accounts.

(B) Determining the weighted average. The weighted average is determined as the sum of the product of each percentage described in paragraph (c)(3)(ii)(A)(1) or (2) of this section and the amount of previously taxed earnings and profits described in that paragraph, divided by the sum of the amounts of previously taxed earnings and profits described in those paragraphs.

(4) Certain acquisitions of stock to which a section 956 amount is attributable. If the covered shareholder acquires ownership of stock of the foreign corporation during the relevant taxable year but on or after the last relevant day of the relevant taxable year (for example, in a general successor transaction), and a portion of a section 956 amount of a United States shareholder is attributable to such stock, then treat such portion of the section 956 amount and any inclusion thereof in gross income of the United States shareholder as being of the covered shareholder for purposes of paragraphs (c)(1)(x) and (xi) of this section.

(5) Currency rule. All adjustments to annual PTEP accounts are made in the functional currency of the foreign corporation, determined, as applicable, by translating an inclusion described in paragraph (c)(1)(ii) of this section into functional currency at the average exchange rate for the relevant taxable year (see §1.951A-5(b)(3)) and by translating previously taxed earnings and profits described in paragraph (c)(1)(iii) of this section into functional currency at the spot rate on the day of the distribution (see section 989(b)). See also §1.961-9 (determining previously taxed earnings and profits described in paragraph (c)(1)(iv) of this section in functional currency), and §1.959-6 (determining current year taxes described in paragraph (c)(1)(v) of this section in functional currency).

(d) Adjustments to dollar basis pools—(1) In general—(i) Increases for U.S. dollar amount of income inclusions under sections 951(a), 951A(a), and 1248(a) or (f). For each addition pursuant to paragraph (c)(1)(i), (ii), (vii), or (xi) of this section of previously taxed earnings and profits relating to a single dollar basis pool, add an amount of basis equal to the income inclusion under section 951(a), 951A(a), or 1248(a) or (f) giving rise to such previously taxed earnings and profits to the dollar basis pool.

(ii) Increases for dollar basis of received or resulting previously taxed earnings and profits. For each addition pursuant to paragraph (c)(1)(iii) or (iv) of this section of previously taxed earnings and profits relating to a single dollar basis pool, add the dollar basis of such previously taxed earnings and profits (determined under §1.959-4 or 1.961-9, as applicable) to the dollar basis pool.

(iii) Decreases for current year taxes. For each reduction pursuant to paragraph (c)(1)(v) of this section to previously taxed earning and profits relating to a single dollar basis pool, reduce the basis in the dollar basis pool by the amount of the current year taxes giving rise to the reduction.

(iv) Decreases for dollar basis of distributed or transferred previously taxed earnings and profits. For each removal pursuant to paragraph (c)(1)(vi) or (viii) of this section of previously taxed earnings and profits relating to a single dollar basis pool, remove the dollar basis of such previously taxed earnings and profits (determined under §1.959-4 or 1.959-7, as applicable) from the dollar basis pool.

(v) Increases for dollar basis of transferred previously taxed earnings and profits, adjusted for foreign currency gain or loss. For each addition pursuant to paragraph (c)(1)(ix) of this section of previously taxed earnings and profits relating to a single dollar basis pool, add the dollar basis of such previously taxed earnings and profits (determined under §1.959-7 and adjusted in accordance with the next sentence) to the dollar basis pool. In applying the preceding sentence, increase (or decrease) the dollar basis of transferred previously taxed earnings and profits by foreign currency gain (or foreign currency loss) that the transferor covered shareholder recognizes with respect to the previously taxed earnings and profits. In addition, determine such foreign currency gain or loss without regard to §1.986-1(c)(3)(i) and (ii) (limitations for previously taxed earnings and profits resulting from section 965) and by treating the deemed covered shareholder in the same manner as a covered shareholder.

(vi) Adjustments for dollar basis of previously taxed earnings and profits to which a section 956 amount is allocated. For each reassignment pursuant to paragraph (c)(1)(x) of this section of previously taxed earnings and profits relating to a single dollar basis pool, remove the dollar basis of such previously taxed earnings and profits (determined under §1.959-5) from the dollar basis pool relating to the section 959(c)(2) PTEP group from which the previously taxed earnings and profits are reassigned and add such basis to the dollar basis pool relating to the section 959(c)(1) PTEP group to which the previously taxed earnings and profits are reassigned.

(2) Currency rule. All adjustments to dollar basis pools are made in U.S. dollars, determined, as applicable, by translating inclusions described in paragraph (d)(1)(i) of this section into U.S. dollars in accordance with section 989(b) and current year taxes described in paragraph (d)(1)(iii) of this section into U.S. dollars in accordance with section 986(a) and §1.986(a)-1.

(e) Adjustments to PTEP tax pools—(1) In general—(i) Increases for foreign income taxes associated with previously taxed earnings and profits received. For each addition pursuant to paragraph (c)(1)(iii) of this section of previously taxed earnings and profits relating to a single PTEP tax pool, add the foreign income taxes that are associated with such previously taxed earnings and profits (determined under §1.959-4(g)) to the PTEP tax pool. Assign such associated foreign income taxes to the creditable PTEP tax group only to the extent the foreign corporation is deemed to pay the taxes under section 960(b)(2) and §1.960-3(c). See paragraph (e)(1)(ii) of this section for increases to PTEP tax pools for current year taxes paid or accrued by the foreign corporation on the receipt of the previously taxed earnings and profits.

(ii) Increases for current year taxes. For each reduction pursuant to paragraph (c)(1)(v) of this section to previously taxed earnings and profits relating to a single PTEP tax pool, add to the PTEP tax pool the current year taxes giving rise to the reduction. Assign such current year taxes to the creditable PTEP tax group only if the foreign corporation is a controlled foreign corporation when the taxes are paid or accrued and a credit for the taxes is not disallowed or suspended at the level of the controlled foreign corporation (see, for example, section 245A(e)(3) and §1.245A(d)-1(a)(2) and sections 901(k)(1), (l), and (m), 909, and 6038(c)(1)(B)).

(iii) Decreases for foreign income taxes associated with distributed or transferred previously taxed earnings and profits. For each removal pursuant to paragraph (c)(1)(vi) or (viii) of this section of previously taxed earnings and profits relating to a single PTEP tax pool, remove the foreign income taxes that are associated with such previously taxed earnings and profits (determined under §1.959-4 or 1.959-7, as applicable) from the PTEP tax pool.

(iv) Increases for foreign income taxes associated with transferred previously taxed earnings and profits. For each addition pursuant to paragraph (c)(1)(ix) of this section of previously taxed earnings and profits relating to a single PTEP tax pool, add the foreign income taxes that are associated with such previously taxed earnings and profits (determined under §1.959-7) to the PTEP tax pool. Assign such associated foreign income taxes to the creditable PTEP tax group only to the extent the taxes related to the creditable PTEP tax group immediately before the general successor transaction.

(v) Adjustments for foreign income taxes associated with previously taxed earnings and profits to which a section 956 amount is allocated. For each reassignment pursuant to paragraph (c)(1)(x) of this section of previously taxed earnings and profits relating to a single PTEP tax pool, remove the foreign income taxes that are associated with such previously taxed earnings and profits (determined under §1.959-5) from the PTEP tax pool relating to the section 959(c)(2) PTEP group from which the previously taxed earnings and profits are reassigned and add such foreign income taxes to the PTEP tax pool relating to the section 959(c)(1) PTEP group to which the previously taxed earnings and profits are reassigned. Assign such associated foreign income taxes to the creditable PTEP tax group only to the extent the taxes relate to the creditable PTEP tax group immediately before the reassignment.

(2) Currency rule. All adjustments to PTEP tax pools are made in U.S. dollars, determined, as applicable, by translating current year taxes described in paragraph (e)(1)(ii) of this section into U.S. dollars in accordance with section 986(a) and §1.986(a)-1.

(f) Timing of adjustments—(1) Annual PTEP accounts. An adjustment to an annual PTEP account is treated as made in accordance with the timing rules in the following table. In the case of adjustments described in paragraphs (c)(1)(iii) through (xi) of this section that are treated as made at the same time, such adjustments are treated as made at that time in sequence (starting with the adjustment in the earliest paragraph).

(2) Dollar basis pools. An adjustment to a dollar basis pool is treated as made concurrently with the related adjustment described in paragraph (c) of this section.

(3) PTEP tax pools. An adjustment to a PTEP tax pool is treated as made concurrently with the related adjustment described in paragraph (c) of this section.

(g) Bottom-up application to tiered foreign corporations. For purposes of applying this section to tiered foreign corporations, this section is applied first to the foreign corporation at the lowest tier, then to the foreign corporation at the next lowest tier, and so on.

Par. 21. Section 1.959-4 is revised to read as follows:

(a) Scope. This section provides the rules for distributions of previously taxed earnings and profits under section 959. Paragraph (b) of this section excludes previously taxed earnings and profits received by a covered shareholder or controlled foreign corporation in a distribution from gross income. Paragraph (c) of this section defines a covered distribution. Paragraph (d) of this section describes rules for analyzing a covered distribution, including rules for determining the extent to which a covered distribution is a distribution of previously taxed earnings and profits. Paragraph (e) of this section provides rules for allocating covered distributions to earnings and profits. Paragraph (f) of this section provides a dollar basis rule. Paragraph (g) of this section provides an associated foreign income taxes rule. See §1.959-10(c)(1) and (2) (Examples 1 and 2) for examples illustrating the application of this section. See also §§1.367(b)-2(j)(2)(ii) and 1.367(b)-3(g)(1) for deemed distributions of previously taxed earnings and profits under other provisions of the Code.

(b) Exclusion from gross income—(1) Distribution by a foreign corporation to a covered shareholder. Previously taxed earnings and profits that are distributed to a covered shareholder, other than previously taxed earnings and profits relating to the taxable section 962 PTEP subgroup, are excluded from the covered shareholder’s gross income.

(2) Distribution by a controlled foreign corporation to another controlled foreign corporation—(i) In general. Previously taxed earnings and profits that are distributed by a controlled foreign corporation to another controlled foreign corporation are excluded from the recipient controlled foreign corporation’s gross income, solely for purposes of determining the recipient controlled foreign corporation’s subpart F income and tested income or tested loss, and provided that the covered shareholder to which the previously taxed earnings and profits relate is a United States shareholder in both controlled foreign corporations.

(ii) Treatment of a specified foreign corporation as a controlled foreign corporation. A specified foreign corporation (as defined in §1.965-1(f)(45)(i)(B)) that is not otherwise a controlled foreign corporation is treated as a controlled foreign corporation for purposes of applying paragraph (b)(2)(i) of this section to previously taxed earnings and profits resulting from the application of section 965 that are distributed by the specified foreign corporation.

(3) Additional consequences. Upon a distribution of previously taxed earnings and profits, see paragraph (d)(5) of this section for adjustments to previously taxed earnings and profits, §1.961-4 for basis adjustments, §1.986(c)-1 for recognition of foreign currency gain or loss if the distribution is to a covered shareholder, and §1.960-3 for deemed paid foreign income taxes if the distribution is to a United States shareholder that is a corporation or to a controlled foreign corporation. See also section 962(d) (previously taxed earnings and profits distributed to a covered shareholder and relating to the taxable section 962 PTEP subgroup are included in gross income); §1.1411-10(c)(1)(i)(A)(1) (previously taxed earnings and profits distributed to a covered shareholder and relating to the taxable section 1411 subgroup are included in net investment income).

(c) Covered distribution—(1) In general. A covered distribution is a distribution of property made by a foreign corporation to its shareholders with respect to its stock, to the extent that the distribution is a dividend (as defined in section 316), determined without regard to section 959(d), and not including an amount treated as a dividend by reason of section 78, 367(b), 964(e)(1), or 1248. In a covered distribution, previously taxed earnings and profits are distributed in accordance with the rules described in paragraph (d) of this section.

(2) [Reserved]

(3) Treatment of a partner’s distributive share of a covered distribution. For purposes of the section 959 regulations, if a portion of a covered distribution is made or is treated as made under this paragraph (c)(3) to a partnership, a partner’s distributive share of such portion is treated as a portion of the covered distribution made to the partner.

(d) Rules for analyzing a covered distribution—(1) Determine each covered shareholder’s share of the covered distribution. First, determine each covered shareholder’s share of the covered distribution, computed as the sum of—

(i) Any portion of the covered distribution that is made to the covered shareholder, and

(ii) Any portions of the covered distribution that are made to upper-tier foreign corporations and assigned to the covered shareholder under §1.951-2.

(2) Determine distributed previously taxed earnings and profits. Second, determine the extent to which each covered shareholder’s share of the covered distribution is a distribution of previously taxed earnings and profits in accordance with paragraph (e) of this section.

(3) Determine dollar basis and associated foreign income taxes. Third, determine the dollar basis of, and foreign income taxes associated with, distributed previously taxed earnings and profits in accordance with paragraphs (f) and (g) of this section.

(4) Treat distributed previously taxed earnings and profits as distributed pro rata with respect to shares of stock of the foreign corporation. Fourth, treat a pro rata portion of all previously taxed earnings and profits distributed in each covered shareholder’s share of the covered distribution as distributed with respect to each share of stock of the foreign corporation owned by the covered shareholder, determined by multiplying all such previously taxed earnings and profits by a fraction. The numerator of the fraction is the sum of any portion of the covered distribution that is made with respect to the share of stock to the covered shareholder and any portions of the covered distribution that are made with respect to the share of stock to upper-tier foreign corporations and assigned to the covered shareholder under §1.951-2. The denominator of the fraction is the amount of the covered shareholder’s share of the covered distribution.

(5) Adjust previously taxed earnings and profits and make related account adjustments. Fifth, decrease the distributing foreign corporation’s previously taxed earnings and profits, and if applicable increase a recipient foreign corporation’s previously taxed earnings and profits, to reflect the covered distribution and make the related adjustments described in §1.959-3 to each covered shareholder’s accounts.

(e) Allocation of distributions—(1) In general. A covered shareholder’s share of a covered distribution (determined under paragraph (d)(1) of this section) is first allocated to previously taxed earnings and profits of the foreign corporation that are with respect to the covered shareholder immediately before the covered distribution (as reflected in the covered shareholder’s annual PTEP accounts with respect to the foreign corporation), to the extent thereof and in accordance with paragraphs (e)(2) through (5) of this section. Any remaining portion of such share is allocated to the foreign corporation’s earnings and profits described in section 959(c)(3).

(2) Priority rules—(i) Section 959(c)(1) rule. Allocate the covered shareholder’s share of the covered distribution first to previously taxed earnings and profits assigned to a section 959(c)(1) PTEP group and then to previously taxed earnings and profits assigned to a section 959(c)(2) PTEP group.

(ii) Rules within section 959(c)(1) PTEP groups. In allocating the covered shareholder’s share of the covered distribution to previously taxed earnings and profits assigned to section 959(c)(1) PTEP groups, allocate first to previously taxed earnings and profits assigned to the reclassified section 965(a) PTEP group, then to previously taxed earnings and profits assigned to the reclassified section 965(b) PTEP group, and finally to previously taxed earnings and profits assigned to the remaining section 959(c)(1) PTEP groups.

(iii) Rules within section 959(c)(2) PTEP groups. In allocating the covered shareholder’s share of the covered distribution to previously taxed earnings and profits assigned to section 959(c)(2) PTEP groups, allocate first to previously taxed earnings and profits assigned to the section 965(a) PTEP group, then to previously taxed earnings and profits assigned to the section 965(b) PTEP group, and finally to previously taxed earnings and profits assigned to the remaining section 959(c)(2) PTEP groups.

(3) Last-in, first-out rule. In allocating the covered shareholder’s share of the covered distribution to previously taxed earnings and profits assigned to a single PTEP group or PTEP groups with the same priority (for example, the section 951(a)(1)(A) PTEP group, section 951A PTEP group, and section 245A(d) PTEP group), allocate first to previously taxed earnings and profits that relate to the most recent taxable year, then to previously taxed earnings and profits that relate to the next most recent taxable year, and so on.

(4) Section 962 ordering rule. In allocating the covered shareholder’s share of the covered distribution to previously taxed earnings and profits that are assigned to a single PTEP group or PTEP groups with the same priority and that relate to the same taxable year, allocate first to previously taxed earnings and profits that are not assigned to the taxable section 962 PTEP subgroup, and then to previously taxed earnings and profits that are assigned to such subgroup.

(5) Pro rata rule. In allocating the covered shareholder’s share of the covered distribution to previously taxed earnings and profits that are assigned to a single PTEP group or PTEP groups with the same priority and that relate to the same taxable year and have the same classification for section 962 purposes (same priority PTEP), allocate to a pro rata portion of same priority PTEP, determined by multiplying all same priority PTEP by a fraction, the numerator of which is the amount to be allocated to same priority PTEP, and the denominator of which is the amount of same priority PTEP.

(f) Dollar basis rule. The dollar basis of previously taxed earnings and profits distributed in a covered shareholder’s share of a covered distribution (determined under paragraph (d)(2) of this section) is computed separately with respect to previously taxed earnings and profits relating to a single dollar basis pool, and in each case is equal to a pro rata portion of the dollar basis pool immediately before the covered distribution. The pro rata portion is determined by multiplying all basis in the dollar basis pool by a fraction, the numerator of which is previously taxed earnings and profits distributed in the covered shareholder’s share of the covered distribution and relating to the dollar basis pool, and the denominator of which is all previously taxed earnings and profits relating to the dollar basis pool.

(g) Associated foreign income taxes rule. The foreign income taxes that are associated with previously taxed earnings and profits distributed in a covered shareholder’s share of a covered distribution (determined under paragraph (d)(2) of this section) are computed separately with respect to previously taxed earnings and profits relating to a single PTEP tax pool, and in each case are equal to a pro rata portion of the PTEP tax pool immediately before the covered distribution. The pro rata portion is determined by multiplying all foreign income taxes in the PTEP tax pool by a fraction, the numerator of which is previously taxed earnings and profits distributed in the covered shareholder’s share of the covered distribution and relating to the PTEP tax pool, and the denominator of which is all previously taxed earnings and profits relating to the PTEP tax pool. Thus, associated foreign income taxes are sourced pro rata from foreign income taxes assigned to the creditable PTEP tax group in the PTEP tax pool and other foreign income taxes in the PTEP tax pool.

Par. 22. Sections 1.959-5 through 1.959-12 are added to read as follows:

Sec.

* * * * *

1.959-5 Exclusion of a section 956 amount from gross income to the extent allocated to previously taxed earnings and profits.

1.959-6 Allocating and apportioning current year taxes to previously taxed earnings and profits of a foreign corporation.

1.959-7 General successor transactions.

1.959-8 and 1.959-9 [Reserved]

1.959-10 Examples.

1.959-11 Transition rules.

1.959-12 Applicability dates.

* * * * *

(a) Scope. This section provides rules for previously taxed earnings and profits to which a section 956 amount is allocated. Paragraph (b) of this section defines a section 956 amount. Paragraph (c) of this section describes rules for analyzing a section 956 amount, including rules for determining the extent to which a section 956 amount is excluded from gross income under section 959(a)(2). Paragraph (d) of this section provides rules for allocating a section 956 amount to previously taxed earnings and profits. Paragraph (e) of this section provides a dollar basis rule. Paragraph (f) of this section provides an associated foreign income taxes rule. See §1.959-10(c)(4) (Example 4) for an example illustrating the application of this section.

(b) Section 956 amount. A section 956 amount is the amount determined under section 956 and §1.956-1 with respect to a covered shareholder and a controlled foreign corporation. A section 956 amount is excluded from gross income in accordance with the rules described in paragraph (c) of this section.

(c) Rules for analyzing a section 956 amount—(1) Determine the portion of the section 956 amount excluded from gross income under section 959(a)(2). First, the portion of the section 956 amount that it is allocated to section 959(c)(2) previously taxed earnings and profits, which is determined in accordance with paragraph (d) of this section, is excluded from the covered shareholder’s gross income.

(2) Determine dollar basis and associated foreign income taxes. Second, determine the dollar basis of, and foreign income taxes associated with, previously taxed earnings and profits to which the section 956 amount is allocated in accordance with paragraphs (e) and (f) of this section.

(3) Adjust previously taxed earnings and profits and make related account adjustments. Third, reassign the controlled foreign corporation’s previously taxed earnings and profits to which the section 956 amount is allocated from section 959(c)(2) PTEP groups to section 959(c)(1) PTEP groups, and if applicable increase the controlled foreign corporation’s previously taxed earnings and profits assigned to the general section 959(c)(1) PTEP group by reason of section 951(a)(1)(B), to reflect the section 956 amount and make the related adjustments described in §1.959-3.

(d) Allocation of section 956 amounts—(1) In general. A covered shareholder’s section 956 amount is first allocated to previously taxed earnings and profits of the controlled foreign corporation that are with respect to the covered shareholder and assigned to section 959(c)(2) PTEP groups (determined as described in paragraph (d)(2) of this section)), to the extent thereof and in accordance with the principles of §1.959-4(e)(2)(iii) through (5). Any remaining portion of the section 956 amount is allocated to the controlled foreign corporation’s earnings and profits described in section 959(c)(3).

(2) Determination of previously taxed earnings and profits. In applying paragraph (d)(1) of this section, previously taxed earnings and profits are determined on the last relevant day of the controlled foreign corporation’s taxable year to which the section 956 amount relates, but are reduced to the extent distributed during the taxable year, and are determined without regard to any transfer of previously taxed earnings and profits from the covered shareholder on (or after) the last relevant day of the taxable year.

(e) Dollar basis rule. The dollar basis of previously taxed earnings and profits to which a covered shareholder’s section 956 amount is allocated (determined under paragraph (d)(1) of this section) is computed separately with respect to previously taxed earnings and profits relating to a single dollar basis pool, and in each case is equal to a pro rata portion of the dollar basis pool determined in the same manner as previously taxed earnings and profits are determined in paragraph (d)(2) of this section. The pro rata portion is determined by multiplying all basis in the dollar basis pool by a fraction, the numerator of which is previously taxed earnings and profits to which the section 956 amount is allocated and relating to the dollar basis pool, and the denominator of the which is all previously taxed earnings and profits relating to the dollar basis pool.

(f) Associated foreign income taxes rule. The foreign income taxes that are associated with previously taxed earnings and profits to which a covered shareholder’s section 956 amount is allocated (determined under paragraph (d)(1) of this section) are computed separately with respect to previously taxed earnings and profits relating to a single PTEP tax pool, and in each case are equal to a pro rata portion of the PTEP tax pool determined in the same manner as previously taxed earnings and profits are determined in paragraph (d)(2) of this section. The pro rata portion is determined by multiplying all foreign income taxes in the PTEP tax pool by a fraction, the numerator of which is previously taxed earnings and profits to which the section 956 amount is allocated and relating to the PTEP tax pool, and the denominator of which is all previously taxed earnings and profits relating to the PTEP tax pool. Thus, associated foreign income taxes are sourced pro rata from foreign income taxes assigned to the creditable PTEP tax group in the PTEP tax pool and other foreign income taxes in the PTEP tax pool.

(a) Scope. This section provides rules for allocating and apportioning current year taxes for purposes of sections 959 and 960(b). Paragraph (b) of this section provides the general rule for determining which foreign income taxes paid or accrued by a foreign corporation may be allocated and apportioned to previously taxed earnings and profits. Paragraph (c) of this section provides rules for the application of §1.861-20 to allocate and apportion current year taxes among corporate PTEP accounts. Paragraph (d) of this section provides additional rules regarding the allocation and apportionment of deductions to previously taxed earnings and profits and a currency translation rule. See §1.959-10(c)(3) (Example 3) for an example illustrating the application of this section.

(b) In general. Current year taxes that a foreign corporation pays or accrues during its taxable year by reason of a PTEP realization event that occurs during the same taxable year are allocated and apportioned to the statutory groupings (as generally described in §1.861-8(a)(4)) of previously taxed earnings and profits of the foreign corporation and to the residual grouping in accordance with the rules of paragraph (c) of this section. For purposes of this section, the statutory groupings are the corporate PTEP accounts of the foreign corporation described in §1.959-2(d)(1). A PTEP realization event is an increase to the previously taxed earnings and profits of a foreign corporation by reason of its receipt of a covered distribution (as determined under §1.959-4) or the application of section 961(c) basis of the foreign corporation to covered gain (as determined under §1.961-9) during the taxable year, as determined under §1.959-2(d)(1). Current year taxes that are paid or accrued with respect to a PTEP realization event that occurs in a different taxable year may not be allocated and apportioned to the corporate PTEP accounts of a foreign corporation. See §1.960-1(d)(3)(ii)(B) for rules regarding the assignment of foreign gross income to the statutory and residual groupings of income of a controlled foreign corporation when the controlled foreign corporation pays or accrues current year taxes with respect to a PTEP realization event that occurs in a different taxable year.

(c) Rules for allocating and apportioning current year taxes to previously taxed earnings and profits. Allocate and apportion current year taxes that a foreign corporation pays or accrues during its taxable year by reason of a PTEP realization event that occurs during the same taxable year (translated, if applicable, into the foreign corporation’s functional currency as described in paragraph (d)(3) of this section) to its statutory groupings of previously taxed earnings and profits and to the residual grouping in accordance with the rules of §1.861-20. For this purpose, foreign gross income that a foreign corporation includes under foreign law by reason of a distribution that it receives, or by reason of its disposition of stock, is assigned to its statutory groupings of previously taxed earnings and profits by treating previously taxed earnings and profits arising from the distribution or disposition as included in the U.S. dividend amount or the U.S. capital gain amount, respectively, for purposes of applying §1.861-20(d)(1). For the definitions of U.S. dividend amount and U.S. capital gain amount, see §1.861-20(b).

(d) Additional rules—(1) No deductions other than deductions for current year taxes paid or accrued with respect to a PTEP realization event that occurs in the same taxable year are allocated or apportioned to the statutory groupings of previously taxed earnings and profits of a foreign corporation. No deductions of a foreign corporation, other than deductions for current year taxes that the foreign corporation pays or accrues during its taxable year with respect to a PTEP realization event that occurs in the same taxable year, may be allocated or apportioned under section 861 to the statutory groupings of previously taxed earnings and profits of the foreign corporation.

(2) Currency rule. For purposes of this section, if current year taxes that a foreign corporation pays or accrues are denominated in a currency other than the foreign corporation’s functional currency, then the current year taxes are translated into the foreign corporation’s functional currency at the spot rate on the day on which the current year taxes are paid or accrued. See section 986(a) and §1.986(a)-1 for rules translating current year taxes into U.S. dollars.

(a) Scope. This section identifies certain transactions in which a foreign corporation’s previously taxed earnings and profits with respect to a covered shareholder transfer to (and thus become previously taxed earnings and profits with respect to) another covered shareholder under section 959 (defined as general successor transactions) and provides rules for determining the previously taxed earnings and profits that transfer. Paragraph (b) of this section provides definitions. Paragraph (c) of this section describes rules for analyzing a general successor transaction, including rules for determining previously taxed earnings and profits that transfer in the general successor transaction. Paragraph (d) of this section describes a fraction determining the pro rata portion of certain previously taxed earnings and profits that transfer. Paragraph (e) of this section provides a dollar basis rule. Paragraph (f) of this section provides an associated foreign income taxes rule. Paragraph (g) of this section provides rules regarding the deemed covered shareholder. See §1.959-10(c)(5) (Example 5) for an example illustrating the application of this section. See also §§1.959-8 and 1.959-9, regarding the extent to which previously taxed earnings and profits transfer under section 959 in a transaction other than a general successor transaction.

(b) General successor transaction—(1) In general. A general successor transaction is any transaction in which a covered shareholder (the successor covered shareholder) acquires ownership of stock of one or more foreign corporations (each, an acquired foreign corporation) that, immediately before the transaction, is owned by another covered shareholder (the transferor covered shareholder), determined without regard to any portion of an acquisition of ownership of stock that results from a transaction described in paragraph (b)(2) of this section. In a general successor transaction, previously taxed earnings and profits of each acquired foreign corporation transfer from the transferor covered shareholder to the successor covered shareholder (and thus become with respect to the successor covered shareholder) in accordance with the rules described in paragraph (c) of this section.

