Tax Years for CFCs and a (Dead, IMO) Exception

Taxable years for CFCs

The One Big Beautiful Bill Act has eleven international changes. One of them deals with the accounting period required for (some) controlled foreign corporations—what the Code calls the “taxable year.”

The default taxable year for a foreign corporation is the accounting period it uses in preparing its books. IRC §6038(e)(4). “Specified” foreign corporations have a required taxable year imposed on them by IRC §898.

A specified foreign corporation is a CFC that has a majority U.S. shareholder (owns more than 50% of the CFC’s stock). IRC 898(b)(1).

A specified foreign corporation has a required taxable year. IRC §898(a). The required taxable year is majority U.S. shareholder’s taxable year. IRC §898(c)(1). Weird exceptions and edge cases exist, of course.

OBBBA nuked an exception

The OBBBA put a bullet through one of those weird exceptions.

It used to be true (in the good old days before July 4, 2025) that a specified foreign corporation could elect a taxable year that started one month before the taxable year of its majority U.S. shareholder. Former IRC §898(c)(2).

That’s gone. No more election.

The OBBBA gives a methodology for getting the specified foreign corporation’s taxable year back in sync with the majority U.S. shareholder’s taxable year.

As near as I can tell, it’s going to create a one-month taxable year for the CFC in addition to the normal 12-month taxable year, resulting in 13 months of income inclusion under subpart F and IRC §951A. But let’s wait for the IRS to publish instructions on how this works.

But that's not important. I told you all of that so I could tell you this.

Exception that allows different taxable years for CFCs

The OBBBA research triggered a memory of something I used a few times in the past. I idly wondered if the strategy would still work.

Antique Proposed Regulations under IRC §898 have an interesting exception to the rule that allowed (and maybe still allows, but I'm wary) a specified foreign corporation to use its normal accounting period as the taxable year for U.S. tax reporting purposes.

Prop. Reg. §1.898-1(c)(1), published in 1992 (thirty-count-them-three years ago! "Are we there yet, Daddy?") says:

In simple terms: if a CFC isn’t passing through subpart F income to its U.S. shareholders, IRC §898 will not require the CFC’s taxable year to synchronize with the majority U.S. shareholder’s taxable year.

It makes sense. The reason taxpayers want a different taxable year for a CFC is to achieve income deferral. But if there is no income to defer (the subpart F inclusion), forcing a foreign corporation onto a different taxable year is pointless.

Notice 95-13 told us exactly why the government created IRC §898:

Well, that’s all cool ‘n stuff.

How I used the exception

I used the exception was mostly in situations where people immigrated to the United States, owning foreign corporations. In the right situations, we did not need to monkey around with two different taxable years: the legacy taxable year used in the foreign country, e.g., India (March 31) or Australia (June 30) and a calendar year for the United States. We could just motor onward using the June 30 taxable year on the Form 5471 . . . until we couldn’t anymore. Mostly, this was a soft-landing strategy for the client.

That was before IRC §951A and net CFC tested income, née global intangible low-taxed income. (That name change is due to the OBBBA).

I don’t think the exception works after IRC §951A

I don't think the exception in the Proposed Regulations works anymore, now that we have IRC §951A income inclusions.

It SHOULD work. The basic policy premise stated in Notice 95-13 makes sense: if there is no income inclusion hitting the U.S. shareholder (from IRC §951(a) or IRC §951A(a)), then the foreign corporation’s accounting period is irrelevant: there’s no deferral happening, so no need to invoke an anti-deferral mechanism.

In that case, preparing the foreign corporation’s Form 5471 on a June 30 taxable year for U.S. purposes makes no difference to the gross income of the U.S. shareholder. Why not extend the Prop. Reg. §1.898-1(c)(1) exception to allow the foreign corporation to use its June 30 taxable year for U.S. tax reporting as well as foreign tax reporting purposes? Why require restated books every year for U.S. purposes only?

Silence is deadly

But that’s not what the exception from the Proposed Regulations allows. I think ever since we were blessed with IRC §951A, the exception in the Proposed Regulations is risky due to silence. Here’s why.

• A specified foreign corporation has a required taxable year. IRC §898(a). (And the required taxable year is the majority U.S. shareholder’s taxable year). That’s the general rule. Until you can find an exception, that’s what you have to do.
• The exception to the general rule (in the Proposed Regulations) says this: If the shareholder of a specified foreign corporation has no subpart F income, then the specified foreign corporation does not have a required taxable year. Therefore, it uses its legacy taxable year (that it uses for foreign tax reporting) for U.S. purposes. IRC §6038(e)(4).

That works, until you consider the existence of IRC §951A.

• If the shareholder of a specified foreign corporation has no subpart F income and no IRC §951A income from the corporation, the exception in Prop. Reg. §1.898-1(c)(1) is partly applicable and partly silent.
• The fact that there is no subpart F income inclusion makes the exception work as to that type of income inclusion. So far, so good.
• Half-measures. The Proposed Regulation exception does not block the application of the general rule of IRC §898(a) in its application to IRC §951A income inclusions.

We have one type of income inclusion specifically addressed, the other one silent. In the event of silence about IRC §951A, the general rule applies: this a specified foreign corporation, so has a required taxable year because IRC §898(a) says so.

I’m not going to use that exception anymore—because of the enactment of IRC §951A. The Proposed Regulations and their exception makes sense. Its heart is in the right place, but until/unless the Proposed Regulations are updated to include a reference to IRC §951A and extend the tax policy logic to both types of income inclusion that affect a U.S. shareholder, there’s too much uncertainty.

Just do the work

Every time I have fretted about accounting periods and taxable years for foreign corporations, it all boiled down to . . . laziness.

It’s a pain to do the work to restate the books of a foreign corporation to the required U.S. taxable year. We humans are funny. We will go to extraordinary lengths to avoid work.

“That’s a lot of work.”

People would ask the late, inimitable Bob A. how to stop having sucky lives and start living the good life. He would explain. (It’s easy to do, hard to keep doing). Upon hearing Bob's suggestions, they would exclaim “That’s a lot of work!” in genuine alarm.

It really was astonishing to hang around Bob and see the rich young man parable in real life. Me, I was flattened so I had nowhere to go but up.

Yeah.

Just do the work. Prepare that one-time short-year Form 5471 to correct the taxable year. Get systems in place for generating financials to the required U.S. taxable year.

The hard way is the easy way.