IRS announces intent to withdraw controversial DPL rules

Withdrawal of the DPL rules

The DPL rules took taxpayers by surprise when they were proposed in August 2024. Under the rules, taxpayers could have income inclusions – but no corresponding deductions – with respect to certain interest or royalty payments that are generally disregarded for US federal income tax purposes. The DPL rules affected many taxpayers with US corporations that hold interests in foreign branches or foreign disregarded entities. The DPL rules were finalized with a few modifications in January 2025 and were scheduled to become applicable to taxpayers beginning in 2026.

The Treasury, under the direction of the new administration, has now determined that disregarded payments should not trigger income inclusions under Section 1503(d) and announced that it would be withdrawing the final DPL regulations. This is a welcome relief for companies. Although many taxpayers have restructured their disregarded loans and licensing arrangements to avoid having income inclusions under the DPL rules, not all taxpayers have been able to do so. Withdrawing the DPL rules gives taxpayers greater flexibility to engage in business operations using disregarded entities without the risk of a US income inclusion.

The Treasury also announced that it will modify the “deemed ordering rule” in Treas. Reg. §1.1503(d)-3(c)(3), which governs the order in which income and losses are matched for purposes of the DCL and DPL rules, to reflect the fact that the DPL rules are withdrawn. It also will modify the DCL anti-avoidance rule to exclude structures that would have been targeted by the DPL rules.

The withdrawal of the DPL rules will apply starting with tax years beginning on or after January 1, 2026 (the same date the now-withdrawn final DPL rules were originally scheduled to take effect). In the meantime, taxpayers may rely on the relief described in the notice.

Extension of DCL transition relief (Pillar Two)

The notice extends transitional relief under the DCL rules for Pillar Two taxes through 2027. Transitional relief was originally provided so that taxpayers would not have to recapture a DCL that was deemed to have a “foreign use” because of certain taxes imposed under the Pillar Two regime. Pillar Two taxes generally apply on a jurisdiction-by-jurisdiction basis and require mandatory blending within a single jurisdiction. There was concern that such blending could cause a dual consolidated loss (even one that was not deductible under foreign domestic law) to be made available for foreign use and be recaptured automatically. This transitional relief now applies to DCLs incurred in tax years beginning before January 1, 2028. Taxpayers have two extra years before Pillar Two taxes could cause them to have foreign use of their DCLs.

No impact on proposed DCL rules

Unfortunately, the notice does not indicate an intent to withdraw the proposed DCL rules generally. The proposed DCL rules include several provisions that are unfavorable to taxpayers. For example, the proposed DCL rules would exclude from the DCL computation certain items arising from ownership of stock, including gain recognized on the sale of stock, dividends from subsidiaries, Section 78 deemed dividends, and Subpart F and global intangible low-taxed income (GILTI) inclusions. This proposed rule, if finalized, would impact many taxpayers that historically have relied on Subpart F or GILTI inclusions to help navigate the DCL rules. It remains unclear whether these rules will be withdrawn or finalized in the future.

The notice does not impact the current DCL anti-avoidance rule or the anti-avoidance rules in the proposed DCL regulations as they apply to DCLs. The current DCL anti-avoidance rule does not apply to certain carved out items, including (i) a reduction or elimination of a DCL solely by reason of intercompany transactions between consolidated group members, (ii) an item of income arising from the ownership of stock, and (iii) attributions to an entity of amounts that are not reflected on the entity’s books and records. The anti-avoidance rule in the proposed DCL regulations does not have carve-outs for those items. Neither of these rules is impacted by the notice, except that, as described above, the proposed anti-avoidance rule will be modified to remove references to the to-be-withdrawn DPL rules.

Request for comments on “all or nothing” rule

The Treasury and the IRS are considering changes to the current “all or nothing” rule under the DCL regulations. The “all or nothing rule” requires the entire amount of a DCL to be recaptured into US income if any portion of that loss is made available for a foreign use. Tax practitioners have long opposed this rule for the harsh consequences it has if even $1 of a DCL is made available for foreign use. The Treasury and the IRS are studying the use of a more proportionate approach and are requesting taxpayer comments on whether the DCL rules can be revised to remove the “all or nothing” rule without being too administratively burdensome.

The Treasury and the IRS are also evaluating whether and how disregarded items should be taken into account for purposes of the DCL rules. One possibility mentioned in the notice is including rules similar to the rules under Section 904 for determining the amount of foreign branch income. In that context, taxpayers must allocate and apportion deductions to foreign branch income based on detailed expense-tracing rules, which are designed to measure more accurately the net income attributable to a branch’s activities. Comments have been requested on this proposal.

If you are interested in preparing a comment letter on these issues, please reach out to the authors of this article or your regular McDermott Will & Schulte lawyer(s). We have previously critiqued the “all or nothing” rule in particular and find it promising that the Treasury has asked for taxpayer input. Comments are due by October 21, 2025.