(2) Certain transactions. A transaction is described in this paragraph (b)(2) if the transaction is—

(i) An issuance of stock or a partnership interest,

(ii) A redemption of stock (within the meaning of section 317(b)) or a liquidating distribution in redemption of a partnership interest, or

(iii) A transfer of stock of a foreign corporation, or any property through which stock of a foreign corporation is owned, if such stock or property is substituted basis property.

(3) Additional consequences. Upon a general successor transaction, see §1.961-5 for basis adjustments and §1.986(c)-1 for recognition of foreign currency gain or loss by the transferor covered shareholder.

(c) Rules for analyzing a general successor transaction—(1) Determine general successor PTEP—(i) In general. First, determine general successor PTEP, which for each acquired foreign corporation is computed by multiplying all previously taxed earnings and profits of the acquired foreign corporation that are with respect to the transferor covered shareholder immediately before the general successor transaction by the fraction computed in accordance with paragraph (d) of this section.

(ii) Previously taxed earnings and profits not eligible to transfer if the general successor transaction is before the last relevant day. In applying paragraph (c)(1)(i) of this section, if the general successor transaction is before the last relevant day of the acquired foreign corporation’s taxable year that includes the general successor transaction, then do not take into account (and thus do not transfer to the successor covered shareholder) any previously taxed earnings and profits that result from an income inclusion of the transferor covered shareholder under section 951(a)(1)(A) or 951A(a) for such taxable year (as accounted for in adjusting annual PTEP accounts pursuant to §1.959-3(c)(1)(i) and (ii)). For example, if the successor covered shareholder acquires less than all of the transferor covered shareholder’s stock of the acquired foreign corporation, and the transferor covered shareholder continues to own the retained stock on the last relevant day, then any previously taxed earnings and profits resulting from the transferor covered shareholder’s income inclusions under section 951(a)(1)(A) and 951A for the acquired foreign corporation’s taxable year do not transfer in the general successor transaction.

(2) Determine section 959(e) successor PTEP. Second, determine section 959(e) successor PTEP, which for each acquired foreign corporation is all the previously taxed earnings and profits of the acquired foreign corporation that, under section 959(e), result from the application of section 1248 to gain recognized by the transferor covered shareholder in the general successor transaction (as accounted for in adjusting annual PTEP accounts pursuant to §1.959-3(c)(1)(vii)).

(3) Determine dollar basis and associated foreign income taxes. Third, determine the dollar basis of, and foreign income taxes associated with, general successor PTEP and section 959(e) successor PTEP in accordance with paragraph (e) of this section.

(4) Transfer previously taxed earnings and profits and make related account adjustments. Fourth, transfer general successor PTEP and section 959(e) successor PTEP from the transferor covered shareholder to the successor covered shareholder and make the related adjustments described in §1.959-3.

(d) Fraction in determining general successor PTEP—(1) In general. In determining general successor PTEP of an acquired foreign corporation, the fraction described in paragraph (c)(1)(i) of this section is computed as follows. The numerator of the fraction is the portion of the acquired foreign corporation’s hypothetical distribution described in paragraph (d)(2) of this section that, under the principles of §1.951-1(e)(2) through (6), would be distributed with respect to the stock of the acquired foreign corporation the ownership of which is acquired by the successor covered shareholder in the general successor transaction. The denominator of the fraction is the amount of such hypothetical distribution. However, if the denominator of the fraction would be zero, then the fraction is considered to be zero.

(2) Hypothetical distribution. The hypothetical distribution described in this paragraph (d)(2) is a hypothetical distribution treated as made by the acquired foreign corporation with respect to stock of the acquired foreign corporation, immediately before the general successor transaction and in an amount equal to the acquired foreign corporation’s previously taxed earnings and profits with respect to the transferor covered shareholder (determined as described in paragraph (c)(1) of this section). In the hypothetical distribution, stock of the acquired foreign corporation is taken into account only to the extent owned by the transferor covered shareholder immediately before the general successor transaction, and the earnings and profits of the acquired foreign corporation are treated as equal to the amount of the hypothetical distribution.

(e) Dollar basis rule—(1) General successor PTEP. The dollar basis of previously taxed earnings and profits composing general successor PTEP (determined under paragraph (c)(1) of this section) is computed separately with respect to previously taxed earnings and profits relating to a single dollar basis pool, and in each case is equal to a pro rata portion of the dollar basis pool immediately before the general successor transaction. The pro rata portion is determined by multiplying all basis in the dollar basis pool by a fraction, the numerator of which is previously taxed earnings and profits composing general successor PTEP and relating to the dollar basis pool, and the denominator of which is all previously taxed earnings and profits relating to the dollar basis pool.

(2) Section 959(e) successor PTEP. The dollar basis of previously taxed earnings and profits composing section 959(e) successor PTEP (determined under paragraph (c)(2) of this section) is equal to the U.S. dollar amount of the income inclusion giving rise to the previously taxed earnings and profits (as accounted for in increasing dollar basis pools pursuant to §1.959-3(d)(1)(i)).

(f) Associated foreign income taxes rule—(1) General successor PTEP. The foreign income taxes that are associated with previously taxed earnings and profits composing general successor PTEP (determined under paragraph (c)(1) of this section) are computed separately with respect to previously taxed earnings and profits relating to a single PTEP tax pool, and in each case are equal to a pro rata portion of the PTEP tax pool immediately before the general successor transaction. The pro rata portion is determined by multiplying all foreign income taxes in the PTEP tax pool by a fraction, the numerator of which is previously taxed earnings and profits composing general successor PTEP and relating to the PTEP tax pool, and the denominator of which is all previously taxed earnings and profits relating to the PTEP tax pool. Thus, associated foreign income taxes are sourced pro rata from foreign income taxes assigned to the creditable PTEP tax group in the PTEP tax pool and other foreign income taxes in the PTEP tax pool.

(2) Section 959(e) successor PTEP. The foreign income taxes associated with previously taxed earnings and profits composing section 959(e) successor PTEP (determined under paragraph (c)(2) of this section) are zero.

(g) Deemed covered shareholder—(1) In general. The deemed covered shareholder is a hypothetical person that is treated as owning all the stock of any foreign corporation that is not owned by a covered shareholder. For purposes of transferring previously taxed earnings and profits under section 959, the deemed covered shareholder is treated in the same manner as a covered shareholder and a reference to a covered shareholder includes the deemed covered shareholder. Thus, for example, if a covered shareholder sells stock of a foreign corporation to a nonresident alien individual, then the sale is a general successor transaction and previously taxed earnings and profits of the foreign corporation transfer from the seller covered shareholder to the deemed covered shareholder under this section. Moreover, if the individual subsequently sells stock of the foreign corporation to a covered shareholder, then previously taxed earnings and profits of the foreign corporation (adjusted consistent with §1.959-3, including to reflect distributions from the foreign corporation to the individual) transfer from the deemed covered shareholder to the buyer covered shareholder under this section.

(2) Determining previously taxed earnings and profits that transfer from the deemed covered shareholder. In a transaction in which previously taxed earnings and profits of a foreign corporation transfer from the deemed covered shareholder to a covered shareholder, the covered shareholder must use a reasonable method in determining the amount and character of the transferred previously taxed earnings and profits and in determining the foreign income taxes associated with the transferred previously taxed earnings and profits. Such method must take into account adjustments to previously taxed earnings and profits with respect to the deemed covered shareholder that would have been made under §1.959-3 if the previously taxed earnings and profits were respect to a covered shareholder.

§1.959-10 Examples.

(a) In general. This section provides examples that illustrate the application of §§1.959-1 through 1.959-9.

(b) Assumed facts. For purposes of the examples in this section, unless otherwise indicated, the following facts are assumed:

(1) US1 and US2 are unrelated domestic corporations that are covered shareholders, each of which uses the U.S. dollar as its functional currency and has a combined pool election in effect under §1.959-2(c). Neither US1 nor US2 is a member of a consolidated group (as defined in §1.1502-1(h)).

(2) F1 and F2 are foreign corporations, each of which is a controlled foreign corporation and uses the British pound (£) as its functional currency.

(3) PRS is a partnership.

(4) Each entity uses the calendar year as its taxable year, and no entity has a short taxable year.

(5) Tables depicting annual PTEP accounts, dollar basis pools, or PTEP tax pools do not depict accounts or PTEP groups with a balance of zero.

(c) Examples—(1) Example 1: Exclusion from gross income of previously taxed earnings and profits distributed in a covered distribution—(i) Facts. US1 directly owns all 100 shares of the single class of outstanding stock of F1. In year 3, F1 makes a £300x distribution of money with respect to its stock (£3x with respect to each share), and the entirety of this £300x is a covered distribution (a dividend as defined in section 316, determined without regard to section 959(d)). Immediately before the covered distribution, F1 has £180x of previously taxed earnings and profits with respect to US1, none of which is assigned to the taxable section 962 PTEP group. This example only analyzes the extent to which previously taxed earnings and profits are distributed and excluded from gross income under section 959. See paragraph (c)(2) of this section (Example 2) for an illustration of composition, dollar basis, and associated foreign income taxes of distributed previously taxed earnings and profits, along with foreign currency gain or loss under section 986(c) and deemed paid taxes under section 960(b). See also §1.961-4 (basis reductions and gain recognition for distributions of previously taxed earnings and profits).

(ii) Analysis. For purposes of analyzing the covered distribution, US1’s share of the covered distribution is the entire £300x because that amount of the covered distribution is made to US1. See §1.959-4(d)(1). Such share is allocated first to F1’s previously taxed earnings and profits that are with respect to US1 immediately before the covered distribution (£180x) and then to F1’s earnings and profits described in section 959(c)(3) and, therefore, is a distribution of £180x of previously taxed earnings and profits and £120x of earnings and profits described in section 959(c)(3). See §1.959-4(d)(2) and (e)(1). These previously taxed earnings and profits are treated as distributed pro rata with respect to the stock of F1 on which US1’s share of the covered distribution is made. See §1.959-4(d)(4). Accordingly, £1.8x of previously taxed earnings and profits is treated as distributed with respect to each share of F1 stock, computed by multiplying the £180x distributed previously taxed earnings and profits by a fraction, the numerator of which is the portion of US1’s share of the covered distribution that is made with respect to the share of F1 stock (£3x), and the denominator of which is the amount of US1’s share of the covered distribution (£300x). See id. US1 excludes the £180x of previously taxed earnings and profits distributed to it from its gross income. See §1.959-4(b)(1); see also §1.312-8(c) (US1’s receipt of previously taxed earnings and profits does not increase its earnings and profits).

(iii) Alternative facts: split-ownership—(A) Facts. The facts are the same as in paragraph (c)(1)(i) of this section (Example 1), except as follows. US1 owns all the outstanding stock of F2, and US1 directly owns 80%, and F2 directly owns 20%, of the stock of F1. Thus, US1 receives a £240x portion, and F2 receives a £60x portion, of the £300x covered distribution made by F1. Under §1.951-2, US1 is assigned the entirety of the £60x portion of the covered distribution received by F2.

(B) Analysis. For purposes of analyzing the covered distribution, US1’s share of the covered distribution is the entire £300x, the sum of the portion of the covered distribution that is made to US1 (£240x) and the portion of the covered distribution that is made to F2 and assigned to US1 under §1.951-2 (£60x). See §1.959-4(d)(1). As is the case in paragraph (c)(1)(ii) of this section, such share is treated as a distribution of £1.8x of previously taxed earnings and profits with respect to each share of F1 stock (and F1’s previously taxed earnings and profits with respect to US1 are reduced by the £180x of distributed previously taxed earnings and profits). Accordingly, US1 is treated as receiving £144x of previously taxed earnings and profits (£1.8x × 80 shares of F1 stock directly owned by US1) and F2 is treated as receiving £36x of previously taxed earnings and profits (£1.8x × 20 shares of F1 stock directly owned by F2). US1 excludes the £144x of previously taxed earnings and profits distributed to it from its gross income. See §1.959-4(b)(1). F2 excludes the £36x of previously taxed earnings distributed to it from its gross income, solely for purposes of determining its subpart F income and tested income or tested loss. See §1.959-4(b)(2)(i).

(iv) Alternative facts: partnership-structure—(A) Facts. The facts are the same as in paragraph (c)(1)(i) of this section (Example 1), except as follows. PRS directly owns all the stock of F1. US1 and US2, in the aggregate, directly own all the interests in PRS, and PRS’s partnership agreement provides that US1 has a 60% share, and US2 has a 40% share, of any of PRS’s items of income, gain, deduction, or loss. The covered distribution made by F1 is equal to £500x (£5x with respect to each share) and thus gives rise to £500x of dividend income to PRS, of which US1 has a £300x distributive share (£500x × 60%) and US2 has a £200x distributive share (£500x × 40%). Immediately before the covered distribution, F1 has no previously taxed earnings and profits with respect to US2.

(B) Analysis—(1) US1’s share of the covered distribution. US1 is treated as receiving £300x of the covered distribution, equal to its distributive share of the covered distribution. See §1.959-4(c)(3). Therefore, for purposes of analyzing the covered distribution, US1’s share of the covered distribution is £300x (the amount of the covered distribution treated as made to US1). See §1.959-4(d)(1). For such share, the results are the same as in paragraph (c)(1)(ii) of this section.

(2) US2’s share of the covered distribution. US2 is treated as receiving £200x of the covered distribution, equal to its distributive share of the covered distribution. See §1.959-4(c)(3). Therefore, for purposes of analyzing the covered distribution, US2’s share of the covered distribution is £200x (the amount of the covered distribution treated as made to US2). See §1.959-4(d)(1). The entirety of such share is a distribution of earnings and profits described in section 959(c)(3) because F1 has no previously taxed earnings and profits with respect to US2. See §1.959-4(d)(2) and (e)(1). US2 excludes none of its £200x distributive share of the covered distribution from its gross income under section 959 because none of the covered distribution received by US2 is previously taxed earnings and profits.

(2) Example 2: Composition, dollar basis, and associated foreign income taxes of distributed previously taxed earnings and profits—(i) Facts. US1 directly owns all 100 shares of the single class of outstanding stock of F1. In year 8, F1 makes a £225x distribution of money with respect to its stock (£2.25x with respect to each share), and the entirety of this £225x is a covered distribution. On the day of the covered distribution, the spot rate is $1:£0.4. Tables 1 through 3 in this paragraph (c)(2)(i) provide F1’s previously taxed earnings and profits with respect to US1, determined immediately before the covered distribution and thus reflecting adjustments pursuant to §1.959-3 for US1’s income inclusions under sections 951(a)(1)(A) and 951A (£80x and £70x, respectively) for F1’s taxable year ending on December 31 of year 8. Some of the previously taxed earnings and profits are previously taxed earnings and profits that were distributed to F1 by other foreign corporations in earlier years. The adjusted applicable percentage with respect to previously taxed earnings and profits that resulted from section 965(a) or (b) and relate to the general category is 60%, and the section 965(c) deduction percentage with respect to previously taxed earnings and profits that resulted from 965(a) and relate to the general category is 60%.

(ii) Analysis—(A) Distributed previously taxed earnings and profits. The entirety of US1’s share of the covered distribution (£225x) is allocated to F1’s previously taxed earnings and profits that are with respect to US1 immediately before the covered distribution because such previously taxed earnings and profits (£285x, computed as £150x + £75x + £60x, as set forth in table 1 in paragraph (c)(2)(i) of this section), are at least equal to such share. See §1.959-4(d)(2) and (e)(1). Specifically, US1’s share of the covered distribution is allocated first to the £65x of previously taxed earnings and profits assigned to the reclassified section 951A PTEP group, second to the £20x of previously taxed earnings and profits assigned to the section 965(a) PTEP group, and third to the £20x of previously taxed earnings and profits assigned to the section 965(b) PTEP group. See §1.959-4(e)(2). The remaining portion of US1’s share of the covered distribution (£120x, computed as £225x × £65x × £20x × £20x) is allocated pro rata to previously taxed earnings and profits that relate to year 8 and, therefore, is allocated to £40x of previously taxed earnings and profits assigned to the section 951(a)(1)(A) PTEP group and relating to year 8 and the general category (computed as £50x × £120x/£150x), £24x of previously taxed earnings and profits assigned to the section 951(a)(1)(A) PTEP group and relating to year 8 and the passive category (computed as £30x × £120x/£150x), and £56x of previously taxed earnings and profits assigned to the section 951A PTEP group and relating to year 8 and the section 951A category (computed as £70x × £120x/£150x). See §1.959-4(e)(3) and (e)(5). US1 excludes the £225x of previously taxed earnings and profits distributed to it from its gross income. See §1.959-4(b)(1); see also §1.961-4 (basis reductions and gain recognition for distributions of previously taxed earnings and profits).

(B) Dollar basis and foreign currency gain or loss. The dollar basis of previously taxed earnings and profits distributed in US1’s share of the covered distribution (described in paragraph (c)(2)(ii)(A) of this section) is computed separately with respect to previously taxed earnings and profits relating to a single dollar basis pool, and in each case is equal to a pro rata portion of the dollar basis pool immediately before the covered distribution (determined by multiplying all basis in the dollar basis pool by a fraction, the numerator of which is previously taxed earnings and profits distributed in the US1’s share of the covered distribution and relating to the dollar basis pool, and the denominator of which is all previously taxed earnings and profits relating to the dollar basis pool). See §1.959-4(f). Under §1.986(c)-1, US1 recognizes foreign currency gain or loss with respect to previously taxed earnings and profits distributed to it, determined by translating the previously taxed earnings and profits into U.S. dollars using the spot rate on the day of the covered distribution and then subtracting from that U.S. dollar amount the dollar basis of the previously taxed earnings and profits. US1 does not recognize 60% (the section 965(c) deduction percentage) of the foreign currency gain or loss with respect to the previously taxed earnings and profits relating to the section 965(a) PTEP group. Table 1 in this paragraph (c)(2)(ii)(B) provides computations for dollar basis and foreign currency gain or loss with respect to each group of distributed previously taxed earnings and profits. Thus, US1 recognizes a total of $8.8x of foreign currency gain and $28.8x of foreign currency loss.

(C) Associated foreign income taxes. The foreign income taxes that are associated with previously taxed earnings and profits distributed in US1’s share of the covered distribution (described in paragraph (c)(2)(ii)(A) of this section) are computed separately with respect to previously taxed earnings and profits relating to a single PTEP tax pool, and in each case are equal to a pro rata portion of the PTEP tax pool immediately before the covered distribution (determined by multiplying all foreign income taxes in the PTEP tax pool by a fraction, the numerator of which is previously taxed earnings and profits distributed in US1’s share of the covered distribution and relating to the PTEP tax pool, and the denominator of which is all previously taxed earnings and profits relating to the PTEP tax pool). See §1.959-4(g). Table 1 in this paragraph (c)(2)(ii)(C) provides these computations (and refers to associated foreign income taxes sourced from the creditable PTEP tax group as “creditable taxes” and associated foreign income taxes not sourced from the creditable PTEP tax group as “other taxes”).

(D) Deemed paid taxes. Under section 960(b), because F1 is a controlled foreign corporation in which US1 is a United States shareholder, US1 is deemed to pay the foreign income taxes properly attributable to previously taxed earnings and profits distributed to it, which are the foreign income taxes that are both associated with the previously taxed earnings and profits and sourced from the creditable PTEP tax group. See §1.960-3(b). Thus, US1 is deemed to pay $51.7x of foreign income taxes ($2.9x + $2.8x + $26x + $10x + $10x). Under §1.965-5(c), US1 is disallowed a credit for 60% (the adjusted applicable percentage) of the foreign income taxes deemed paid with respect to the previously taxed earnings and profits relating to the section 965(a) PTEP group or section 965(b) PTEP group, with the result that in each case US1 is disallowed a credit for $6x of the foreign income taxes deemed paid with respect to each of those groups of previously taxed earnings and profits ($10x × 60%).

(E) Account adjustments. To reflect the covered distribution, the distributed previously taxed earnings and profits, the dollar basis of the distributed previously taxed earnings and profits, and the foreign income taxes associated with the distributed previously taxed earnings and profits are removed from US1’s annual PTEP accounts, dollar basis pools, and PTEP tax pools with respect to F1. See §1.959-3(c)(1)(vi), (d)(1)(iv), and (e)(1)(iii). These adjustments are treated as made concurrently with the covered distribution. See §1.959-3(f). In addition, the distributed previously taxed earnings and profits, and the foreign income taxes associated with distributed previously taxed earnings and profits, are removed from F1’s corporate PTEP accounts and corporate PTEP tax pools for US1, and these adjustments are also treated as made concurrently with the covered distribution. See §1.959-2(d).

(iii) Alternative facts: distribution of built-in loss property—(A) Facts. The facts are the same as in paragraph (c)(2)(i) of this section (Example 2), except that, in the covered distribution (which continues to be £225x), F1 distributes property other than money. At the time of the covered distribution, the fair market value of the property is £225x and F1’s adjusted basis of the property is £250x. Thus, the covered distribution decreases F1’s earnings and profits by £250x. See sections 301(b)(1) and 312(a)(3).

(B) Analysis. The results are the same as in paragraph (c)(2)(ii) of this section and thus the covered distribution decreases F1’s previously taxed earnings and profits by £225x. The remainder of the £250x decrease to F1’s earnings and profits under section 312(a)(3) is accounted for by decreasing (including below zero, if applicable) F1’s earnings and profits described in section 959(c)(3) by £25x.

(iv) Alternative facts: distribution to a foreign corporation—(A) Facts. The facts are the same as in paragraph (c)(2)(i) of this section (Example 2), except as follows. US1 directly owns all the stock of F2, and F2 directly owns all 100 shares of the single class of stock of F1. Thus, F2 receives the entirety of the £225x covered distribution made by F1. Under §1.951-2, US1 is assigned the entirety of the £225x covered distribution received by F2.

(B) Analysis. The results are the same as described in paragraph (c)(2)(ii) of this section, except that F2 excludes the £225x of distributed previously taxed earnings and profits from its gross income in accordance with §1.959-4(b)(2), US1 does not recognize foreign currency gain or loss with respect to the distributed previously taxed earnings and profits in accordance with §1.986(c)-1(c), and F2 is deemed to pay the $51.7x of foreign income taxes that are both associated with the distributed previously taxed earnings and profits and sourced from the creditable PTEP tax group in accordance with §1.960-3(c). In addition, the distributed previously taxed earnings and profits (£225x), the dollar basis of the distributed previously taxed earnings and profits ($566.5x), and the foreign income taxes associated with the distributed previously taxed earnings and profits ($51.7x + $1.9x = $53.6x) are added to US1’s annual PTEP accounts, dollar basis pools, and PTEP tax pools with respect to F2. See §1.959-3(c)(1)(iii), (d)(1)(ii), and (e)(1)(i). Only the $51.7x portion of the associated foreign income taxes that F2 is deemed to pay are assigned to the creditable PTEP tax group within US1’s PTEP tax pools with respect to F2. See §1.959-3(e)(1)(i). These adjustments are treated as made at the beginning of F2’s taxable year ending on December 31 of year 8. See §1.959-3(f). In addition, the distributed previously taxed earnings and profits, and the foreign income taxes associated with the distributed previously taxed earnings and profits, are added to F2’s corporate PTEP accounts and corporate PTEP tax pools for US1, and these adjustments are also treated as made at the beginning of F2’s taxable year ending on December 31 of year 8. See §1.959-2(d).

(3) Example 3: Current year taxes imposed on a covered distribution—(i) Facts. US1 directly owns 60%, and US2 directly owns 40%, of the single class of outstanding stock of F2. F2 owns all the outstanding stock of F1. In year 3, F1 makes a £500x covered distribution to F2. Foreign withholding taxes of £75x (£500x × 15%) are paid on the covered distribution. F2 takes foreign income taxes into account when paid, the withholding taxes meet the definition of current year taxes for F2’s taxable year ending on December 31 of year 3, and, other than pursuant to section 245A(d), no credits for taxes are disallowed or suspended at the level of F2. On the day of the covered distribution, the spot rate is $1:£0.5. Under §1.959-4, the entirety of US1’s £300x share of the covered distribution (£500x × 60%) is a distribution of F1’s previously taxed earnings and profits with respect to US1, and none of US2’s £200x share of the covered distribution (£500x × 40%) is a distribution of previously taxed earnings and profits. The distributed previously taxed earnings and profits consist of £120x of previously taxed earnings and profits assigned to the section 951(a)(1)(A) PTEP group and relating to year 2 and the passive category (Character A PTEP), £80x of previously taxed earnings and profits assigned to the section 245A(d) PTEP group and relating to year 2 and the passive category (Character B PTEP), £70x of previously taxed earnings and profits assigned to the section 951(a)(1)(A) PTEP group and relating to year 1 and the general category (Character C PTEP), and £30x of previously taxed earnings and profits assigned to the section 951(a)(1)(A) PTEP group and relating to year 1 and the passive category (Character D PTEP), as summarized in table 1 in this paragraph (c)(3)(i). This example only analyzes the allocation and apportionment of the current year taxes and related adjustments to previously taxed earnings and profits accounts. See also §1.959-4 (exclusion from gross income of previously taxed earnings and profits received in a distribution); §1.986(c)-1(c) (no foreign currency gain or loss recognized in distributions of previously taxed earnings and profits to a foreign corporation); §1.961-4 (basis reductions and gain recognition for distributions of previously taxed earnings and profits).

(ii) Analysis—(A) In general. As a result of the covered distribution, which is a PTEP realization event, F2 has £300x of previously taxed earnings and profits with respect to US1 and £0 of previously taxed earnings and profits with respect to US2. The foreign gross income that F2 includes by reason of its receipt of the covered distribution is assigned to the statutory groupings, which are described in §1.959-2(d)(1), and residual grouping by treating the previously taxed earnings and profits arising from such distribution as included in the U.S. dividend amount for purposes of §1.861-20(d)(1). See §1.959-6(c). The relevant statutory groupings are F2’s corporate PTEP accounts that were increased by reason of its receipt of a covered distribution which was previously taxed earnings and profits with respect to US1 and the remaining portion of the covered distribution is assigned to the residual income grouping. See id. The £75x of current year taxes imposed on the covered distribution is allocated and apportioned to the previously taxed earnings and profits (US1’s share of the covered distribution) and the residual income grouping (US2’s share of the covered distribution) pro rata, with the result that £45x (£75x × £300x/£500x) is allocated and apportioned to previously taxed earnings and profits arising from the covered distribution and the remaining £30 (£75x × £200x/£500x) is assigned to the residual income grouping. See id.

(B) Allocation and apportionment of current year taxes among PTEP groups. The £45x of current year taxes allocated and apportioned to the previously taxed earnings and profits arising from the PTEP realization event with respect to US1 is further allocated and apportioned among the section 904 categories and PTEP groups within each corporate PTEP account that is increased by reason of F2’s PTEP realization event. See §1.959-6(b) and (c). Accordingly, £18x of current year taxes is allocated and apportioned to Character A PTEP (£45x × £120x/£300x), £12x of current year taxes is allocated and apportioned to Character B PTEP £45x × £80x/£300x), £10.5x of current year taxes is allocated and apportioned to Character C PTEP (£45x × £70x/£300x), and £4.5x of current year taxes is allocated and apportioned to Character D PTEP (£45x × £30x/£300x), each within F2’s corporate PTEP account with respect to US1.

(C) Account adjustments—(1) Shareholder-level accounts. After the current year taxes are allocated and apportioned to the corporate PTEP accounts of F2 with respect to US1, the previously taxed earnings and profits in US1’s PTEP groups within its annual PTEP accounts are reduced to reflect the current year taxes allocated and apportioned to the corresponding PTEP groups of F2. See §1.959-3(c)(1)(v). These adjustments are treated as made at the beginning of F2’s taxable year ending on December 31 of year 3. See §1.959-3(f). Concurrently with this reduction, US1’s dollar basis pools with respect to F2 are reduced by $90x, the U.S. dollar amount of the reduction that reflects the current year taxes allocated and apportioned to the distributed previously taxed earnings and profits (£45x × $1/£0.5), and $90x of current year taxes is added to US1’s PTEP tax pools with respect to F2. See §1.959-3(d)(1)(iii) and (d)(2), (e)(1)(ii) and (e)(2); see also section 986(a) and §1.986(a)-1 (translation of foreign income taxes into U.S. dollars). Tables 1 through 3 in this paragraph (c)(3)(ii)(C) summarize the adjustments to US1’s accounts to reflect the current year taxes.

