Treasury and IRS Announce Intent to Issue Proposed Regulations on Section 898

The U.S. Treasury Department and the Internal Revenue Service recently issued Notice 2025-72, announcing their intent to release proposed regulations under Section 70352 of Public Law 119-21, commonly known as the One Big Beautiful Bill Act. The notice addresses the repeal of Internal Revenue Code Section 898(c)(2) and outlines transition guidance for specified foreign corporations affected by the change.

For multinational structures with U.S. ownership, these changes introduce new compliance considerations, including short taxable years, foreign tax allocation mechanics, and required accounting period adjustments.

Key Takeaways

• Section 898(c)(2) has been repealed for tax years beginning after November 30, 2025, eliminating the one-month deferral election for specified foreign corporations (SFCs).
• Affected SFCs will have a short taxable year as they transition to the required tax year of their majority U.S. shareholders.
• Notice 2025-72 provides allocation rules for foreign income taxes paid or accrued during the short year and the succeeding year.
• Automatic accounting period change procedures apply, and no Form 1128 is required when following Rev. Proc. 2006-45.
• Section 987 rules may also be impacted, with proposed regulations expected to shift amortization of pretransition amounts to a 120-month framework.

What Changed Under Section 898

Repeal of the One-Month Deferral Election

Section 898(c)(2) previously allowed certain specified foreign corporations (SFCs) to elect a tax year beginning one month earlier than the tax year of their majority U.S. shareholders. This election provided limited flexibility in aligning foreign income and tax reporting.

The One Big Beautiful Bill Act repealed this provision for tax years beginning after November 30, 2025. As a result, SFCs that previously relied on the one-month deferral election must now adopt the same tax year as their majority U.S. shareholders.

This required alignment creates a short taxable year for affected SFCs during the transition, as the former deferral year ends before the required tax year begins.

Transition Rules for Affected Foreign Corporations

Section 70352(c) of the Act includes a transition rule for SFCs required to change their tax year due to the repeal. Under this rule:

• The tax year change is treated as initiated by the corporation
• The change is deemed to be made with the consent of the Secretary of the Treasury
• The IRS is directed to issue guidance on allocating foreign taxes paid or accrued during the short taxable year and the succeeding year

Notice 2025-72 provides that guidance and clarifies how these transitional rules are intended to operate.

How Foreign Taxes Are Allocated During the Short Year

A key issue arising from the repeal of Section 898(c)(2) is how foreign income taxes should be allocated between the short taxable year and the following full year. Notice 2025-72 establishes a structured allocation framework for specified foreign income taxes.

Allocation Methodology

The notice outlines the following approach:

1. Identification of specified foreign income taxes
   These are foreign net income taxes accrued by an SFC in its first required year, which is the short taxable year.
2. Application of Reg. §1.861-20
   The specified foreign income taxes are allocated and apportioned to the appropriate income groups and previously taxed earnings and profits (PTEP) groups under Reg. §1.960-1(d).
3. Allocation between tax periods
   Taxes are allocated first to the short taxable year and then to the succeeding year, based on the proportion of foreign taxable income attributable to each period. Taxpayers may use either:
   • A closing-of-the-books method, or
   • A ratable allocation method consistent with Reg. §1.1502-76(b)
4. Accrual treatment
   The amount of foreign income tax allocated to each period is treated as accruing in that year for all purposes of the Internal Revenue Code, except Sections 905(c) and 986(a).

Why the Allocation Guidance Matters

These allocation rules are intended to ensure that foreign taxes are matched with the income to which they relate for U.S. tax purposes. By doing so, the guidance helps prevent distortions in foreign tax credit calculations during the transition period and reduces the risk of under- or over-crediting foreign taxes in years affected by the repeal.

Required Accounting Period Change for SFCs

An SFC that is also a controlled foreign corporation must make an accounting period change to move from a one-month deferral tax year to its required tax year, which is the tax year of its majority U.S. shareholders. This change applies to the first tax year beginning after November 30, 2025.

Automatic Change Procedure

Existing guidance under Rev. Proc. 2006-45 provides an automatic accounting period change procedure for C corporations and SFCs. An SFC should generally qualify to use this automatic procedure when:

• Changing its accounting period to the required tax year under Section 898, or
• Adopting a 52–53-week tax year that references the required tax year

No separate request for IRS approval is required when the change is made in accordance with this guidance.

Short Period Filing Requirements

The one-month gap between the end of the former deferral year and the end of the required tax year constitutes a short taxable year. For this short period:

• Taxable income must be annualized
• Tax must be computed under Section 443(b) and Reg. §1.443-1(b)
• The controlling U.S. shareholder must file Form 5471 for the short period with the heading:
  “Filed under Rev. Proc. 2006-45”
• No Form 1128 is required
• If additional U.S. shareholders exist, notification requirements under Reg. §1.964-1(c)(3)(iii) apply

If the SFC is also required to file Form 1120F, that return must be filed using the required tax year for the first year beginning after November 30, 2025, with a copy of Form 5471 attached to reflect the automatic accounting period change.

Section 987 Considerations

Notice 2025-72 also addresses the interaction between the tax year change and the final 2024 Section 987 regulations.

Under those regulations:

• Pretransition gain generally consists of net accumulated unrecognized Section 987 gain
• Pretransition loss consists of suspended Section 987 loss, subject to the loss-to-the-extent-of-gain rule
• If a current rate election is in effect and annual recognition is not, all pretransition amounts are treated as net accumulated unrecognized pretransition gain or loss

Taxpayers may elect to amortize pretransition amounts ratably over a 10-year period beginning with the transition year. Notice 2025-72 announces that forthcoming proposed regulations would modify this election to require recognition over a 120-month period, with special rules applicable to short taxable years. For calendar-year taxpayers, this change would generally produce the same economic result as the existing 10-year approach.

What Multinational Taxpayers Should Be Thinking About Now

Although proposed regulations have not yet been issued, Notice 2025-72 provides meaningful insight into the IRS’s intended framework. Multinational taxpayers with specified foreign corporations should consider:

• Whether a short taxable year will be triggered by the repeal
• How foreign income taxes will be allocated across reporting periods
• Required accounting period changes and related filing mechanics
• Potential downstream effects on foreign tax credits and Section 987 balances

Advisory Perspective

Changes to tax year alignment and foreign tax allocation often have broader implications across a multinational structure. Advance planning can help identify and address these impacts before they create reporting or compliance challenges.

VSH CPAs’ International and Cross-Border team works with clients to interpret evolving guidance and apply it thoughtfully within the context of their broader business objectives.

Frequently Asked Questions (FAQs)

What is Section 898 and why does it matter?

Section 898 governs the tax year of certain foreign corporations owned by U.S. shareholders. Its repeal removes the ability for specified foreign corporations to maintain a tax year that begins one month earlier than their majority U.S. shareholders’ tax year.

Who is affected by the repeal of the one-month deferral election?

Specified foreign corporations with majority U.S. ownership that previously elected a one-month deferral tax year are affected. These entities must now conform their tax year to that of their majority U.S. shareholders.

When does the repeal take effect?

The repeal applies to tax years beginning after November 30, 2025.

How are foreign income taxes allocated during the short year?

Notice 2025-72 requires foreign income taxes to be allocated first to the short taxable year and then to the succeeding year, based on the proportion of foreign taxable income attributable to each period. Taxpayers may use either a closing-of-the-books or ratable allocation method.

What should multinational taxpayers do now?

Multinational taxpayers should evaluate whether their foreign subsidiaries are affected, assess the impact of a short taxable year, review foreign tax credit implications, and prepare for required accounting period and filing changes.