The one-month deferral election

Prior to the OBBBA, Section 898(c)(2) allowed certain foreign corporations to adopt a taxable year beginning one month earlier than the taxable year of their majority US shareholder. Many taxpayers made this one-month deferral election, which allowed them to delay the effect of certain changes in law by up to 11 months.

The OBBBA repealed this election, effective for taxable years beginning after November 30, 2025. For foreign corporations that previously made this election, repeal results in a mandatory one-month short taxable year to realign the foreign corporation’s tax year with that of its majority US shareholder. The US Department of the Treasury (Treasury) and the IRS recognize that this forced realignment may create distortions in how foreign income taxes are matched to US taxable income. Without guidance, a full year of foreign taxes could be treated as accruing in that one-month short taxable year, even though only one month of income is recognized for US federal income tax purposes. This could cause the foreign corporation to have a loss during that one-month short taxable year and prevent the taxpayer from getting any foreign tax credits.

In Notice 2025-72, the Treasury and the IRS provide guidance for taxpayers facing a one-month short taxable year. The notice describes forthcoming Section 898 regulations that will apply a structured framework for allocating foreign net income taxes that accrue in the short taxable year (specified foreign income taxes). The rules identify the foreign taxes subject to allocation, apply modified Section 1.861-20 principles to assign those taxes to relevant income groups, and allocate the taxes between the short taxable year and the succeeding full taxable year. The allocation percentage generally is based on the ratio of foreign law taxable income attributable to the short year versus the full foreign year.

The proposed framework also provides that taxes assigned to previously taxed earnings and profits (PTEP) groups will be fully allocated to the short taxable year and adjusts the allocation mechanics where Treas. Reg. Sec. 1.901-2(f)(5) “covered events” occur. While the amounts allocated to each period will be treated as accruing in those respective years for subpart F, global intangible low-taxed income, earnings and profits, and Section 960 deemed-paid credit purposes, all specified foreign income taxes will be treated as accruing in the short taxable year for purposes of Sections 905(c) and 986(a). This ensures that any later adjustments to those foreign tax liabilities relate back to the short year, avoiding additional complexity and preventing misalignment in foreign tax credit computations.

Section 987 transition rules

Notice 2025-72 also addresses how Section 987 transition rules should apply when taxpayers encounter short taxable years, including years shortened because of the repeal of Section 898(c)(2). Under the existing Section 987 regulations, taxpayers may elect to recognize pretransition foreign currency gain or loss ratably over a 10-year transition period. The Treasury and the IRS now intend to modify this rule so that pretransition gain or loss is recognized ratably over 120 months rather than a fixed number of taxable years. This change avoids distortions and preserves proportional recognition where a taxpayer’s first or subsequent taxable years are shorter than 12 months.

For taxpayers that have already recognized a ratable portion of pretransition gain or loss in a short year ending before November 25, 2025, that short year will be treated as containing a full 12 months solely for purposes of determining the remaining months in the amortization schedule. This rule ensures consistent treatment and prevents taxpayers from being penalized simply because the initial applicable year was compressed by statutory changes.

Reliance

Taxpayers may rely on the allocation rules and Section 987 modifications described in Notice 2025-72 for relevant taxable years until formal regulations are issued, provided the rules are applied consistently. The Treasury and the IRS also request comments on whether the allocation regime should be extended to other categories of foreign taxes (such as partnership-level taxes that may be indirectly affected by year-end conformity) and whether additional multiyear rules warrant similar adjustments in light of short taxable years created by the OBBBA.

Conclusion

Notice 2025-72 provides essential transitional guidance for multinational groups facing timing mismatches in foreign tax and foreign currency regimes as a result of the repeal of the one-month deferral election. CFCs and their US shareholders should begin modeling the potential impact on foreign tax credit capacity, high-tax exception and high-tax exclusion calculations, Section 960 deemed-paid credits, earnings and profits, and the timing of Section 987 gain and loss. Taxpayers must revisit tax-year alignment decisions, evaluate systems for tracking foreign-law taxable income across short periods, and consider whether comments should be submitted to the Treasury to address administrative hurdles or unintended consequences.