(2) Corporate-level accounts. Concurrently with the adjustments described in paragraph (c)(3)(ii)(C)(1) of this section, the previously taxed earnings and profits in F2’s corporate PTEP accounts for US1 are reduced by £45x and the foreign income taxes in F2’s corporate PTEP tax pools for US1 are increased by $90x. See §1.959-2(d).

(4) Example 4: Section 956 amount—(i) Facts. Individual A, a citizen of the United States, owns all the outstanding stock of F1 and does not make an election to apply the provisions of section 962 for any taxable year. For F1’s taxable year ending on December 31 of year 3, the last relevant day is December 31 and Individual A’s section 956 amount (amount determined under section 956 and §1.956-1) is £200x. At the beginning of the last relevant day, F1 has £125x of previously taxed earnings and profits with respect to Individual A, all of which relate to F1’s taxable year ending on December 31 of year 1 and are assigned to section 959(c)(2) PTEP groups. On the last relevant day, F1 makes a £75x covered distribution to Individual A, the entirety of which is allocated to (and thus is a distribution of) F1’s previously taxed earnings and profits with respect to Individual A under §1.959-4. This example only analyzes the extent to which the section 956 amount is allocated to previously taxed earnings and profits and excluded from gross income under section 959, along with related adjustments to annual PTEP accounts. See also §1.959-3(d) and (e) (related adjustments to dollar basis pools and PTEP tax pools).

(ii) Analysis—(A) Allocation to previously taxed earnings and profits. Individual A’s section 956 amount is first allocated to F1’s previously taxed earnings and profits that are with respect to Individual A and assigned to section 959(c)(2) PTEP groups on the last relevant day, but reduced to reflect the covered distribution (£50x, computed as £125x × £75x). See §1.959-5(c)(1) and (d). The £50x portion of the section 956 amount allocated to previously taxed earnings and profits is excluded from Individual A’s gross income. See §1.959-5(c)(1). Under section 951(a)(1)(B), Individual A includes the remaining £150x of the section 956 amount (translated into U.S. dollars in accordance with section 989(b)) in its gross income.

(B) Annual PTEP account adjustments. To reflect the section 956 amount, the £50x of previously taxed earnings and profits to which the section 956 amount is allocated are reassigned from section 959(c)(2) PTEP groups to section 959(c)(1) PTEP groups within Individual A’s annual PTEP accounts relating to F1’s taxable year ending on December 31 of year 1, and then £150x of previously taxed earnings and profits are added to Individual A’s annual PTEP accounts relating to F1’s taxable year ending on December 31 of year 3, where they are assigned to the general section 959(c)(1) PTEP group. See §1.959-3(c)(1)(x) and (xi). These adjustments are treated as made at the end of the last day of F1’s taxable year ending on December 31 of year 3. See §1.959-3(f)(1).

(5) Example 5: General successor transaction—(i) Facts. US1 directly owns all 100 shares of the single class of outstanding stock of F1. On June 30 of year 3, US1 sells 40 shares of stock of F1 to US2 for money equal to the fair market value of the shares. Section 304 does not apply to the sale. Immediately before the sale, F1 has £180x of previously taxed earnings and profits with respect to US1, none of which resulted from an income inclusion of US1 for F1’s taxable year ending on December 31 of year 3 under section 951(a)(1)(A) or 951A(a) because F1 has no subpart F income or tested income for such taxable year. As a result of gain that US1 recognizes on the sale and includes in gross income as a dividend under section 1248(a) by reason of F1’s earnings and profits described in section 959(c)(3), F1’s previously taxed earnings and profits with respect to US1 are increased by £20x under section 959(e) and §1.959-3(c)(1)(vii), concurrently with the sale. This example only discusses the extent to which previously taxed earnings and profits transfer under section 959. See also §1.959-3 (related adjustments to annual PTEP accounts, dollar basis pools, and PTEP tax pools); §1.986(c)-1 (recognition of foreign currency gain or loss with respect to transferred previously taxed earnings and profits).

(ii) Analysis—(A) In general. The sale is a general successor transaction in which F1 is an acquired foreign corporation, US1 is the transferor covered shareholder, and US2 is the successor covered shareholder. See §1.959-7(b)(1). As described in paragraphs (c)(5)(ii)(B) and (C) of this section, there is £72x of general successor PTEP and £20x of section 959(e) successor PTEP. Such previously taxed earnings and profits transfer from US1 to US2, concurrently with the general successor transaction. See §1.959-3(f)(1).

(B) General successor PTEP. General successor PTEP is a pro rata portion of F1’s previously taxed earnings and profits that are with respect to US1 immediately before the general successor transaction (£180x), determined by multiplying all such previously taxed earnings and profits by 40%, which is the percentage of a £180x hypothetical distribution treated as made by F1 immediately before the general successor transaction that would be distributed with respect to stock of F1 that US2 acquires in the general successor transaction. See §1.959-7(c)(1)(i) and (d). Thus, there is £72x of general successor PTEP, sourced pro rata from each PTEP group within each of US1’s annual PTEP accounts with respect to F1. See also §1.959-7(e)(1) and (f)(1) (rules for determining the dollar basis and associated foreign income taxes of general successor PTEP).

(C) Section 959(e) successor PTEP. Section 959(e) successor PTEP is all £20x of F1’s previously taxed earnings and profits with respect to US1 that, under section 959(e), result from the application of section 1248 to gain recognized by US1 in the general successor transaction. See §1.959-7(c)(2); see also §1.959-7(e)(2) and (f)(2) (providing the dollar basis of section 959(e) successor PTEP, and providing that the foreign income taxes associated with section 959(e) successor PTEP is zero).

(iii) Alternative facts: previously taxed earnings and profits not eligible to transfer—(A) Facts. The facts are the same as in paragraph (c)(5)(i) of this section (Example 5), except as follows. F1 has £10x of subpart F income for its taxable year ending on December 31 of year 3 and thus US1 includes £6x (£10x × 60% of stock of F1 retained by US1) in its gross income for such taxable year under section 951(a)(1)(A). Consequently, F1 has an additional £6x of previously taxed earnings and profits with respect to US1 immediately before the sale.

(B) Analysis. The results are the same as described in paragraph (c)(5)(ii) of this section. None of the additional £6x of previously taxed earnings and profits transfer to US2 because the general successor transaction is before December 31 of year 3, the last relevant day of F1’s taxable year that includes the general successor transaction. See §1.959-7(c)(1)(ii).

(iv) Alternative facts: deemed covered shareholder—(A) Facts. The facts are the same as in paragraph (c)(5)(i) of this section (Example 5), except that the purchaser of the shares of stock of F1 is a nonresident alien individual (Individual B).

(B) Analysis. The results are the same as described in paragraph (c)(5)(ii) of this section, applied by substituting the deemed covered shareholder (who is a hypothetical person treated as owning all the stock of F1 owned by Individual B) for US2. See §1.959-7(g). Thus, if a covered shareholder subsequently acquires a portion of Individual B’s stock of F1, then a portion of F1’s previously taxed earnings and profits with respect to the deemed covered shareholder (adjusted consistent with §1.959-3, including to reflect any distributions from F1 to Individual B) transfer from the deemed covered shareholder to the acquiror covered shareholder.

(a) Scope. This section sets forth transition rules for the section 959 regulations. Paragraph (b) of this section addresses the establishment of annual PTEP accounts, dollar basis pools, and corporate PTEP accounts and provides for adjustments to reflect the transition tax under section 965. Paragraph (c) of this section addresses the establishment of PTEP tax pools, corporate PTEP tax pools, adjusted applicable percentages, and section 965(c) deduction percentages. Paragraph (d) of this section treats a domestic partnership (including an S corporation) as a covered shareholder for periods in which §1.958-1(d)(1) does not apply. Paragraph (e) converts accounts of a domestic partnership (including an S corporation) to accounts of covered shareholders owning interests in the domestic partnership when both §1.958-1(d)(1) and the section 959 regulations apply.

(b) Establishing annual PTEP accounts, dollar basis pools, and corporate PTEP accounts and adjustments for section 965 transition tax—(1) In general. When applying the 2019 notice provisions pursuant to §1.959-12(c) (interim application of 2019 notice provisions), or the section 959 regulations (other than §§1.959-8 and 1.959-9) pursuant to §1.959-12(d) (optional early application), to a taxable year of a foreign corporation, annual PTEP accounts, dollar basis pools, and corporate PTEP accounts are established and adjusted in accordance with the rules described in paragraphs (b)(2) and (3) of this section.

(2) Establishment of accounts—(i) In general. As of the beginning of the first taxable year of the foreign corporation to which the 2019 notice provisions apply, or, if earlier, the first taxable year of the foreign corporation to which the section 959 regulations (other than §§1.959-8 and 1.959-9) apply, a reasonable method (consistently applied) must be used to establish annual PTEP accounts, dollar basis pools, and corporate PTEP accounts reflecting the foreign corporation’s previously taxed earnings and profits, including to reflect adjustments to previously taxed earnings and profits that would have been made if the principles of §§1.959-2 through 1.959-5 and 1.959-7 were to have previously applied. Establishing accounts in accordance with the preceding sentence includes conforming any of a covered shareholder’s existing previously taxed earnings and profits accounts with respect to the foreign corporation, or dollar basis accounts with respect to the previously taxed earnings and profits, to the requirements of §1.959-2. In addition, a covered shareholder is treated as consistently applying a reasonable method only if the covered shareholder and any covered shareholders with which the covered shareholder joins in filing a Federal income tax return apply that method with respect to all foreign corporations in which the covered shareholders own stock.

(ii) Multi-year accounts—(A) Previously taxed earnings and profits. To the extent a covered shareholder has an account reflecting previously taxed earnings and profits of the foreign corporation that relate to two or more taxable years and are described in the next sentence (multi-year PTEP account), a reasonable method to conforming the multi-year PTEP account to the requirements of §1.959-2 includes treating such previously taxed earnings and profits as assigned to the general section 959(c)(1) PTEP group or the section 951(a)(1)(A) PTEP group (as applicable) within an annual PTEP account that relates to the last taxable year of the foreign corporation ending on or before December 31, 2017, and the section 904 category to which the multi-year PTEP account relates. Previously taxed earnings and profits are described in this sentence to the extent they are described in section 959(c)(1)(A) by reason of section 951(a)(1)(B) and not by reason of section 959(a)(2); described in section 959(c)(1)(B), including by reason of section 959(a)(3) (before its repeal); or described in section 959(c)(2) by reason of section 951(a)(1)(A) and without regard to section 965(a), 965(b)(4)(A), 951A(f)(2), 245A(e)(2), 959(e), or 964(e)(4).

(B) Dollar basis. To the extent a covered shareholder has an account reflecting the dollar basis of previously taxed earnings and profits of the foreign corporation that relate to two or more taxable years (multi-year dollar basis account), a reasonable method for conforming the multi-year dollar basis account to the requirements of §1.959-2 includes treating previously taxed earnings and profits to which the multi-year dollar basis account relates as having a dollar basis equal to a pro rata portion of the multi-year dollar basis account, and placing that dollar basis into the related dollar basis pool. The pro rata portion is determined by multiplying the multi-year dollar basis account by a fraction, the numerator of which is previously taxed earnings and profits to which the multi-year dollar basis account relates, and the denominator of which is all previously taxed earnings and profits to which the multi-year dollar basis account relates.

(3) Adjustments for section 965 transition tax—(i) Increases for amounts included in gross income under section 951(a)(1)(A) by reason of section 965(a). When adding previously taxed earnings and profits to annual PTEP accounts to reflect an amount a covered shareholder includes in gross income under section 951(a)(1)(A) with respect to the foreign corporation by reason of section 965(a), assign such previously taxed earnings and profits to the section 965(a) PTEP group (rather than the section 951(a)(1)(A) PTEP group).

(ii) Increases for section 965(b) reductions. For purposes of adjusting annual PTEP accounts and dollar basis pools, treat an amount that a covered shareholder would have included in gross income under section 951(a)(1)(A) with respect to the foreign corporation but for section 965(b) and §1.965-1(b)(2) or 1.965-8(b), as applicable, as included in the covered shareholder’s gross income under section 951(a)(1)(A) with respect to the foreign corporation, and assign previously taxed earnings and profits resulting from such treatment to the section 965(b) PTEP group (rather than the section 951(a)(1)(A) PTEP group).

(c) Establishing PTEP tax pools, corporate PTEP tax pools, adjusted applicable percentages, and section 965(c) deduction percentages—(1) In general. As of the beginning of the first taxable year of a foreign corporation to which the section 959 regulations (other than §§1.959-8 and 1.959-9) apply pursuant to §1.959-12(b) (general applicability date) or, if applicable, §1.959-12(d) (optional early application), PTEP tax pools, corporate PTEP tax pools, adjusted applicable percentages, and section 965(c) deduction percentages reflecting the foreign corporation’s previously taxed earnings and profits must be established in accordance with the rules described in paragraphs (c)(2) through (4) of this section.

(2) PTEP tax pools and corporate PTEP tax pools. PTEP tax pools and corporate PTEP tax pools are established by adding a pro rata portion of the foreign corporation’s prior-law PTEP group taxes with respect to a prior-law PTEP group (defined in this paragraph (c)(2)) to each PTEP tax pool with respect to the foreign corporation, determined by multiplying such prior-law PTEP group taxes by a fraction. The numerator of the fraction is the balance of the prior-law PTEP group that is previously taxed earnings and profits relating to the PTEP tax pool, and the denominator of the fraction is the balance of the prior-law PTEP group. For purposes of this paragraph (c)(2), prior-law PTEP group taxes and prior-law PTEP groups mean PTEP group taxes and PTEP groups, respectively, as defined in §1.960-3 as contained in 26 CFR part 1 revised as of April 1, 2024.

(3) Adjusted applicable percentage. An adjusted applicable percentage is established with respect to all of the foreign corporation’s previously taxed earnings and profits assigned to the reclassified section 965(a) PTEP group, reclassified section 965(b) PTEP group, section 965(a) PTEP group, and section 965(b) PTEP group within a covered shareholder’s annual PTEP accounts relating to the same section 904 category by calculating a weighted average of the applicable percentages (as defined in §1.965-5(d)) with respect to the previously taxed earnings and profits. The weighted average is determined as the sum of the product of each such applicable percentage and the amount of previously taxed earnings and profits to which the applicable percentage relates, divided by the sum of the amount of previously taxed earnings and profits described in the preceding sentence. For purposes of this paragraph (c)(3), applicable percentages and previously taxed earnings and profits are determined as of the beginning of the taxable year.

(4) Section 965(c) deduction percentage. A section 965(c) deduction percentage is established with respect to all of the foreign corporation’s previously taxed earnings and profits assigned to the reclassified section 965(a) PTEP group and section 965(a) PTEP group within a covered shareholder’s annual PTEP accounts relating to the same section 904 category by calculating a weighted average of the percentages for which foreign currency gain or loss recognized under section 986(c) with respect to distributions of the previously taxed earnings and profits would be reduced under §1.986(c)-1 as contained in 26 CFR part 1 revised as of April 1, 2024. The weighted average is determined as the sum of the product of each such percentage and the amount of previously taxed earnings and profits to which the percentage relates, divided by the sum of the amount of previously taxed earnings and profits described in the preceding sentence. For purposes of this paragraph (c)(4), percentages for which foreign currency gain or loss would be reduced under §1.986(c)-1 and previously taxed earnings and profits are determined as of the beginning of the taxable year.

(d) Treatment of domestic partnerships (including S corporations) before application of §1.958-1(d)(1). For purposes of the section 959 regulations, a domestic partnership (including an S corporation) is treated as a covered shareholder for any taxable year of the domestic partnership to which §1.958-1(d)(1) does not apply. If a domestic partnership is treated as a covered shareholder, then rules regarding distributions of previously taxed earnings and profits apply to the domestic partnership in its capacity as a covered shareholder before those rules apply to covered shareholders that own interests in the domestic partnership. In such a case, for example, a covered distribution made to the domestic partnership is first a distribution of the distributing foreign corporation’s previously taxed earnings and profits with respect to the partnership and then, to the extent remaining, a distribution of the distributing foreign corporation’s previously taxed earnings and profits with respect to covered shareholders owning interests in the partnership.

(e) Converting domestic partnership-level (including S corporation-level) accounts to partner-level accounts after the application of §1.958-1(d)(1)—(1) In general. As of the beginning of the first taxable year of a domestic partnership (including an S corporation) to which both §1.958-1(d)(1) and the section 959 regulations (other than §§1.959-8 and 1.959-9) apply (pursuant to §1.959-12(c) (general applicability date) or (d) (optional early application)), the domestic partnership’s accounts described in §1.959-2 with respect to a foreign corporation are converted to accounts of covered shareholders owning interests in the partnership in accordance with the rules described in paragraphs (e)(2) through (4) of this section.

(2) Rules for converting accounts-(i) Allocate previously taxed earnings and profits to each covered shareholder—(A) In general. First, allocate a pro rata portion of the foreign corporation’s previously taxed earnings and profits with respect to the domestic partnership to each covered shareholder owning an interest in the partnership at the beginning of the taxable year, determined by multiplying all the foreign corporation’s previously taxed earnings and profits with respect to the partnership by a fraction. The numerator of the fraction is the liquidation value of the covered shareholder’s interest in the partnership, and the denominator of the fraction is the aggregate liquidation value of all partners’ interests in the partnership (determined in each case under paragraph (e)(2)(i)(B) of this section).

(B) Liquidation value. For purposes of this paragraph (e)(2)(i), the liquidation value of a partner’s interest in the partnership is the amount of cash the partner would receive with respect to the interest if, at the beginning of the taxable year, the partnership (and any partnership through which the partner indirectly owns an interest in the partnership) sold all of its property for an amount of cash equal to the fair market value of the property (taking into account section 7701(g)), satisfied all of its liabilities (other than those described in §1.752-7), paid an unrelated third party to assume all of its §1.752-7 liabilities in a fully taxable transaction, and then the partnership (and any partnership through which the partner indirectly owns an interest in the partnership) liquidated. Moreover, any change to a partnership agreement made with a principal purpose of altering the allocation of previously taxed earnings and profits under this paragraph (e)(2)(i) is disregarded.

(ii) Compute dollar basis and associated foreign income taxes. Second, treat the dollar basis of, or foreign income taxes associated with, previously taxed earnings and profits allocated to each covered shareholder as the same as what would be the dollar basis of, or foreign income taxes associated with, the previously taxed earnings and profits under §1.959-4 if the previously taxed earnings and profits were distributed at the beginning of the taxable year.

(iii) Eliminate the domestic partnership’s accounts and increase covered shareholders’ accounts. Third, eliminate the domestic partnership’s annual PTEP accounts, dollar basis pools, and PTEP tax pools with respect to the foreign corporation. Concurrently with such eliminations, increase each covered shareholder’s annual PTEP accounts, dollar basis pools, and PTEP tax pools with respect to the foreign corporation to reflect the foreign corporation’s previously taxed earnings and profits that are allocated to the covered shareholder or the dollar basis of, or foreign income taxes associated with, the previously taxed earnings and profits, as applicable.

(3) Coordination with section 986(c). No foreign currency gain or loss is recognized with respect to previously taxed earnings and profits under section 986(c) as a result of previously taxed earnings and profits ceasing to be with respect to the domestic partnership pursuant to this paragraph (e) (notwithstanding §1.986(c)-1).

(4) Coordination with deemed covered shareholder rules. The portion, if any, of the foreign corporation’s previously taxed earnings and profits with respect to the domestic partnership that does not give rise to an increase to a covered shareholder’s annual PTEP accounts with respect to the foreign corporation under paragraph (e)(1) of this section becomes previously taxed earnings and profits of the foreign corporation with respect to the deemed covered shareholder for purposes of subsequently transferring the previously taxed earnings and profits under section 959. See §1.959-7(g) for rules regarding the deemed covered shareholder.

(a) Scope. This section sets forth applicability dates for the section 959 regulations. Paragraph (b) of this section provides the general applicability dates. Paragraph (c) of this section provides interim application for certain provisions. Paragraph (d) of this section allows early application.

(b) In general. Sections 1.959-1 through 1.959-7 and 1.959-10 and 1.959-11 apply to taxable years of foreign corporations beginning on or after [date of publication of final regulations in the Federal Register] and to taxable years of persons for which such taxable years of those foreign corporations are relevant.

(c) Interim application of 2019 notice provisions—(1) In general. For taxable years of United States shareholders (and successors in interest) ending after December 14, 2018, and to which §§1.959-1 through 1.959-7 and 1.959-10 and 1.959-11 do not apply pursuant to paragraph (b) or (d) of this section, and taxable years of foreign corporations ending with or within such taxable years, the 2019 notice provisions (defined in paragraph (c)(2) of this section) and §1.959-11 apply.

(2) 2019 notice provisions. The 2019 notice provisions means §§1.959-1(c) (treatment of an S corporation), 1.959-2 (accounting of previously taxed earnings and profits), 1.959-3 (adjustments to shareholder-level accounts and, consequently, foreign corporation-level accounts), 1.959-4(e) and 1.959-5(d) (allocation of distributions and section 956 amounts), and the relevant definitions in §1.959-1(b), along with treating previously taxed earnings and profits as distributed under section 959 only to the extent that the distribution is a dividend (as defined in section 316), determined without regard to section 959(d). For purposes of applying the 2019 notice provisions, the PTEP groups listed in the following table may be used in lieu of the PTEP groups listed in §1.959-2, the portions of §§1.959-2 and 1.959-3 relating to PTEP tax pools, corporate PTEP tax pools, adjusted applicable percentages, and section 965(c) deduction percentages do not apply, and the portions of §§1.959-3 through 1.959-5 and 1.959-7 relating to the timing of adjustments and determinations do not apply.

(d) Early application—(1) In general. Sections 1.959-1 through 1.959-7 and 1.959-10 and 1.959-11 may be applied to a taxable year of a foreign corporation not described in paragraph (b) of this section, and then must be applied to all succeeding taxable years of the foreign corporation not described in paragraph (b) of this section, if the conditions described in paragraphs (d)(2) through (4) of this section are satisfied. The foreign corporation described in the preceding sentence is the early application corporation and any taxable years to which the early application corporation applies §§1.959-1 through 1.959-7, 1.959-10, and 1.959-11 pursuant to the preceding sentence are the early application years.

(2) Consistent application condition—(i) In general. The provisions described in paragraph (d)(2)(ii) of this section are applied in their entirety to the early application years and all taxable years of covered shareholders for which the early application years are relevant. In addition, §§1.959-1 through 1.959-7, 1.959-10, and 1.959-11 are applied in their entirety pursuant to paragraph (d) of this section to all taxable years that both are of foreign corporations that are related to the early application corporation and end on or after the later of the last day of the first early application year and the first day on which the foreign corporations are related to the early application corporation. For purposes of the preceding sentence, foreign corporations are related if the foreign corporations bear a relationship to each other described in section 267(b).

(ii) Provisions. The provisions described in this paragraph (d)(2)(ii) are §§1.163(j)-7(g)(2)(ii), 1.245A(d)-1(d), 1.312-6(f), 1.312-8(c), 1.861-20, 1.904-6(e), 1.905-3, 1.905-4(c)(6), 1.951-1, 1.951-2, 1.951A-1(d), 1.951A-2(c)(1)(vi), 1.952-1(c)(4), 1.954-1(c)(1)(iii)(C), 1.959-1 through 1.959-7, 1.959-10, 1.959-11, 1.960-1, 1.960-3, 1.961-1 through 1.961-5, 1.961-8 through 1.961-13, 1.965-5(d)(5), 1.986(a)-1, 1.986(c)-1, and 1.1502-59.

(3) Open period of limitations condition. The period of limitations on assessment for each taxable year described in paragraph (d)(2) of this section is open under section 6501.

(4) Written consent condition. Each covered shareholder described in paragraph (d)(2) of this section provides to the early application corporation a written statement in which the covered shareholder consents to apply the rules described in paragraph (d)(2) of this section to the taxable years of the covered shareholder described in paragraph (d)(2) of this section and affirms that the period of limitations on assessment for each such taxable year is open under section 6501.

Par. 23. Section 1.960-1 is amended by:

The additions and revisions read as follows:

(a) Overview—(1) Scope of §§1.960-1 through 1.960-3. This section and §1.960-2 provide rules for attributing foreign income taxes paid or accrued by a controlled foreign corporation to its income that a corporate United States shareholder of the controlled foreign corporation takes into account in determining its subpart F inclusion or GILTI inclusion amount. This section provides definitions, identifies the statutory and residual groupings for purposes of section 960(a) and (d), and sets forth computational rules for determining the amount of income and taxes assigned to each grouping. Section 1.960-2 provides rules for computing the amount of foreign income taxes deemed paid by a corporate United States shareholder of a controlled foreign corporation under section 960(a) and (d). Section 1.960-3 provides rules for determining the foreign income taxes that are deemed paid by a corporate United States shareholder in a controlled foreign corporation, or by a controlled foreign corporation that is a shareholder in another controlled foreign corporation, under section 960(b). This section, §1.960-2, and §1.960-3 provide the exclusive rules for determining the foreign income taxes deemed paid by a domestic corporation or controlled foreign corporation under section 960. Only foreign income taxes paid or accrued by a controlled foreign corporation that are properly attributable under these rules to an item of income that a corporate United States shareholder of the controlled foreign corporation includes as a subpart F inclusion or GILTI inclusion amount may be deemed paid by the domestic corporation under section 960(a) or (d). Only foreign income taxes that are properly attributable under §1.960-3 to previously taxed earnings and profits that are distributed by a controlled foreign corporation may be deemed paid by a domestic corporation or a controlled foreign corporation under section 960(b). This section, §1.960-2, and §1.960-3 also apply for purposes of any provision that treats a taxpayer as a domestic corporation that is deemed to pay foreign income taxes or treats a foreign corporation as a controlled foreign corporation for purposes of section 960. See, for example, sections 962(a)(2) and 1293(f).

* * * * *

(b) * * *

(1) Annual PTEP account. The term annual PTEP account has the meaning provided in §1.959-1(b).

* * * * *

(3) Current taxable year. The term current taxable year means the U.S. taxable year of a controlled foreign corporation which ends with or within the U.S. taxable year of a United States shareholder of the controlled foreign corporation.

* * * * *

(15) Previously taxed earnings and profits. The term previously taxed earnings and profits has the meaning provided in §1.959-1(b).

(16) PTEP group. The term PTEP group has the meaning provided in §1.959-1(b).

(17) PTEP realization event. The term PTEP realization event has the meaning provided in §1.959-1(b).

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(21) Specified section 959(a) distribution. The term specified section 959(a) distribution means a distribution of previously taxed earnings and profits, as determined under §1.959-4, that a domestic corporation that is a United States shareholder in a controlled foreign corporation receives (or is treated as receiving pursuant to §1.959-4(c)(3)) from the controlled foreign corporation and that is excluded from the income of the recipient domestic corporation under §1.959-4(b)(1).

(22) Section 959(b) distribution. The term section 959(b) distribution means a distribution of previously taxed earnings and profits, as determined under §1.959-4, that a controlled foreign corporation receives from another controlled foreign corporation and that is excluded from the income of the recipient controlled foreign corporation for purposes of determining the recipient controlled foreign corporation’s subpart F income and tested income or tested loss under §1.959-4(b)(2).

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(c) * * *

(1) * * *

(i) First, items of gross income of a controlled foreign corporation for the current taxable year are assigned to section 904 categories and included in income groups within those section 904 categories under the rules in paragraph (d)(2) of this section. See section 959 and the regulations thereunder for rules regarding the receipt of a section 959(b) distribution by a controlled foreign corporation.

(ii) Second, deductions (other than for current year taxes) of a controlled foreign corporation for the current taxable year are allocated and apportioned to reduce gross income in the section 904 categories and the income groups within a section 904 category. See paragraph (d)(3)(i) of this section. Additionally, the functional currency amounts of current year taxes are allocated and apportioned to reduce gross income in the section 904 categories and the income groups within a section 904 category. See paragraph (d)(3)(ii) of this section. For rules regarding the allocation and apportionment of foreign income taxes paid or accrued by a foreign corporation to previously taxed earnings and profits, see §1.959-6.

(iii) Third, for purposes of computing foreign income taxes deemed paid under section 960(a) and (d), eligible current year taxes that were allocated and apportioned to income groups in the section 904 categories are translated into U.S. dollars in accordance with section 986(a) and §1.986(a)-1.

