The US Treasury and IRS have proposed new CFC rules that replace the last-day ownership test with daily proration, changing how Subpart F income, tested income, and tested loss are allocated among US shareholders from 2026.
The US Treasury and the IRS have proposed regulations (REG-115646-25) establishing rules for allocating a controlled foreign corporation’s (CFC) subpart F income, tested income, and tested loss among US shareholders based on their respective periods of stock ownership during the CFC’s taxable year.
The proposed IRS regulations follow the One, Big, Beautiful Bill Act (OBBBA), specifically regarding how US shareholders must calculate and report their pro rata share of income from controlled foreign corporations (CFCs). The new rules shift from a “last day of the year” ownership test to a daily proration approach, ensuring tax liability is attributed to shareholders based on the specific duration of their ownership during the taxable year.
The key proposed regulations are:
The Core shift: Section 951(a)(1)(A) and the OBBBA amendments
The OBBBA amended Section 951(a)(1)(A) so that a US shareholder may have a Subpart F income inclusion based on stock owned on any day during the CFC’s taxable year, rather than only on the last relevant day. Under revised Section 951(a)(3), the inclusion is generally recognised in the shareholder’s taxable year containing the last day they own the CFC stock.
The daily proration allocation methodology
Proposed Section 1.951-1 generally uses daily proration to allocate Subpart F income, tested income, and tested loss. Separate calculations apply to different CFC year blocks. Weighted-average shares are used when outstanding shares change, while multiple classes of stock require allocation among classes before daily proration. The acquisition day is excluded and the disposition day is included in the ownership period.
Taxable year determinations: Mandatory closings (status change events)
Under proposed Section 1.245A-5 and related Section 1.951-1 rules, a foreign corporation must close its taxable year when it becomes or ceases to be a CFC. The closing occurs at the end of the status-change day. Special rules under Section 958 apply to determine the relevant US shareholders, including look-through treatment for domestic partnerships. The rules prevent income from non-CFC periods from affecting US tax inclusions.
Taxable year determinations: Elective closings (significant ownership variances)
Proposed Section 1.951-1 permits an elective taxable-year closing when a significant ownership variance results in an aggregate decrease of more than 50 percentage points in Section 958(a) US shareholder ownership. Specified transfers include sales, exchanges, redemptions, issuances, and certain partnership-interest changes. The election requires a binding written agreement, filing of an elective year-closing statement, notice to other US persons, and consistency across related CFCs. Anti-abuse rules address related-party transactions and F reorganisations.
Section 951A tested income & tested loss coordination
Proposed Section 1.951A-1 coordinates the new Subpart F rules with Section 951A. US shareholders generally determine their net CFC tested income inclusion amount, while previous rules for allocating QBAI, tested interest expense, and tested interest income are removed. Under the proposed rules, tested loss is generally allocated to common stock, with limited exceptions for preferred stock and equity with liquidation preferences. Subsequent tested income can first restore previously allocated tested losses.
The OBBBA transition rule for Pre-2026 dividends and substantiation
Proposed Section 1.951-4 implements the OBBBA transition rule for certain dividends paid during the transition period. A dividend generally cannot reduce a shareholder’s pro rata Subpart F or tested-income inclusion under former Section 951(a)(2)(B) if it does not increase the taxable income of a US person subject to federal income tax. Special rules cover upper-tier CFCs, publicly held partnerships, RICs, REITs, and exempt organisations. Shareholders claiming the reduction must attach a Pro Rata Share Transition Rule Statement to Form 5471.
Other key provisions
The proposed Section 1.951-1 rules provide for allocation of foreign income taxes when a CFC’s US tax year closes mid-year, using principles similar to Section 1.1502-76(b). A partnership’s taxable year generally does not close solely because its foreign corporate partner’s year closes, with comments requested on potential Section 706 treatment.
Section 951B extends the rules to foreign controlled US shareholders (FCUSSs), although the elective closing is unavailable to them. Form 5471 Schedules A and B are expanded to capture detailed stock ownership changes. Certain outdated rules under Sections 1.245A-5(e) and (f) and 1.1502-80(j) are eliminated for post-2025 CFC years.
Key dates and reliance
The proposed regulations were published on 26 August 2026, with comments due 26 October 2026. They generally apply to foreign corporation taxable years beginning after 31 December 2025. Treasury and the IRS expect final regulations by 4 January 2027.
