IRS Notice 2025-72: Interim guidance after OBBBA

Notice 2025-72 confirms the repeal and provides interim guidance for allocating foreign income taxes during the short year and the succeeding year. Without these rules, foreign taxes could be stranded or misaligned, creating distortions in foreign tax credit (FTC) computations, Subpart F inclusions and GILTI inclusions. Taxpayers may rely on these rules until proposed regulations are published, provided they apply them consistently for both the short year and the following year.

Notice 2025-72 introduces the concept of ‘specified foreign income tax.’ This is a foreign net income tax accrued by an affected SFC (using the accrual method and required to change its year under the repeal) in its first required year, for which the SFC is the section 901 taxpayer. The allocation rules apply only to these specified foreign income taxes. Other foreign taxes—such as partnership-level taxes, withholding taxes or taxes accrued in the succeeding year—are not subject to these special allocation rules and continue to be taken into account in the year they would ordinarily be recognized for U.S. tax purposes.

Foreign income taxes generally accrue when the foreign tax year ends, not ratably throughout the year. This creates a timing mismatch when a U.S. shareholder’s year and the foreign subsidiary’s year do not align—especially during a short transition year. Without special rules, a short-year controlled foreign corporation (CFC) could appear to have little or no foreign taxes allocated to its income, reducing FTC availability and potentially inflating residual U.S. tax.

The interim guidance in Notice 2025-72 mitigates this issue by allowing foreign taxes to be allocated based on income earned during the short period under foreign law, rather than requiring strict accrual at year-end. This approach is generally beneficial because it preserves FTC benefits and avoids distortions in effective tax rate calculations during the transition.

Notice 2025-72 sets forth a multi-step ordering rule for allocating specified foreign income taxes between the short taxable year and the succeeding full year:

1. Identification: First, identify the specified foreign income taxes for the affected SFC.
   
   
2. Allocation and apportionment: Next, allocate and apportion the tax to income groups and previously taxed earnings and profits (PTEP) groups under Reg. sections 1.861-20 and 1.960-1(d)(3)(ii)(B).
   
   
3. Allocation percentage: The portion of foreign law taxable income attributable to the first required year is divided by the total foreign law taxable income for the full foreign year to determine the allocation percentage.
   
   
4. Allocation to U.S. tax years: The specified foreign income tax is then allocated between the short year and the succeeding year based on this percentage. Taxpayers may use either a ‘closing of the books’ method (allocating based on actual foreign taxable income in each period) or a “ratable allocation” method (allocating based on the number of days in each period, if actual income data is not available).
   
   
5. Treatment for U.S. tax purposes: The allocated amounts are treated as accruing in each respective year for U.S. tax purposes that depend on the year of accrual, including Subpart F, GILTI, earnings and profits (E&P), and section 960 deemed paid credits. Sections 905(c) and 986(a) are exceptions and treat the tax as accruing in the first required year.

This ordering rule is intended to ensure that foreign taxes are matched as closely as possible to the income to which they relate, thereby supporting accurate FTC calculations and preventing the stranding of foreign taxes.

The portion of specified foreign income tax allocated to each year is used in determining whether the high-tax exception (for Subpart F) or high-tax exclusion (for GILTI) applies in that year. The ordering rules specifically address this point, ensuring that the correct amount of foreign tax is considered in the relevant year for these purposes. This can be outcome-determinative for taxpayers that are near the high-tax threshold in either the short year or the succeeding year.

The allocation rules in Notice 2025-72 apply primarily to accrual method taxpayers, who recognize foreign taxes when the liability is fixed and the amount can be determined—typically at the end of the foreign tax year. For these taxpayers, the allocation of foreign taxes between the short and full years is critical to ensure proper FTC and U.S. tax computations.

Cash method taxpayers, by contrast, recognize foreign taxes when paid. For these taxpayers, the allocation rules do not apply; foreign taxes are simply taken into account in the year of payment, regardless of the year change.

The allocation rules also do not apply to distributive shares of foreign taxes paid or accrued by a partnership (which are taken into account in the year the partnership income is recognized) or to withholding taxes (which generally accrue close in time to the related income and are not subject to the allocation rules).

As a general rule, once a taxpayer establishes a taxable year, it must obtain IRS approval before making any changes. The standard method for requesting approval is by filing Form 1128, Application to Adopt, Change, or Retain a Tax Year.

However, certain circumstances allow for automatic consent, eliminating the need to file Form 1128. Under Rev. Proc. 2006-45, section 7.02(1)(c), automatic approval applies when a CFC changes its taxable year to either:

• A year beginning one month earlier than the taxable year of its majority U.S. shareholder, or
  
  
• A year that always ends on the same day of the week and references either the majority U.S. shareholder’s year-end or the one-month deferral year-end.

Under the OBBBA repeal transition rule, no Form 1128 is required because the mandatory short year is imposed by statute and treated as made with the Secretary’s consent, even though the result is a change in the SFC’s taxable year for U.S. tax purposes.

The notice confirms that forthcoming proposed regulations will modify the amortization election to allow taxpayers to recognize pretransition section 987 gain or loss ratably over 120 months (10 years) rather than 10 taxable years. This change eliminates the risk of accelerated recognition caused by short taxable years.

Special rules apply for short years ending before Nov. 25, 2025:

• If a taxpayer recognized a portion of pretransition gain or loss under the original rule in a short year, that year is deemed to contain 12 months for purposes of calculating the remaining amortization.
  
  
• The remaining amount is then recognized ratably over the balance of the 120-month schedule (e.g., 108 months if one-tenth was recognized in the short year).