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(v) Fifth, paragraphs (c)(1)(i) through (iv) of this section are repeated for each next higher-tier controlled foreign corporation in the chain.

(vi) Sixth, with respect to the highest-tier controlled foreign corporation in a chain that is owned directly (or indirectly through one or more partnerships) by the domestic corporation, foreign income taxes that are deemed paid under section 960(b)(1) in connection with the receipt of a specified section 959(a) distribution by the domestic corporation are computed under the rules of §1.960-3.

(2) Current taxable year items. For a current taxable year, the items of income and deductions (including for taxes), and the U.S. dollar amounts of current year taxes, that are included in the computations described in this section are the items that a controlled foreign corporation accrues and takes into account during the current taxable year. An item of income with respect to a current taxable year does not include an amount included as subpart F income of a controlled foreign corporation by reason of the recharacterization of a recapture account established in a prior U.S. taxable year (and the corresponding earnings and profits) of the controlled foreign corporation under section 952(c)(2) and §1.952-1(f).

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(d) * * *

(1) Scope. This paragraph (d) provides rules for assigning gross income (including gains) of a controlled foreign corporation for the current taxable year to a section 904 category and income group within a section 904 category, and for allocating and apportioning deductions (including losses and current year taxes) and the U.S. dollar amount of eligible current year taxes of the controlled foreign corporation for the current taxable year among the section 904 categories and income groups within a section 904 category. See §1.959-6 for rules for allocating and apportioning foreign income taxes paid or accrued by a foreign corporation to previously taxed earnings and profits.

(2) * * *

(i) Assigning items of gross income to section 904 categories. Items of gross income of a controlled foreign corporation for the current taxable year are first assigned to a section 904 category of the controlled foreign corporation under §§1.904-4 and 1.904-5. Income of a controlled foreign corporation cannot be assigned to the section 951A category. See §1.904-4(g). But see §1.959-2(b)(2)(i) for rules relating to the assignment of previously taxed earnings and profits to PTEP groups within an annual PTEP account, which may assign previously taxed earnings and profits to the section 951A PTEP group.

(ii) * * *

(A) In general. Gross income within a section 904 category is assigned to a subpart F income group, tested income group, or residual income group under the rules of this paragraph (d)(2)(ii). See §1.959-2(d) for rules regarding the accounting of previously taxed earnings and profits by a foreign corporation.

* * * * *

(D) Residual income group. The term residual income group means the income group within a section 904 category that is not in a subpart F income group or tested income group. For purposes of this paragraph (d)(2)(ii)(D), treat items of gross income that give rise to previously taxed earnings and profits described in §1.959-6(b) as gross income in a residual income group. See paragraph (d)(3)(ii)(B) of this section for rules regarding the assignment of foreign gross income to the statutory and residual groupings of income of a controlled foreign corporation when the controlled foreign corporation pays or accrues current year taxes with respect to a PTEP realization event that occurs in a different taxable year.

* * * * *

(3) Allocation and apportionment of deductions among section 904 categories and income groups within a section 904 category—(i) In general. Gross income of a controlled foreign corporation in each income group within each section 904 category is reduced by deductions (including losses and current year taxes) of the controlled foreign corporation for the current taxable year under the rules in this paragraph (d)(3)(i). For purposes of this paragraph (d)(3), allocate and apportion current year taxes arising by reason of a PTEP realization event that occurs in the same taxable year to the residual income group within a section 904 category under §1.959-6(c). For additional rules regarding the allocation and apportionment of deductions (including foreign income taxes) paid or accrued by a foreign corporation to previously taxed earnings and profits, see §1.959-6.

(A) * * * See paragraph (d)(3)(ii) of this section for special rules for allocating and apportioning current year taxes to section 904 categories and income groups.

* * * * *

(ii) * * *

(A) * * * For special rules regarding current year taxes paid or accrued with respect to a PTEP realization event that occurs in a different taxable year, see paragraph (d)(3)(ii)(B) of this section. For purposes of determining foreign income taxes deemed paid under section 960(a) and (d) and §1.960-2, the U.S. dollar amount of eligible current year taxes is assigned to the section 904 categories and income groups to which the eligible current year taxes are allocated and apportioned.

(B) Current year taxes that a controlled foreign corporation pays or accrues that relate to a PTEP realization event that occurs in a different U.S. taxable year. If a current year tax is allocated and apportioned by reference to foreign gross income that includes previously taxed earnings and profits with respect to a PTEP realization event that occurs in a different taxable year, the foreign gross income is assigned to the subpart F income group, tested income group, or residual income group to which the income that gave rise to the previously taxed earning and profits would be assigned if that income were recognized by that controlled foreign corporation under Federal income tax principles in the current taxable year. For example, a net basis tax paid or accrued with respect to a section 959(b) distribution that occurred in the preceding taxable year would be assigned to a section 904 category and to a subpart F income group, tested income group, or residual income group by reference to the income that gave rise to the previously taxed earnings and profits.

(e) Current year taxes related to a residual income group are not deemed paid. Current year taxes paid or accrued by a controlled foreign corporation that are allocated and apportioned under paragraph (d)(3)(ii) of this section to a residual income group cannot be deemed paid under section 960 for any taxable year, except to the extent such taxes are allocated and apportioned to previously taxed earnings and profits under §1.959-6 and deemed paid by a domestic corporation under §1.960-3.

(f) Example. The following example illustrates the application of this section and §1.960-3.

(1) Facts—(i) CFC1 and CFC2. CFC1, a controlled foreign corporation, conducts business in Country X. CFC1 uses the “u” as its functional currency. At all relevant times, 1u=$1. CFC1 owns all the stock of CFC2, a controlled foreign corporation. All the stock of CFC1 and CFC2 is owned (within the meaning of section 958(a)) by corporate United States shareholders that use the calendar year as their U.S. taxable year. CFC1 and CFC2 both use the calendar year as their U.S. and foreign taxable years.

(ii) Income of CFC1 and CFC2. In Year 3, CFC1 earns 2,000,000u of gross income that is foreign base company sales income, and 1,000,000u of interest income from unrelated persons, for both U.S. and Country X tax law purposes. Under Country X tax law, CFC1’s interest income is exempt from tax. In Year 3, CFC1 also receives a section 959(b) distribution from CFC2 of 4,000,000u of previously taxed earnings and profits, in the general category and relating to a single PTEP group and taxable year. There are no foreign income taxes associated with the previously taxed earnings and profits distributed by CFC2 at the level of CFC2 under §1.959-4. The section 959(b) distribution is treated as a dividend taxable to CFC1 under Country X tax law. In Year 3, CFC2 earns no gross income and receives no distributions.

(iii) Deductions of CFC1 and CFC2 other than taxes. For both U.S. and Country X tax purposes, in Year 3, CFC1 incurs 1,500,000u of deductible expenses other than current year taxes that are allocable to all gross income. For U.S. tax purposes, under §§1.861-8 through 1.861-14T, 1,000,000u of the deductions are apportioned to CFC1’s foreign base company sales income and 500,000u of the deductions are apportioned to CFC1’s interest income. Under Country X tax law, 1,000,000u of deductions are apportioned to the 4,000,000u treated as a dividend, and 500,000u of deductions are apportioned to the 2,000,000u of foreign base company sales income. Under Country X tax law, no deductions are apportioned to the interest income. Under Country X tax law, CFC1 pays eligible current year taxes of 900,000u on a base of 4,500,000u (7,000,000u gross income × 1,000,000u exemption and 1,500,000u deductions) consisting of 3,000,000u (4,000,000u × 1,000,000u) of previously taxed earnings and profits, 1,000,000u of interest income (exempt from tax under Country X law), and 1,500,000u (2,000,000u × 500,000u) of foreign base company sales income. In Year 3, CFC2 has no expenses (including current year taxes).

(2) Analysis—(i) CFC2. Under paragraph (c)(1) of this section, the computational rules of paragraph (c)(1) of this section are applied beginning with CFC2. However, CFC2 has no gross income or expenses in Year 3. Accordingly, the computational rules in paragraphs (c)(1)(i) through (iv) of this section are not relevant with respect to CFC2. Under paragraph (c)(1)(v) of this section, the rules in paragraph (c)(1)(i) through (iv) of this section are then applied to CFC1.

(ii) CFC1—(A) Step 1. Under paragraph (c)(1)(i) of this section, CFC1’s items of gross income for the current taxable year are assigned to section 904 categories and included in income groups within those section 904 categories. Under paragraph (d)(2)(i) of this section and §1.904-4, the interest income is passive category income and the foreign base company sales income is general category income. Under paragraph (d)(2)(ii) of this section, the 1,000,000u of interest income is assigned to a subpart F income group (the “FPHCI income group”) within the passive category because it is foreign personal holding company income described in §1.954-1(c)(1)(iii)(A)(1)(i) that falls within a single group of income under §1.904-4(c)(3)(iii) for passive income that is subject to no withholding tax or other foreign tax. The 2,000,000u of foreign base company sales income is assigned to a subpart F income group within the general category (the “FBCSI income group”), because it is foreign base company income described in §1.954-1(c)(1)(iii)(A)(2)(i). Under paragraph (d)(2) of this section, the 4,000,000u of previously taxed earnings and profits is treated as a U.S. dividend amount (as defined in §1.861-20(b)(21)) and is assigned to the residual income group within the general category for purposes of applying section 960(a) and (d) and §§1.960-1 and 1.960-2.

(B) Step 2—(1) Allocation and apportionment of deductions other than taxes. Under paragraph (c)(1)(ii) of this section, CFC1’s deductions for the current taxable year are allocated and apportioned among the section 904 categories and income groups within a section 904 category that were increased as provided in paragraph (c)(1)(i) of this section. Under paragraph (d)(3)(i) of this section and §§1.861-8 through 1.861-14T, 1,000,000u of deductions are allocated and apportioned to the FBCSI income group within the general category, and 500,000u of deductions are allocated and apportioned to the FPHCI income group within the passive category. Therefore, CFC1 has 1,000,000u (2,000,000u × 1,000,000u) of pre-tax income attributable to the FBCSI income group within the general category and 500,000u (1,000,000u × 500,000u) of pre-tax income attributable to the FPHCI income group within the passive category. For U.S. tax purposes, no deductions other than eligible current year taxes are allocated and apportioned to the 4,000,000u of previously taxed earnings and profits in CFC1’s residual income group within the general category because no deductions of CFC1 other than deductions for current year taxes are allocated and apportioned to previously taxed earnings and profits under section 861. See paragraph (d)(3)(i) of this section and §1.959-6(d)(1).

(2) Allocation and apportionment of current year taxes. Under paragraph (c)(1)(ii) of this section, CFC1’s current year taxes are allocated and apportioned among the section 904 categories and income groups within a section 904 category that were increased as provided in paragraph (c)(1)(i) of this section. Under paragraphs (d)(3)(i) and (ii) of this section, for purposes of allocating and apportioning taxes to reduce the income in a section 904 category or an income group, §1.861-20 (as modified by §1.904-6(c)) is applied to determine the amount of foreign taxable income, computed under Country X tax law but characterized under Federal income tax law, in each section 904 category and income group that is included in the Country X tax base. For Country X tax purposes, 1,000,000u of deductions are allocated and apportioned to CFC1’s 4,000,000u of previously taxed earnings and profits, which is assigned to the residual income grouping within the general category, 500,000u of deductions are allocated and apportioned to the FBCSI income group within the general category, and no deductions are allocated and apportioned to the FPHCI income group in the passive category. Therefore, for Country X tax purposes, CFC1 has 3,000,000u of foreign taxable income assigned to the residual income group within the general category, 1,500,000u of foreign taxable income assigned to the FBCSI income group within the general category, and no taxable income assigned to the FPHCI income group within the passive category. Under paragraphs (d)(3)(i) and (ii) of this section and §1.959-6, 600,000u (3,000,000u/4,500,000u × 900,000u) of the 900,000u eligible current year taxes paid by CFC1 are related to the residual income group within the general category, and 300,000u (1,500,000u/4,500,000u × 900,000u) are related to the FBCSI income group within the general category. No current year taxes are allocated or apportioned to the FPHCI income group within the passive category because the interest expense is exempt from Country X tax. See §1.959-6 for rules allocating and apportioning the 600,000u of current year taxes among the corporate PTEP accounts, section 904 categories, and PTEP groups. Thus, for U.S. tax purposes, CFC1 has 3,400,000u of previously taxed earnings and profits (4,000,000u × 600,000u) in the residual income group within the general category (see §§1.959-2 and 1.959-3 for rules relating to accounting for previously taxed earnings and profits), 500,000u of income in the FPHCI income group within the passive category, and 700,000u of income (1,000,000u × 300,000u) in the FBCSI income group within the general category.

(C) Step 3. Under paragraph (c)(1)(iii) of this section, for purposes of computing foreign income taxes deemed paid under section 960(a), CFC1 has $300,000 of current year taxes in the FBCSI income group within the general category. Under paragraph (e) of this section, the United States shareholders of CFC1 cannot claim a credit with respect to the $600,000 of taxes on CFC1’s income in the residual income group under section 960, except to the extent the taxes are allocated and apportioned to previously taxed earnings and profits under §1.959-6 and deemed paid by a domestic corporation under section 960(b) and §1.960-3.

(D) Step 4. Under paragraph (c)(1)(iv) of this section, the United States shareholders of CFC1 compute current year taxes deemed paid under section 960(a) and (d) and the rules of §1.960-2. None of the Country X tax is allocated to CFC1’s FPHCI income group. Therefore, there are no current year taxes deemed paid by CFC1’s United States shareholders with respect to their passive category subpart F inclusions. Country X tax equal to $300,000 is allocated and apportioned to CFC1’s FBCSI income group. Therefore, $300,000 of the current year taxes are deemed paid by CFC1’s United States shareholders with respect to their general category subpart F inclusions. See §1.960-2(b)(5) and (c)(7) for examples of the application of section 960(a) and (d) and the rules in §1.960-2. The remaining $600,000 of Country X tax is allocated and apportioned to the residual income group within the general category with respect to the previously taxed earnings and profits and will generally be allocated and apportioned to previously taxed earnings and profits under the rules in §1.959-6.

(E) Step 5. Paragraph (c)(1)(v) of this section does not apply because CFC1 is the highest-tier controlled foreign corporation in the chain.

(F) Step 6. Paragraph (c)(1)(vi) of this section does not apply because CFC1 did not make a specified section 959(a) distribution.

Par. 24. Section 1.960-3 is revised to read as follows:

(a) Scope. This section provides rules for determining foreign income taxes that are deemed paid under section 960(b) with respect to the receipt of distributions of previously taxed earnings and profits. Paragraph (b) of this section describes the foreign income taxes that a domestic corporation is deemed to pay with respect to its receipt of a specified section 959(a) distribution. Paragraph (c) of this section describes the foreign income taxes that a controlled foreign corporation is deemed to pay with respect to its receipt of a section 959(b) distribution. For rules regarding the maintenance and adjustment by a foreign corporation of corporate PTEP accounts and corporate PTEP tax pools with respect to each of its covered shareholders, see §1.959-2(d). For rules regarding the maintenance and adjustment by a covered shareholder of annual PTEP accounts and PTEP tax pools with respect to a foreign corporation in which it owns stock, see §§1.959-2(b) and 1.959-3(c) and (e).

(b) Foreign income taxes deemed paid under section 960(b)(1)—(1) In general. A domestic corporation that is a United States shareholder of a controlled foreign corporation is deemed to have paid the foreign income taxes that are properly attributable to a specified section 959(a) distribution that it receives from the controlled foreign corporation and that have not been deemed to have been paid by a domestic corporation under section 960 for the current taxable year or any prior taxable year. A credit for foreign income taxes deemed paid under this section may be subject to disallowance under other provisions of the Code or regulations in this title that apply at the level of the United States shareholder.

(2) Properly attributable. The foreign income taxes that are properly attributable to a specified section 959(a) distribution are the foreign income taxes that are removed under §§1.959-2(d)(2) and 1.959-3(e)(1)(iii) from each creditable PTEP tax group (as defined in §1.959-2(b)(4)(ii)) by reason of the specified section 959(a) distribution.

(c) Foreign income taxes deemed paid under section 960(b)(2)—(1) In general. A controlled foreign corporation is deemed to have paid the foreign income taxes that are properly attributable to a section 959(b) distribution that it receives from another controlled foreign corporation and that have not been deemed to have been paid by a domestic corporation under section 960 for the current taxable year or any prior taxable year.

(2) Properly attributable. The foreign income taxes that are properly attributable to a section 959(b) distribution received by a controlled foreign corporation are the foreign income taxes that are removed under §§1.959-2(d)(2) and 1.959-3(e)(1)(iii) from each creditable PTEP tax group (as defined in §1.959-1(b)) by reason of the section 959(b) distribution.

Par. 25. Section 1.960-7 is amended by:

The addition reads as follows:

* * * * *

(c) Sections 1.960-1 and 1.960-3 apply to taxable years of a foreign corporation that begin on or after [date of publication of final regulations in the Federal Register] or are early application years (as described in §1.959-12(d)), and to taxable years of a domestic corporation that is a United States shareholder of the foreign corporation in which or with which such taxable years of such foreign corporation end. See §§1.960-1 and 1.960-3 as contained in 26 CFR part 1 revised as of April 1, 2024, for a version of these sections applicable to prior taxable years.

Par. 26. Section 1.961-1 is revised to read as follows:

(a) Overview—(1) In general. The section 961 regulations provide rules for basis adjustments related to previously taxed earnings and profits. Section 1.961-1 sets forth definitions and rules of general applicability. Section 1.961-2 describes the types of property units and types of basis for purposes of applying section 961. Section 1.961-3 provides basis increases for income inclusions. Section 1.961-4 provides reductions to basis and gain recognition for distributions of previously taxed earnings and profits. Section 1.961-5 provides basis adjustments for foreign currency gain or loss and for general successor transactions. Sections 1.961-6 and 1.961-7 are reserved. Section 1.961-8 describes the consequences of positive derived basis. Section 1.961-9 describes the consequences of positive section 961(c) basis. Section 1.961-10 describes the consequences of negative derived basis and negative section 961(c) basis. Section 1.961-11 provides for the inclusion by United States shareholders in a controlled foreign corporation of the controlled foreign corporation’s income arising under section 961(c). Section 1.961-12 provides examples illustrating the application of the section 961 regulations. Section 1.961-13 sets forth transition rules. Section 1.961-14 sets forth applicability dates. See §1.1502-59 for additional rules for a consolidated group.

(2) Scope. This section sets forth definitions and rules of general applicability for purposes of the section 961 regulations. Paragraph (b) of this section provides definitions. Paragraph (c) of this section provides rules relating to S corporations. Paragraph (d) of this section provides an anti-avoidance rule.

(b) Definitions. The definitions in §1.959-1(b) apply for purposes of the section 961 regulations, with the following additions.

Acquired partnership. The term acquired partnership has the meaning provided in §1.961-5(c)(1).

Common basis. The term common basis means a partnership’s adjusted basis of an item of property, excluding any basis that is solely with respect to a specific partner (for example, a section 743(b) basis adjustment or derived basis).

Covered gain. The term covered gain has the meaning provided in §1.961-9(c)(1).

Derived basis. The term derived basis means basis described in §1.961-2(d)(2).

Derivative ownership unit. The term derivative ownership unit has the meaning provided in §1.961-2(d)(1).

Lookback PTEP. The term lookback PTEP has the meaning provided in §1.961-9(f)(3)(ii).

Lower-tier partnership interest. The term lower-tier partnership interest has the meaning provided in §1.961-8(d).

Midyear transaction. The term midyear transaction has the meaning provided in §1.961-3(c)(2).

Mirrored PTEP. The term mirrored PTEP has the meaning provided in §1.961-9(f)(2)(ii).

Negative derived basis. The term negative derived basis means the amount by which derived basis with respect to a covered shareholder of a derivative ownership unit is less than zero.

Negative section 961(c) basis. The term negative section 961(c) basis means the amount by which section 961(c) basis with respect to a covered shareholder of a section 961(c) ownership unit is less than zero.

Net foreign currency gain. The term net foreign currency gain has the meaning provided in §1.961-5(b)(2).

Net foreign currency loss. The term net foreign currency loss has the meaning provided in §1.961-5(b)(2).

Nonrecognition transaction. The term nonrecognition transaction has the meaning provided in section 7701(a)(45).

Positive derived basis. The term positive derived basis means the amount by which derived basis with respect to a covered shareholder of a derivative ownership unit is greater than zero.

Positive section 961(c) basis. The term positive section 961(c) basis means the amount by which section 961(c) basis with respect to a covered shareholder of a section 961(c) ownership unit is greater than zero.

Property unit. The term property unit has the meaning provided in §1.961-2(b).

Relevant taxable year. The term relevant taxable year has the meaning provided in §1.961-3(b).

Section 951(a)(1)(A) inclusion amount. The term section 951(a)(1)(A) inclusion amount has the meaning provided in §1.961-3(c)(1)(ii).

Section 951(a)(1)(B) inclusion amount. The term section 951(a)(1)(B) inclusion amount has the meaning provided in §1.961-3(c)(1)(iii).

Section 961 regulations. The term section 961 regulations means the regulations in this part issued under section 961.

Section 961(a) ownership unit. The term section 961(a) ownership unit has the meaning provided in §1.961-2(c).

Section 961(c) basis. The term section 961(c) basis means basis described in §1.961-2(e)(2).

Section 961(c) income. The term section 961(c) income has the meaning provided in §1.961-11(b).

Section 961(c) ownership unit. The term section 961(c) ownership unit has the meaning provided in §1.961-2(e)(1).

Section 961(c) PTEP. The term section 961(c) PTEP has the meaning provided in §1.961-9(f)(1).

Transferred units. The term transferred units has the meaning provided in §1.961-8(b)(1) or §1.961-9(c)(1), as applicable.

Transferring partnership. The term transferring partnership has the meaning provided in §1.961-8(b)(1).

Upper-tier partnership. The term upper-tier partnership has the meaning provided in §1.961-8(d).

(c) Treatment of an S corporation—(1) In general. Except as provided in paragraph (c)(2) of this section, for purposes of the section 961 regulations, an S corporation is treated in the same manner as a domestic partnership, a reference to a domestic partnership includes an S corporation, and shareholders of an S corporation are treated as partners of such partnership. See section 1373(a). As applicable, the treatment of an S corporation and its shareholders under the preceding sentence is determined by replacing any partnership-specific provision with the equivalent provision for S corporations (for example, a reference to an adjustment under section 705 to a partner’s basis in its partnership interest refers to the adjustment under section 1367 to a shareholder’s basis in its stock of an S corporation).

(2) Treatment as a covered shareholder for taxable years for which elective entity treatment applies for §1.958-1(d)(1) purposes. See §1.961-13(c) for a rule treating an S corporation as a covered shareholder for any taxable year of the S corporation for which §1.958-1(d)(1) does not apply and §1.961-13(d) for a transition rule converting basis with respect to an S corporation to basis with respect to covered shareholders owning interests in the S corporation once the S corporation is no longer treated as a covered shareholder.

(d) Anti-avoidance rule. If a transaction, series of transactions, plan, or arrangement is engaged in with a principal purpose of avoiding the purposes of section 961 and the section 961 regulations, then appropriate adjustments are made, which may include adjustments to disregard the transaction, series of transactions, plan, or arrangement.

Par. 27. Section 1.961-2 is revised to read as follows:

(a) Scope. This section describes the types of property units and types of basis for purposes of applying section 961. Paragraph (b) of this section defines a property unit and provides the general rule for basis of a property unit. Paragraphs (c) through (e) of this section provide definitions and rules for section 961(a) ownership units, derivative ownership units, and section 961(c) ownership units, respectively. See §§1.961-3 through 1.961-11 for basis adjustments and the effects of basis and §1.961-12(c)(1) (Example 1) for an example illustrating the application of this section.

(b) Property unit. A property unit is a section 961(a) ownership unit, derivative ownership unit, or section 961(c) ownership unit, as applicable (defined in paragraphs (c) through (e) of this section). Basis in a property unit must be established and maintained in U.S. dollars in accordance with this section and the adjustments prescribed in the section 961 regulations.

(c) Section 961(a) ownership unit. A section 961(a) ownership unit is a share of stock of a foreign corporation directly owned by a covered shareholder, or an interest in a partnership directly owned by a covered shareholder and through which the covered shareholder owns stock of a foreign corporation. A covered shareholder is provided adjusted basis in a section 961(a) ownership unit.

(d) Derivative ownership unit—(1) In general. A derivative ownership unit is a share of stock of a foreign corporation directly owned by a partnership and owned (indirectly) by one or more covered shareholders through only one or more partnerships, or an interest in a partnership directly owned by another partnership and through which one or more covered shareholders own stock of a foreign corporation through only partnerships. A partnership is provided derived basis in a derivative ownership unit in accordance with paragraph (d)(2) of this section.

(2) Derived basis. Derived basis is basis of a derivative ownership unit that must be established and maintained separately with respect to each covered shareholder that owns the derivative ownership unit through only one or more partnerships. Derived basis with respect to a covered shareholder may be a positive or negative amount and is treated as an attribute of the partnership that directly owns the derivative ownership unit.

(e) Section 961(c) ownership unit—(1) In general. A section 961(c) ownership unit is a share of stock of a foreign corporation directly owned by a controlled foreign corporation and owned (indirectly) by one or more covered shareholders. A controlled foreign corporation is provided section 961(c) basis in a section 961(c) ownership unit in accordance with paragraph (e)(2) of this section.

(2) Section 961(c) basis. Section 961(c) basis is basis of a section 961(c) ownership unit that must be established and maintained separately with respect to each covered shareholder that owns the section 961(c) ownership unit. Section 961(c) basis with respect to a covered shareholder may be a positive or negative amount and is treated as an attribute of the controlled foreign corporation that directly owns the section 961(c) ownership unit. Section 961(c) basis applies only for the purposes prescribed in the section 961 regulations and, therefore, for example does not affect the amount of the controlled foreign corporation’s gross income or the amount of its earnings and profits.

Par. 28. Sections 1.961-3 through 1.961-14 are added to read as follows:

Sec.

* * * * *

1.961-3 Basis increases for certain income inclusions.

1.961-4 Basis reductions and gain recognition for distributions.

1.961-5 Basis adjustments for foreign currency gain or loss and for general successor transactions.

1.961-6 and 1.961-7 [Reserved]

1.961-8 Application of positive derived basis to covered shareholders’ distributive shares of gain or loss.

1.961-9 Exclusion from gross income of previously taxed earnings and profits resulting from positive section 961(c) basis.

1.961-10 Gain recognition for negative basis.

1.961-11. Amounts included in gross income of United States shareholders.

1.961-12 Examples.

1.961-13 Transition rules.

1.961-14 Applicability dates.

* * * * *

(a) Scope. This section provides the increases to basis under section 961 for inclusions under sections 951(a) and 951A(a) and §1.961-11. Paragraph (b) of this section provides the general rule, pursuant to which, to reflect a covered shareholder’s income inclusions for a controlled foreign corporation’s taxable year, basis of certain property units (shares of stock of the controlled foreign corporation directly owned by the covered shareholder, property through which the covered shareholder owns (indirectly) stock of the controlled foreign corporation, and shares of stock of the controlled foreign corporation owned (indirectly) by the covered shareholder), is increased. Paragraph (c) of this section describes the specific rules for increasing basis pursuant to paragraph (b) of this section. Paragraph (d) of this section determines certain basis increases based on distributions of previously taxed earnings and profits by the controlled foreign corporation during the taxable year. Paragraph (e) of this section determines certain basis increases based on a hypothetical distribution, to the extent paragraph (d) of this section does not increase basis. Paragraph (f) of this section provides limitations on basis increases in certain cases. See §1.961-12(c)(2) (Example 2) for an example illustrating the application of this section.

(b) In general. To reflect a covered shareholder’s income inclusions for a taxable year of a controlled foreign corporation (such taxable year for which this section is being applied, the relevant taxable year), basis of property units that are shares of stock of the controlled foreign corporation owned by the covered shareholder, and basis of any property units through which the covered shareholder owns stock of the controlled foreign corporation, is in each case increased in accordance with the rules described in paragraph (c) of this section. Generally, under those rules, basis increases begin at the level of stock of the controlled foreign corporation and then tier through property units through which the covered shareholder owns such stock, with at each level basis increases allocated among property units based on how previously taxed earnings and profits resulting from the income inclusions are, or likely will be, distributed on the property units (thus, the allocations may differ from the extent to which the income inclusions are attributable to the property units). Solely for purposes of this section, a reference to the basis of a property unit means adjusted basis in the case of a section 961(a) ownership unit, derived basis with respect to the covered shareholder in the case of a derivative ownership unit, or section 961(c) basis with respect to the covered shareholder in the case of a section 961(c) ownership unit.

(c) Rules for increasing basis—(1) Determine amount of income inclusions giving rise to increases to basis—(i) In general. First, determine the amount of the covered shareholder’s income inclusions with respect to the controlled foreign corporation for the relevant taxable year that give rise to increases to basis under section 961, computed as the sum of the section 951(a)(1)(A) inclusion amount and section 951(a)(1)(B) inclusion amount (defined in paragraphs (c)(1)(ii) and (iii) of this section).

(ii) Section 951(a)(1)(A) inclusion amount. The section 951(a)(1)(A) inclusion amount is the sum of any amount (in U.S. dollars) that the covered shareholder includes in gross income with respect to the controlled foreign corporation for the relevant taxable year under section 951(a)(1)(A) or 951A(a) or §1.961-11.

(iii) Section 951(a)(1)(B) inclusion amount. The section 951(a)(1)(B) inclusion amount is the amount (in U.S. dollars) that the covered shareholder includes in gross income with respect to the controlled foreign corporation for the relevant taxable year under section 951(a)(1)(B).

(2) Determine if any midyear transactions occur. Second, determine if any midyear transactions (which affect the timing of certain basis adjustments under paragraphs (d) and (e) of this section) occur within the relevant taxable year. A midyear transaction is any sale, exchange, or other disposition (including an issuance or redemption) occurring before the last relevant day of the relevant taxable year and involving one or more items of property that, immediately before or after the sale, exchange, or other disposition are stock of the controlled foreign corporation owned by the covered shareholder or property through which the covered shareholder owns stock of the controlled foreign corporation.

(3) Apply actual distribution rule. Third, if, before the last relevant day of the relevant taxable year, the controlled foreign corporation distributes previously taxed earnings and profits with respect to the covered shareholder in a covered distribution (determined under §1.959-4), then increase basis for a portion of the section 951(a)(1)(A) inclusion amount in accordance with paragraph (d) of this section.

(4) Apply hypothetical distribution rule. Fourth, increase basis for any remaining portion of the section 951(a)(1)(A) inclusion amount and the section 951(a)(1)(B) inclusion amount in accordance with paragraph (e) of this section.

(d) Actual distribution rule—(1) In general. For each distribution described in paragraph (c)(3) of this section (starting with the earliest distribution), increase basis of property units that are shares of stock of the controlled foreign corporation and, if applicable, property units through which the covered shareholder owns such shares, in accordance with paragraphs (d)(2) and (3) of this section. Treat each such increase to basis as made at the beginning of the first day of the relevant taxable year, unless the distribution is made after any midyear transactions, in which case treat each such increase as made immediately after the midyear transaction that most recently precedes the distribution.

(2) Increases to basis of shares of stock of the controlled foreign corporation. Increase the basis of each property unit that is a share of stock of the controlled foreign corporation that the covered shareholder owns on the last relevant day of the relevant taxable year by the amount of the adjustment required under §1.961-4 (basis reductions and gain recognition for distributions) to such basis by reason of the distribution, subject to the following limitation. Do not increase the basis of the share by an amount greater than the product of the section 951(a)(1)(A) inclusion amount, reduced by all increases to basis under this paragraph (d)(2) by reason of earlier distributions, and a fraction, the numerator of which is the portion of the distribution that is made with respect to the share, and the denominator of which is the amount of the distribution.

(3) Increases to basis of property units through which the covered shareholder owns stock of the controlled foreign corporation. If, when the distribution is made, the covered shareholder owns stock of the controlled foreign corporation through one or more property units, then increase the basis of each such property unit by the portion of the hypothetical distribution described in paragraph (e)(2) of this section (modified as described in the next sentence) that would be distributed with respect to the property unit in accordance with paragraph (e)(3) of this section, subject to the limitations in paragraph (f) of this section. For purposes of this paragraph (d)(3), the hypothetical distribution is treated as made when the distribution of previously taxed earnings and profits is made, the amount of the hypothetical distribution is equal to the increase to basis under paragraph (d)(2) of this section by reason of the distribution of previously taxed earnings and profits, and, at the level of the controlled foreign corporation, the hypothetical distribution is made in the same manner as the distribution of previously taxed earnings and profits.

(e) Hypothetical distribution rule—(1) In general. Increase the basis of each property unit that the covered shareholder owns on the last relevant day of the relevant taxable year by the portion of the hypothetical distribution described in paragraph (e)(2) of this section that would be distributed with respect to the property unit in accordance with paragraph (e)(3) of this section, subject to the limitations in paragraph (f) of this section. Except as provided in paragraph (e)(4) of this section, treat a portion of each such increase to basis as made at the end of the last day of the relevant taxable year, determined by multiplying the amount of the increase to basis by a fraction, the numerator of which is the section 951(a)(1)(B) inclusion amount, and the denominator of which is the amount of the hypothetical distribution. Treat the remaining portion of each such increase to basis as made at the beginning of the first day of the relevant taxable year on which the covered shareholder owns the property unit, unless there are any midyear transactions, in which case treat each such remaining portion as made immediately after the last midyear transaction occurring during the relevant taxable year.

(2) Hypothetical distribution. The hypothetical distribution described in this paragraph (e)(2) is a hypothetical distribution treated as made by the controlled foreign corporation, through all property (if any) through which the covered shareholder owns stock of the controlled foreign corporation, to the covered shareholder on the last relevant day of the relevant taxable year. The amount of the hypothetical distribution is equal to the section 951(a)(1)(A) inclusion amount, reduced by any increases to basis under paragraph (d)(2) of this section, plus the section 951(a)(1)(B) inclusion amount. In the hypothetical distribution, stock of the controlled foreign corporation and other property is taken into account only to the extent owned by the covered shareholder on the last relevant day, and the earnings and profits of the controlled foreign corporation and any foreign corporations through which the hypothetical distribution is treated as made are in each case treated as equal to the amount of the hypothetical distribution.

(3) Distribution rights. The portion of the hypothetical distribution that would be distributed with respect to a property unit is determined under the principles of §1.951-1(e)(2) through (6). However, an earlier distribution affects property units’ distribution rights for purposes of the hypothetical distribution to the extent such earlier distribution results in the section 951(a)(1)(A) inclusion amount increasing basis under paragraph (d) of this section.

(4) Certain increase to basis for section 951(a)(1)(B) inclusion amount. If basis of a property unit is increased pursuant to the second sentence of paragraph (e)(1) of this section, and at the end of the last day of the relevant taxable year the covered shareholder either does not own the property unit or owns the property unit in a manner different than how the covered shareholder owns the property unit at the time of the hypothetical distribution described in paragraph (e)(2) of this section, then treat such increase to basis as made immediately before the transaction in which the covered shareholder ceases to own the property unit in the same manner as it owns the property unit at the time of such hypothetical distribution. In addition, treat such increase to basis as made after the determination of any amount that must be included in gross income as a dividend (for example, under section 1248 or §1.367(b)-4) as a result of such transaction.

(f) Limitations—(1) Section 961(c) ownership units that are not stock of a controlled foreign corporation. Section 961(c) basis of a section 961(c) ownership unit is increased only if the section 961(c) ownership unit is a share of stock of a controlled foreign corporation.

(2) Taxable section 962 previously taxed earnings and profits. The portion of an income inclusion that gives rise to previously taxed earnings and profits relating to the taxable section 962 PTEP subgroup does not increase adjusted basis of a section 961(a) ownership unit or derived basis of a derivative ownership unit.

(3) Derivative ownership units that are partially owned by foreign corporations. If a derivative ownership unit is owned (indirectly) by one or more foreign corporations, then an increase to derived basis of the derivative ownership unit resulting from a hypothetical distribution described in paragraph (d)(3) or (e)(2) of this section cannot exceed the portion of the hypothetical distribution that would be distributed to the covered shareholder through only the derivative ownership unit and any interests in partnerships.

(a) Scope. This section sets forth the rules for reducing basis and recognizing gain under section 961 for distributions of previously taxed earnings and profits. Paragraph (b) of this section describes adjustments to section 961(a) ownership units in the case of distributions of previously taxed earnings and profits to a covered shareholder. Paragraph (c) of this section describes adjustments to derivative ownership units in the case of distributions of previously taxed earnings and profits through one or more partnerships to one or more covered shareholders. Paragraph (d) of this section describes adjustments to section 961(c) ownership units in the case of distributions of previously taxed earnings and profits to a controlled foreign corporation. Paragraph (e) of this section provides timing rules for when adjustments are treated as made. Paragraph (f) of this section provides rules regarding the treatment of gain recognized under this section. See §1.961-12(c)(3) (Example 3) for an example illustrating the application of this section.

(b) Adjustments to section 961(a) ownership units—(1) In general. If a covered shareholder receives previously taxed earnings and profits that are excluded from its gross income under section 959(a) and §1.959-4, then the resulting adjustments under section 961 to the covered shareholder’s adjusted basis of section 961(a) ownership units are determined in accordance with the rules described in paragraph (b)(2) of this section.

(2) Rules for adjusting basis—(i) Determine amounts of adjustments. First, determine the amount of the adjustment to the covered shareholder’s adjusted basis of each section 961(a) ownership unit, which is equal to the dollar basis of, and foreign income taxes associated with, previously taxed earnings and profits that are received with respect to such section 961(a) ownership unit (determined under §1.959-4), but only including foreign income taxes for which the covered shareholder is allowed a credit under section 901.

(ii) Reduce basis. Second, reduce the covered shareholder’s adjusted basis of each section 961(a) ownership unit by the amount of the adjustment to such adjusted basis (determined under paragraph (b)(2)(i) of this section), but not below zero.

(iii) Recognize gain. Third, to the extent that the amount of an adjustment to the covered shareholder’s adjusted basis of a section 961(a) ownership unit (determined under paragraph (b)(2)(i) of this section) exceeds such adjusted basis, treat the covered shareholder as recognizing gain with respect to such section 961(a) ownership unit in accordance with paragraph (f) of this section.

(c) Adjustments to derivative ownership units—(1) In general. If, through a partnership, one or more covered shareholders receive previously taxed earnings and profits that are excluded from the covered shareholders’ gross income under section 959(a) and §1.959-4, then the resulting adjustments under section 961 to the partnership’s derived basis of derivative ownership units are determined in accordance with the rules described in paragraph (c)(2) of this section. In the case of tiered partnerships, each tiered partnership’s derived basis of derivative ownership units is adjusted as described in paragraph (c)(2) of this section, starting with the partnership at the lowest tier.

(2) Rules for adjusting basis—(i) Determine amounts of adjustments. First, determine the amount of the adjustment to the partnership’s derived basis with respect to each covered shareholder of each derivative ownership unit, which is equal to the dollar basis of, and foreign income taxes associated with, previously taxed earnings and profits that are both with respect to such covered shareholder and received with respect to such derivative ownership unit (determined under §1.959-4).

(ii) Reduce positive derived basis. Second, reduce the partnership’s derived basis with respect to each covered shareholder of each derivative ownership unit by the amount of the adjustment to such derived basis (determined under paragraph (c)(2)(i) of this section), but not below zero.

(iii) Reduce positive section 743(b) basis (if applicable) and increase negative derived basis. Third, to the extent that the amount of an adjustment to the partnership’s derived basis with respect to a covered shareholder of a derivative ownership unit (determined under paragraph (c)(2)(i) of this section) exceeds the related reduction to positive derived basis (determined under paragraph (c)(2)(ii) of this section), reduce the covered shareholder’s positive section 743(b) basis adjustment of such derivative ownership unit (if applicable), but not below zero, and then, if applicable, reduce such derived basis below zero, but only to the extent permitted under paragraph (c)(3) of this section.

(iv) Recognize and allocate gain. Fourth, to the extent that the amount of an adjustment to the partnership’s derived basis with respect to a covered shareholder of a derivative ownership unit (determined under paragraph (c)(2)(i) of this section) exceeds the aggregate of the related reductions to derived basis (determined under paragraphs (c)(2)(ii) and (iii) of this section) and positive section 743(b) basis (determined under paragraph (c)(2)(iii) of this section), treat the partnership as recognizing gain with respect to such derivative ownership unit in accordance with paragraph (f) of this section, and allocate the gain solely to the covered shareholder.

(3) Limitation on reducing derived basis—(i) In general. An adjustment to a partnership’s derived basis with respect to a covered shareholder of a derivative ownership unit can reduce (or further reduce) such derived basis below zero only to the extent of the amount of common basis of such derivative ownership unit available with respect to the covered shareholder (determined under paragraph (c)(3)(ii) of this section), less, if applicable, the covered shareholder’s negative section 743(b) basis adjustment of the derivative ownership unit (expressed as a positive amount).

(ii) Determining common basis available with respect to the covered shareholder. In applying paragraph (c)(3)(i) of this section, the amount of common basis of the derivative ownership unit available with respect to the covered shareholder is equal to the product of the following amounts—

(A) The partnership’s common basis of the derivative ownership unit (translated, if applicable, into U.S. dollars at the spot rate on the day on which the adjustment described in paragraph (c)(3)(i) of this section would be treated as reducing basis), reduced by all negative derived basis of the derivative ownership unit (determined immediately before the adjustment described in paragraph (c)(3)(i) of this section would be treated as made); and

(B) A fraction, the numerator of which is the amount by which the adjustment described in paragraph (c)(3)(i) of this section would reduce derived basis with respect to the covered shareholder below zero if derived basis could be reduced without limitation, and the denominator of which is the sum of the amounts by which the adjustment described in paragraph (c)(3)(i) of this section and any concurrent adjustments to derived basis with respect to other covered shareholders would reduce derived basis of the derivative ownership unit below zero if derived basis could be reduced without limitation.

(d) Adjustments to section 961(c) ownership units—(1) In general. If a controlled foreign corporation receives previously taxed earnings and profits that are excluded from its gross income under section 959(b) and §1.959-4, then the resulting adjustments under section 961 to the controlled foreign corporation’s section 961(c) basis of section 961(c) ownership units are determined in accordance with the rules described in paragraph (d)(2) of this section.

(2) Rules for adjusting basis—(i) Determine amounts of adjustments. First, determine the amount of the adjustment to the controlled foreign corporation’s section 961(c) basis with respect to each covered shareholder of each section 961(c) ownership unit, which is equal to the dollar basis of, and foreign income taxes associated with, previously taxed earnings and profits that are both with respect to such covered shareholder and received with respect to such section 961(c) ownership unit (determined under §1.959-4).

(ii) Reduce basis. Second, reduce the controlled foreign corporation’s section 961(c) basis with respect to each covered shareholder of each section 961(c) ownership unit by the amount of the adjustment to such section 961(c) basis, including below zero, but only to the extent permitted under paragraph (d)(3) of this section.

(iii) Recognize and assign gain. Third, to the extent that the amount of an adjustment to the controlled foreign corporation’s section 961(c) basis with respect to a covered shareholder of a section 961(c) ownership unit (determined under paragraph (d)(2)(i) of this section) exceeds the related reduction to section 961(c) basis (determined under paragraph (d)(2)(ii) of this section), treat the controlled foreign corporation as recognizing gain with respect to such section 961(c) ownership unit in accordance with paragraph (f) of this section, and assign the gain solely to the covered shareholder.

(3) Limitation on reducing section 961(c) basis—(i) In general. An adjustment to a controlled foreign corporation’s section 961(c) basis with respect to a covered shareholder of a section 961(c) ownership unit can reduce (or further reduce) such section 961(c) basis below zero only to the extent of the amount of adjusted basis of such section 961(c) ownership unit available with respect to the covered shareholder (determined under paragraph (d)(3)(ii) of this section).

(ii) Determining adjusted basis available with respect to the covered shareholder. In applying paragraph (d)(3)(i) of this section, the amount of adjusted basis of the section 961(c) ownership unit available with respect to the covered shareholder is equal to the product of the following amounts—

(A) The controlled foreign corporation’s adjusted basis of the section 961(c) ownership unit (translated, if applicable, into U.S. dollars at the spot rate on the day on which the adjustment described in paragraph (d)(3)(i) of this section would be treated as reducing basis), reduced by all negative section 961(c) basis of the section 961(c) ownership unit (determined immediately before the adjustment described in paragraph (d)(3)(i) of this section would be treated as made); and

(B) A fraction, the numerator of which is the amount by which the adjustment described in paragraph (d)(3)(i) of this section would reduce section 961(c) basis with respect to the covered shareholder below zero if section 961(c) basis could be reduced without limitation, and the denominator of which is the sum of the amounts by which the adjustment described in paragraph (d)(3)(i) of this section and any concurrent adjustments to section 961(c) basis with respect to other covered shareholders would reduce section 961(c) basis of the section 961(c) ownership unit below zero if section 961(c) basis could be reduced below zero without limitation.

(e) Timing of basis reductions—(1) Basis of stock. A reduction to basis of stock of a foreign corporation under paragraph (b), (c), or (d) of this section is treated as made concurrently with the distribution giving rise to the basis reduction (and before any other adjustment to basis by reason of the distribution, for example, under section 301(c)(2)).

(2) Basis of partnership interests. A reduction to basis of an interest in a partnership under paragraph (b) or (c) of this section is treated as made concurrently with the adjustment under section 705 to such interest in the partnership by reason of the distribution giving rise to the basis reduction.

(f) Treatment of gain—(1) In general. Gain treated as recognized with respect to a section 961(a) ownership unit, derivative ownership unit, or section 961(c) ownership unit under paragraph (b), (c), or (d) of this section is treated as gain from a sale or exchange of such ownership unit occurring concurrent with when the adjustment described in that paragraph would be treated as reducing basis.

(2) Gain recognized by a partnership. Gain treated as recognized by a partnership under paragraph (c) of this section constitutes an item of gain solely with respect to the covered shareholder to which it is allocated and has no effect on any partnership’s computation or allocation of any other item under section 703 or 704 or on the covered shareholder’s capital account. The gain is treated as the covered shareholder’s distributive share of gain of the partnership (derived through each partnership through which the covered shareholder owns the partnership recognizing the gain, if applicable) and is taken into account in adjusting basis under section 705.

(3) Gain recognized by a controlled foreign corporation. Gain treated as recognized by a controlled foreign corporation under paragraph (d) of this section is gain recognized pursuant to section 961(c). Such gain applies only for purposes of determining amounts included in gross income of United States shareholders of the controlled foreign corporation under §1.961-11 and, therefore, for example does not affect the controlled foreign corporation’s items of gross income for purposes of section 952 or 951A or its earnings and profits.

(4) Translation rule. If applicable, gain treated as recognized by a partnership or controlled foreign corporation under paragraph (c) or (d) of this section is translated into functional currency at the spot rate on the day on which the gain is treated as recognized.

(a) Scope. This section sets forth the rules for adjusting basis under section 961 for foreign currency gain or loss recognized with respect to previously taxed earnings and profits under section 986(c) and for general successor transactions. Paragraph (b) of this section provides the adjustments for foreign currency gain or loss. Paragraph (c) of this section provides the adjustments for general successor transactions. Paragraph (d) of this section coordinates with section 743(b).

(b) Adjustments for foreign currency gain or loss—(1) In general. If a covered shareholder recognizes foreign currency gain or loss with respect to a foreign corporation’s previously taxed earnings and profits under §1.986(c)-1 in a transaction other than a distribution of the previously taxed earnings and profits, then basis of property units that are shares of stock of the foreign corporation owned by the covered shareholder, and basis of any property units through which the covered shareholder owns stock of the foreign corporation, is in each case adjusted in accordance with the rules described in paragraphs (b)(2) through (4) of this section. Generally, under those rules, basis adjustments begin at the level of stock of the foreign corporation and then tier through property units through which the covered shareholder owns such stock, with at each level basis adjustments allocated among property units based on proportionate shares of foreign currency gain or loss. Solely for purposes of this paragraph (b), a reference to the basis of a property unit means adjusted basis in the case of a section 961(a) ownership unit, derived basis with respect to the covered shareholder in the case of a derivative ownership unit, or section 961(c) basis with respect to the covered shareholder in the case of a section 961(c) ownership unit.

(2) Determine net foreign currency gain or loss. First, determine the amount of foreign currency gain or loss that gives rise to adjustments to basis, computed by comparing the sum of all foreign currency gain and the sum of all foreign currency loss that the covered shareholder recognizes with respect to the foreign corporation’s previously taxed earnings and profits in the transaction under §1.986(c)-1(b), without regard to §1.986(c)-1(b)(3)(i) and (ii) (limitations for previously taxed earnings and profits resulting from section 965). The excess of the sum of foreign currency gain over the sum of foreign currency loss is net foreign currency gain, and the excess of the sum of foreign currency loss over the sum of foreign currency gain is net foreign currency loss.

(3) Determine each property unit’s share of net foreign currency gain or loss—(i) In general. Second, determine each property unit’s share of net foreign currency gain or net foreign currency loss by multiplying the net foreign currency gain or net foreign currency loss, as applicable, by a fraction (which is based on a hypothetical distribution by the foreign corporation of previously taxed earnings and profits with respect to which the covered shareholder recognizes, or would recognize, foreign currency gain or loss in the transaction). The numerator of the fraction is the portion of the hypothetical distribution described in paragraph (b)(3)(ii) of this section that, under the principles of §1.951-1(e)(2) through (6), would be distributed with respect to the property unit, and the denominator of the fraction is the amount of such hypothetical distribution.

(ii) Hypothetical distribution. The hypothetical distribution described in this paragraph (b)(3)(ii) is a hypothetical distribution treated as made by the foreign corporation, through all property (if any) through which the covered shareholder owns stock of the foreign corporation, to the covered shareholder immediately before the transaction. The amount of the hypothetical distribution is equal to all previously taxed earnings and profits of the foreign corporation with respect to which the covered shareholder recognizes (or, but for §1.986(c)-1(b)(3)(i) and (ii), would recognize) any foreign currency gain or loss in the transaction. In the hypothetical distribution, stock of the foreign corporation is taken into account only to the extent owned by the covered shareholder immediately before but not immediately after the transaction, and other property is taken into account only to the extent owned by the covered shareholder immediately before the transaction. The earnings and profits of the foreign corporation and any foreign corporations through which the hypothetical distribution is treated as made are in each case treated as equal to the amount of the hypothetical distribution.

(4) Adjust basis—(i) In general. Third, adjust the basis of each property unit in accordance with paragraph (b)(4)(ii) or (iii) of this section, as applicable, starting with property units at the lowest tier and subject to the limitation in paragraph (b)(4)(iv) of this section. Treat each such adjustment to basis as made immediately before the transaction (and therefore take the adjustments into account in determining the Federal income tax consequences of the transaction).

(ii) Basis increases for net foreign currency gain. In the case of net foreign currency gain, increase the basis of each property unit by the property unit’s share of the net foreign currency gain (determined under paragraph (b)(3) of this section).

(iii) Basis reductions and gain recognition for net foreign currency loss. In the case of net foreign currency loss, reduce the basis of each property unit by the property unit’s share of net foreign currency loss (determined under paragraph (b)(3) of this section) or recognize gain in accordance with the principles of §1.961-4 (applied by treating such share of net foreign currency loss as the amount of the adjustment to basis described in §1.961-4(b)(2)(i), (c)(2)(i), or (d)(2)(i), as applicable).

(iv) Limitation for section 961(c) ownership units. Section 961(c) basis of a section 961(c) ownership unit is adjusted only if the section 961(c) ownership unit is a share of stock of a controlled foreign corporation. A specified foreign corporation (as defined in §1.965-1(f)(45)(i)(B)) that is not otherwise a controlled foreign corporation is treated as a controlled foreign corporation for purposes of applying this paragraph (b)(4) to foreign currency gain or loss with respect to previously taxed earnings and profits resulting from the application of section 965(a).

(c) Successor basis—(1) In general. In a general successor transaction, derived basis of each partnership in which the successor covered shareholder acquires ownership of a partnership interest (each an acquired partnership), and section 961(c) basis of each acquired foreign corporation, transfers from the transferor covered shareholder to the successor covered shareholder (and thus becomes derived basis or section 961(c) basis with respect to the successor covered shareholder) in accordance with the rules described in paragraph (c)(2) this section. Solely for purposes of this paragraph (c), a reference to the basis of a property unit means derived basis with respect to the transferor covered shareholder in the case of a derivative ownership unit, or section 961(c) basis with respect to the transferor covered shareholder in the case of a section 961(c) ownership unit.

(2) Rules for transferring basis—(i) Allocate basis before adjustment for foreign currency gain or loss. First, for each property unit directly owned by an acquired partnership or acquired foreign corporation, allocate to the successor covered shareholder a pro rata portion of the basis of the property unit immediately before the adjustments pursuant to paragraph (b) of this section by reason of the general successor transaction, determined by multiplying such basis by a fraction. The numerator of the fraction is the value of the interest in the acquired partnership or stock of the acquired corporation, as applicable, ownership of which is acquired by the successor covered shareholder in the general successor transaction. The denominator of the fraction is the total value of all the interests of the acquired partnership or all the stock of the acquired foreign corporation, as applicable, that the transferor covered shareholder owns immediately before the general successor transaction.

(ii) Adjust allocations for foreign currency gain or loss. Second, adjust the allocation of basis of each property unit as follows. Increase the allocation to the successor covered shareholder by the amount of the increase to basis of the property unit pursuant to paragraph (b) of this section by reason of the general successor transaction. Decrease the allocation to the successor covered shareholder by the amount of the reduction to basis of the property unit pursuant to paragraph (b) of this section by reason of the general successor transaction.

(iii) Transfer of successor basis. Third, transfer basis from the transferor covered shareholder to the successor covered shareholder by reducing basis with respect to the transferor covered shareholder, and increasing basis with respect to the successor covered shareholder, of each property unit by the amount of basis of the property unit allocated to the successor covered shareholder under paragraphs (c)(2)(i) and (ii) of this section (if such amount is positive) or, if such amount is negative, by increasing basis with respect to the transferor covered shareholder and reducing basis with respect to the successor covered shareholder by such amount, expressed as a positive number. Treat each such transfer of basis as made concurrently with the general successor transaction.

(3) Deemed covered shareholder—(i) In general. For purposes of transferring basis under this paragraph (c), the deemed covered shareholder is treated in the same manner as a covered shareholder and a reference to a covered shareholder includes the deemed covered shareholder. Thus, for example, if a covered shareholder sells an interest in a partnership that directly owns stock of a foreign corporation to a nonresident alien individual in a general successor transaction, then derived basis of the partnership transfers from the seller covered shareholder to the deemed covered shareholder under this paragraph (c). Moreover, if the individual subsequently sells the partnership interest to a covered shareholder, then derived basis of the partnership (adjusted consistent with the section 961 regulations, including to reflect distributions from the foreign corporation to the individual) transfers from the deemed covered shareholder to the buyer covered shareholder under this paragraph (c).

(ii) Treatment as controlled foreign corporation stock. Solely for purposes of determining section 961(c) basis that transfers to or from the deemed covered shareholder under this paragraph (c), any foreign corporation in which the deemed covered shareholder is treated as owning stock is treated as a controlled foreign corporation (to the extent the foreign corporation is not otherwise a controlled foreign corporation). Thus, for example, if a covered shareholder sells stock of an upper-tier foreign corporation that directly owns stock of a lower-tier foreign corporation to a nonresident alien individual in a general successor transaction, the upper-tier foreign corporation’s shares of stock in the lower-tier foreign corporation remain section 961(c) ownership units and section 961(c) basis of the upper-tier foreign corporation transfers from the seller covered shareholder to the deemed covered shareholder under this paragraph (c) even if the upper-tier foreign corporation ceases to be a controlled foreign corporation as a result of the sale. Consequently, if the individual subsequently sells the stock of the upper-tier foreign corporation to a covered shareholder and, as a result, the upper-tier foreign corporation becomes a controlled foreign corporation, then section 961(c) basis of the upper-tier foreign corporation (adjusted consistent with the section 961 regulations, including to reflect distributions from the lower-tier foreign corporation to the upper-tier foreign corporation) transfers from the deemed covered shareholder to the buyer covered shareholder under this paragraph (c).

(iii) Determining basis that transfers from the deemed covered shareholder. In a transaction in which basis of a derivative ownership unit or section 961(c) ownership unit transfers from the deemed covered shareholder to a covered shareholder, the covered shareholder must use a reasonable method in determining the amount of transferred basis. Such method must take into account adjustments to basis with respect to the deemed covered shareholder that would have been made under the section 961 regulations if the basis were with respect to a covered shareholder during the time that it was with respect to the deemed covered shareholder.

(d) Coordination of successor derived basis with section 743(b). For purposes of a basis adjustment under section 743(b) with respect to a derivative ownership unit directly owned by an acquired partnership, the amount of any basis adjustment with respect to the successor covered shareholder to the acquired partnership’s assets is calculated under §1.743-1(d) and allocated under §1.755-1(b) by including any derived basis in the basis of the derivative ownership unit that is transferred to the successor covered shareholder under paragraph (c)(2) of this section for purposes of gain and loss calculations and basis allocations under those provisions.

§1.961-8 Application of positive derived basis to covered shareholders’ distributive shares of gain or loss.

(a) Scope. This section describes the consequences of a partnership’s positive derived basis. Paragraph (b) of this section applies positive derived basis to covered shareholders’ distributive shares of gain or loss recognized by a partnership on a sale, exchange, or other disposition of derivative ownership units. Paragraph (c) of this section describes related basis adjustments to certain partnership interests directly owned by a covered shareholder. Paragraph (d) of this section describes related basis adjustments to certain lower-tier partnership interests directly owned by an upper-tier partnership. See §1.961-12(c)(4) (Example 4) for an example illustrating the application of this section.

(b) Sale, exchange, or other disposition of derivative ownership units with positive derived basis—(1) In general. In a sale, exchange, or other disposition by a partnership (transferring partnership) of one or more derivative ownership units (transferred units), each partner’s distributive share of gain or loss recognized by the transferring partnership on the sale, exchange, or other disposition is first determined without regard to derived basis (taking into a partner’s section 743(b) basis adjustment). Then, positive derived basis is applied to each covered shareholder’s distributive share of such gain or loss in accordance with paragraph (b)(2) of this section. Such application of positive derived basis to a covered shareholder’s distributive share is treated as an application of positive derived basis by the transferring partnership, unless the covered shareholder owns the transferred units through multiple partnerships, in which case only partnerships in which the covered shareholder directly owns an interest are treated as applying the positive derived basis.

(2) Application of positive derived basis—(i) In general. A covered shareholder’s distributive share of gain or loss with respect to transferred units (determined without regard to derived basis, and expressed as a negative amount in the case of a distributive share of loss) is adjusted by subtracting the transferring partnership’s positive derived basis with respect to the covered shareholder of the transferred units, subject to the limitations in paragraphs (b)(2)(ii) and (iii) of this section, as applicable.

(ii) Limitation in nonrecognition transactions. In a nonrecognition transaction, the amount of positive derived basis that is taken into account in applying paragraph (b)(2)(i) of this section with respect to the covered shareholder is limited to the excess of the amount of positive derived basis that would be taken into account by the covered shareholder but for this paragraph (b)(2)(ii) over the covered shareholder’s share of the gain realized but not recognized by the transferring partnership with respect to the transferred units. The covered shareholder’s share of such realized-but-not-recognized gain is determined by multiplying the amount of that gain of the transferring partnership by a fraction, the numerator of which is the covered shareholder’s distributive share of gain recognized by the transferring partnership with respect to the transferred units (determined without regard to derived basis), and the denominator of which is the amount of gain recognized by the transferring partnership with respect to the transferred units (determined without regard to derived basis).

(iii) Limitation on loss. Positive derived basis can create or increase a distributive share of loss only if loss is, or would be if there were a loss, recognized by the transferring partnership on the sale, exchange, or other disposition of the transferred units and a current deduction in respect of the loss is, or would be, allowable.

(iv) Translation rule. If applicable, positive derived basis is translated into functional currency at the spot rate on the day on which the sale, exchange, or other disposition occurs.

(c) Basis adjustment to top-tier partnership interest. In the case of a partnership interest that is directly owned by a covered shareholder and through which the covered shareholder owns the transferred units described in paragraph (b) of this section, adjusted basis of such interest is adjusted under section 705 after taking into account the partnership’s application of positive derived basis to the covered shareholder’s distributive share of gain or loss with respect to the transferred units (determined under paragraph (b)(2) of this section).

(d) Basis adjustments to lower-tier partnership interests. In the case of a partnership interest (lower-tier partnership interest) that is directly owned by another partnership (upper-tier partnership) and through which a covered shareholder owns the transferred units described in paragraph (b) of this section, the upper-tier partnership’s basis in such lower-tier partnership interest is adjusted as described in this paragraph (d). Common basis in the lower-tier partnership interest is adjusted under section 705 without regard to the application of positive derived basis to the covered shareholder’s distributive share of gain or loss with respect to the transferred units (determined under paragraph (b)(2) of this section). Concurrently with and taking into account the adjustment under section 705, derived basis with respect to the covered shareholder of the lower-tier partnership interest is reduced by the amount of positive derived basis applied to the covered shareholder’s distributive share of gain or loss with respect to the transferred units (determined under paragraph (b)(2) of this section) or gain is recognized in accordance with the principles of §1.961-4 (applied by treating such amount of applied positive derived basis as the amount of the adjustment to basis described in §1.961-4(c)(2)(i)). If there is more than one lower-tier partnership, adjustments to derived basis under this paragraph (d) are made starting with the partnership at the lowest tier.

(a) Scope. This section describes the consequences of positive section 961(c) basis. Paragraph (b) of this section excludes from gross income previously taxed earnings and profits resulting from the application of section 961(c) basis to covered gain. Paragraph (c) of this section defines covered gain. Paragraph (d) of this section describes rules for analyzing covered gain. Paragraph (e) of this section provides rules for applying positive section 961(c) basis to covered gain. Paragraph (f) of this section provides rules characterizing covered gain as previously taxed earnings and profits. Paragraph (g) of this section provides a dollar basis rule. Paragraph (h) of this section provides a rule allocating previously taxed earnings and profits to shares of stock. See §1.961-12(c)(5) (Example 5) for an example illustrating the application of this section.

(b) Exclusion from gross income of previously taxed earnings and profits resulting from section 961(c) basis. Previously taxed earnings and profits that result from the application of a controlled foreign corporation’s section 961(c) basis to covered gain are excluded from the controlled foreign corporation’s gross income, solely for purposes of determining the controlled foreign corporation’s subpart F income and tested income or tested loss, and provided that the covered shareholder to which the previously taxed earnings and profits relate is a United States shareholder in the controlled foreign corporation.

(c) Covered gain—(1) In general. Covered gain is all gain recognized by a controlled foreign corporation on a sale, exchange, or other disposition of one or more section 961(c) ownership units that are shares of stock of a single corporation (transferred units), determined without regard to loss recognized on any transferred unit and without regard to section 961(c) basis. Covered gain includes amounts treated as gain from a sale, exchange, or other disposition (for example, under section 301(c)(3)), other than gain recognized pursuant to section 961(c) (for example, for distributions of previously taxed earnings and profits in excess of basis under §1.961-4(d)). Section 961(c) basis is applied to covered gain, and previously taxed earnings and profits result from such application of section 961(c) basis, in accordance with the rules described in paragraph (d) of this section.

(2) Coordination with dividend recharacterization provisions. Section 964(e)(1) (or any provision of the Code or regulations in this title that would treat covered gain as a dividend in whole or in part) does not apply to the portion of covered gain to which section 961(c) basis is applied and that, consequently, is previously taxed earnings and profits.

(d) Rules for analyzing covered gain—(1) Determine each covered shareholder’s share of the covered gain. First, determine each covered shareholder’s share of the covered gain, computed as the portion of the covered gain that is assigned to the covered shareholder under §1.951-2.

(2) Apply section 961(c) basis. Second, apply the controlled foreign corporation’s positive section 961(c) basis to each covered shareholder’s share of the covered gain in accordance with paragraph (e) of this section.

(3) Characterize covered gain as previously taxed earnings and profits. Third, characterize the portion of each covered shareholder’s share of the covered gain to which section 961(c) basis is applied as previously taxed earnings and profits of the controlled foreign corporation in accordance with paragraph (f) of this section. Such characterization does not reduce previously taxed earnings and profits of the foreign corporation in which shares of stock are transferred units or any foreign corporation in which stock is owned through the transferred units.

(4) Determine dollar basis. Fourth, determine the dollar basis of previously taxed earnings and profits resulting from section 961(c) basis in accordance with paragraph (g) of this section.

(5) Treat resulting previously taxed earnings and profits as recognized with respect to particular transferred units. Fifth, treat previously taxed earnings and profits resulting from section 961(c) basis as recognized with respect to particular transferred units by allocating such previously taxed earnings and profits in accordance with paragraph (h) of this section. Such allocation is taken into account, for example, in applying section 964(e)(1) (taking into account paragraph (c)(2) of this section) to gain recognized with respect to a particular transferred unit.

(6) Adjust previously taxed earnings and profits and make related account adjustments. Sixth, increase the controlled foreign corporation’s previously taxed earnings and profits to reflect previously taxed earnings and profits resulting from section 961(c) basis and make the related adjustments described in §1.959-3 to each covered shareholder’s accounts.

(e) Application of positive section 961(c) basis—(1) In general. In a sale, exchange, or other disposition in which a controlled foreign corporation recognizes covered gain, the controlled foreign corporation’s positive section 961(c) basis with respect to a covered shareholder of the transferred units is applied to such covered shareholder’s share of the covered gain (determined under paragraph (d)(1) of this section), to the extent thereof and subject to the limitation in paragraph (e)(2) of this section.

(2) Limitation in nonrecognition transactions. In a nonrecognition transaction, the amount of positive section 961(c) basis that is taken into account in applying paragraph (e)(1) of this section with respect to the covered shareholder is limited to the excess of the amount of positive section 961(c) basis that would be taken into account by the covered shareholder but for this paragraph (e)(2) over the covered shareholder’s share of the gain realized but not recognized by the controlled foreign corporation with respect to the transferred units. The covered shareholder’s share of such realized-but-not-recognized gain is determined by multiplying the amount of that gain of the controlled foreign corporation by a fraction, the numerator of which is the covered shareholder’s share of covered gain with respect to the transferred units (determined under paragraph (d)(1) of this section), and the denominator of which is the amount of covered gain with respect to the transferred units (determined under paragraph (c)(1) of this section).

(3) Translation rule. If applicable, positive section 961(c) basis is translated into functional currency of the controlled foreign corporation at the spot rate on the day on which the sale, exchange, or other disposition occurs.

(4) Unused positive section 961(c) basis. See §1.961-11(c)(2) and (e) for rules applying positive section 961(c) basis in excess of covered gain to gain recognized pursuant to section 961(c).

(f) Characterization of covered gain as previously taxed earnings and profits—(1) In general. The portion of a covered shareholder’s share of covered gain to which section 961(c) basis is applied (determined under paragraph (d)(2) of this section) is characterized as previously taxed earnings and profits with respect to the covered shareholder (section 961(c) PTEP) in accordance with the rules described in paragraphs (f)(2) through (4) of this section.

(2) Mirroring rule—(i) In general. The portion of section 961(c) PTEP that does not exceed the amount of mirrored PTEP (defined in paragraph (f)(2)(ii) of this section) has the same character as a pro rata portion of mirrored PTEP. The pro rata portion is determined by multiplying mirrored PTEP by a fraction, the numerator of which is the portion of section 961(c) PTEP described in the preceding sentence and the denominator of which is the amount of mirrored PTEP.

(ii) Mirrored PTEP. For purposes of this paragraph (f)(2), mirrored PTEP is—

(A) All previously taxed earnings and profits that transfer from the covered shareholder under §1.959-7 in the sale, exchange, or other disposition in which the covered gain is recognized (or that would so transfer if the transferred units were sold in a general successor transaction); and

(B) All previously taxed earnings and profits that would exist if foreign income taxes associated with previously taxed earnings and profits described in paragraph (f)(2)(ii)(A) of this section (determined under §1.959-7 and, if applicable, translated into the functional currency of the foreign corporation to which the previously taxed earnings and profits would relate at the spot rate on the day on which the sale, exchange, or other disposition occurs) were treated as an additional amount of such previously taxed earnings and profits.

(iii) Currency rule. For purposes of this paragraph (f)(2), if any previously taxed earnings and profits described in paragraph (f)(2)(ii) of this section are denominated in a currency other than the functional currency of the controlled foreign corporation recognizing the covered gain, then such previously taxed earnings and profits are translated into such controlled foreign corporation’s functional currency at the spot rate on the day on which the covered gain is recognized.

(3) Lookback rule—(i) In general. The portion of section 961(c) PTEP that is not characterized under paragraph (f)(2) of this section, if any, and that does not exceed the amount of lookback PTEP (defined in paragraph (f)(3)(ii) of this section) has the same character as a pro rata portion of lookback PTEP. The pro rata portion is determined by multiplying lookback PTEP by a fraction, the numerator of which is the portion of section 961(c) PTEP described in the preceding sentence and the denominator of which is the amount of lookback PTEP.

(ii) Lookback PTEP. For purposes of this paragraph (f)(3), lookback PTEP is all previously taxed earnings and profits that both—

(A) Resulted from an income inclusion under section 951(a) or 951A(a) of the covered shareholder attributable to the transferred units (including stock owned through the transferred units); and

(B) Were related to a taxable year of a foreign corporation ending during the 36-month period that ends on the day on which the covered gain is recognized.

(iii) Currency rule. For purposes of this paragraph (f)(3), if any previously taxed earnings and profits described in paragraph (f)(3)(ii) of this section are denominated in a currency other than the functional currency of the controlled foreign corporation recognizing the covered gain, then such previously taxed earnings and profits are translated into such controlled foreign corporation’s functional currency by translating the U.S. dollar amount of the income inclusion giving rise to the previously taxed earnings and profits at the spot rate on the day on which the covered gain is recognized.

(4) Section 245A(d) PTEP rule. The portion of section 961(c) PTEP that is not characterized under paragraphs (f)(2) and (3) of this section, if any, is characterized as relating to the section 245A(d) PTEP group, the taxable year of the controlled foreign corporation in which the covered gain is recognized, and the general category income under section 904(d)(1)(D).

(g) Dollar basis rule. The dollar basis of previously taxed earnings and profits with respect to a covered shareholder that result from section 961(c) basis (determined under paragraph (d)(3) of this section) is equal to the U.S. dollar amount of the section 961(c) basis giving rise to such previously taxed earnings and profits.

(h) Allocation of previously taxed earnings and profits—(1) In general. Previously taxed earnings and profits with respect to a covered shareholder that result from section 961(c) basis (determined under paragraph (d)(3) of this section) are allocated to transferred units in accordance with the rules of paragraph (h)(2) of this section.

(2) Rules—(i) Stacking rule. First, allocate to each transferred unit an amount of previously taxed earnings and profits equal to the lesser of the amount of positive section 961(c) basis with respect to the covered shareholder of the transferred unit (to the extent taken into account in applying paragraph (e)(1) of this section) and the portion of the covered shareholder’s share of the covered gain that is recognized with respect to the transferred unit.

(ii) Pro rata rule. Second, allocate to each transferred unit a pro rata portion of any amount of previously taxed earnings and profits not allocated under paragraph (h)(2)(i) of this section, determined by multiplying such amount by a fraction. The numerator of the fraction is the portion of the covered shareholder’s share of the covered gain that is recognized with respect to the transferred unit, less the amount of previously taxed earnings and profits allocated to the transferred unit under paragraph (h)(2)(i) of this section. The denominator of the fraction is the amount of previously taxed earnings and profits not allocated under paragraph (h)(2)(i) of this section.

(a) Scope. This section describes the consequences of negative derived basis and negative section 961(c) basis. Paragraph (b) of this section sets forth a rule requiring gain recognition for negative derived basis. Paragraph (c) of this section sets forth a rule requiring gain recognition for negative section 961(c) basis. See §1.961-12(c)(6) and (7) (Examples 6 and 7) for examples illustrating the application of this section.

(b) Gain recognition for negative derived basis—(1) In general. If a partnership has negative derived basis of a derivative ownership unit, then, in any transaction involving the derivative ownership unit (for example, a sale, exchange, or distribution under section 301(c)(2)), the partnership is treated as recognizing gain with respect to the derivative ownership unit in accordance with the rules described in paragraphs (b)(2) through (5) of this section.

(2) Amount of gain—(i) In general. The amount of the gain recognized is equal to the additional amount of gain, plus the lesser amount of loss (expressed as a positive amount), that the partnership would have recognized in the transaction if, immediately before the transaction, the partnership’s common basis of the derivative ownership unit were reduced by all negative derived basis of the derivative ownership unit. Thus, for example, in a sale of the derivative ownership unit, the amount of the gain recognized is generally equal to the sum of all negative derived basis of the derivative ownership unit and, in a nonrecognition transaction, the amount of the gain recognized may be less than the sum of all negative derived basis of the derivative ownership unit.

(ii) Special rule if derivative ownership unit ceases to be a derivative ownership unit. If the derivative ownership unit is not a derivative ownership unit immediately after the transaction (including, for example, because the derivative ownership unit is redeemed, or becomes directly owned by a foreign corporation or covered shareholder, in the transaction), then, notwithstanding paragraph (b)(2)(i) of this section, the amount of the gain recognized is equal to the sum of all negative derived basis of the derivative ownership unit.

(iii) Translation rule. If applicable, negative derived basis is translated into functional currency at the spot rate on the day on which the transaction involving the derivative ownership unit occurs.

(3) Allocation of gain. A pro rata portion of the gain is allocated to each covered shareholder, determined by multiplying the amount of such gain by a fraction. The numerator of the fraction is the negative derived basis with respect to the covered shareholder of the derivative ownership unit, and the denominator of the fraction is the sum of all negative derived basis of the derivative ownership unit.

(4) Treatment of gain. The gain is treated in the same manner as gain recognized under §1.961-4(c) for distributions of previously taxed earnings and profits in excess of basis (and thus the rules in §1.961-4(f) apply to the gain), except that the gain is recognized concurrently with, but separate from, the transaction.

(5) Negative derived basis eliminated to the extent it gives rise to gain. Negative derived basis is eliminated to the extent it increases the amount of gain recognized under this paragraph (b), concurrent with the transaction.

(c) Gain recognition for negative section 961(c) basis—(1) In general. If a controlled foreign corporation has negative section 961(c) basis of a section 961(c) ownership unit, then, in any transaction involving the section 961(c) ownership unit (for example, a sale, exchange, or distribution under section 301(c)(2)), the controlled foreign corporation is treated as recognizing gain with respect to the section 961(c) ownership unit in accordance with the rules described in paragraphs (c)(2) through (5) of this section.

(2) Amount of gain—(i) In general. The amount of the gain recognized is equal to the additional amount of gain, plus the lesser amount of loss (expressed as a positive amount), that the controlled foreign corporation would have recognized in the transaction if, immediately before the transaction, the controlled foreign corporation’s adjusted basis of the section 961(c) ownership unit were reduced by all negative section 961(c) basis of the section 961(c) ownership unit. Thus, for example, in a sale of the section 961(c) ownership unit, the amount of the gain recognized is generally equal to the sum of all negative section 961(c) basis of the section 961(c) ownership unit and, in a nonrecognition transaction, the amount of the gain recognized may be less than the sum of all negative section 961(c) basis of the section 961(c) ownership unit.

(ii) Special rule if section 961(c) ownership unit ceases to be a section 961(c) ownership unit. If the section 961(c) ownership unit is not a section 961(c) ownership unit immediately after the transaction (including, for example, because the section 961(c) ownership unit is redeemed, or becomes directly owned by a covered shareholder, in the transaction), then, notwithstanding paragraph (c)(2)(i) of this section, the amount of the gain recognized is equal to the sum of all negative section 961(c) basis of the section 961(c) ownership unit.

(iii) Translation rule. If applicable, negative section 961(c) basis is translated into functional currency of the controlled foreign corporation at the spot rate on the day on which the transaction involving the section 961(c) ownership unit occurs.

(3) Assignment of gain. A pro rata portion of the gain is assigned to each covered shareholder, determined by multiplying the amount of such gain by a fraction. The numerator of the fraction is the negative section 961(c) basis with respect to the covered shareholder of the section 961(c) ownership unit, and the denominator of the fraction is the sum of all negative section 961(c) basis of the section 961(c) ownership unit.

(4) Treatment of gain. The gain is treated in the same manner as gain recognized under §1.961-4(d) for distributions of previously taxed earnings and profits in excess of basis (and thus the rules in §1.961-4(f) apply to the gain), except that the gain is recognized concurrently with, but separate from, the transaction. Thus, the gain is recognized pursuant to section 961(c) and therefore applies only for purposes of determining amounts included in gross income of United States shareholders of the controlled foreign corporation under §1.961-11.

(5) Negative section 961(c) basis eliminated to the extent it gives rise to gain. Negative section 961(c) basis is eliminated to the extent it increases the amount of gain recognized under this paragraph (c), concurrent with the transaction.

(a) Scope. This section sets forth rules regarding amounts that United States shareholders of a controlled foreign corporation must include in gross income under section 961(c) to account for gain recognized by the controlled foreign corporation pursuant to section 961(c) (for distributions of previously taxed earnings and profits in excess of basis under §1.961-4(d), for foreign currency loss in excess of basis under §1.961-5(b), or for negative section 961(c) basis under §1.961-10(c)). Paragraph (b) of this section provides the general rule. Paragraph (c) of this section allocates gain recognized pursuant to section 961(c) to a United States shareholder. Paragraph (d) of this section adjusts allocations of gain to reflect transfers of stock of the controlled foreign corporation. Paragraph (e) of this section determines loss recognized under section 961(c) with respect to a United States shareholder. See §1.961-12(c)(8) (Example 8) for an example illustrating the application of this section. See also §1.961-3, regarding basis increases for an inclusion under this section.

(b) In general. If a United States shareholder owns stock of a controlled foreign corporation on the last relevant day of a taxable year of the controlled foreign corporation, and the controlled foreign corporation recognizes gain pursuant to section 961(c) within that taxable year (all such gain, section 961(c) income), then the United States shareholder includes in gross income the amount of section 961(c) income that is allocated to the United States shareholder (determined under paragraph (c) of this section). The inclusion is for the United States shareholder’s taxable year in which or with which the controlled foreign corporation’s taxable year ends and is treated in the same manner as an amount included in gross income under section 951(a)(1)(A) solely for purposes of increasing basis under §1.961-3 and translation into U.S. dollars under 989(b).

(c) Allocation of section 961(c) income. For purposes of paragraph (b) of this section, the amount of the controlled foreign corporation’s section 961(c) income that is allocated to a United States shareholder is the excess (if any) of—

(1) The sum of any portions of section 961(c) income that are assigned to the United States shareholder under §1.961-4, 1.961-5, or 1.961-10, adjusted, if applicable, in accordance with paragraph (d) of this section as a result of transfers of stock of the controlled foreign corporation; over

(2) The amount of loss that the controlled foreign corporation is treated as recognizing under section 961(c) with respect to the United shareholder in accordance with paragraph (e) of this section.

(d) Rules for transfers of stock of the controlled foreign corporation—(1) General successor transactions—(i) General successor transaction occurring before the last relevant day. For purposes of paragraph (c)(1) of this section, if the controlled foreign corporation is an acquired foreign corporation in a general successor transaction that occurs before the last relevant day of the controlled foreign corporation’s taxable year, then treat a pro rata portion of section 961(c) income that is both recognized before the general successor transaction and assigned to the transferor covered shareholder under §1.961-4, 1.961-5, or 1.961-10 as instead assigned to the successor covered shareholder, determined by multiplying such section 961(c) income by the fraction described in §1.961-5(c)(2)(i) for determining the controlled foreign corporation’s section 961(c) basis that transfers in the general successor transaction.

(ii) General successor transaction occurring on or after the last relevant day. For purposes of paragraph (c)(1) of this section, if the controlled foreign corporation is an acquired foreign corporation in a general successor transaction that occurs on or after the last relevant day of the controlled foreign corporation’s taxable year, then treat a pro rata portion of section 961(c) income that is both recognized after the general successor transaction and assigned to the successor covered shareholder under §1.961-4, 1.961-5, or 1.961-10 as instead assigned to the transferor covered shareholder, determined by multiplying such section 961(c) income by the fraction described in §1.961-5(c)(2)(i) for determining the controlled foreign corporation’s section 961(c) basis that transfers in the general successor transaction.

(2) Other transfers. The principles of paragraph (d)(1) of this section apply to transactions, other than general successor transactions, in which the controlled foreign corporation’s 961(c) basis transfers to another covered shareholder.

(e) Determining loss under section 961(c)—(1) In general. For purposes of paragraph (c)(2) of this section, the amount of loss that the controlled foreign corporation is treated as recognizing under section 961(c) with respect to the United States shareholder is, subject to the limitations in paragraph (e)(2) of this section, equal to the sum of the controlled foreign corporation’s positive section 961(c) basis with respect to the United States shareholder of section 961(c) ownership units that are sold, exchanged, or otherwise disposed of by the controlled foreign corporation within the controlled foreign corporation’s taxable year, reduced by the amount of such positive section 961(c) basis that is applied to covered gain under §1.961-9.

(2) Limitations—(i) In general. Positive section 961(c) basis of section 961(c) ownership units increases the amount of loss that the controlled foreign corporation is treated as recognizing under section 961(c) only if loss is, or would be if there were a loss, recognized by the controlled foreign corporation on the sale, exchange, or other disposition of the section 961(c) ownership units and a current deduction in respect of the loss is, or would be, allowable.

(ii) Loss recognized only to the extent of certain gain. Positive section 961(c) basis of section 961(c) ownership units that are shares of stock of a single foreign corporation increases the amount of loss that the controlled foreign corporation is treated as recognizing under section 961(c) only to the extent of the portion of the amount described in paragraph (c)(1) of this section that is recognized with respect to stock of such foreign corporation.

(3) Translation rule. If applicable, positive section 961(c) basis of section 961(c) ownership units is translated into the controlled foreign corporation’s functional currency at the spot rate on the day of the sale, exchange, or other disposition of the section 961(c) ownership units.

(a) In general. This section provides examples that illustrate the application of §§1.961-1 through 1.961-11.

(b) Assumed facts. For purposes of the examples in this section, unless otherwise indicated, the following facts are assumed for U.S. tax purposes:

(1) US1 and US2 are unrelated domestic corporations that are covered shareholders, each of which uses the U.S. dollar as its functional currency and chooses to claim a credit for foreign income taxes pursuant to section 901. Neither US1 nor US2 is a member of a consolidated group (as defined in §1.1502-1(h)).

(2) F1, F2, and F3 are foreign corporations, each of which is a controlled foreign corporation and uses the British pound (£) as its functional currency.

(3) PRS1 and PRS2 are partnerships.

(4) Each entity uses the calendar year as its taxable year, and no entity has a short taxable year.

(5) There are no adjustments under section 743(b) to the basis of any partnership property.

(c) Examples—(1) Example 1: Types of property units and basis—(i) Facts. US1 directly owns 60, and US2 directly owns 40, of the 100 shares of the single class of outstanding stock of F1. F1 directly owns all 50 shares of the single class of outstanding stock of F2. This example only analyzes the types of basis provided under section 961 in the items of property.

(ii) Analysis. Each of the 60 shares of stock of F1 directly owned by US1 and the 40 shares of stock of F1 directly owned by US2 is a section 961(a) ownership unit in which the covered shareholder (US1 or US2) is provided adjusted basis. See §1.961-2(c). In addition, each of the 50 shares of stock of F2 directly owned by F1, a controlled foreign corporation, is a section 961(c) ownership unit in which F1 is provided section 961(c) basis. See §1.961-2(e)(1). F1’s section 961(c) basis in each section 961(c) ownership unit is maintained separately with respect to each of US1 and US2. See §1.961-2(e)(2). Further, each of the section 961(a) ownership units and section 961(c) ownership units is a property unit, and adjusted basis or section 961(c) basis in the property unit, as applicable, is maintained in U.S. dollars. See §1.961-2(b).

(iii) Alternative facts: partnership structure—(A) Facts. The facts are the same as paragraph (c)(1)(i) of this section (Example 1), except that US1 and US2, in the aggregate, directly own all the interests in PRS1, and PRS1 directly owns all 100 of the shares of stock of F1.

(B) Analysis. The interest in PRS1 directly owned by each of US1 and US2 is a section 961(a) ownership unit in which the covered shareholder (US1 or US2) is provided adjusted basis. See §1.961-2(c). In addition, each of the 100 shares of stock of F1 directly owned by PRS1 is a derivative ownership unit in which PRS1 is provided derived basis. See §1.961-2(d)(1). PRS1’s derived basis in each derivative ownership unit is established and maintained separately with respect to each of US1 and US2. See §1.961-2(d)(2). Further, as is the case in paragraph (c)(1)(ii) of this section, each of the 50 shares of stock of F2 directly owned by F1, a controlled foreign corporation, is a section 961(c) ownership unit in which F1 is provided section 961(c) basis, and that basis is maintained separately with respect to each of US1 and US2. Moreover, each of the section 961(a) ownership units, derivative ownership units, and section 961(c) ownership units is a property unit, and adjusted basis, derived basis, or section 961(c) basis in the property unit, as applicable, is maintained in U.S. dollars. See §1.961-2(b).

(2) Example 2: Basis increases for income inclusions—(i) Facts. US1 directly owns all 100 shares of the single class of outstanding stock of F1, and F1 directly owns all 50 shares of the single class of outstanding stock of F2. Thus, the shares of stock of F1 directly owned by US1 are section 961(a) ownership units, and the shares of stock of F2 directly owned by F1 are section 961(c) ownership units. For F2’s taxable year ending on December 31 of year 3, the last relevant day is December 31 and US1 includes $80x in gross income under section 951(a)(1)(A) (its pro rata share of F2’s subpart F income, translated into U.S. dollars in accordance with section 989(b)) and $120x in gross income under section 951A(a) (the portion of its GILTI inclusion amount that is treated as with respect to F2 for the taxable year under section 951A(f)(2)). F2 does not make any covered distributions, and therefore does not distribute any previously taxed earnings and profits, during the taxable year. This example only analyzes basis increases for the income inclusions. See also §1.312-6(f) (income inclusions increase US1’s earnings and profits); §1.959-3 (adjustments to previously taxed earnings and profits accounts).

(ii) Analysis—(A) In general. To reflect US1’s income inclusions for F2’s taxable year ending on December 31 of year 3, basis of shares of stock of F2, and basis of shares of stock of F1 (property units through which US1 owns stock of F2), is in each case increased in accordance with §1.961-3. See §1.961-3(b). In the case of stock of F2, F1’s section 961(c) basis with respect to US1 is increased because shares of stock of F2 are section 961(c) ownership units and F2 is a controlled foreign corporation, as required by §1.961-3(f)(1). In the case of stock of F1, US1’s adjusted basis is increased because shares of stock of F1 are section 961(a) ownership units. Paragraph (c)(2)(ii)(B) of this section provides the specific increases to basis.

(B) Increases to basis of each property unit. The amount of US1’s income inclusions with respect to F2 that give rise to increases to basis under section 961 is $200x ($80x + $120x). See §1.961-3(c)(1). In determining the specific increases to basis, the actual distribution rule in §1.961-3(d) does not apply because F2 does not distribute any previously taxed earnings and profits before the last relevant day. See §1.961-3(c)(3). Thus, the hypothetical distribution rule in §1.961-3(e) determines the entirety of the increases to basis for the income inclusions. See §1.961-3(c)(4). Under the hypothetical distribution rule, the basis of each share of stock of F2 is increased by $4x ($200x ÷ 50 shares), and the basis of each share of stock of F1 is increased by $2x ($200x ÷ 100 shares), which in each case is equal to the portion of a $200x hypothetical distribution treated as made by F2 through all tiers to US1 on the last relevant day that would be distributed with respect to the property unit. See §1.961-3(e). These increases to basis are treated as made at the beginning of F2’s taxable year 3 because there are no midyear transactions and the entirety of the $200x of income inclusions is under section 951(a)(1)(A) or 951A(a). See §1.961-3(c)(2) and (e)(1). Accordingly, at the beginning of F2’s taxable year 3, F1 increases its section 961(c) basis with respect to US1 of each share of stock of F2 by $4x, and US1 increases its adjusted basis of each share of stock of F1 by $2x.

(iii) Alternative facts: midyear transaction and actual distribution rule—(A) Facts. The facts are the same as in paragraph (c)(2)(i) of this section, except as follows. On January 1 of year 3, US1 directly owns all the stock of F2. On March 31 of year 3, F2 distributes previously taxed earnings and profits to US1 (pro rata with respect to the shares of stock of F2) and, consequently, US1 is required under §1.961-4 (basis reductions and gain recognition for distributions) to adjust its adjusted basis of each share of stock of F2 by $3x (the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are distributed on the share). On June 30 of year 3, F1 is formed and US1 immediately contributes all its stock of F2 to F1 in exchange for 100 shares of stock of F1. Thus, before the contribution, shares of stock of F2 are section 961(a) ownership units and, beginning as of the contribution, all the shares of stock of F1 are section 961(a) ownership units and all the shares of stock of F2 are section 961(c) ownership units.

(B) Analysis—(1) In general. To reflect US1’s income inclusions for F2’s taxable year ending on December 31 of year 3, basis of shares of stock of F2, and basis of shares of stock of F1 (property units through which US1 owns stock of F2), is in each case increased in accordance with §1.961-3. See §1.961-3(b). In the case of stock of F2, because shares of the stock are section 961(a) ownership units before the contribution and section 961(c) ownership units after the contribution, the type of basis that is increased depends on the timing of adjustments. Specifically, in the case of stock of F2 and an increase to basis that is treated as made before the contribution, the basis that is increased is US1’s adjusted basis because shares of stock of F2 are section 961(a) ownership units before the contribution. In the case of stock of F2 and an increase to basis that is treated as made after the contribution, the basis that is increased is F1’s section 961(c) basis with respect to US1 because shares of stock of F2 are section 961(c) ownership units after the contribution and F2 is a controlled foreign corporation, as required by §1.961-3(f)(1). In the case of stock of F1, US1’s adjusted basis is increased because shares of stock of F1 are section 961(a) ownership units. Paragraph (c)(2)(iii)(B)(2) of this section provides the specific increases to basis.

(2) Increases to basis of each property unit. The amount of US1’s income inclusions with respect to F2 that give rise to increases to basis under section 961 is $200x ($80x + $120x). See §1.961-3(c)(1). In determining the specific increases to basis for the income inclusions, the actual distribution rule in §1.961-3(d) applies because F2’s distribution of previously taxed earnings and profits is made before the last relevant day. See §1.961-3(c)(3). Under the actual distribution rule, basis of each share of stock of F2 is increased by $3x, which is equal to the adjustment required under §1.961-4 to the basis of such share by reason of the distribution, and thus basis of stock of F2 increases by $150x in total ($3x × 50 shares). See §1.961-3(d)(2). These increases to basis are treated as made at the beginning of F2’s taxable year because the distribution is made before the contribution of all the stock of F2 to F1, the sole midyear transaction occurring within the taxable year. See §1.961-3(c)(2) and (d)(1). Then, the hypothetical distribution rule in §1.961-3(e) determines increases to basis for the remaining $50x of income inclusions ($200x of income inclusions × $150x of basis increases to stock of F2 under the actual distribution rule). See §1.961-3(c)(4). Under the hypothetical distribution rule, the basis of each share of stock of F2, and the basis of each share of stock of F1, is increased by the portion of a $50x hypothetical distribution treated as made by F2 through all tiers to US1 on the last relevant day that would be distributed with respect to the property unit. See §1.961-3(e). These increases to basis are treated as made immediately after the contribution (the sole midyear transaction occurring within F2’s taxable year). See §1.961-3(e)(1). Table 1 in this paragraph (c)(2)(iii)(B)(2) provides the increases to basis.

(iv) Alternative facts: partnership structure and section 951(a)(1)(B) inclusion—(A) Facts. The facts are the same as in paragraph (c)(2)(i) of this section (Example 2), except as follows. US1 is a citizen of the United States (rather than a domestic corporation), referred to as Individual A for purposes of the rest of this paragraph (c)(2)(iv), and does not make an election to apply the provisions of section 962 for any taxable year. PRS1 directly owns all the stock of F1, and Individual A owns 60%, and a nonresident alien individual owns 40%, of the interests in PRS1. Thus, the interest in PRS1 directly owned by Individual A is a section 961(a) ownership unit, the shares of stock of F1 directly owned by PRS1 are derivative ownership units, and the shares of stock of F2 directly owned by F1 are section 961(c) ownership units. In addition, for F2’s taxable year ending on December 31 of year 3, Individual A includes $80x in gross income under section 951(a)(1)(A) (its pro rata share of F2’s subpart F income, translated into U.S. dollars in accordance with section 989(b)), $120x in gross income under section 951A(a) (the portion of its GILTI inclusion amount that is treated as with respect to F2 for the taxable year under section 951A(f)(2)), and $50x in gross income under section 951(a)(1)(B) (the portion of its section 956 amount that is not allocated to previously taxed earnings and profits, translated into U.S. dollars in accordance with section 989(b)).

(B) Analysis—(1) In general. To reflect Individual A’s income inclusions for F2’s taxable year ending on December 31 of year 3, basis of shares of stock of F2, and basis of shares of stock of F1 and basis of Individual A’s interest in PRS1 (property units through which Individual A owns stock of F2), is in each case increased in accordance with §1.961-3. See §1.961-3(b). In the case of stock of F2, the basis that is increased is F1’s section 961(c) basis with respect to Individual A because shares of stock of F2 are section 961(c) ownership units and F2 is a controlled foreign corporation, as required by §1.961-3(f)(1). In the case of stock of F1, PRS1’s derived basis with respect to Individual A is increased because shares of stock of F1 are derivative ownership units. In the case of Individual A’s interest in PRS1, Individual A’s adjusted basis is increased because its interest in PRS1 is a section 961(a) ownership unit. Paragraph (c)(2)(iv)(B) of this section provides the specific increases to basis.

(2) Increases to basis of each property unit. The amount of Individual A’s income inclusions with respect to F2 that give rise to increases to basis under section 961 is $250x ($80x + $120x + $50x). See §1.961-3(c)(1). The hypothetical distribution rule in §1.961-3(e) determines the entirety of the increases to basis for the income inclusions. See §1.961-3(c)(3) and (4). Under the hypothetical distribution rule, the basis of each property unit is increased by the portion of a $250x hypothetical distribution treated as made by F2 through all tiers to Individual A on the last relevant day that would be distributed with respect to the property unit (determined by regarding stock of F2 and other property only to the extent owned by Individual A on the last relevant day). See §1.961-3(e). In addition, because 20% of the $250x of income inclusions is under section 951(a)(1)(B) ($50x/$250x), 20% of each increase to basis is treated as made at the end of the last day of F2’s taxable year (which is when the previously taxed earnings and profits resulting from the income inclusion under section 951(a)(1)(B) are added to previously taxed earnings and profits accounts), with the remaining 80% treated as made at the beginning of the taxable year (which is when the previously taxed earnings and profits resulting from the income inclusions under sections 951(a)(1)(A) and 951A(a) are added to previously taxed earnings and profits accounts). See §1.961-3(e)(1). Table 1 in this paragraph (c)(2)(iii)(B)(2) provides the increases to basis.

(3) Example 3: Basis reductions and gain recognition for distributions—(i) Facts. US1 and US2, in the aggregate, directly own all the shares of the single class of outstanding stock of F1. In year 3, F1 makes a covered distribution (pro rata with respect to the shares of stock of F1). Under §1.959-4, the entirety of the portion of the covered distribution received by each of US1 and US2 is previously taxed earnings and profits excluded from the covered shareholder’s (US1’s or US2’s) gross income. In addition, the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are distributed on each share of stock of F1 owned by US1 is $6x, and the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are distributed on each share of stock of F1 owned by US2 is $4x. Immediately before the covered distribution, US1’s adjusted basis of each of its shares of stock of F1 is $4.5x, and US2’s adjusted basis of each of its shares of stock of F1 is $3x. Each of US1 and US2 is deemed to pay the entirety of the associated foreign income taxes of the previously taxed earnings and profits distributed to it under section 960(b) (because all such taxes are sourced from the creditable PTEP tax group and the covered shareholder is a United States shareholder of F1) and is allowed a credit under section 901 for the entirety of such taxes. This example only analyzes adjustments to basis of US1’s and US2’s shares of stock of F1 (section 961(a) ownership units) under section 961. See also §1.959-3 (adjustments to previously taxed earnings and profits accounts).

(ii) Analysis—(A) In general. Under §1.961-4(b), each of US1 and US2 reduces its adjusted basis of, and if applicable recognizes gain with respect to, each share of stock of F1 on which it receives previously taxed earnings and profits. The specific adjustments are provided in paragraphs (c)(3)(ii)(B) through (D) of this section and summarized in table 1 in this paragraph (c)(3)(ii)(A).

(B) US1’s receipt of previously taxed earnings and profits. As a result of US1’s receipt of previously taxed earnings and profits, the amount of the adjustment to US1’s adjusted basis of each of its shares of stock of F1 is $6x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits received on the share. See §1.961-4(b)(2)(i). Consequently, US1 reduces its adjusted basis of each of its shares of stock of F1 ($4.5x) to $0 and then is treated as recognizing $1.5x of gain with respect to the share (computed as the excess of the $6x adjustment to basis over the $4.5x reduction to basis). See §1.961-4(b)(2)(ii) and (iii).

(C) US2’s receipt of previously taxed earnings and profits. As a result of US2’s receipt of previously taxed earnings and profits, the amount of the adjustment to US2’s adjusted basis of each of its shares of stock of F1 is $4x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits received on the share. See §1.961-4(b)(2)(i). Consequently, US2 reduces its adjusted basis of each of its shares of stock of F1 ($3x) to $0 and then is treated as recognizing $1x of gain with respect to the share (computed as the excess of the $4x adjustment to basis over the $3x reduction to basis). See §1.961-4(b)(2)(ii) and (iii).

(D) Timing of adjustments. The reductions to adjusted basis described in paragraphs (c)(3)(ii)(B) and (C) of this section are treated as made, and the gains described in those paragraphs are treated as recognized, concurrently with the covered distribution. See §1.961-4(e)(1) and (f)(1).

(iii) Alternative facts: previously taxed earnings and profits received through a partnership—(A) Facts. The facts are the same as in paragraph (c)(3)(i) of this section (Example 3), except as follows. PRS1 directly owns all the shares of the single class of outstanding stock of F1, and US1 and US2, in the aggregate, directly own all the interests in PRS1. Under §1.959-4, the entirety of the portion of the covered distribution treated as received by each of US1 and US2 through PRS1 is previously taxed earnings and profits excluded from the covered shareholder’s (US1’s or US2’s) gross income. In addition, the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US1 and distributed on each share of stock of F1 is $6x, and the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US2 and distributed on each share of stock of F1 is $4x. Immediately before the covered distribution, for each share of stock of F1, PRS1’s common basis is $2.5x, its derived basis with respect to US1 is $3x, and its derived basis with respect to US2 is $2x. This paragraph (c)(3)(iii) analyzes adjustments to basis of PRS1’s shares of stock of F1 (derivative ownership units) under section 961. See also §1.961-4(b) (related adjustments to basis of US1’s and US2’s interests in PRS1).

(B) Analysis—(1) In general. Under §1.961-4(c), PRS1 reduces its derived basis of, and if applicable recognizes gain with respect to, each share of stock of F1 on which US1 or US2 receives previously taxed earnings and profits through PRS1. The specific adjustments are provided in paragraphs (c)(3)(iii)(B)(2) through (5) of this section and summarized in table 1 in this paragraph (c)(3)(iii)(B)(1).

(2) US1’s receipt of previously taxed earnings and profits through PRS1. As a result of US1’s receipt of previously taxed earnings and profits through PRS1, the amount of the adjustment to PRS1’s derived basis with respect to US1 of each of PRS1’s shares of stock of F1 is $6x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US1 and received on the share. See §1.961-4(c)(2)(i). Consequently, PRS1 reduces its derived basis with respect to US1 of each of its shares of stock of F1 ($3x) to $0 and then reduces such derived basis below zero in accordance with the limitation in §1.961-4(c)(3), which permits a $1.5x reduction below zero to the derived basis because $1.5x of PRS1’s common basis of the share is available with respect to US1 (as described in paragraph (c)(3)(iii)(B)(4) of this section). See §1.961-4(c)(2)(ii) and (iii), (c)(3)(i). Further, PRS1 is treated as recognizing $1.5x of gain with respect to each of its shares of stock of F1 (computed as the excess of the $6x adjustment to basis over the sum of the $3x reduction to positive derived basis and the $1.5x reduction of derived basis below zero), and this gain is allocated solely to US1. See §1.961-4(c)(2)(iv); see also §1.961-4(f)(2) (taking the gain into account in adjusting US1’s basis in its interest in PRS1 under section 705).

(3) US2’s receipt of previously taxed earnings and profits through PRS1. As a result of US2’s receipt of previously taxed earnings and profits through PRS1, the amount of the adjustment to PRS1’s derived basis with respect to US2 of each of PRS1’s shares of stock of F1 is $4x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US2 and received on the share. See §1.961-4(c)(2)(i). Consequently, PRS1 reduces its derived basis with respect to US2 of each of its shares of stock of F1 ($2x) to $0 and then reduces such derived basis below zero in accordance with the limitation in §1.961-4(c)(3), which permits a $1x reduction below zero to the derived basis because $1x of PRS1’s common basis of the share is available with respect to US2 (as described in paragraph (c)(3)(iii)(B)(4) of this section). See §1.961-4(c)(2)(ii) and (iii) and (c)(3)(i). Further, PRS1 is treated as recognizing $1x of gain with respect to each of its shares of stock of F1 (computed as the excess of the $4x adjustment to basis over the sum of the $2x reduction to positive derived basis and the $1x reduction of derived basis below zero), and this gain is allocated solely to US2. See §1.961-4(c)(2)(iv); see also §1.961-4(f)(2) (taking the gain into account in adjusting US2’s basis in its interest in PRS1 under section 705).

(4) Available common basis. For each of PRS1’s shares of stock of F1, the amount of common basis of the share that is available with respect to each of US1 and US2 is determined by multiplying $2.5x (the common basis of the share, reduced by all negative derived basis of the share existing immediately before the distribution being analyzed, of which there is none) by a fraction. See §1.961-4(c)(3)(ii). The numerator of the fraction is the amount by which PRS1’s derived basis with respect to the covered shareholder of the share would be reduced below zero if derived basis could be reduced without limitation and, accordingly, is $3x in the case of the derived basis with respect to US1 (computed as the excess of the $6x adjustment to basis over the $3x reduction to positive derived basis) and is $2x in the case of derived basis with respect to US2 (computed as the excess of the $4x adjustment to basis over the $2x reduction to positive derived basis). The denominator of the fraction is the sum of the amounts by which any of PRS1’s derived basis of the share would be reduced below zero if derived basis could be reduced without limitation ($5x, computed as the $3x with respect to US1 plus the $2x with respect to US2). Therefore, for each of PRS1’s shares of stock of F1, there is $1.5x of common basis available with respect to US1 ($2.5x × $3x/$5x) and $1x of common basis available with respect to US2 ($2.5x × $2x/$5x), and this common basis permits a $1.5x and $1x reduction below zero to derived basis with respect to US1 and US2, respectively (as described in paragraphs (c)(3)(iii)(B)(2) and (3) of this section). See also §1.961-10(b) (gain resulting from negative derived basis is allocated to covered shareholders in proportion to relative negative derived basis).

(5) Timing of adjustments. The reductions to derived basis described in paragraphs (c)(3)(iii)(B)(2) and (3) of this section are treated as made, and the gains described in those paragraphs are treated as recognized, concurrently with the covered distribution. See §1.961-4(e)(1) and (f)(1).

(iv) Alternative facts: previously taxed earnings and profits received by a controlled foreign corporation—(A) Facts. The facts are the same as in paragraph (c)(3)(i) of this section (Example 3), except as follows. US1 and US2, in the aggregate, directly own all the outstanding stock of F2 and are United States shareholders of F2. F2 directly owns all the shares of the single class of outstanding stock of F1. Under §1.959-4, the entirety of each of US1’s and US2’s share of F1’s covered distribution is previously taxed earnings and profits excluded from F2’s gross income for purposes of determining its subpart F income and tested income or tested loss. In addition, the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US1 and distributed on each share of stock of F1 is $6x, and the sum of the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US2 and distributed on each share of stock of F1 is $4x. Immediately before the covered distribution, for each share of stock of F1, F2’s adjusted basis is £1.25x, its section 961(c) basis with respect to US1 is $3x, and its section 961(c) basis with respect to US2 is $2x. On the day of the covered distribution, the spot rate is $1:£0.5. This paragraph (c)(3)(iv) analyzes adjustments to basis of F2’s shares of stock of F1 (section 961(c) ownership units) under section 961.

(B) Analysis—(1) In general. Under §1.961-4(d), F2 reduces its section 961(c) basis of, and if applicable recognizes gain with respect to, each share of stock of F1 on which it receives previously taxed earnings and profits. The specific adjustments are provided in paragraphs (c)(3)(iv)(B)(2) through (5) of this section and summarized in table 1 in this paragraph (c)(3)(iv)(B)(1).

(2) F2’s receipt of previously taxed earnings and profits with respect to US1. As a result of F2’s receipt of previously taxed earnings and profits with respect to US1, the amount of the adjustment to F2’s section 961(c) basis with respect to US1 of each of F2’s shares of stock of F1 is $6x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US1 and received on the share. See §1.961-4(d)(2)(i). Consequently, F2 reduces its section 961(c) basis with respect to US1 of each of its shares of stock of F1 ($3x) to $0 and then reduces such section 961(c) basis below zero in accordance with the limitation in §1.961-4(d)(3), which permits a $1.5x reduction below zero to the section 961(c) basis because $1.5x of F2’s adjusted basis of the share is available with respect to US1 (as described in paragraph (c)(3)(iv)(B)(4) of this section). See §1.961-4(d)(2)(ii) and (d)(3)(i). Further, F2 is treated as recognizing £0.75x of gain with respect to each of its shares of stock of F1 (computed as the excess of the $6x adjustment to basis over the sum of the $3x reduction to positive section 961(c) basis and the $1.5x reduction of section 961(c) basis below zero ($1.5x excess), with such excess of $1.5x translated into British pounds at $1:£0.5), and this gain is assigned solely to US1. See §1.961-4(d)(2)(iii) and (f)(4). Moreover, the gain applies only for purposes of determining amounts included in gross income of US1 and US2 (the United States shareholders of F2) under §1.961-11. See §1.961-4(f)(3).

(3) F2’s receipt of previously taxed earnings and profits with respect to US2. As a result of F2’s receipt of previously taxed earnings and profits with respect to US2, the amount of the adjustment to F2’s section 961(c) basis with respect to US2 of each of F2’s shares of stock of F1 is $4x, the dollar basis and associated foreign income taxes of the previously taxed earnings and profits that are both with respect to US2 and received on the share. See §1.961-4(d)(2)(i). Consequently, F2 reduces its section 961(c) basis with respect to US2 of each of its shares of stock of F1 ($2x) to $0 and then reduces such section 961(c) basis below zero in accordance with the limitation in §1.961-4(d)(3), which permits a $1x reduction below zero to the section 961(c) basis because $1x of F2’s adjusted basis of the share is available with respect to US2 (as described in paragraph (c)(3)(iv)(B)(4) of this section). See §1.961-4(d)(2)(ii) and (d)(3)(i). Further, F2 is treated as recognizing £0.5x of gain with respect to each of its shares of stock of F1 (computed as the excess of the $4x adjustment to basis over the sum of the $2x reduction to positive section 961(c) basis and the $1x reduction of section 961(c) basis below zero ($1x excess), with such excess of $1x translated into British pounds at $1:£0.5), and this gain is assigned solely to US2. See §1.961-4(d)(2)(iii) and (f)(4). Moreover, the gain applies only for purposes of determining amounts included in gross income of US1 and US2 (the United States shareholders of F2) under §1.961-11. See §1.961-4(f)(3).

(4) Available adjusted basis. For each of F2’s shares of stock of F1, the amount of adjusted basis of the share that is available with respect to each of US1 and US2 is determined by multiplying $2.5x (the £1.25x of adjusted basis of the share translated into U.S. dollars at $1:£0.5, reduced by all negative derived basis of the share existing immediately before the distribution being analyzed, of which there is none) by a fraction. See §1.961-4(d)(3)(ii). The numerator of the fraction is the amount by which F2’s section 961(c) basis with respect to the covered shareholder of the share would be reduced below zero if section 961(c) basis could be reduced without limitation and, accordingly, is $3x in the case of the section 961(c) basis with respect to US1 (computed as the excess of the $6x adjustment to basis over the $3x reduction to positive section 961(c) basis) and is $2x in the case of section 961(c) basis with respect to US2 (computed as the excess of the $4x adjustment to basis over the $2x reduction to positive section 961(c) basis). The denominator of the fraction is the sum of the amounts by which any of F2’s section 961(c) basis of the share would be reduced below zero if section 961(c) basis could be reduced without limitation ($5x, computed as the $3x with respect to US1 plus the $2x with respect to US2). Therefore, for each of F2’s shares of stock of F1, there is $1.5x of adjusted basis available with respect to US1 ($2.5x × $3x/$5x) and $1x of adjusted basis available with respect to US2 ($2.5x × $2x/$5x), and this adjusted basis permits a $1.5x and $1x reduction below zero to section 961(c) basis with respect to US1 and US2, respectively (as described in paragraphs (c)(3)(iv)(B)(2) and (3) of this section). See also §1.961-10(c) (gain resulting from negative section 961(c) basis is allocated to covered shareholders in proportion to relative negative section 961(c) basis).

(5) Timing of adjustments. The reductions to section 961(c) basis described in paragraphs (c)(3)(iv)(B)(2) and (3) of this section are treated as made, and the gains described in those paragraphs are treated as recognized, concurrently with the covered distribution. See §1.961-4(e)(1) and (f)(1).

(4) Example 4: Use of positive derived basis—(i) Facts. US1 and a nonresident alien individual, in the aggregate, directly own all the interests in PRS1. PRS1 directly owns all the shares of the single class of outstanding stock of F1 (derivative ownership units). In year 3, PRS1 sells all the stock of F1 for money equal to the stock’s fair market value. Section 304 does not apply to the sale. US1’s distributive share of gain recognized by PRS1 on the sale is $60x, determined without regard to derived basis. Immediately before the sale (and taking into account any adjustments under §1.961-5(b) resulting from the sale), PRS1’s positive derived basis with respect to US1 of the shares of stock of F1 is $50x in total. In addition, PRS1 has no negative derived basis in any of the shares. This example only analyzes the application of positive derived basis to US1’s distributive share of gain on the sale. See also §1.959-3 (adjustments to previously taxed earnings and profits accounts); §1.959-7 (transfer of previously taxed earnings and profits in general successor transactions); §1.986(c)-1 (foreign currency gain or loss recognized in general successor transactions).

(ii) Analysis. PRS1 is treated as applying its $50x of positive derived basis with respect to US1 of the stock of F1 to US1’s $60x distributive share of gain on the sale. See §1.961-8(b). As result, US1’s distributive share of gain on the sale is adjusted by $50x, to a $10x distributive share of gain. See also §1.961-8(c) (for purposes of adjusting US1’s adjusted basis of its interest in PRS1 under section 705, US1’s distributive share on the sale is $10x of gain).

(iii) Alternative facts: positive derived basis creates a distributive share of loss—(A) Facts. The facts are the same as in paragraph (c)(4)(i) of this section, except that PRS1’s positive derived basis with respect to US1 of the shares of stock of F1 is $75x in total. In addition, if there were a loss in PRS1’s stock of F1, PRS1 would recognize all such loss in the sale and a current deduction in respect of the loss would be allowable.

(B) Analysis. PRS1 is treated as applying its $75x of positive derived basis with respect to US1 of the stock of F1 to US1’s $60x distributive share of gain on the sale. See §1.961-8(b). As result, US1’s distributive share of the gain on the sale is adjusted by $75x, to a $15x distributive share of loss. See also §1.961-8(c) (for purposes of adjusting US1’s adjusted basis of its interest in PRS1 under section 705, US1’s distributive share on the sale is $15x of loss).

(iv) Alternative facts: tiered partnerships—(A) Facts. The facts are the same as in paragraph (c)(4)(i) of this section (Example 4), except as follows. US1 and a nonresident alien individual, in the aggregate, directly own all the interests in PRS2. PRS2 and a nonresident alien individual, in the aggregate, directly own all the interests in PRS1. US1’s distributive share of gain recognized by PRS1 on the sale (through its interest in PRS2) is $55x, determined without regard to derived basis.

(B) Analysis. PRS2 is treated as applying PRS1’s $50x of positive derived basis with respect to US1 of the stock of F1 to US1’s $55x distributive share of gain on the sale. See §1.961-8(b). As result, US1’s distributive share of gain on the sale is adjusted by $50x, to a $5x distributive share of gain. See also §1.961-8(c) (for purposes of adjusting US1’s adjusted basis of its interest in PRS2 under section 705, US1’s distributive share on the sale is $5x of gain); §1.961-8(d) (for purposes of adjusting PRS2’s common basis of its interest in PRS1 under section 705, PRS2’s distributive share of gain is determined without regard to the application of positive derived basis; concurrently with the adjustment under section 705, reducing PRS2’s derived basis with respect to US1 of the interest in PRS1 by $50x, the amount of positive derived basis applied to US1’s distributive share of gain).

(5) Example 5: Use of positive section 961(c) basis—(i) Facts. US1 and a nonresident alien individual, in the aggregate, directly own all the shares of the single class of outstanding stock of F1. F1 directly owns all the shares of the single class of outstanding stock of F2 (section 961(c) ownership units). In year 3, F1 sells all the stock of F2 for money equal to the stock’s fair market value. Section 304 does not apply to the sale. F1 recognizes £100x of gain on the sale, determined without regard to loss recognized on any share and without regard to section 961(c) basis. This £100x is covered gain and US1 is assigned a £60x portion of the covered gain under §1.951-2. Immediately before the sale (and taking into account any adjustments under §1.961-5(b) resulting from the sale), F1’s positive section 961(c) basis with respect to US1 of the shares of stock of F2 is £50x in total (as translated from U.S. dollars into British pounds at the spot rate on the day of the sale). In addition, F1 has no negative section 961(c) basis in any of the shares. Table 1 in this paragraph (c)(5)(i) provides the previously taxed earnings and profits of F2 that transfer from US1 in the sale to a successor covered shareholder under §1.959-7 (total of £44x), along with the foreign income taxes that are associated with such previously taxed earnings and profits (total of £6x, as translated from U.S. dollars into British pounds at the spot rate on the day of the sale for purposes of §1.961-9(f)(2)). This example only analyzes the extent to which previously taxed earnings and profits result from the application of F1’s section 961(c) basis and are excluded from F1’s gross income under section 961(c). See also §1.959-3 (adjustments to previously taxed earnings and profits accounts); §1.986(c)-1 (foreign currency gain or loss recognized in general successor transactions).

(ii) Analysis—(A) In general. For purposes of analyzing the covered gain, US1’s share of the covered gain is £60x because that amount of the covered gain is assigned to US1 under §1.951-2. See §1.961-9(d)(1). All £50x of F1’s positive section 961(c) basis with respect to US1 of the stock of F2 is applied to such share. See §1.961-9(d)(2) and (e)(1). As a result, £50x of the covered gain is previously taxed earnings and profits of F1 with respect to US1, characterized as described in paragraph (c)(5)(ii)(B) of this section. See §1.961-9(d)(3) and (f)(1). F1 excludes the £50x of previously taxed earnings resulting from section 961(c) basis from its gross income, solely for purposes of determining its subpart F income and tested income or tested loss. See §1.961-9(b).

(B) Character of previously taxed earnings and profits resulting from section 961(c) basis. The mirroring rule in §1.961-9(f)(2) determines the specific character of all £50x of F1’s previously taxed earnings and profits resulting from section 961(c) basis because the amount of such previously taxed earnings and profits does not exceed the amount of mirrored PTEP, of which there is £50x. See §1.961-9(f)(2)(i). The mirrored PTEP is the previously taxed earnings and profits described in table 1 to paragraph (c)(5)(i) of this section, determined by treating foreign income taxes associated with transferred previously taxed earnings and profits as additional previously taxed earnings and profits (£44x + £6x). See §1.961-9(f)(2)(ii). Under the mirroring rule, the £50x of previously taxed earnings and profits resulting from section 961(c) basis have the same character as the £50x of mirrored PTEP, as summarized in table 1 in this paragraph (c)(5)(ii)(B). See §1.961-9(f)(2)(i); see also §1.961-9(g) and (h) (dollar basis rule and rule for allocating previously taxed earnings and profits to specific shares of stock).

(iii) Alternative facts: unused section 961(c) basis—(A) Facts. The facts are the same as in paragraph (c)(5)(i) of this section (Example 5), except that the amount of F1’s covered gain is £70x (instead of £100x) and US1 is assigned a £42x (instead of £60x) portion of the covered gain under §1.951-2.

(B) Analysis. For purposes of analyzing the covered gain, US1’s share of the covered gain is £42x, and £42x of F1’s £50x of positive section 961(c) basis with respect to US1 of the stock of F2 is applied to such share. See §1.961-9(d)(1) and (2), (e)(1). As a result, £42x of the covered gain is previously taxed earnings and profits of F1 with respect to US1, with the same character as a pro rata portion of the previously taxed earnings and profits set forth in table 1 to paragraph (c)(5)(ii)(B) of this section, determined by multiplying all such previously taxed earnings and profits by 84% (computed as $42x of previously taxed earnings and profits resulting from section 961(c) basis divided by £50x of mirrored PTEP). See §1.961-9(d)(3), (f)(1) and (2). Moreover, the £8x of F1’s positive section 961(c) basis that is not applied to the covered gain is taken into account only for purposes of determining amounts included in gross income of United States shareholders of F1 under §1.961-11.

(6) Example 6: Gain recognition for negative derived basis—(i) Facts. US1 and US2, in the aggregate, directly own all the interests in PRS1. PRS1 directly owns all the shares of the single class of stock of F1 (derivative ownership units). In year 3, PRS1 sells all the stock of F1 for money equal to the stock’s fair market value. Section 304 does not apply to the sale, and the shares of stock of F1 remain derivative ownership units immediately after the sale (because the buyer is a partnership the interests in which are owned by one or more covered shareholders). PRS1 recognizes $2x of loss with respect to each share of stock of F1, determined without regard to derived basis and allocated to US1 and US2 in accordance with section 704. Immediately before the sale (and taking into account any adjustments under §1.961-5(b) resulting from the sale), for each share of stock of F1, PRS1’s derived basis with respect to US1 is negative $1.5x and its derived basis with respect to US2 is negative $1x. This example only analyzes the consequences of negative derived basis in the sale. See also §1.959-3 (adjustments to previously taxed earnings and profits accounts); §1.959-7 (transfer of previously taxed earnings and profits in general successor transactions); §1.986(c)-1 (foreign currency gain or loss recognized in general successor transactions).

(ii) Analysis. As a result of negative derived basis, PRS1 is treated as recognizing gain with respect to each share of stock of F1. See §1.961-10(b)(1). For each share of stock of F1, the amount of such gain is $2.5x, which is the lesser amount of loss ($2x, expressed as a positive amount), plus the additional amount of gain ($0.5x), that PRS1 would have recognized with respect to the share if PRS1’s common basis of the share were reduced by $2.5x (the sum of all PRS1’s negative derived basis of the share), and thus all negative derived basis gives rise to gain. See §1.961-10(b)(2)(i); compare paragraph (c)(6)(iii) of this section (scenario where less than all negative derived basis gives rise to gain). A pro rata portion of the $2.5x of gain treated as recognized with respect to each share of stock of F1 is allocated to US1 and US2 by multiplying the amount of such gain by a fraction, the numerator of which is PRS1’s negative derived basis with respect to the covered shareholder of the share ($1.5x in the case of US1, and $1x in the case of US2), and the denominator of which is the sum of all PRS1’s negative derived basis of the share ($2.5x). See §1.961-10(b)(3). Thus, in addition to the allocation in accordance with section 704 of the $2x of loss that PRS1 recognizes with respect to each share of stock of F1, US1 is allocated $1.5x, and US2 is allocated $1x, of the $2.5x of gain treated as recognized by PRS1 with respect to each share of stock of F1. See §1.961-10(b)(4); see also §1.961-4(f)(2) (gain allocated to US1 or US2 is taken into account in adjusting US1’s or US2’s basis in its interest in PRS1 under section 705).

(iii) Alternative facts: section 301(c)(2) distribution—(A) Facts. The facts are the same as in paragraph (c)(6)(i) of this section (Example 6), except as follows. PRS1 does not sell any stock of F1. In year 3, F1 makes a distribution that is $10x with respect to each share of its stock. None of the distribution is a covered distribution because F1 has no accumulated or current year earnings and profits in year 3. Immediately before the distribution, for each share of stock of F1, PRS1’s common basis is $12x, its derived basis with respect to US1 is negative $1.5x, and its derived basis with respect to US2 is negative $1x. Thus, section 301(c)(2) applies to the entirety of the $10x that is distributed with respect to each share of stock of F1. This example only analyzes the consequences of negative derived basis in the distribution.

(B) Analysis. PRS1 determines the amount of gain it is treated as recognizing as a result of negative derived basis by calculating the additional amount of gain that it would have recognized with respect to each share of stock of F1 under section 301(c)(3) if its common basis of the share were reduced by $2.5x (the sum of all PRS1’s negative derived basis of the share). See §1.961-10(b)(2)(i). Specifically, if PRS1’s common basis of each share were reduced by $2.5x, the common basis would be $9.5x ($12x × $2.5x), such that the distribution of $10x on the share would result in $9.5x being treated as a return of basis under section 301(c)(2) and $0.5x being treated as gain recognized under section 301(c)(3). Thus, PRS1 is treated as recognizing $0.5x of gain with respect to each share as a result of the $2.5x of negative derived basis of the share, and PRS1 retains the remaining $2x of negative derived basis of the share (which, under these facts, is equal to the portion of the common basis of the share that is not reduced by the distribution under section 301(c)(2) ($12x × $10x, or $2x)). A pro rata portion of the $0.5x of gain treated as recognized with respect to each share of stock of F1 is allocated to US1 and US2 by multiplying the amount of such gain by a fraction, the numerator of which is PRS1’s negative derived basis with respect to the covered shareholder of the share ($1.5x in the case of US1, and $1x in the case of US2), and the denominator of which is the sum of all PRS1’s negative derived basis of the share ($2.5x). See §1.961-10(b)(3). Thus, US1 is allocated $0.3x, and US2 is allocated $0.2x, of the $0.5x of gain treated as recognized by PRS1 with respect to each share of stock of F1. See §1.961-10(b)(4); see also §1.961-4(f)(2) (gain allocated to US1 or US2 is taken into account in adjusting US1’s or US2’s basis in its interest in PRS1 under section 705). Immediately after the distribution, for each share of stock of F1, PRS1’s derived basis with respect to US1 is negative $1.2x (negative $1.5x + $0.3x) and its derived basis with respect to US2 is negative $0.8x (negative $1x + $0.2x). See §1.961-10(b)(5).

(7) Example 7: Gain recognition for negative section 961(c) basis—(i) Facts. US1 and US2, in the aggregate, directly own all the shares of the single class of stock of F1 and are United States shareholders of F1. F1 directly owns all the shares of the single class of stock of F2 (section 961(c) ownership units). In year 3, F1 sells all the stock of F2 for money equal to the stock’s fair market value. Section 304 does not apply to the sale, and the shares of stock of F2 remain section 961(c) ownership units immediately after the sale (because the buyer is a controlled foreign corporation). F1 recognizes £2x of loss with respect to each share of stock of F2, determined without regard to section 961(c) basis. Immediately before the sale (and taking into account any adjustments under §1.961-5(b) resulting from the sale), for each share of stock of F2, F1’s section 961(c) basis with respect to US1 is negative £1.5x and its section 961(c) basis with respect to US2 is negative £1x (as translated from U.S. dollars into British pounds at the spot rate on the day of the sale). This example only analyzes the consequences of negative section 961(c) basis in the sale. See also §1.959-3 (adjustments to previously taxed earnings and profits accounts); §1.959-7 (transfer of previously taxed earnings and profits in general successor transactions); §1.986(c)-1 (foreign currency gain or loss recognized in general successor transactions).

(ii) Analysis. As a result of negative section 961(c) basis, F1 is treated as recognizing gain with respect to each share of stock of F2. See §1.961-10(c)(1). For each share of stock of F2, the amount of such gain is £2.5x, which is the lesser amount of loss (£2x, expressed as a positive amount), plus the additional amount of gain (£0.5x), that F1 would have recognized with respect to the share if F1’s adjusted basis of the share were reduced by £2.5x (the sum of all F1’s negative section 961(c) basis of the share), and thus all negative section 961(c) basis gives rise to gain. See §1.961-10(c)(2)(i); compare paragraph (c)(7)(iii) of this section (scenario where less than all negative section 961(c) basis gives rise to gain). A pro rata portion of the £2.5x of gain treated as recognized with respect to each share of stock of F2 is assigned to US1 and US2 by multiplying the amount of such gain by a fraction, the numerator of which is F1’s negative section 961(c) basis with respect to the covered shareholder of the share (£1.5x in the case of US1, and £1x in the case of US2), and the denominator of which is the sum of all F1’s negative section 961(c) basis of the share (£2.5x). See §1.961-10(c)(3). Thus, US1 is assigned £1.5x, and US2 is assigned £1x, of the £2.5x of gain treated as recognized by F1 with respect to each share of stock of F2. Moreover, the gain applies only for purposes of determining amounts included in gross income of US1 and US2 (the United States shareholders of F1) under §1.961-11. See §1.961-10(c)(4); see also §§1.961-4(f)(3) (the gain does not affect F1’s items of gross income for purposes of section 952 or 951A or its earnings and profits).

(iii) Alternative facts: section 351 exchange with boot—(A) Facts. The facts are the same as in paragraph (c)(7)(i) of this section (Example 7), except as follows. Instead of the sale, F1 contributes property, including all its stock of F2, to F3, a controlled foreign corporation, in exchange for stock of F3 and money equal, in the aggregate, to the fair market value of the contributed property. Other unrelated persons also contribute property to F3 in exchange for stock of F3 as part of the same transaction. Section 351(b) applies to F1’s exchange, but sections 304 and 362(e) do not, and no income inclusions are required under §1.367(b)-4. The shares of stock of F2 remain section 961(c) ownership units immediately after the contribution (because F3 is a controlled foreign corporation). In the exchange, for each share of stock of F2, F1 receives stock of F3 and £10x of money but recognizes no gain because F1’s adjusted basis of the share is £2x greater than the fair market value of the share. Immediately before the exchange (and taking into account any adjustments under §1.961-5(b) resulting from the exchange), for each share of stock of F2, F1’s section 961(c) basis with respect to US1 is negative £1.5x and its section 961(c) basis with respect to US2 is negative £1x (as translated from U.S. dollars into British pounds at the spot rate on the day of the exchange). This example only analyzes the consequences of negative section 961(c) basis in the exchange.

(B) Analysis. F1 determines the amount of gain it is treated as recognizing as a result of negative section 961(c) basis by calculating the additional amount of gain that it would have recognized with respect to each share of stock of F2 under section 351(b) if its adjusted basis of the share were reduced by £2.5x (the sum of all F1’s negative section 961(c) basis of the share). See §1.961-10(c)(2)(i). Specifically, a £2.5x reduction to F1’s adjusted basis of each share would convert a £2x loss on the share into a £0.5x gain, which would then be recognized pursuant to section 351(b) in the exchange. Thus, F1 is treated as recognizing £0.5x of gain with respect to each share as a result of the £2.5x of negative section 961(c) basis of the share, and the remaining £2x of negative section 961(c) basis of the share is retained (which, under these facts, is equal to the loss in the share that is not recognized in the exchange (£2x, the excess of the adjusted basis of the share over the fair market value of the share)). A pro rata portion of the £0.5x of gain treated as recognized with respect to each share of stock of F2 is assigned to US1 and US2 by multiplying the amount of such gain by a fraction, the numerator of which is F1’s negative section 961(c) basis with respect to the covered shareholder of the share (£1.5x in the case of US1, and £1x in the case of US2), and the denominator of which is the sum of all F1’s negative section 961(c) basis of the share (£2.5x). See §1.961-10(c)(3). Thus, US1 is assigned £0.3x, and US2 is assigned £0.2x, of the £0.5x of gain treated as recognized by F1 with respect to each share of stock of F2. Moreover, the gain applies only for purposes of determining amounts included in gross income of US1 and US2 (the United States shareholders of F1) under §1.961-11. See §1.961-10(c)(4); see also §§1.961-4(f)(3) (the gain does not affect F1’s items of gross income for purposes of section 952 or 951A or its earnings and profits). Immediately after the exchange, for each share of stock of F2, the functional currency amount of F3’s section 961(c) basis with respect to US1 is negative £1.2x (negative £1.5x + £0.3x) and its section 961(c) basis with respect to US2 is negative £0.8x (negative £1x + £0.2x). See §1.961-10(c)(5).

(8) Example 8: Amounts included in gross income of United States shareholders—(i) Facts. US1 and US2, in the aggregate, directly own all the shares of the single class of stock of F1 and are United States shareholders of F1. F1 directly owns all the shares of the single class of stock of each of F2 and F3 (section 961(c) ownership units). For F1’s taxable year ending on December 31 of year 3, F1 recognizes £50x of section 961(c) income. The section 961(c) income consists of £10x of gain recognized as a result of F1’s receipt of previously taxed earnings and profits from F2 and £40x of gain recognized as a result of F1’s sale of stock of F3 with negative section 961(c) basis. US1 and US2 are assigned equal portions of the £10x gain under §1.961-4(d) (basis reductions and gain recognition for distributions) and US2 is assigned all the £40x gain under §1.961-10(c) (gain recognition for negative basis). F1 has no positive section 961(c) basis in any of the sold shares of stock of F3. This example only analyzes the allocation of F1’s section 961(c) income and resulting inclusions in gross income of United States shareholders under section 961(c).

(ii) Analysis. Under §1.961-11, F1’s £50x of section 961(c) income is allocated to each of US1 and US2 by adding up the amounts of the section 961(c) income that are assigned to each United States shareholder. See §1.961-11(c). No additional computations are required because F1 does not recognize any loss under section 961(c) and there are no transfers of stock of F1. See id. Thus, US1 is allocated £5x (£5x of gain with respect to stock of F2 plus £0 of gain with respect to stock of F3), and US2 is allocated £45x (£5x of gain with respect to stock of F2 plus £40x of gain with respect to stock of F3), of the section 961(c) income. Accordingly, US1 includes £5x in its gross income and US2 includes £45x in its gross income, in each case for the United States shareholder’s (US1’s or US2’s) taxable year ending on December 31 of year 3 and translated into U.S. dollars in accordance with section 989(b). See §1.961-11(b). Under §1.961-3, each of US1’s and US2’s income inclusion increases its adjusted basis of its stock of F1 by the U.S. dollar amount of the inclusion.

(iii) Alternative facts: loss under section 961(c)—(A) Facts. The facts are the same as in paragraph (c)(8)(i) of this section (Example 8), except as follows. F1 is treated as recognizing £7x of loss under section 961(c) with respect to US2 because F1 has positive section 961(c) basis with respect to US2 in some of the sold shares of stock of F3 and, under §1.961-9, all but £7x of such positive section 961(c) basis is applied to US2’s share of covered gain recognized by F1 on the sale of stock of F3.

(B) Analysis. Under §1.961-11, F1’s £50x of section 961(c) income is allocated to each of US1 and US2 by first adding up the amounts of the section 961(c) income that are assigned to the United States shareholder (£5x in the case of US1, and £45x in the case of US2) and then reducing (but not below zero) such sum by the amount of loss F1 is treated as recognizing under section 961(c) with respect to the United States shareholder (£0 in the case of US1, and £7x in the case of US2). See §1.961-11(c). Thus, US1 is allocated £5x (£5x × £0), and US2 is allocated £38x (£45x × £7x), of the section 961(c) income. Accordingly, US1 includes £5x in its gross income and US2 includes £38x in its gross income, in each case for the United States shareholder’s (US1’s or US2’s) taxable year ending on December 31 of year 3 and translated into U.S. dollars in accordance with section 989(b). See §1.961-11(b). Under §1.961-3, each of US1’s and US2’s income inclusion increases its adjusted basis of its stock of F1 by the U.S. dollar amount of the inclusion.

(a) Scope. This section sets forth transition rules for the section 961 regulations. Paragraph (b) of this section addresses the establishment of derived basis of a partnership and section 961(c) basis of a controlled foreign corporation. Paragraph (c) of this section treats a domestic partnership (including an S corporation) as a covered shareholder for periods in which §1.958-1(d)(1) does not apply. Paragraph (d) of this section converts basis with respect to a domestic partnership (including an S corporation) to basis with respect to covered shareholders owning interests in the domestic partnership when both §1.958-1(d)(1) and the section 961 regulations first apply.

(b) Establishing derived basis of a partnership and section 961(c) basis of a controlled foreign corporation—(1) In general. As of the beginning of the first taxable year of a foreign corporation to which the section 961 regulations (other than §§1.961-6 and 1.961-7) apply pursuant to §1.961-14(b), a partnership’s derived basis of derivative ownership units, and a controlled foreign corporation’s section 961(c) basis of section 961(c) ownership units, that are shares of stock of the foreign corporation or property through one or more covered shareholders own stock of the foreign corporation must be established in accordance with the rules described in paragraphs (b)(2) through (5) of this section.

(2) Derived basis—(i) In general. The partnership’s derived basis of each derivative ownership unit is established by increasing derived basis with respect to each covered shareholder by the U.S. dollar amount of derived basis with respect to the covered shareholder that would exist at the beginning of the taxable year (and therefore would not have been decreased in a distribution or general successor transaction, for example) if the principles of §§1.961-2 through 1.961-5, 1.961-8, and 1.961-10 were to have previously applied, determined using a reasonable method (consistently applied to each foreign corporation whose stock is owned by the partnership and with respect to each covered shareholder that owns an interest in the partnership). In the case of a domestic partnership, the increase described in the preceding sentence is determined without regard to an income inclusion of the domestic partnership or any lower-tier domestic partnership (for example, an income inclusion of the domestic partnership under section 951(a)(1)(A) that occurs in a period before §1.958-1(d) applies to the domestic partnership).

(3) Section 961(c) basis. The controlled foreign corporation’s section 961(c) basis of each section 961(c) ownership unit is established by increasing section 961(c) basis with respect to each covered shareholder by the U.S. dollar amount of section 961(c) basis with respect to the covered shareholder that would exist at the beginning of the taxable year (and therefore would not have been decreased in a distribution or general successor transaction, for example) if the principles of §§1.961-2 through 1.961-5, 1.961-9, 1.961-10, and 1.961-11 were to have previously applied, determined using a reasonable method (consistently applied to each foreign corporation whose stock is owned by the controlled foreign corporation and with respect to each covered shareholder that owns stock in the controlled foreign corporation).

(4) Treatment of a specified foreign corporation as a controlled foreign corporation. A specified foreign corporation (as defined in §1.965-1(f)(45)(i)(B)) that is not otherwise a controlled foreign corporation is treated as a controlled foreign corporation for purposes of the application of the principles of §1.961-3 to an income inclusion under section 951(a)(1)(A) by reason of section 965(a).

(5) Anti-duplication rule. Derived basis or section 961(c) basis is increased under this paragraph (b) to reflect an income inclusion under section 951(a)(1)(A) or 951A(a) only to the extent such an increase would not duplicate basis (including basis previously used) at the level of the partnership or the controlled foreign corporation, as applicable, to reflect the income inclusion (for example, in the case of a foreign partnership, basis previously provided under §1.965-2(h)(5)(ii)).

(c) Treatment of domestic partnerships (including S corporations) before application of §1.958-1(d)(1). For purposes of the section 961 regulations, a domestic partnership (including an S corporation) is treated as a covered shareholder for any taxable year of the domestic partnership to which §1.958-1(d)(1) does not apply. If a domestic partnership is treated as a covered shareholder, then rules regarding derived basis (of a partnership that is owned by the domestic partnership) or section 961(c) basis (of a controlled foreign corporation that is owned by the domestic partnership) apply to the domestic partnership in its capacity as a covered shareholder before those rules apply to a covered shareholder that owns interests in the domestic partnership. In such a case, for example, covered gain recognized by a controlled foreign corporation and assigned to the domestic partnership is first previously taxed earnings and profits by reason of the controlled foreign corporation’s positive section 961(c) basis with respect to the domestic partnership and then, to the extent remaining, previously taxed earnings and profits by reason of positive section 961(c) basis with respect to covered shareholders owning interests in the domestic partnership.

(d) Converting basis with respect to domestic partnerships (including S corporations) to basis with respect to partners (or shareholders) after the application of §1.958-1(d)(1)—(1) In general. As of the beginning of the first taxable year of a domestic partnership (including an S corporation) to which both §1.958-1(d)(1) and the section 961 regulations (other than §§1.961-6 and 1.961-7) apply (pursuant to §1.961-14(b)), the rules described in paragraphs (d)(2) through (4) of this section apply to convert—

(i) A lower-tier partnership’s derived basis with respect to the domestic partnership of derivative ownership units (if such derived basis was earlier established pursuant to paragraphs (b)(2) and (c) of this section) to derived basis with respect to covered shareholders owning interests in the domestic partnership; and

(ii) A controlled foreign corporation’s section 961(c) basis with respect to the domestic partnership of section 961(c) ownership units (if such section 961(c) basis was earlier established pursuant to paragraphs (b)(3) and (c) of this section) to section 961(c) basis with respect to covered shareholders owning interests in the domestic partnership.

(2) Rules for converting derived basis with respect to a domestic partnership—(i) Allocate derived basis to each covered shareholder. First, allocate a pro rata portion of the lower-tier partnership’s derived basis with respect to the domestic partnership of each derivative ownership unit to each covered shareholder owning an interest in the domestic partnership at the beginning of the taxable year, determined by multiplying the derived basis with respect to the domestic partnership by the fraction described in §1.959-11(e)(2)(i)(A) for the covered shareholder and the domestic partnership.

(ii) Transfer derived basis. Second, transfer to each covered shareholder the portion of the lower-tier partnership’s derived basis with respect to the domestic partnership of each derivative ownership unit that is allocated to the covered shareholder under paragraph (d)(2)(i) of this section.

(3) Rules for converting section 961(c) basis with respect to a domestic partnership—(i) Allocate section 961(c) basis to each covered shareholder. First, allocate a pro rata portion of the controlled foreign corporation’s section 961(c) basis with respect to the domestic partnership of each section 961(c) ownership unit to each covered shareholder owning an interest in the domestic partnership at the beginning of the taxable year, determined by multiplying the section 961(c) basis with respect to the domestic partnership by the fraction described in §1.959-11(e)(2)(i)(A) for the covered shareholder and the domestic partnership.

(ii) Transfer section 961(c) basis. Second, transfer to each covered shareholder the portion of the controlled foreign corporation’s section 961(c) basis with respect to the domestic partnership of each section 961(c) ownership unit that is allocated to the covered shareholder under paragraph (d)(3)(i) of this section.

(4) Coordination with deemed covered shareholder rules. The portion, if any, of the lower-tier partnership’s derived basis with respect to the domestic partnership, or the controlled foreign corporation’s section 961(c) basis with respect to the domestic partnership, that does not increase derived basis or section 961(c) basis with respect to a covered shareholder becomes with respect to the deemed covered shareholder for purposes of subsequently transferring the basis under §1.961-5(c).

(a) Scope. This section sets forth applicability dates for the section 961 regulations. Paragraph (b) of this section provides the applicability dates.

(b) Applicability dates. Sections 1.961-1 through 1.961-5 and 1.961-8 through 1.961-13 apply to taxable years of foreign corporations that begin on or after [date of publication of final regulations in the Federal Register] or are early application years (as described in §1.959-12(d)) and to taxable years of persons for which such taxable years of those foreign corporations are relevant.

Par. 29. Section 1.962-1 is amended by:

The addition reads as follows: