Federal Register / Vol. 71, No. 167 / Tuesday, August 29, 2006 / Proposed Rules 51155 

Dated: August 7, 2006. 

Jeffrey Shuren, 

Assistant Commissioner for Policy. 

[FR Doc. E6–14263 Filed 8–28–06; 8:45 am] 

BILLING CODE 4160–01–S 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–121509–00] 

RIN 1545–AY54 

Exclusion From Gross Income of 

Previously Taxed Earnings and Profits, 

and Adjustments to Basis of Stock in 

Controlled Foreign Corporations and 

of Other Property 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: This document contains 

proposed regulations that provide 

guidance relating to the exclusion from 

gross income of previously taxed 

earnings and profits under section 959 

of the Internal Revenue Code (Code) and 

related basis adjustments under section 

961 of the Code. These regulations 

reflect relevant statutory changes made 

in years subsequent to 1983. These 

regulations also address a number of 

issues that the current section 959 and 

section 961 regulations do not clearly 

answer. These regulations, in general, 

will affect United States shareholders of 

controlled foreign corporations and 

their successors in interest. 

DATES: Written or electronic comments 

and requests for a public hearing must 

be received by November 27, 2006. 

ADDRESSES: Send submissions to: 

CC:PA:LPD:PR (REG–121509–00), 

Internal Revenue Service, P.O. Box 

7604, Ben Franklin Station, Washington, 

DC 20044 or send electronically, via the 

IRS Internet site at http://www.irs.gov/ 

regs or via the Federal eRulemaking 

Portal at http://www.regulations.gov 

(IRS REG–121509–00). 

FOR FURTHER INFORMATION CONTACT: 

Concerning the proposed regulations, 

Ethan Atticks, (202) 622–3840; 

concerning submissions of comments, 

Kelly Banks, (202) 622–0392 (not tollfree numbers). 

SUPPLEMENTARY INFORMATION: 

Background 

This document contains proposed 

amendments to 26 CFR part 1 under 

sections 959 and 961. Section 959(a)(1) 

generally provides an exclusion from 

the gross income of a United States 

shareholder for distributions of earnings 

and profits of a foreign corporation 

attributable to amounts which are, or 

have been, included in a United States 

shareholder’s gross income under 

section 951(a). Section 959(a)(2) 

excludes from the gross income of a 

United States shareholder earnings and 

profits attributable to amounts which 

are, or have been, included in the gross 

income of a United States shareholder 

under section 951(a) which would, but 

for section 959(a)(2), be again included 

in gross income of a United States 

shareholder under section 951(a)(1)(B) 

as an amount determined under section 

956 (section 956 amounts). Earnings and 

profits of a foreign corporation included 

in a United States shareholder’s gross 

income under section 951(a) are referred 

to as previously taxed earnings and 

profits or previously taxed income (PTI). 

Section 959(b) generally provides that 

for purposes of section 951(a), PTI shall 

not, when distributed through a chain of 

ownership described in section 958(a), 

be included in the gross income of a 

controlled foreign corporation (CFC) in 

such chain for purposes of the 

application of section 951(a) to such 

CFC. 

Section 959(c) generally provides for 

the allocation of distributions by a 

foreign corporation to three different 

categories of the corporation’s earnings 

and profits: (1) PTI attributable to 

section 956 amounts that are included 

in the gross income of a United States 

shareholder under section 951(a)(1)(B) 

and section 956 amounts that would 

have been so included but for section 

959(a)(2), (2) PTI attributable to amounts 

included in gross income under section 

951(a)(1)(A), and (3) other earnings and 

profits (non-PTI). Section 959(f) 

provides for the allocation of section 

956 amounts first to PTI arising from a 

United States shareholder’s income 

inclusions under section 951(a)(1)(A) 

and then to non-PTI. In addition, 

section 959(f) provides a priority rule 

under which actual distributions of 

earnings and profits are taken into 

account before section 956 amounts. 

Certain amounts are treated as 

amounts included in the gross income 

of a United States shareholder under 

section 951(a)(1)(A) for purposes of 

section 959. For example, section 959(e) 

generally provides that any amount 

included in the gross income of any 

person as a dividend by reason of 

subsection (a) or (f) of section 1248 is 

treated for purposes of section 959 as an 

amount included in the gross income of 

such person under section 951(a)(1)(A). 

Section 961 authorizes the Secretary 

of the Treasury to promulgate 

regulations adjusting the basis of stock 

in a foreign corporation, as well as the 

basis of other property by reason of 

which a United States person is 

considered under section 958(a) to own 

stock in a foreign corporation. Section 

961(a) generally provides for an increase 

in a United States shareholder’s basis in 

its CFC stock, or in the property by 

reason of which it is considered to own 

such stock, by the amount required to be 

included in its gross income under 

section 951(a) with respect to such 

stock. 

Under section 961(b), and the 

regulations thereunder, when a United 

States person receives an amount which 

is excluded from gross income under 

section 959(a), the adjusted basis of the 

foreign corporation stock or the property 

by reason of which the shareholder is 

considered to own such stock is reduced 

by the amount of the exclusion. In 

addition, section 961(c) generally 

provides for regulations under which 

adjustments similar to those provided 

for under section 961(a) and (b) are 

made to the basis of stock in a CFC 

which is owned by another CFC (and 

certain other CFCs in the chain) for the 

purpose of determining the amount 

included under section 951 in the gross 

income of a United States shareholder. 

Section 959 was enacted so that PTI 

is excluded from gross income and, 

thus, not taxed again when distributed 

by the foreign corporation. Moreover, 

section 959 effects the relevant gross 

income exclusion at the earliest possible 

point. Thus, the ‘‘allocation of 

distribution’’ rules of section 959(c) 

ensure that distributions from the 

foreign corporation are to be paid first 

out of earnings and profits attributable 

to amounts that have been previously 

included in income by the United States 

shareholders. Accordingly, as a result of 

its section 951(a)(1) inclusion, a United 

States shareholder is made whole by 

receiving, without further U.S. tax, PTI 

attributable to its stock in a foreign 

corporation before it receives any 

taxable distributions from the foreign 

corporation. Section 961, which adjusts 

basis in the stock in a foreign 

corporation for PTI attributable to such 

stock, also ensures that PTI is not taxed 

twice if the stock in the foreign 

corporation is sold before the PTI is 

distributed. 

The existing regulations under 

sections 959 and 961 were published in 

1965. See TD 6795 (1965–1 CB 287). 

Minor amendments were made to the 

regulations in 1974, 1978, and 1983. See 

TD 7334 (1975–1 CB 246); TD 7545 

(1978–1 CB 245); TD 7893 (1983–1 CB 

132). The regulations have not been 

updated since 1983 to reflect relevant 


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statutory changes in subsequent years. 

For example, section 959(e) (described 

above) was added by the Deficit 

Reduction Act of 1984 (Pub. L. 98–369). 

Section 304(b)(6) was enacted by the 

IRS Restructuring and Reform Act of 

1998 (Pub. L. 105–206) and provides 

that in the case of a section 304 

transaction in which the acquiring 

corporation or the issuing corporation is 

a foreign corporation, the Secretary of 

the Treasury is to prescribe regulations 

providing rules to prevent the multiple 

inclusion of any item in income and to 

provide appropriate basis adjustments, 

including rules modifying the 

application of sections 959 and 961. The 

determination of the amount includible 

in a United States shareholder’s gross 

income as a result of a CFC’s 

investments in United States property 

under section 956 was modified by the 

Omnibus Budget Reconciliation Act of 

1993 (Pub. L. 103–66). Congress enacted 

section 961(c) (described in this 

preamble) as part of the Taxpayer Relief 

Act of 1997 (Pub. L. 105–34) and further 

modified the provision in the Gulf 

Opportunity Zone Act of 2005 (Pub. L. 

109–135). Section 986 was added to the 

Code by the Tax Reform Act of 1986 

(Pub. L. 99–514) and provides that 

earnings and profits of foreign 

corporations are maintained in the 

foreign corporation’s functional 

currency and translated into United 

States dollars when taken into account 

by a United States person at the 

appropriate exchange rate specified in 

section 989. 

Further, in addition to raising issues 

about the complexities of section 959 in 

cross-chain stock sales subject to section 

304(a)(1), commentators and taxpayers 

have raised a number of other issues 

that the current section 959 regulations 

do not clearly answer. For example, 

issues have been raised about 

distributions of PTI through a chain of 

CFCs and the status of PTI when a 

United States shareholder’s stock in a 

foreign corporation is sold to a foreign 

person. There are numerous other 

examples where the existing section 959 

regulations simply do not provide 

sufficient guidance. As a result, 

additional regulatory guidance is 

needed to address these and other 

section 959 issues. In addition, the IRS 

and Treasury Department are currently 

studying the new section 954(c)(6) rule 

enacted by the Tax Increase Prevention 

and Reconciliation Act of 2005 (Pub. L. 

109–222), which provides for lookthrough treatment of payments between 

related CFCs under the foreign personal 

holding company rules of section 

954(c), to determine whether that rule 

requires any additional regulatory 

guidance under section 959. Any such 

guidance will be included in a 

subsequent project. 

Explanation of Provisions 

These proposed regulations provide 

guidance with respect to a number of 

issues that are not specifically 

addressed in the current regulations and 

also resolve some of the complexities 

raised regarding the application of 

sections 959 and 961. The guidance 

needed to answer open issues under 

sections 959 and 961 is intended to be 

consistent with the legislative intent of 

avoiding double taxation and allowing 

United States persons to receive the full 

benefit of their PTI at the earliest 

possible time. 

In order to carry out this legislative 

intent, these regulations propose new 

rules that are primarily based on 

maintaining shareholder accounts for 

PTI. As described in this preamble, 

maintaining shareholder accounts for 

PTI will better ensure that taxpayers are 

able to receive distributions of PTI 

before receiving taxable distributions, 

provide consistency for treatment of PTI 

by taxpayers and also, provide more 

rational and clear rules for resolving 

many of the issues that have been raised 

by taxpayers since the current section 

959 regulations were issued. Under the 

proposed rules, earnings and profits will 

still be maintained at the foreign 

corporation level in the PTI and non-PTI 

categories described in section 959(c) on 

an aggregate basis with respect to all of 

the foreign corporation’s outstanding 

shares. 

The proposed rules also would 

modify the current regulations to reflect 

amendments to the law since 1965, such 

as the addition of section 959(e) and 

section 961(c), and the modification of 

sections 304 and 956. Minor changes 

have also been proposed to reflect 

changes in IRS titles and organizational 

units used in the current regulations. 

A. Shareholder-Level Exclusion Under 

Section 959(a) 

1. In General 

Section 959 provides rules for the 

exclusion from gross income of PTI. 

Prop. Reg. § 1.959–1 describes the scope 

and purpose of the proposed regulations 

under section 959 in paragraph (a), and 

provides definitions in paragraph (b). 

Paragraph (c) generally provides for the 

exclusion from a covered shareholder’s 

gross income of a distribution or section 

956 amount based upon the amount of 

adjustments made to a shareholder’s PTI 

accounts with respect to the relevant 

stock under Prop. Reg. § 1.959–3 

because of that distribution or section 

956 amount, as discussed below. A 

covered shareholder is defined to mean 

a person who is (1) a United States 

person who owns stock (within the 

meaning of section 958(a)) in a foreign 

corporation and who has had a section 

951(a) inclusion with respect to its stock 

in such corporation, (2) a ‘‘successor in 

interest’’ (defined in this preamble), or 

(3) a corporation that is not described in 

(1) or (2) and that owns stock (within 

the meaning of section 958(a)) in a 

foreign corporation in which another 

corporation is a covered shareholder 

described in (1) or (2), if both 

corporations are members of the same 

consolidated group. 

2. Shareholder PTI Accounts 

Prop. Reg. § 1.959–1(d)(1) requires 

each covered shareholder of a foreign 

corporation to maintain a PTI account 

for each share of stock in a foreign 

corporation that the shareholder owns 

directly, or indirectly under section 

958(a). Although the PTI account is 

share specific, as a matter of 

administrative convenience, Prop. Reg. 

§ 1.959–1(d)(1) permits a shareholder to 

maintain the account with respect to an 

entire block of stock in foreign 

corporation if the PTI attributable to 

each share in the block is the same. For 

a discussion of the rules for maintaining 

a PTI account, see Part C of this 

discussion. 

3. Successors in Interest 

Section 959(a) extends the exclusion 

from gross income for PTI to any United 

States person who acquires from any 

person any portion of the interest of a 

United States shareholder (as the term is 

defined in section 951(b) or section 

953(c)(1)(A)) in a foreign corporation, 

but only to the extent of that portion 

and subject to such proof of the identity 

of such interest as the Secretary of the 

Treasury may by regulations prescribe. 

Consequently, Prop. Reg. § 1.959–

1(d)(2)(i) provides that a transferee of 

stock in a foreign corporation acquires 

the PTI account of the transferor for 

such stock and may exclude PTI from 

gross income under section 959(a) by 

reference to the PTI account for the 

stock acquired, if the transferee is a 

United States person that can prove the 

right to the exclusion (successor in 

interest). 

In order to establish a United States 

person’s right to the exclusion, the 

proposed regulations provide that a 

person must attach a statement to its 

return that provides that it is excluding 

amounts from gross income because it is 

a successor in interest and that provides 

the name of the foreign corporation. 


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Further, a person must be prepared to 

provide, within 30 days upon the 

request of the Director of Field 

Operations, certain additional 

information (e.g., evidence showing that 

the earnings and profits for which an 

exclusion is claimed are PTI and that 

such amounts were not previously 

excluded from the gross income of a 

United States person). The information 

that may be required under these 

proposed regulations remains 

substantially unchanged from the 

information that is currently required to 

be included in a statement with the 

United States person’s return under 

§ 1.959–1(d). 

Moreover, Prop. Reg. § 1.959–

1(d)(2)(ii) provides that the amount of 

the PTI account for stock that is 

transferred to someone who is not a 

successor in interest (e.g., a foreign 

person) is preserved unchanged during 

the period of such person’s ownership 

of such stock. However, section 959(a) 

extends the section 959(a) exclusion to 

a United States person who acquires a 

United States shareholder’s interest in a 

foreign corporation from any person. 

Accordingly, Prop. Reg. § 1.959–

1(d)(2)(i) provides that if a United States 

person acquires stock in a foreign 

corporation from a person that is not a 

successor in interest, such as a foreign 

person, and the United States person 

qualifies as a successor in interest, the 

United States person acquires the PTI 

account attributable to the foreign 

corporation stock acquired and may 

exclude PTI from gross income under 

section 959(a) by reference to the PTI 

account for such stock. 

B. CFC-Level Exclusion Under Section 

959(b) 

The earnings and profits of a CFC 

(lower-tier CFC) attributable to amounts 

which are, or have been, included in the 

gross income of a United States 

shareholder under section 951(a) shall 

not, when distributed through a chain of 

ownership described in section 958(a), 

be also included in the gross income of 

the CFC receiving the distribution 

(upper-tier CFC) in such chain for 

purposes of the application of section 

951(a) to such upper-tier CFC with 

respect to such United States 

shareholder. Prop. Reg. § 1.959–2 

contains rules relating to the section 

959(b) exclusion. These rules are 

intended to reflect the holding of Rev. 

Rul. 82–16 (1982–1 CB 106) as well as 

rules regarding cross-chain sales of 

stock in a foreign corporation by a CFC 

subject to section 304(a)(1). 

In Rev. Rul. 82–16, an upper-tier CFC, 

70 percent owned by a United States 

shareholder (USP) and 30 percent 

owned by a foreign person, received a 

distribution of $200x of earnings and 

profits from a lower-tier CFC whollyowned by the upper-tier CFC. The 

lower-tier CFC had earned $100x of 

subpart F income for the year of the 

distribution ($70x of which was 

included in USP’s gross income under 

section 951(a)) and a $100 of nonsubpart F income. The ruling held that 

$100x, rather than $70x, was excluded 

from the gross income of the upper-tier 

CFC under section 959(b). If only $70x 

were excluded, USP would be required 

to include in gross income $21x of 

subpart F income with respect to the 

remaining $30x included in the uppertier CFC’s gross income, resulting in a 

total inclusion in USP’s gross income of 

$91x ((70% × $30) + (70% × $100)). 

Prop. Reg. § 1.959–2(a) addresses the 

issue raised in Rev. Rul. 82–16, and 

accordingly, provides that, the amount 

of the exclusion provided under section 

959(b) is the entire amount distributed 

by the lower-tier CFC to the upper-tier 

CFC that gave rise (in whole or in part) 

to an adjustment of the United States 

shareholder’s PTI accounts with respect 

to the stock it owns (within the meaning 

of section 958(a)) in the lower-tier and 

upper-tier CFC under Prop. Reg. 

§ 1.959–3(e)(3) (discussed in this 

preamble). This amount shall not 

exceed the earnings and profits of the 

distributor CFC attributable to amounts 

described in section 951(a). Such 

amount is not limited to the amount of 

the adjustment to the United States 

shareholder’s PTI account. 

For example, under the facts of Rev. 

Rul. 82–16, the amount excluded from 

the upper-tier CFC’s gross income for 

purposes of applying section 951(a) to 

USP under Prop. Reg. § 1.959–2(a) is 

$100x. That is, the entire amount of the 

earnings and profits distributed by the 

lower-tier CFC that were attributable to 

amounts described in section 951(a) and 

that caused an adjustment to USP’s PTI 

accounts in both the upper- and lowertier CFCs under Prop. Reg. § 1.959–

3(e)(3). 

Prop. Reg. § 1.959–2(a) produces 

results consistent with Rev. Rul. 82–16, 

while ensuring that section 959(b) does 

not inappropriately prevent taxation 

under section 951(a) of a United States 

shareholder that has acquired stock in a 

CFC from a person who was not taxed 

on the subpart F income of a lower-tier 

CFC in the year such income was earned 

(e.g., a foreign person). For example, 

assume the same facts as those of Rev. 

Rul. 82–16, except that: (1) The subpart 

F income was earned by the lower-tier 

CFC in year 1, (2) another United States 

shareholder (DC) acquired the 30 

percent interest in the upper-tier CFC in 

year 2 from the foreign person with a 

zero PTI account, and (3) the lower-tier 

CFC did not distribute any property 

until year 3. Under Prop. Reg. § 1.959–

2(a), the section 959(b) exclusion for the 

upper-tier CFC for purposes of 

calculating USP’s section 951(a) 

inclusion is still $100. In contrast, Prop. 

Reg. § 1.959–2(a) provides that the 

section 959(b) exclusion for the uppertier CFC for purposes of determining 

DC’s section 951(a) inclusion is zero 

because none of the earnings and profits 

distributed were attributable to amounts 

included in income under section 951(a) 

with respect to DC or the person to 

whom DC is a successor in interest. 

Therefore, DC may have an income 

inclusion under section 951(a). 

In addition, Prop. Reg. § 1.959–2(b) 

provides guidance with respect to the 

application of section 959(b) in the 

context of stock sales subject to section 

304(a)(1) where the selling corporation 

is a CFC. The proposed regulations 

clarify that in the case of a deemed 

redemption resulting from a transaction 

described in section 304(a)(1) in which 

earnings and profits of an acquiring 

foreign corporation or an acquired 

foreign corporation or both are deemed 

distributed to a selling CFC, the selling 

CFC is deemed for purposes of section 

959(b) to receive such distributions 

through a chain of ownership described 

under section 958(a). 

C. Maintenance of PTI Accounts 

The proposed regulations contain 

detailed rules regarding the 

maintenance of shareholder PTI 

accounts and the maintenance of pools 

of PTI and non-PTI earnings and profits 

with respect to a foreign corporation, 

including rules for adjusting PTI 

accounts as a result of certain 

transactions. In addition, the proposed 

regulations provide rules for covered 

shareholders that have more than one 

share of stock in a foreign corporation 

and covered shareholders that are 

members of a consolidated group. 

1. Shareholder-Level Accounting of PTI 

The proposed regulations provide that 

a covered shareholder’s PTI account 

with respect to its stock in a foreign 

corporation shall identify the amounts 

included in gross income by a United 

States shareholder under section 

951(a)(1)(A) with respect to the stock 

(PTI described in section 959(c)(2)), and 

amounts that are included in the gross 

income of a United States shareholder 

under section 951(a)(1)(B) and section 

956 amounts that would have been so 

included but for section 959(a)(2) (PTI 

described in section 959(c)(1)) by such 

shareholder who owns the stock or by 


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a successor in interest. A shareholder 

account must also reflect these amounts 

in the functional currency of the foreign 

corporation and the annual dollar basis 

of each category of PTI in the account. 

2. Corporate-Level Accounting of PTI 

The proposed regulations also provide 

that separate aggregate categories (with 

respect to all of the shareholders of a 

foreign corporation) of PTI described in 

section 959(c)(1) and section 959(c)(2) 

and non-PTI shall be maintained with 

respect to foreign corporations. These 

categories of earnings and profits of a 

foreign corporation shall be maintained 

in the functional currency of the foreign 

corporation. 

The proposed regulations reflect the 

basic allocation rules under section 

959(c) and (e). Those rules provide that 

distributions are considered to be made 

on a last-in first-out basis under section 

316(a), first from any PTI described in 

section 959(c)(1), then from PTI 

described in section 959(c)(2), and 

finally from non-PTI earnings and 

profits. In addition, section 956 amounts 

are allocated first to section 959(c)(2) 

earnings and profits and then to non-PTI 

earnings and profits. Consequently, PTI 

resulting from section 956 amounts in a 

prior year cannot exclude section 956 

amounts in a later year from otherwise 

being included in a United States 

shareholder’s gross income under 

section 951(a)(1)(B). 

The proposed regulations also provide 

that these allocations to PTI are made in 

conjunction with the shareholder-level 

adjustments to shareholder-level PTI 

accounts. In addition, any adjustments 

to earnings and profits required under 

section 312 or other sections of the Code 

or Treasury regulations shall generally 

be made only to non-PTI. 

3. Foreign Currency and Foreign Tax 

Credit Rules 

The proposed regulations also contain 

several rules that reflect the significant 

changes made to the foreign currency 

translation rules since the existing 

section 959 regulations were issued. The 

proposed regulations also contain rules 

regarding the foreign tax credit rules 

relating to PTI. 

a. Dollar Basis Pooling Election 

The proposed regulations provide that 

a shareholder account must reflect the 

annual dollar basis of each category of 

PTI in the account. However, Prop. 

Reg.§ 1.959–3(b)(2)(ii) allows taxpayers 

to elect to treat distributions as being 

made from a single pool of post-1986 

PTI for purposes of computing foreign 

currency gain or loss under section 

986(c) and basis adjustments under 

section 961 with respect to distributions 

of PTI. Thus, the reduction of the basis 

of shares in a foreign corporation and 

the foreign currency gain (or loss) 

attributable to a PTI distribution may 

both be determined by assigning a pro 

rata portion of the shareholder’s 

aggregate dollar basis in its PTI account 

to a distribution of PTI. Notice 88–71 

(1988–2 C.B. 374) makes this pooled 

approach available to taxpayers for 

purposes of section 986(c) at the 

taxpayer’s election, but it does not 

provide guidance as to how this election 

is made. The proposed regulations 

provide that the election is made by 

using a dollar basis pool to compute 

foreign currency gain or loss under 

section 986(c) with respect to 

distributions of PTI of a foreign 

corporation, or to compute gain or loss 

with respect to its stock in the foreign 

corporation, whichever occurs first. Any 

subsequent change in the taxpayer’s 

method of assigning dollar basis may 

only be made with the consent of the 

Commissioner. 

b. Taxes and Other Expenses 

Attributable to PTI 

Prop. Reg. § 1.959–3(c) provides that 

the corporate-level and shareholderlevel PTI accounts are reduced by the 

functional currency amount of any 

income, war profits, or excess profits 

taxes imposed by any foreign country or 

a possession of the United States on or 

with respect to PTI as it is distributed 

by a foreign corporation to another 

foreign corporation through a chain of 

ownership described in section 958(a). 

The proposed regulations further 

provide that such taxes are not added to 

the foreign corporation’s post-1986 

foreign income taxes pool, which is 

maintained with respect to the foreign 

corporation’s post-1986 undistributed 

earnings. Rather, such taxes are 

maintained in a separate account and 

allowed as a credit pursuant to section 

960(a)(3) when the associated PTI is 

distributed to a United States 

shareholder (or its successor in interest). 

This rule ensures that amounts 

previously included in income that are 

used to pay creditable foreign taxes and 

so are unavailable for distribution to 

covered shareholders reduce the amount 

of PTI available for distribution but may 

be claimed as a foreign tax credit at the 

appropriate time. The proposed 

regulations also provide for 

corresponding adjustments to the 

covered shareholder’s dollar basis of the 

PTI account. 

Prop. Reg. § 1.959–3(d) provides that 

no expenses of a foreign corporation, 

other than creditable foreign income 

taxes described in Prop. Reg. § 1.959–

3(c), shall be allocated and apportioned 

to reduce PTI. By allocating all such 

expenses to non-PTI, this rule preserves 

the amount of PTI that may be 

distributed to a United States 

shareholder (or its successor in interest) 

in a non-taxable manner. 

4. Adjustment of Shareholder PTI 

Accounts 

The proposed regulations generally 

provide rules for the adjustment of a 

covered shareholder’s PTI account upon 

an inclusion of income by the 

shareholder under section 951, an actual 

distribution of earnings and profits to 

the shareholder, or a determination of a 

section 956 amount with respect to the 

shareholder. The proposed regulations 

provide that the adjustment of PTI 

accounts occur according to the 

ordering rules of section 959 to 

determine the tax consequences of the 

various events. For purposes of 

determining the tax consequences to a 

covered shareholder in a foreign 

corporation, the proposed regulations 

provide that with respect to a foreign 

corporation’s taxable year, and for the 

taxable year of the covered shareholder 

in which or with which such taxable 

year of the foreign corporation ends, the 

following events are taken into account 

in the following order: (1) The covered 

shareholder’s inclusion of subpart F 

income or other amounts in gross 

income under section 951(a)(1)(A) for a 

taxable year, (2) any actual distributions 

of current or accumulated earnings and 

profits by a foreign corporation during 

the year, including redemptions treated 

as distributions of property to which 

section 301 applies pursuant to section 

302(d); and (3) any investments in 

United States property by a CFC during 

the year resulting in a section 956 

amount for one or more United States 

shareholders for the year. For purposes 

of the proposed regulations, amounts 

included in the gross income of any 

person as a dividend under section 

1248(a) or (f) are generally treated as 

section 951(a)(1)(A) inclusions. 

Thus, under Prop. Reg. § 1.959–

3(e)(2), at the end of the foreign 

corporation’s taxable year, a 

shareholder’s PTI account is first 

adjusted upward by the amount of any 

subpart F income included in gross 

income by the shareholder under 

section 951(a) with respect to the 

shareholder’s stock in the foreign 

corporation. Next, a shareholder’s PTI 

account is adjusted downward by the 

amount of any distributions of PTI to 

the shareholder with respect to the stock 

during the year. However, a PTI account 

can never be reduced below zero. Third, 

to the extent that any section 956 


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amount for the year is equal to (or less 

than) the amount of PTI described in 

section 959(c)(2), an amount of such PTI 

equal to the section 956 amount is 

reclassified as PTI described in section 

959(c)(1), but does not decrease the 

shareholder’s PTI account. Finally, the 

shareholder’s PTI account is adjusted 

upward by any section 956 amount in 

excess of the PTI described in section 

959(c)(2) for the year. Corresponding 

adjustments are made to the dollar basis 

of the PTI account. 

This sequence of adjustments may be 

affected by the PTI sharing rules 

discussed below. Although the sharing 

rules are described in greater detail in 

Prop. Reg. §§ 1.959–3(f) and (g), the 

order of the adjustments described in 

these sections are provided for in the 

steps described in Prop. Reg. § 1.959–

3(e)(2). 

The amount of a downward 

adjustment to the covered shareholder’s 

PTI account under the second step 

described above is excluded from the 

shareholder’s gross income under 

section 959(a)(1) and Prop. Reg. § 1.959–

1(c)(1). Similarly, the amount of section 

959(c)(2) PTI which is reclassified as 

section 959(c)(1) PTI under the third 

step described above is excluded from 

the covered shareholder’s gross income 

under section 959(a)(2) and Prop. Reg. 

§ 1.959–1(c)(2). 

5. Adjustment to PTI Accounts Upon 

Distributions to Intermediary CFCs 

Where stock in a lower-tier CFC is 

owned indirectly by a United States 

shareholder (or successor in interest) 

through one or more upper-tier CFCs in 

a chain of ownership under section 

958(a), the shareholder’s PTI accounts 

with respect to stock in the relevant 

foreign corporations in the chain must 

be adjusted when the lower-tier CFC 

makes a distribution of PTI to an uppertier CFC in the chain. Prop. Reg. 

§ 1.959–3(e)(3) provides that the 

shareholder’s PTI account with respect 

to stock in the distributing foreign 

corporation is decreased by the amount 

of PTI distributed with respect to such 

stock, and the shareholder’s PTI account 

with respect to stock in the recipient 

foreign corporation is increased by the 

same amount (in addition to being 

increased by any non-PTI portion of the 

distribution that results in an inclusion 

in the shareholder’s gross income under 

section 951(a) as subpart F income of 

the receiving CFC). Prop. Reg. § 1.959–

3(e)(3) provides a spot rate translation 

convention for cases in which the 

distributing and receiving corporations 

use different functional currencies. 

6. Effect of Deficits in Earnings and 

Profits 

Prop. Reg. § 1.959–3(e)(5) provides 

that a shareholder’s PTI account is not 

adjusted to take into account any deficit 

in earnings and profits of the 

corporation for the taxable year. Deficits 

will reduce only the non-PTI of the 

corporation under section 312. 

7. Distribution in Excess of the PTI 

Account 

Under Prop. Reg. § 1.959–3(e)(5), 

when a foreign corporation distributes 

to a shareholder an amount exceeding 

the PTI account with respect to the 

relevant stock, the treatment of the 

excess amount depends on the facts and 

circumstances. Subject to the PTI 

sharing rules discussed below, the 

excess amount of a distribution 

generally is treated as a dividend under 

section 316 to the extent of the 

distributing corporation’s non-PTI, and 

thereafter as a return of capital 

(reducing the shareholder’s basis in its 

stock in the foreign corporation) under 

section 301(c)(2). Any portion of the 

distribution remaining after the 

shareholder’s basis of the stock in the 

foreign corporation is reduced to zero is 

treated as capital gain under section 

301(c)(3). 

8. PTI Sharing Rules 

The purpose of section 959 is to 

prevent double taxation of amounts that 

have been previously included in gross 

income by a United States shareholder 

under section 951(a) and, importantly, 

to prevent such double taxation at the 

earliest possible time. Section 951 

subjects a United States shareholder to 

tax on undistributed income of a CFC, 

so the ordering rule of section 959(c) 

effectuates this statutory purpose by 

treating actual distributions to the 

shareholder as coming first out of PTI. 

As one of the goals of section 959 is to 

treat distributions as first coming from 

PTI, the IRS and Treasury Department 

believe that a United States shareholder 

(or successor in interest) should be 

entitled to exclude from gross income 

under section 959(a) all of a foreign 

corporation’s distributions of earnings 

and profits and section 956 amounts to 

the extent of PTI associated with any of 

the United States person’s stock in the 

foreign corporation, before that person 

is required to include additional 

distributions of earnings and profits or 

section 956 amounts of the foreign 

corporation in gross income. 

The IRS and Treasury Department 

believe that similar rules should apply 

with respect to members of a 

consolidated group. Although the 

taxation of a consolidated group 

represents a hybrid of single and 

separate entity treatment, consolidated 

attribute utilization is generally based 

on single entity treatment. For example, 

when determining consolidated taxable 

income for a given year, subject to 

certain limitations, the group is entitled 

to offset its income with any 

consolidated net operating losses that 

are carried forward to such year 

(regardless of which member or 

members recognized the income or 

incurred the losses). Given the broad 

regulatory authority of section 1502 and 

the statutory mandate in section 959 to 

allow United States shareholders (or 

successors in interest) to recover PTI at 

the earliest possible time, the IRS and 

Treasury Department believe that PTI is 

an attribute for which single entity 

treatment of United States consolidated 

groups is appropriate. As a result, the 

IRS and Treasury Department have 

concluded that a shareholder of a 

foreign corporation that is a member of 

a consolidated group should be entitled 

to exclude from gross income under 

section 959(a) all of a foreign 

corporation’s distributions of earnings 

and profits, and section 956 amounts, to 

the extent of PTI associated with any 

stock in the foreign corporation owned 

by any member of the consolidated 

group (with appropriate adjustments). 

Therefore, the proposed regulations 

provide for sharing of PTI between 

accounts of different members of a 

consolidated group in a manner similar 

to the sharing of PTI between multiple 

accounts of a single shareholder, as 

described below. 

a. Shareholder With Multiple PTI 

Accounts 

Prop. Reg. § 1.959–3(f) provides a 

special rule that applies when a United 

States shareholder has more than one 

PTI account with respect to stock in a 

foreign corporation, and during its 

taxable year, the foreign corporation 

distributes earnings and profits in an 

amount that exceeds one or more of 

such PTI accounts. In that case, the 

shareholder’s PTI accounts with respect 

to all of its other stock in the foreign 

corporation that it owns at the end of 

the foreign corporation’s taxable year 

shall be reduced, in the aggregate, by the 

amount of the excess, on a pro rata basis 

by reference to the level of such PTI 

accounts (after such PTI accounts have 

first been adjusted to reflect any 

distributions of earnings and profits 

with respect to those blocks of stock). 

The aggregate reduction in such PTI 

accounts produces a corresponding 

increase in the PTI account that would 

have been exceeded by the amount 


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distributed but for the operation of this 

sharing rule. That PTI account is then 

reduced to zero to reflect the amount of 

earnings and profits distributed with 

respect to that block of stock during the 

year. 

Similarly, if the section 959(c)(2) 

portion of a PTI account for a share in 

a foreign corporation is exceeded by the 

section 956 amount attributable to the 

share, the aggregate amount of the 

section 959(c)(2) portion of the PTI 

accounts for all other stock of the 

foreign corporation owned by the 

shareholder on the last day of the 

foreign corporation’s taxable year is 

available for purposes of excluding the 

section 956 amount from gross income 

under section 959(a)(2). 

b. Shareholder That Is a Member of a 

Consolidated Group 

Prop. Reg. § 1.959–3(g) provides 

similar sharing rules where stock in a 

foreign corporation is owned by two or 

more members of a consolidated group. 

For purposes of administrative 

convenience, however, this rule focuses 

on whether the shareholders are 

members of the same consolidated 

group at the end of the foreign 

corporation’s taxable year and not at the 

time the PTI in question was generated. 

Specifically, if the total amount of a 

United States shareholder’s PTI account 

or accounts for stock in a foreign 

corporation is exceeded by the amount 

of earnings and profits distributed by 

the corporation to the shareholder 

during the year, the PTI accounts of 

other members of the shareholder’s 

consolidated group who own stock in 

the corporation are decreased on a pro 

rata basis (after adjustment) and the 

shareholder’s PTI accounts or account, 

as the case may be, will be 

correspondingly increased and then 

adjusted downward to zero. 

Similarly, if the total amount of the 

section 959(c)(2) portion of a 

shareholder’s PTI account or accounts 

for stock in a foreign corporation is 

exceeded by the shareholder’s section 

956 amount for the year, the aggregate 

amount of the section 959(c)(2) portions 

of the PTI accounts of other member’s 

of the shareholder’s consolidated group 

at the end of the foreign corporation’s 

taxable year who own stock in the 

foreign corporation will be available to 

the shareholder for purposes of 

excluding the section 956 amount from 

gross income under section 959(a)(2). 

9. Redemptions, Including Section 304 

Transactions 

The proposed regulations provide 

rules for the adjustment of PTI accounts 

and the effect on the corporation’s nonPTI when a foreign corporation redeems 

its stock. The effect of a distribution in 

redemption of stock (redemption 

distribution) depends on whether the 

redemption distribution is treated as a 

payment in exchange for the stock 

under sections 302(a) or 303, or as a 

distribution of property to which 

section 301 applies pursuant to section 

302(d). 

a. Redemptions Treated as Sales or 

Exchanges 

If a redemption distribution is treated 

as a sale or exchange, generally the 

amount chargeable to the earnings and 

profits of the redeeming corporation is 

limited by section 312(n)(7) to a ratable 

share of the earnings and profits. Where 

the redeeming corporation is a foreign 

corporation and there is a PTI account 

with respect to the redeemed stock, the 

proposed regulations provide that 

section 312(n)(7) is applied by limiting 

the reduction of the redeeming 

corporation’s earnings and profits to an 

amount which does not exceed the sum 

of (1) the amount in the PTI account for 

the redeemed stock and (2) a ratable 

share of the corporation’s non-PTI 

attributable to the redeemed shares, if 

any. This sum first reduces the PTI 

account with respect to the redeemed 

stock and then reduces the corporation’s 

non-PTI. 

The IRS and Treasury Department 

believe that, in the case where a foreign 

corporation redeems stock in a 

transaction treated as a sale or exchange 

for an amount that is less than the PTI 

account for that stock, it would be 

inappropriate to transfer the remainder 

of the PTI account to any other PTI 

accounts with respect to stock in the 

foreign corporation. Under section 

961(a) and the regulations thereunder, 

the basis of stock in a foreign 

corporation is increased by the amount 

included in the shareholder’s gross 

income under section 951(a), which is 

reflected in the PTI account with respect 

to such stock. The shareholder recovers 

this increase in basis upon a sale of the 

stock, preventing the shareholder from 

suffering double taxation on gain 

attributable to PTI (or in appropriate 

cases enabling the shareholder to 

recognize a loss). Consequently, under 

the proposed regulations, the remainder 

of the PTI account in the situation 

described above is not transferred to any 

other PTI account because it was 

already accounted for in the treatment 

of the redemption as a sale or exchange. 

Any corporate-level PTI attributable to 

the redeemed stock that remains after 

the reduction under section 312(n)(7) 

loses its character as PTI and is 

reclassified as non-PTI of the 

corporation. The IRS and Treasury 

Department believe that because the 

redeemed shareholder is able to use the 

loss resulting from the redemption to 

offset other income, its excess PTI must 

become other earnings and profits that 

remain with the foreign corporation so 

that those earnings and profits can be 

subject to tax. 

b. Redemptions Treated as Section 301 

Distributions 

If, under section 302(d), a redemption 

distribution is treated as a distribution 

of property to which section 301 

applies, the proposed regulations 

provide that the rules of Prop. Reg. 

§§ 1.959–1 and –3 shall apply in the 

same manner as they do to any other 

distribution to which section 301(c) 

applies. The PTI account with respect to 

the redeemed stock is reduced by the 

amount of the redemption distribution. 

If the redemption distribution exceeds 

such PTI account, the sharing rules 

described above regarding 

nonredemptive distributions of earnings 

and profits will be applicable. If, 

instead, the PTI account with respect to 

the redeemed shares exceeds the 

amount of the redemption distribution, 

the excess PTI is reallocated to the PTI 

accounts with respect to the remaining 

stock in the foreign corporation in a 

manner consistent with, and in 

proportion to, the proper adjustments of 

the basis in the remaining shares of the 

foreign corporation pursuant to § 1.302–

2(c). Accordingly, the proposed 

regulations also require proper 

adjustment of the basis of the 

shareholder’s remaining stock in the 

redeeming corporation, and of stock in 

the redeeming corporation held by 

related persons (not limited to members 

of the shareholder’s consolidated 

group). 

c. Deemed Redemptions Under Section 

304 

With respect to amounts paid to 

acquire stock in a transaction described 

in section 304(a)(1) and to which 

section 301(c) applies, the rules of Prop. 

Reg. §§ 1.959–1 and –3 shall apply in 

the same manner as they do to any other 

distribution to which section 301(c) 

applies. As discussed below, the sharing 

rules described above are applicable to 

such redemption distributions that are 

treated as distributions of property to 

which section 301 applies. In addition, 

a covered shareholder receiving such a 

distribution of earnings and profits shall 

have a PTI account with respect to the 

stock of each foreign corporation 

deemed to have distributed its earnings 

and profits under section 304(b)(2). 


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The Senate Report on the IRS 

Restructuring and Reform Act of 1998 

states with respect to the Secretary’s 

authority to prescribe regulations 

resulting from the enactment of section 

304(b)(6), ‘‘It is expected that such 

regulations will provide for an 

exclusion from income for distributions 

from earnings and profits of the 

acquiring corporation and the issuing 

corporation that represent previously 

taxed income under subpart F. It further 

is expected that such regulations will 

provide for appropriate adjustments to 

the basis of stock held by the 

corporation treated as receiving the 

distribution or by the corporation that 

had the prior inclusion with respect to 

the previously taxed income.’’ S. Rep. 

No. 105–174 at 179 (1998). The 

Conference agreement on the Act 

follows the Senate amendment. H.R. 

Conf. Rep. No. 105–599 (1998). 

In the case where members of a 

United States consolidated group own 

stock in the issuing corporation and the 

acquiring corporation in a section 

304(a)(1) transaction, the PTI accounting 

and sharing rules are intended to 

prevent double taxation of PTI, as 

intended by Congress in enacting 

sections 304(b)(6) and 959. A lower-tier, 

cross-chain acquisition of stock is 

generally subject to section 304(a)(1) 

and the transferor is treated as having 

transferred the stock in the issuing 

corporation to the acquiring corporation 

in exchange for stock in the acquiring 

corporation in a transaction to which 

section 351(a) applies. The acquiring 

corporation is treated as having 

redeemed those shares pursuant to a 

redemption distribution to which 

section 301 applies. As a result, in 

accordance with these regulations, a PTI 

account with respect to the stock in the 

foreign corporation that is treated as 

redeemed under section 304(a)(1) would 

be considered to arise at the time of the 

transaction. Any PTI accounts with 

respect to stock in the foreign 

corporation owned by other members of 

the shareholder’s consolidated group 

would be reduced, and the PTI account 

of the redeemed shareholder increased 

(and then reduced to zero), under the 

PTI sharing rules described above. 

D. Basis Adjustments 

The proposed regulations contain 

corresponding amendments to the 

regulations under section 961. These 

proposed regulations generally provide 

for increases and reductions in the basis 

of foreign corporation stock or other 

property through which foreign 

corporation stock is owned which 

match the increases and reductions in 

the PTI account with respect to such 

stock under the section 959 proposed 

regulations. The proposed regulations 

provide translation conventions for 

determining dollar basis adjustments 

under section 961 as a result of 

inclusions under section 951(a), 

distributions, and the foreign income 

taxes imposed on PTI as it is distributed 

through tiers of foreign corporations. 

The proposed regulations also 

implement section 961(c) by providing 

for adjustments to the basis of stock in 

a CFC that is held by another CFC in a 

chain of ownership described in section 

958(a) for the purpose of determining 

the amount properly includible in gross 

income under section 951(a) by a United 

States shareholder upon a sale of stock 

in a lower-tier CFC. 

The regulations also contain rules 

describing basis adjustments resulting 

from cross-chain sales of foreign 

corporation stock under section 

304(a)(1). 

E. Basis Adjustments of Consolidated 

Group Members 

In the case where there is sharing of 

PTI among members of a U.S. 

consolidated group, the proposed 

regulations also clarify the interaction of 

the investment adjustment provisions in 

the consolidated return regulations with 

the section 961 basis adjustment 

provisions. Accordingly, the proposed 

regulations clarify that a consolidated 

group member who utilizes PTI of 

another member shall treat the increase 

in its PTI account as the receipt of tax 

exempt income under Prop. Reg. 

§ 1.1502–32(b)(3)(ii)(D), and a member 

whose PTI is utilized shall treat the 

reduction in its PTI account as a 

noncapital nondeductible expense 

under Prop. Reg. § 1.1502–

32(b)(3)(iii)(B) for purposes of making 

the investment adjustments required by 

§ 1.1502–32. 

F. Proposed Effective Date and 

Transition Rule 

These regulations are proposed to 

apply to taxable years of foreign 

corporations beginning on or after the 

date these regulations are published as 

final regulations in the Federal Register, 

and taxable years of U.S. shareholders 

with or within which such taxable years 

of foreign corporations end. After these 

regulations become effective, foreign 

corporations and shareholders who are 

currently accounting for PTI in a 

manner other than that which is 

provided in these regulations may use 

any reasonable method to conform their 

current accounting of PTI to the rules 

provided in these regulations. 

Request for Comments 

A. Coordination of Shareholder-Level 

and Corporate-Level Accounts 

Prop. Reg. § 1.959–3(e)(4) requires 

aggregate categories of PTI to be 

maintained at the corporate level and to 

be adjusted in accordance with 

adjustments made to the individual 

shareholder-level PTI accounts. No 

explicit rules are provided for how 

shareholder-level and corporate-level 

PTI information is to be shared between 

the shareholders of a foreign 

corporation. Comments are requested on 

whether such information sharing rules 

are necessary, and if so, how they 

should operate to ensure conformity 

between shareholder-level and 

corporate-level PTI accounting. 

B. PTI and Consolidated Groups 

The application of the PTI sharing 

rules in the proposed regulations result 

in corresponding adjustments to the 

basis of stock in the sharing member 

corporations (and potentially higher tier 

members) held by other members of the 

shareholder’s consolidated group. As 

noted above, the IRS and Treasury 

Department believe that the PTI sharing 

rules result in the corresponding basis 

adjustments under the current 

investment adjustment provisions. 

There is some tension between single 

and separate entity treatment of a 

consolidated group regarding the PTI 

sharing rules, and the IRS and Treasury 

Department are continuing to study how 

to balance the policy in favor of 

minimizing multiple income inclusions 

with the policy of preserving the 

location of attributes within a 

consolidated group. In particular, the 

IRS and Treasury Department are 

concerned about the potential basis 

shifting that may occur as a result of the 

PTI sharing rules. The IRS and Treasury 

Department request comments on the 

proposed rules and whether there are 

more appropriate rules for determining 

the basis of: (1) The stock in a member 

of the consolidated group that transfers 

PTI to another member of the 

consolidated group under the proposed 

regulations, (2) the stock in the member 

of the consolidated group that receives 

the transferred PTI under the proposed 

regulations and (3) the stock in the 

higher tier members of the consolidated 

group that directly or indirectly own the 

stock in the members of the 

consolidated group whose PTI accounts 

are affected by the sharing rules in the 

proposed regulations. 

The proposed regulations do not limit 

the application of the PTI sharing rules 

between members of a consolidated 

group to PTI earned by a foreign 


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corporation while the member with 

excess PTI was a member of such group. 

The IRS and Treasury Department did 

not adopt such a limitation out of 

concern that it would be overly complex 

and concern that such a limitation 

might not be consistent with the 

successor in interest rule. However, the 

IRS and Treasury Department recognize 

that some may believe that such a 

limitation might be more consistent 

with other attribute sharing rules in the 

consolidated group context. 

Consequently, the IRS and Treasury 

Department request comments as to 

whether a limitation on PTI sharing 

between members of a consolidated 

group similar to those of § 1.1502–21(c) 

is appropriate. 

The IRS and Treasury Department 

believe that transactions described in 

section 304 are generally covered by the 

PTI sharing rules contained in Prop. 

Reg. §§ 1.959–3(h)(1) through (3) that 

are applicable to typical redemptions. 

However, a specific rule has also been 

provided in Prop. Reg. § 1.959–3(h)(4) 

that makes the PTI sharing rules 

explicitly applicable to transactions 

described in section 304(a)(1) that are 

treated as distributions of property to 

which section 301 applies. The IRS and 

Treasury Department request comments 

regarding whether the PTI sharing rules 

should also be made explicitly 

applicable to transactions described in 

section 304(a)(1) that are treated as sales 

or exchanges or to transactions 

described in section 304(a)(2). In 

addition, comments are requested on 

whether rules should be provided to 

address the proper allocation of PTI 

after a transaction described in section 

355. 

C. PTI and Section 367(b) Transactions 

On November 15, 2000, the IRS and 

Treasury Department issued proposed 

regulations in the Federal Register (65 

FR 69138) (REG–116050–99) addressing 

(1) the carryover of certain tax 

attributes, such as earnings and profits 

and foreign income tax accounts, when 

two corporations combine in a section 

367(b) transaction described in section 

381, and (2) the allocation of certain tax 

attributes when a corporation 

distributes stock in another corporation 

in a section 367(b) transaction (a foreign 

divisive transaction). In the preamble to 

those proposed regulations, the IRS and 

Treasury Department indicated that 

further guidance under section 959 

would be required prior to addressing 

PTI issues that arise under section 

367(b). At that time the IRS and 

Treasury Department requested 

comments with respect to proposed 

§ 1.367(b) regarding whether PTI should 

be transferable and retain its character 

as PTI for section 959 purposes, as well 

as the various implications that result 

from that determination. Additionally, 

in the 2000 proposed regulations, the 

IRS and Treasury Department requested 

comments with respect to § 1.367(b)–8 

of the proposed regulations regarding 

the proper adjustment of the PTI of a 

CFC following a foreign divisive 

transaction. 

On August 8, 2006, the IRS and 

Treasury Department issued final 

regulations under §§ 1.367(b)–3 and –7 

with respect to the carryover of non-PTI 

amounts, among other things, while 

reserving final regulations under 

§ 1.367(b)–8 with respect to the 

allocation of tax attributes in foreign 

divisive transactions. 

The IRS and Treasury Department 

invite comments regarding the proper 

extension of the principles in these 

proposed regulations (including 

shareholder-level accounting of PTI and 

the PTI sharing rules) to §§ 1.367(b)–3 

and –7, as well as Prop. Reg. 

§ 1.367(b)—8. 

D. Foreign Currency Gain or Loss and 

Foreign Tax Credits With Respect to PTI 

Distributions 

Under section 986(c) of the Code, 

foreign currency gain or loss with 

respect to distributions of PTI that is 

attributable to movements in exchange 

rates between the date(s) of the income 

inclusion that created the PTI and the 

distribution of such PTI shall be 

recognized and treated as ordinary 

income or loss from the same source as 

the associated income inclusion. The 

IRS and Treasury Department invite 

comments regarding additional 

guidance that may be needed under 

section 986(c) in light of the proposed 

regulations under section 959. The IRS 

and Treasury Department also invite 

comments regarding additional 

guidance that is needed to ensure that 

section 960(a)(3) provides appropriate 

foreign tax credit rules with respect to 

taxes imposed on PTI that is distributed 

through tiers of foreign corporations. 

E. Section 962 

The IRS and Treasury Department 

have not determined how the proposed 

accounting rules and basis rules should 

apply to a United States individual 

shareholder who has elected to be taxed 

as a corporation under section 962. 

Therefore, those rules are reserved for 

future study. The IRS and Treasury 

Department, however, invite comments 

about how the PTI rules and basis rules 

should apply for purposes of section 

962. 

F. Section 961(c) Basis Adjustments 

Section 961(c) is by its terms only 

applicable for purposes of determining 

the amount included under section 951 

in gross income of a United States 

shareholder. Consequently, the IRS and 

Treasury Department have so limited 

the application of Prop. Reg. § 1.961–3. 

In the event of a sale of a lower-tier CFC 

by an upper-tier CFC for which the rules 

of section 961(c) are implicated in 

determining the gain on the sale, the 

basis created in the lower-tier CFC stock 

for purposes of applying section 951 

would not apply, for example, to 

determine the earnings and profits of 

the upper-tier CFC. However, the IRS 

and Treasury Department are concerned 

about the potential double taxation that 

may result in the event of the later 

distribution of these earnings and 

profits to a United States person. 

G. Transition Rule 

These regulations are proposed to 

apply to taxable years of foreign 

corporations beginning on or after the 

date these regulations are published as 

final regulations in the Federal Register, 

and taxable years of U.S. shareholders 

with or within which such taxable years 

of foreign corporations end. After these 

regulations become effective, foreign 

corporations and shareholders who are 

currently accounting for PTI in a 

manner other than that which is 

provided in these regulations may use 

any reasonable method to conform their 

current accounting of PTI to the rules 

provided in these regulations. 

Comments are requested on whether 

more detailed transition rules should be 

provided, and, if so, how such transition 

rules should operate to conform existing 

methods of PTI accounting with the 

method of PTI accounting required by 

these regulations. 

Special Analyses 

It has been determined that this notice 

of proposed rulemaking is not a 

significant regulatory action as defined 

in Executive Order 12866. Therefore, a 

regulatory assessment is not required. It 

has also been determined that section 

553(b) of the Administrative Procedure 

Act (5 U.S.C. chapter 5) does not apply 

to these regulations and because the 

proposed regulation does not impose a 

collection of information on small 

entities, the Regulatory Flexibility Act 

(5 U.S.C. Ch. 6) does not apply. 

Pursuant to section 7805(f) of the Code, 

this notice of proposed rulemaking will 

be submitted to the Chief Counsel for 

Advocacy of the Small Business 

Administration for comment on its 

impact on small business. 


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Comments and Requests for Public 

Hearing 

Before these proposed regulations are 

adopted as final regulations, 

consideration will be given to any 

written (a signed original and eight (8) 

copies) or electronic comments that are 

submitted timely to the IRS. The IRS 

and Treasury Department request 

comments on the clarity of the proposed 

rules and how they can be made easier 

to understand. All comments will be 

available for public inspection and 

copying. A public hearing will be 

scheduled if requested in writing by any 

person that timely submits written 

comments. If a public hearing is 

scheduled, notice of the date, time, and 

place for the public hearing will be 

published in the Federal Register. 

Drafting Information 

The principal author of these 

regulations is Ethan Atticks, Office of 

Associate Chief Counsel (International). 

However, other personnel from the IRS 

and Treasury Department participated 

in their development. 

List of Subjects in 26 CFR Part 1 

Income Taxes, Reporting and 

recordkeeping requirements. 

Proposed Amendments to the 

Regulations 

Accordingly, 26 CFR part 1 is 

proposed to be amended as follows: 

PART 1—INCOME TAXES 

Paragraph 1. The authority citation 

for part 1 is amended by removing all 

entries for § 1.1502–12 and § 1.1502–32 

and by adding entries in numerical 

order to read, in part, as follows: 

Authority: 26 U.S.C. 7805 * * * 

Section 1.959–1 also issued under 26 

U.S.C. 304(b)(6), 959 and 1502. 

Section 1.959–2 also issued under 26 

U.S.C. 304(b)(6) and 959. 

Section 1.959–3 also issued under 26 

U.S.C. 304(b)(6), 959 and 1502. 

Section 1.959–4 also issued under 26 

U.S.C. 304(b)(6) and 959. * * * 

Section 1.961–1 also issued under 26 

U.S.C. 961. 

Section 1.961–2 also issued under 26 

U.S.C. 961. 

Section 1.961–3 also issued under 26 

U.S.C. 961. 

Section 1.961–4 also issued under 26 

U.S.C. 304(b)(6) and 961. * * * 

Section 1.1502–12 also issued under 26 

U.S.C. 959, 961 and 1502. * * * 

Section 1.1502–32 also issued under 26 

U.S.C. 301, 959, 961, 1502 and 1503. * * * 

Par. 2. Section 1.959–1 is revised to 

read as follows: 

§ 1.959–1 Exclusion from gross income of 

United States persons of previously taxed 

earnings and profits. 

(a) In general. Section 959(a) provides 

an exclusion whereby the earnings and 

profits of a foreign corporation 

attributable to amounts which are, or 

have been, included in a United States 

shareholder’s gross income under 

section 951(a) are not taxed again when 

distributed (directly or indirectly 

through a chain of ownership described 

in section 958(a)) from such foreign 

corporation to such shareholder (or any 

other United States person who acquires 

from any person any portion of the 

interest of such United States 

shareholder in such foreign corporation, 

but only to the extent of such portion, 

and subject to such proof of the identity 

of such interest as the Secretary may by 

regulations prescribe). Section 959(a) 

also excludes from gross income of a 

United States shareholder earnings and 

profits attributable to amounts which 

are, or have been, included in the gross 

income of such shareholder under 

section 951(a) which would, but for 

section 959(a)(2), be again included in 

the gross income of such shareholder (or 

any other United States person who 

acquires from any person any portion of 

the interest of such United States 

shareholder in such foreign corporation, 

but only to the extent of such portion, 

and subject to such proof of the identity 

of such interest as the Secretary may by 

regulations prescribe) under section 

951(a)(1)(B). Section 959(b) provides 

that for purposes of section 951(a), the 

earnings and profits of a CFC 

attributable to amounts that are, or have 

been, included in the gross income of a 

United States shareholder under section 

951(a) shall not, when distributed 

through a chain of ownership described 

in section 958(a), be included in the 

gross income of a CFC in such chain for 

purposes of the application of section 

951(a) to such CFC with respect to such 

United States shareholder (or any other 

United States person who acquires from 

any person any portion of the interest of 

such United States shareholder in such 

foreign corporation, but only to the 

extent of such portion, and subject to 

such proof of the identity of such 

interest as the Secretary may by 

regulations prescribe). Section 959(c) 

provides rules for the allocation of 

distributions to the various categories of 

previously taxed earnings and profits of 

a foreign corporation and the foreign 

corporation’s non-previously taxed 

earnings and profits. Section 959(d) 

provides that, except as provided in 

section 960(a)(3), any distribution 

excluded from gross income under 

section 959(a) shall be treated as a 

distribution which is not a dividend; 

except that such distributions shall 

immediately reduce earnings and 

profits. Section 959(e) provides that, for 

purposes of sections 959 and 960(b), any 

amount included in the gross income of 

any person as a dividend by reason of 

subsection (a) or (f) of section 1248 shall 

be treated as an amount included in the 

gross income of such person (or, in any 

case to which section 1248(e) applies, of 

the domestic corporation referred to in 

section 1248(e)(2)) under section 

951(a)(1)(A). Section 959(f)(1) provides 

rules for the allocation of amounts 

which would, but for section 959(a)(2), 

be included in gross income under 

section 951(a)(1)(B) to certain 

previously taxed earnings and profits of 

a foreign corporation and nonpreviously taxed earnings and profits. 

Section 959(f)(2) provides an ordering 

rule pursuant to which the rules of 

section 959 are applied first to actual 

distributions and then to amounts 

which would, but for section 959, be 

included in gross income under section 

951(a)(1)(B). Paragraph (b) of this 

section provides a list of definitions. 

Paragraph (c) of this section provides 

rules for the exclusion from gross 

income under section 959(a)(1) of 

distributions of earnings and profits by 

a foreign corporation and the exclusion 

from gross income under section 

959(a)(2) of amounts which would, but 

for section 959, be included in gross 

income under section 951(a)(1)(B). 

Paragraph (d) of this section provides 

for the establishment and acquisition of 

previously taxed earnings and profits 

accounts by shareholders of foreign 

corporations. Section 1.959–2 provides 

rules for the exclusion from gross 

income of a CFC of distributions of 

previously taxed earnings and profits 

from another CFC in a chain of 

ownership described in section 958(a). 

Section 1.959–3 provides rules for the 

allocation of distributions and section 

956 amounts to the earnings and profits 

of a CFC and for the maintenance and 

adjustment of previously taxed earnings 

and profits accounts by shareholders of 

foreign corporations. Section 1.959–4 

provides for the treatment of actual 

distributions that are excluded from 

gross income under section 959(a). 

(b) Definitions. For purposes of this 

section through § 1.959–4 and § 1.961–

1 through § 1.961–4, the terms listed in 

this paragraph are defined as follows: 

(1) Previously taxed earnings and 

profits means the earnings and profits of 

a foreign corporation, computed in 

accordance with sections 964 and 986(b) 

and the regulations thereunder, 

attributable to section 951(a) inclusions. 


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(2) Previously taxed earnings and 

profits account means an account 

reflecting the previously taxed earnings 

and profits of a foreign corporation (if 

any) that are attributable to section 

951(a) inclusions. 

(3) Dollar basis means the United 

States dollar amounts included in 

income with respect to the previously 

taxed earnings and profits included in a 

shareholder’s previously taxed earnings 

and profits account. 

(4) Covered shareholder means a 

person who is one of the following—

(i) A United States person who owns 

stock (within the meaning of section 

958(a)) in a foreign corporation and who 

has had a section 951(a) inclusion with 

respect to its stock in such corporation; 

(ii) A successor in interest, as defined 

in paragraph (b)(5) of this section; or 

(iii) A corporation that is not 

described in paragraphs (b)(4)(i) or (ii) 

of this section and that owns stock 

(within the meaning of section 958(a)) 

in a foreign corporation in which 

another corporation is a covered 

shareholder described in paragraph 

(b)(4)(i) or (ii) of this section, if both 

corporations are members of the same 

consolidated group. 

(5) Successor in interest means a 

United States person who acquires, from 

any person, ownership (within the 

meaning of section 958(a)) of stock in a 

foreign corporation, for which there is a 

previously taxed earnings and profits 

account and who establishes to the 

satisfaction of the Director of Field 

Operations the right to the exclusion 

from gross income provided by section 

959(a) and this section. To establish the 

right to the exclusion, the shareholder 

must attach to its return for the taxable 

year a statement that provides that it is 

excluding amounts from gross income 

because it is a successor in interest 

succeeding to one or more previously 

taxed earnings and profits accounts with 

respect to shares it owns in a foreign 

corporation. Included in the statement 

shall be the name of the foreign 

corporation. In addition, that 

shareholder must be prepared to 

provide the following information 

within 30 days upon request by the 

Director of Field Operations—

(i) The name, address, and taxable 

year of the foreign corporation and of all 

the other corporations, partnerships, 

trusts, or estates in any applicable chain 

of ownership described in section 

958(a); 

(ii) The name, address, and taxpayer 

identification number, if any, of the 

person from whom the stock interest 

was acquired; 

(iii) A description of the stock interest 

acquired and its relation, if any, to a 

chain of ownership described in section 

958(a); 

(iv) The amount for which an 

exclusion under section 959(a) and 

paragraph (c) of this section is claimed; 

and 

(v) Evidence showing that the 

earnings and profits for which an 

exclusion is claimed are previously 

taxed earnings and profits, that such 

amounts were not previously excluded 

from the gross income of a United States 

person, and the identity of the United 

States shareholder who originally 

included such amounts in gross income 

under section 951(a). The acquiring 

person shall also furnish to the Director 

of Field Operations such other 

information as may be required by the 

Director of Field Operations in support 

of the exclusion. 

(6) Block of stock shall have the 

meaning provided in § 1.1248–2(b) with 

the additional requirement that the 

previously taxed earnings and profits 

attributable to each share of stock in 

such block must be the same. 

(7) Consolidated group shall have the 

meaning provided in § 1.1502–1(h). 

(8) Member shall have the meaning 

provided in § 1.1502–1(b). 

(9) Section 951(a) inclusion means a 

section 951(a)(1)(A) inclusion or an 

amount included in the gross income of 

a United States shareholder under 

section 951(a)(1)(B). 

(10) Section 951(a)(1)(A) inclusion 

means—

(i) An amount included in a United 

States shareholder’s gross income under 

section 951(a)(1)(A); 

(ii) An amount included in the gross 

income of any person as a dividend by 

reason of subsection (a) or (f) of section 

1248 (or, in any case to which section 

1248(e) applies, an amount included in 

the gross income of the domestic 

corporation referred to in section 

1248(e)(2)); or 

(iii) An amount described in section 

1293(c). 

(11) Section 956 amount means an 

amount determined under section 956 

for a United States shareholder with 

respect to a single share or, if a 

shareholder maintains a previously 

taxed earnings and profits account with 

respect to a block of stock, a block of 

such shareholder’s stock in the CFC. 

(12) Section 959(c)(1) earnings and 

profits means the previously taxed 

earnings and profits of a foreign 

corporation attributable to amounts that 

have been included in the gross income 

of a United States shareholder under 

section 951(a)(1)(B) (or which would 

have been included except for section 

959(a)(2) and § 1.959–2) and amounts 

that have been included in gross income 

under section 951(a)(1)(C) as it existed 

prior to its repeal (or which would have 

been included except for section 

959(a)(3) as it existed prior to its repeal). 

(13) Section 959(c)(2) earnings and 

profits means the previously taxed 

earnings and profits of a foreign 

corporation attributable to section 

951(a)(1)(A) inclusions. 

(14) Non-previously taxed earnings 

and profits means the earnings and 

profits of a foreign corporation other 

than the corporation’s previously taxed 

earnings and profits. 

(15) CFC means a controlled foreign 

corporation within the meaning of 

either section 953(c)(1)(B) or section 

957. 

(16) United States shareholder means 

a United States person who qualifies as 

a United States shareholder under either 

section 951(b) or section 953(c)(1)(A). 

(c) Amount excluded from gross 

income—(1) Distributions. In the case of 

a distribution of earnings and profits to 

a covered shareholder with respect to 

stock in a foreign corporation, an 

amount shall be excluded from such 

shareholder’s gross income equal to the 

total amount by which such 

shareholder’s previously taxed earnings 

and profits account with respect to such 

stock is decreased under § 1.959–3 

because of the distribution. 

(2) Section 956 amounts. In a case 

where a covered shareholder has a 

section 956 amount for a CFC’s taxable 

year, an amount shall be excluded from 

such shareholder’s gross income equal 

to the amount of section 959(c)(2) 

earnings and profits in any 

shareholder’s previously taxed earnings 

and profits account that are reclassified 

as section 959(c)(1) earnings and profits 

under § 1.959–3 because of that section 

956 amount. 

(d) Shareholder accounts—(1) In 

general. Any person who is subject to 

§ 1.959–3 shall maintain a previously 

taxed earnings and profits account with 

respect to each share of stock it owns 

(within the meaning of section 958(a)) 

in a foreign corporation. Although the 

account is share specific, the account 

may be maintained with respect to each 

block of the stock in the foreign 

corporation. Such account shall be 

maintained in accordance with § 1.959–

3. 

(2) Acquisition of account—(i) In 

general. If any person acquires, from 

any other person, ownership of shares of 

stock in a foreign corporation (within 

the meaning of section 958(a)) the prior 

shareholder’s previously taxed earnings 

and profits account with respect to such 

stock becomes the previously taxed 

earnings and profits account of the 

acquirer. 


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(ii) Acquisition of account by a person 

other than a successor in interest. If 

such acquirer is not a successor in 

interest (a foreign person for example), 

the previously taxed earnings and 

profits account with respect to the stock 

acquired shall remain unchanged for the 

period that the stock is owned by such 

acquirer. See also § 1.959–3(e), 

providing account adjustment rules that 

apply only for acquired PTI accounts if 

the acquirer is a successors in interest. 

(3) The application of this paragraph 

(d) is illustrated by the following 

examples: 

Example 1. Shareholder previously taxed 

earnings and profits account. (i) Facts. DP, a 

United States shareholder owns all of the 100 

shares of the only class of stock in FC, a CFC. 

The 100 shares are a block of stock. DP and 

FC use the calendar year as their taxable year 

and FC uses the U.S. dollar as its functional 

currency. FC earns $100x of subpart F 

income in year 1 and $100x of non-subpart 

income. DP includes $100x in gross income 

under section 951(a). 

(ii) Analysis. As a result of DP’s inclusion 

of $100x of gross income under section 

951(a), DP has a previously taxed earnings 

and profits account with respect to each of 

its 100 shares equal to $1x or should DP 

choose to maintain its previously taxed 

earnings and profits account on a block basis, 

an account of $100x with respect to its entire 

interest in FC. 

Example 2. Acquisition of previously taxed 

earnings and profits account. (i) Facts. 

Assume the same facts as Example 1, but that 

in year 2, a nonresident alien, FP, contributes 

property to FC to acquire 1000 newly issued 

shares of FC of the same class held by DP. 

In year 10, DP sells all of its FC shares to FP. 

In year 15, FP sells all of its shares in FC to 

USP, a United States person. Any income 

earned by FC after year 1 is non-subpart F 

income. The only distributions by FC during 

this period are a $100x pre-sale distribution 

to FP in year 15 and another $100x 

distribution in year 16 to USP. 

(ii) Analysis. In year 2, DP retains its 

previously taxed earnings and profits account 

of $100x as a result of its section 951(a) 

inclusion in year 1 regardless of the fact that 

FC is no longer a CFC and DP no longer holds 

a sufficient interest in FC to be a United 

States shareholder with respect to FC. In year 

10, pursuant to paragraph (d)(2)(i) of this 

section, FP acquires a $100x previously taxed 

earnings and profits account with respect to 

DP’s block of stock in FC that FP acquired. 

In year 15, FP receives a distribution of 

$100x of earnings and profits from FC, but FP 

may not exclude any of this distribution from 

gross income because FP is a nonresident 

alien. Consequently, pursuant to paragraph 

(d)(2)(ii) of this section, even though it 

acquired a previously taxed earnings and 

profits account from DP of $100x the account 

remains unchanged during FP’s ownership of 

the FC stock. However, if USP can make the 

showing required in paragraph (b)(5) of this 

section, USP may exclude the $100x 

distribution in year 16 under section 

959(a)(1) and paragraph (c) of this section to 

the extent that the distribution results in a 

decrease of the $100x previously taxed 

earnings and profits account that USP 

acquired from FP pursuant to the account 

adjustment rules of § 1.959–3. 

Par. 3. Section 1.959–2 is revised to 

read as follows: 

§ 1.959–2 Exclusion from gross income of 

CFCs of previously taxed earnings and 

profits. 

(a) Exclusion from gross income—(1) 

In general. The earnings and profits of 

a CFC (lower-tier CFC) attributable to 

amounts which are, or have been, 

included in the gross income of a 

United States shareholder under section 

951(a) shall not, when distributed 

through a chain of ownership described 

in section 958(a), be also included in the 

gross income of the CFC receiving the 

distribution (upper-tier CFC) in such 

chain for purposes of the application of 

section 951(a) to such upper-tier CFC 

with respect to such United States 

shareholder. The amount of the 

exclusion provided under this 

paragraph is the entire amount 

distributed by the lower-tier CFC to the 

upper-tier CFC that gave rise (in whole 

or in part) to an adjustment of the 

United States shareholder’s previously 

taxed earnings and profits accounts with 

respect to the stock it owns (within the 

meaning of section 958(a)) in the lowerand upper-tier CFC under § 1.959–

3(e)(3). This amount shall not exceed 

the earnings and profits of the lower-tier 

CFC attributable to amounts described 

in section 951(a)(1) (without regard to 

pro rata share). The exclusion from the 

income of such distributee CFC also 

applies with respect to any other United 

States shareholder who is a successor in 

interest. 

(2) Examples. The application of this 

paragraph (a) is illustrated by the 

following examples: 

Example 1. Distribution attributable to 

subpart F income of lower-tier CFC. (i) Facts. 

FC, a CFC, is 70% owned by DP, a United 

States person, and 30% owned by FP, a 

nonresident alien. FC owns all the stock in 

FS, a CFC. DP, FP, FC and FS all use the 

calendar year as their taxable year and FC 

and FS use the U.S. dollar as their functional 

currency. In year 1, FS earns $100x of passive 

income described in section 954(c) and $50x 

of non-subpart F income. On the last day of 

year 1, FS distributes $100x to FC that would 

qualify as subpart F income of FC. On the last 

day of year 1, FC distributes $70x to DP and 

$30x to FP. 

(ii) Analysis. DP is required to include 

$70x in its gross income under section 951(a) 

as a result of FS’s earning $100x of subpart 

F income for the year. Consequently, the 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

with respect to its indirect ownership of 

stock in FS is increased to $70x. Under 

§ 1.959–3(e)(3), as a result of the $100x 

distribution paid by FS to FC, DP’s 

previously taxed earnings and profits account 

is reduced by its pro rata share of the 

distribution ($70x). In addition, FS’s nonpreviously taxed earnings and profits are 

reduced by the remaining $30x. Under 

paragraph (a) of this section, the amount of 

the exclusion under paragraph (a) is equal to 

the amount distributed, not to exceed the 

amount of earnings and profits that gave rise 

to the previously taxed income that is being 

distributed. Consequently, the entire $100x 

distribution (as opposed to only $70x) is 

excluded from FC’s gross income for 

purposes of determining whether DP has an 

inclusion under section 951(a) as a result of 

FC’s receiving the distribution from FS. The 

receipt of the distribution from FS increases 

FC’s earnings and profits by $100x ($70x of 

which is previously taxed earnings and 

profits and $30x of which is non-previously 

taxed earnings and profits). 

Example 2. Transferee shareholder. (i) 

Facts. The facts are the same as in Example 

1 except that neither FS nor FC makes any 

distributions in year 1. In year 2, FP sells its 

stock in FC to DT, a United States person. On 

the last day of year 2, FS distributes $100x 

to FC that would qualify as subpart F income 

of FC. FS has no earnings and profits for year 

2, and FC has no earnings for year 2 other 

than the distribution from FS. 

(ii) Analysis. With respect to DP, the 

analysis is the same as that in Example 1. 

However, for purposes of DT’s determination 

of the amount includible in its gross income 

under section 951(a) with respect to FC for 

year 2, none of the $100x distribution is 

excluded from FC’s gross income for 

purposes of applying section 951(a) with 

respect to DT’s interest in FC because none 

of earnings and profits distributed by FS to 

FC are attributable to amounts which are, or 

have been, included in the gross income of 

DT or the person to whom DT is a successor 

in interest (FP). Consequently, DT must 

include $30x in gross income under section 

951(a) for year 2 as its pro rata share of FC’s 

subpart F income of $100x ($100x × 30%). 

Thereafter, DT has a previously taxed 

earnings and profits account consisting of 

$30x with respect to its stock in FC and FC 

has $100x of previously taxed earnings and 

profits. 

Example 3. Mixed distribution. (i) Facts. 

The facts are the same as in Example 1, 

except that on the last day of year 1, FS 

distributes $150x to FC that would qualify as 

subpart F income of FC, which in turn 

distributes $105x to DP and $45x to FP. 

(ii) Analysis. Under the analysis in 

Example 1 and pursuant to paragraph (a) of 

this section, $100x of the distribution from 

FS to FC is excluded from FC’s gross income 

for purposes of determining DP’s inclusion 

under section 951(a) with respect to FC’s 

receipt of the distribution from FS. However, 

DP’s pro rata share of the remaining $50, or 

$35 ($50 × 70%), is included in DP’s gross 

income under section 951(a). Consequently, 

the previously taxed earnings and profits in 

DP’s previously taxed earnings and profits 

account with respect to its stock in FC is 

increased from $70x to $105x pursuant to 

§ 1.959–3(e)(2)(i). That account is then 


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reduced to $0, however, as a result of the 

distribution of $105x to DP pursuant to 

§ 1.959–3(e)(2)(ii) and DP excludes the 

distribution of $105x from FC from its gross 

income for year 1 under section 959(a)(1) and 

§ 1.959–1(c). 

(b) Section 304(a)(1) transactions—(1) 

Deemed redemption treated as a 

distribution. In the case of a stock 

acquisition under section 304(a)(1) 

treated as a distribution to which 

section 301 applies, the selling CFC 

shall be deemed for purposes of section 

959(b) and paragraph (a) of this section 

to receive such distributions through a 

chain of ownership described under 

section 958(a). 

(2) The application of this paragraph 

(c) is illustrated by the following 

example: 

Example. Cross-chain acquisition of CFC 

stock by a CFC from another CFC. (i) Facts. 

DP, a domestic corporation, owns all of the 

stock in two foreign corporations, FX and FY. 

FX owns all of the stock in foreign 

corporation FZ. DP, FX, FY, and FZ all use 

the calendar year as their taxable year and 

the U.S. dollar as their functional currency. 

During year 1, FY purchases all of the stock 

in FZ from FX for $80x in a transaction 

described in section 304(a)(1). At the end of 

year 1, before taking into account the 

purchase of FZ’s stock, FY has section 

959(c)(2) earnings and profits of $20x and 

non-previously taxed earnings and profits of 

$10x, and FZ has section 959(c)(2) earnings 

and profits of $50x and non-previously taxed 

earnings and profits of $0. 

(ii) Analysis. Under section 304(a)(1), FX is 

deemed to have transferred the FZ stock to 

FY in exchange for FY stock in a transaction 

to which section 351 applies, and FY is 

treated as having redeemed, for $80x, the FY 

stock deemed issued to FX. The payment of 

$80x is treated as a distribution to which 

section 301 applies. Under section 304(b)(2), 

the determination of the amount which is a 

dividend (and the source) is made as if the 

distribution were made, first, by FY to the 

extent of its earnings and profits, $30x, and 

then by FX to the extent of its earnings and 

profits, $50x. Under paragraph (c)(1) of this 

section, FX is deemed to receive the 

distributions from FY and FZ through a chain 

of ownership described in section 958(a). 

Under paragraph (a) of this section, the 

amount of FY’s previously taxed earnings 

and profits, $20x, and the amount of FZ’s 

previously taxed earnings and profits, $50x, 

distributed to FX are excluded from the gross 

income of FX. Accordingly, only $10x is 

included in FX’s gross income. 

Par. 4. Section 1.959–3 is revised to 

read as follows: 

§ 1.959–3 Maintenance and adjustment of 

previously taxed earnings and profits 

accounts. 

(a) In general. This section provides 

rules for the maintenance and 

adjustment of previously taxed earnings 

and profits accounts by shareholders 

and with respect to foreign corporations. 

Paragraph (b) of this section provides 

general rules governing the accounting 

of previously taxed earnings and profits 

at the shareholder level and corporate 

level. Paragraph (c) of this section 

provides rules regarding the treatment 

of foreign taxes when previously taxed 

earnings and profits are distributed by a 

foreign corporation through a chain of 

ownership described in section 958(a). 

Paragraph (d) of this section provides 

rules regarding the allocation of other 

expenses to previously taxed earnings 

and profits. Paragraph (e)(1) of this 

section addresses the adjustment of 

shareholder-level previously taxed 

earnings and profits accounts as a result 

of certain transactions. Paragraph (e)(2) 

of this section provides rules 

establishing the order in which 

adjustments are to be made to a covered 

shareholder’s previously taxed earnings 

and profits account. Paragraph (e)(3) of 

this section provides rules regarding 

distributions of previously taxed 

earnings and profits in a chain of 

ownership described in section 958(a). 

Paragraph (e)(4) of this section provides 

for the maintenance and adjustment of 

aggregate categories of previously taxed 

and non-previously taxed earnings and 

profits at the corporate level with 

adjustments to individual shareholderlevel accounts. Paragraph (e)(5) of this 

section provides rules for the effect of a 

foreign corporation’s deficit in earnings 

and profits on previously taxed earnings 

and profits. Paragraph (f) of this section 

provides rules regarding the treatment 

of previously taxed earnings and profits 

when a shareholder has multiple 

previously taxed earnings and profits 

accounts. Paragraph (g) of this section 

provides rules regarding the treatment 

of previously taxed earnings and profits 

when more than one shareholder in a 

foreign corporation is a member of the 

same consolidated group. Paragraph (h) 

of this section provides rules governing 

the adjustment of previously taxed 

earnings and profits accounts in the case 

of a redemption. 

(b) Corporate-level and shareholderlevel accounting of previously taxed 

earnings and profits—(1) Shareholderlevel accounting. A shareholder’s 

previously taxed earnings and profits 

account with respect to its stock in a 

foreign corporation shall identify the 

amount of section 959(c)(1) earnings 

and profits and the amount of section 

959(c)(2) earnings and profits 

attributable to such stock for each 

taxable year of the foreign corporation 

and shall be maintained in the 

functional currency of such foreign 

corporation. A shareholder account 

must also reflect the annual dollar basis 

of each category of previously taxed 

earnings and profits in the account. See 

§ 1.959–3(e) of this section for rules 

regarding the adjustment of shareholder 

previously taxed earnings and profits 

accounts. 

(2) Corporate-level accounting. 

Separate aggregate categories of section 

959(c)(1), section 959(c)(2) and nonpreviously taxed earnings and profits 

(earnings and profits described in 

section 959(c)(3)) shall be maintained 

with respect to a foreign corporation. 

These categories of earnings and profits 

of the foreign corporation shall be 

maintained in the functional currency of 

the foreign corporation. For purposes of 

this section, distributions are allocated 

to a foreign corporation’s earnings and 

profits under section 316(a) by applying 

first section 316(a)(2) and then section 

316(a)(1) to each of these three 

categories of earnings and profits. 

Section 956 amounts shall be treated as 

attributable first to section 959(c)(2) 

earnings and profits and then to nonpreviously taxed earnings and profits. 

These allocations are made in 

conjunction with the rules for making 

corporate-level adjustments to 

previously taxed earnings and profits 

under § 1.959–3(e)(4). 

(3) Classification of earnings and 

profits—(i) In general. For purposes of 

this section, earnings and profits are 

classified as to year and category of 

earnings and profits in the year in 

which such amounts are included in 

gross income of a United States 

shareholder under section 951(a) and 

are reclassified as to category of 

earnings and profits in the year in 

which such amounts would be so 

included but for the provisions of 

section 959(a)(2) and § 1.959–1(c)(2). 

Such classifications do not change by 

reason of a subsequent distribution of 

such amounts to an upper-tier 

corporation in a chain of ownership 

described in section 958(a). This 

paragraph shall apply to distributions 

by one foreign corporation to another 

foreign corporation and by a foreign 

corporation to a United States person. 

(ii) Dollar basis pooling election. For 

purposes of computing foreign currency 

gain or loss under section 986(c) and 

adjustments to stock basis under section 

961(b) and (c) with respect to 

distributions of previously taxed 

earnings and profits of any foreign 

corporation, in lieu of maintaining 

annual dollar basis accounts with 

respect to previously taxed earnings and 

profits described in paragraph (b)(1) of 

this section, a taxpayer may maintain an 

aggregate dollar basis pool that reflects 

the dollar basis of all of the 

corporation’s previously taxed earnings 


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and profits described in sections 

959(c)(1) and 959(c)(2) and treat a pro 

rata portion of the dollar basis pool as 

attributable to distributions of such 

previously taxed earnings and profits. A 

taxpayer makes this election by using a 

dollar basis pool to compute foreign 

currency gain or loss under section 

986(c) with respect to distributions of 

previously taxed earnings and profits of 

the foreign corporation, or to compute 

gain or loss with respect to its stock in 

the foreign corporation, whichever 

occurs first. Any subsequent change in 

the taxpayer’s method of assigning 

dollar basis may be made only with the 

consent of the Commissioner. 

(4) Examples. The application of this 

paragraph (b) is illustrated by the 

following examples: 

Example 1. Distribution. (i) Facts. DP, a 

United States shareholder, owns 100% of the 

only class of stock in FC, a CFC, which, in 

turn, owns 100% of the only class of stock 

in FS, a CFC. DP, FC and FS all use the 

calendar year as their taxable year. FC and FS 

both use the u as their functional currency. 

During year 1, FC earns 100u of non-subpart 

F income and invests 100u in United States 

property. DP must include 100u in its gross 

income for year 1 under section 951(a)(1)(B) 

with respect to FC. For year 2, FS has no 

subpart F income or investment of earnings 

in United States property but FS has 100u of 

non-previously taxed earnings and profits 

which it distributes to FC. The distribution 

of 100u to FC is subpart F income of FC and 

DP must include the 100u in its gross income 

for year 2 under section 951(a)(1)(A). Also in 

year 2, FC has non-subpart F income of 100u. 

The exchange rates at all times in year 1 and 

year 2, respectively, are 1u = $1 and 1u = 

$1.20. 

(ii) Analysis. With respect to FC, the 

earnings and profits are classified as follows: 

100u of section 959(c)(1) earnings and profits 

from year 1, 100u of section 959(c)(2) 

earnings and profits from year 2, and 100u 

of non-previously taxed earnings and profits 

from year 2. The dollar basis with respect to 

the section 959(c)(1) earnings and profits is 

$100 and the dollar basis with respect to the 

section 959(c)(2) earnings and profits is $120. 

Example 2. Subsequent distribution in a 

later year. (i) Facts. Assume the same facts 

as in Example 1, except that during year 3 

neither FC nor FS has any earnings and 

profits or deficit in earnings and profits or 

section 956 amount, but FC distributes 100u 

to DP on December 31, year 3, at which time 

the spot exchange rate is 1u = $1.30. 

(ii) Analysis. For purposes of section 959 

and 961, the 100u distribution of FC shall be 

considered attributable to FC’s section 

959(c)(1) earnings and profits for year 1. The 

section 959(c)(1) earnings and profits are 

reduced by 100u and the dollar basis of the 

account is reduced by $100. Since the spot 

rate at the time of the 100u distribution to DP 

is 1u = $1.30, DP recognizes foreign currency 

gain of $30 ((100 × 1.3) ¥ (100 × 1)). 

Example 3. Dollar basis pooling election. 

(i) Facts. Assume the same facts as in 

Example 2, except that DP elected to 

maintain the dollar basis of its previously 

taxed earnings and profits account on a 

pooled basis for purposes of section 986(c) 

and section 961 as provided in paragraph 

(b)(3)(ii) of this section. 

(ii) Analysis. The section 959(c)(1) earnings 

and profits are reduced by 100u, but the 

dollar basis of the account is reduced by $110 

((100u/200u) × $220). In addition, DP 

recognizes foreign currency gain under 

section 986(c) of $20 ($130 ¥ ((100u/200u) 

× $220)). 

(c) Treatment of certain foreign taxes. 

(1) For purposes of this section, when 

previously taxed earnings and profits 

are distributed by a foreign corporation 

through a chain of ownership described 

in section 958(a) such earnings and 

profits shall be reduced by the 

functional currency amount of any 

income, war profits, or excess profits 

taxes imposed by any foreign country or 

a possession of the United States on or 

with respect to such earnings and 

profits. Any such taxes shall not be 

included in the foreign corporation’s 

pools of post-1986 foreign income taxes 

maintained for purposes of sections 902 

and 960(a)(1). Such taxes shall be 

maintained in a separate account and 

allowed as a credit as provided under 

section 960(a)(3) when the associated 

previously taxed earnings and profits 

are distributed. The taxpayer’s dollar 

basis in the previously taxed earnings 

and profits account shall be reduced by 

the dollar amount of such taxes, 

translated in accordance with section 

986(a). 

(2) The application of this paragraph 

(c) is illustrated by the following 

example: 

Example. Imposition of foreign taxes on a 

CFC. (i) Facts. DP, a United States 

shareholder, owns 100% of the only class of 

stock in foreign corporation FC, a CFC, 

which, in turn, owns 100% of the only class 

of stock in FS, a CFC. DP, FC, and FS all use 

the calendar year as their taxable year. FC 

and FS both use the u as their functional 

currency. During year 1, FS earns 90u of 

subpart F income, after incurring 10u of 

foreign income tax allocable to such income 

under § 1.954–1(c), has earnings and profits 

in excess of 90u, and makes no distributions. 

DP must include 90u, translated at the 

average exchange rate for the year of 1u = $1 

as provided in section 989(b)(3), in its gross 

income for year 1 under section 

951(a)(1)(A)(i). As of the end of year 1, FS has 

section 959(c)(2) earnings and profits of 90u. 

During year 2, FS has neither earnings and 

profits nor a deficit in earnings and profits 

but distributes 90u to FC, and, by reason of 

section 959(b) and § 1.959–2, such amount is 

not includible in the gross income of DP for 

year 2 under section 951(a) with respect to 

FC. FC incurs a withholding tax of 9u on the 

90u distribution from FS (10% of 90u) and 

an additional foreign income tax of 11u by 

reason of the inclusion of the distribution in 

its taxable income for foreign tax purposes in 

year 2. The average exchange rate for year 2 

is 1u = $2. 

(ii) Analysis. At the end of year 2, FS has 

section 959(c)(2) earnings and profits of 0 

(90u¥90u); and FC has section 959(c)(2) 

earnings and profits of 70u (90u¥9u¥11u). 

DP’s dollar basis in the 70u section 959(c)(2) 

earnings and profits account with respect to 

FC is $50 ($90 inclusion¥$18 withholding 

tax¥$22 income tax). The $40 of foreign 

taxes imposed on FC with respect to the 

previously taxed earnings and profits are not 

included in FC’s post-1986 foreign income 

taxes pool. A foreign tax credit with respect 

to the $40 of foreign tax attributable to the 

70u of previously taxed earnings and profits 

will be allowed under section 960(a)(3) upon 

distribution of such previously taxed 

earnings and profits. 

(d) Treatment of other expenses. 

Except as provided in paragraph (c) of 

this section, no expense paid or accrued 

by a foreign corporation shall be 

allocated or apportioned to the 

previously taxed earnings and profits of 

such corporation. 

(e) Adjustments to previously taxed 

earnings and profits account—(1) In 

general. A covered shareholder’s 

previously taxed earnings and profits 

account (including the dollar basis in 

such account) is adjusted in the manner 

provided in paragraphs (e)(2), (f) and (g) 

of this section, except as otherwise 

provided in paragraph (e)(3) of this 

section. For adjustments to a previously 

taxed earnings and profits account in 

the case of redemptions, see paragraph 

(h) of this section. 

(2) Order and amount of adjustments. 

As of the close of a foreign corporation’s 

taxable year, and for the taxable year of 

the covered shareholder in which or 

with which such taxable year of the 

foreign corporation ends, the covered 

shareholder shall make any of the 

following adjustments that are 

applicable for that year to the previously 

taxed earnings and profits account for 

the stock owned for any portion of such 

year (within the meaning of section 

958(a)) in the foreign corporation in the 

following order—

(i) Step 1. Section 951(a)(1)(A) 

inclusion. Increase the amount of 

section 959(c)(2) earnings and profits 

and the associated dollar basis in the 

account by the amount of the section 

951(a)(1)(A) inclusion with respect to 

such stock; 

(ii) Step 2. Distributions on such 

stock. (A) Decrease the amount of the 

section 959(c)(1) earnings and profits in 

the account (but not below zero), and 

then the amount of section 959(c)(2) 

earnings and profits in the account (but 

not below zero) by the amount of 

earnings and profits distributed to the 

covered shareholder during the year 

with respect to such stock, decrease the 


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dollar basis in the account by the dollar 

amount attributable to the distributed 

earnings and profits; and 

(B) Increase the amount of the 

earnings and profits and associated 

dollar basis, in the account first to the 

extent provided under paragraph (f)(1) 

of this section and then to the extent 

provided under paragraph (g)(1) of this 

section and then reduce the account to 

zero; 

(iii) Step 3. Reallocation from other 

accounts with respect to redemptions. 

Increase the amount of the earnings and 

profits and associated dollar basis in the 

account to the extent provided under 

paragraph (h)(3)(ii) of this section. 

(iv) Step 4. Section 956 amount. 

Reclassify the section 959(c)(2) earnings 

and profits and associated dollar basis 

in such shareholder’s previously taxed 

earnings and profits account with 

respect to such stock as section 959(c)(1) 

earnings and profits in an amount equal 

to the lesser of—

(A) The covered shareholder’s section 

956 amount for the taxable year with 

respect to such stock; or 

(B) The amount of the section 

959(c)(2) earnings and profits 

attributable to such stock. 

(v) Step 5. Reallocation to other 

accounts with respect to distributions. 

Decrease the amount of section 959(c)(1) 

earnings and profits and associated 

dollar basis in the account, and 

thereafter the amount of section 

959(c)(2) earnings and profits and 

associated dollar basis in the account to 

the extent provided under paragraph 

(f)(1) of this section and then under 

paragraph (g)(1) of this section; 

(vi) Step 6. Reclassification with 

respect to section 956 amounts. 

Reclassify the section 959(c)(2) earnings 

and profits and the associated dollar 

basis attributable to such stock as 

section 959(c)(1) earnings and profits to 

the extent provided under paragraph 

(f)(2) of this section and then to the 

extent provided in paragraph (g)(2) of 

this section. 

(vii) Step 7. Further adjustment for 

section 956 amounts. Increase the 

amount of section 959(c)(1) earnings 

and profits and the associated dollar 

basis in the account by any amount 

included in the covered shareholder’s 

gross income for the year under section 

951(a)(1)(B) with respect to such stock. 

(3) Intercorporate distributions. If a 

foreign corporation receives a 

distribution of earnings and profits from 

another foreign corporation that is in a 

chain of ownership described in section 

958(a), a covered shareholder’s 

previously taxed earnings and profits 

accounts with respect to the stock in 

each foreign corporation in such chain 

shall be adjusted at the end of the 

respective corporation’s taxable year, 

and for the taxable year of the covered 

shareholder in which or with which 

such taxable year of the foreign 

corporation ends, as follows: 

(i) The covered shareholder’s 

previously taxed earnings and profits 

account with respect to stock in the 

distributor shall be decreased (but not 

below zero), at the same time that the 

covered shareholder would make 

adjustments under paragraph (e)(2)(ii) of 

this section, by the amount of the 

distribution and the associated dollar 

basis. Such decrease to the covered 

shareholder’s previously taxed earnings 

and profits account shall be made first 

to the section 959(c)(1) earnings and 

profits and thereafter to the section 

959(c)(2) earnings and profits in such 

account. 

(ii) Except as provided in paragraph 

(c) of this section, the section 959(c)(1) 

earnings and profits and section 

959(c)(2) earnings and profits in the 

covered shareholder’s previously taxed 

earnings and profits account with 

respect to the stock in the distributee 

shall be increased, at the same time that 

the covered shareholder would make 

adjustments under paragraph (e)(2)(i) of 

this section, by an amount equal to the 

decrease under paragraph (e)(3)(i) of this 

section and to the extent the 

distribution is out of non-previously 

taxed earnings and profits of the 

distributor, to the extent provided under 

paragraph (e)(2) of this section. If the 

receiving corporation uses a non-dollar 

functional currency that differs from the 

functional currency used by the 

distributing corporation, then—

(A) The amount of increase shall be 

the spot value of the distribution in the 

receiving corporation’s functional 

currency at the time of the distribution; 

and 

(B) The dollar basis of the amount 

distributed shall be carried over from 

the distributing corporation to the 

receiving corporation. 

(4) Effect on foreign corporation’s 

earnings and profits. Adjustments to a 

shareholder’s previously taxed earnings 

and profits account in accordance with 

this section shall result in 

corresponding adjustments to the 

appropriate aggregate category or 

categories of earnings and profits of the 

foreign corporation. If an adjustment to 

a foreign corporation’s earnings and 

profits is required (other than as a result 

of the previous sentence) the adjustment 

shall be made only to the nonpreviously taxed earnings and profits of 

the corporation except to the extent 

provided in paragraph (h)(2)(i) of this 

section. Moreover, if a distribution to a 

taxpayer exceeds such taxpayer’s 

previously taxed earnings and profits 

account with respect to stock it owns 

(within the meaning of section 958(a)) 

in the foreign corporation making the 

distribution, the distribution may only 

be treated as a dividend under section 

316 by applying section 316(a)(1) and 

(2) to the non-previously taxed earnings 

and profits of the foreign corporation. 

(5) Deficits in earnings and profits. If 

a foreign corporation has a deficit in 

earnings and profits, as determined 

under section 964(a) and § 1.964–1, for 

any taxable year, a covered 

shareholder’s previously taxed earnings 

and profits account with respect to its 

stock in such foreign corporation shall 

not be adjusted to take into account the 

deficit and the deficit shall be applied 

only to the non-previously taxed 

earnings and profits of the foreign 

corporation. 

(6) Examples. The application of this 

paragraph (e) is illustrated by the 

following examples: 

Example 1. Distribution to a United States 

shareholder. (i) Facts. DP, a United States 

shareholder, owns 100% of the only class of 

stock in FC, a CFC. Both DP and FC use the 

calendar year as their taxable year. FC uses 

the ‘‘u’’ as its functional currency. During 

year 1, FC derives 100u of subpart F income, 

and such amount is included in DP’s gross 

income under section 951(a)(1)(A). The 

average exchange rate for year 1 is 1u = $1. 

At the end of year 1, FC’s current and 

accumulated earnings and profits (before 

taking into account distributions made 

during year 1) are 500u. Also, on December 

31, year 1, when the spot exchange rate is 1u 

= $1.10, FC distributes 50u of earnings and 

profits to DP. 

(ii) Analysis. At the end of year 1, the 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

are first increased from 0 to 100u, pursuant 

to paragraph (e)(2)(i) of this section as a 

result of the subpart F inclusion of 100u and 

then reduced from 100u to 50u, pursuant to 

paragraph (e)(2)(ii) of this section as a result 

of the distribution. DP’s dollar basis in the 

100u of previously taxed earnings and profits 

is $100 (the dollar amount of the income 

inclusion under section 951(a)(1)(A)). See 

section 989(b)(3). The 50u distribution is 

excluded from DP’s gross income pursuant to 

§ 1.959–1(c)(1). Pursuant to paragraph (e)(4) 

of this section, at the end of year 1, FC has 

section 959(c)(2) earnings and profits of 50u 

and non-previously taxed earnings and 

profits of 400u. DP’s dollar basis in the 

previously taxed earnings and profits account 

is reduced by a pro rata share of the dollar 

amount included in income under section 

951(a)(1)(A), or by $50 (50u distribution/ 

100u previously taxed earnings and profits x 

$100 dollar basis). DP recognizes foreign 

currency gain under section 986(c) of $5 ($55 

spot value of 50u distribution¥$50 basis). 

Example 2. Net deficit in earnings and 

profits. (i) Facts. Assume the same facts as 

in Example 1, except that FC has a net deficit 


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in earnings and profits of 500u for year 2. At 

the end of Year 1, FC has 50u of section 

959(c)(2) earnings and profits and 400u of 

non-previously taxed earnings and profits. 

(ii) Analysis. At the end of year 2, DP’s 

section 959(c)(2) earnings and profits for year 

1 remains at 50u, pursuant to paragraph (e)(5) 

of this paragraph, because a shareholder’s 

previously taxed earnings and profits account 

is not adjusted to take into account the CFC’s 

deficit in earnings and profits. Pursuant to 

paragraph (e)(4) of this section, at the end of 

year 2, FC’s non-previously taxed earnings 

and profits are reduced to (100u), and no 

adjustment is made to FC’s previously taxed 

earnings and profits, which remains at 50u. 

Example 3. Distribution and section 956 

inclusion in same year. Assume the same 

facts as in Example 1, except that DP also has 

a section 956 amount for year 1 with respect 

to its stock in FC of 200u. 

(ii) Analysis. At the end of year 1, 

adjustments are made to DP’s previously 

taxed earnings and profits account in its FC 

stock in the following order: First, the section 

959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

are increased from 0 to 100u pursuant to 

paragraph (e)(2)(i) of this section as a result 

of the subpart F inclusion. Then, the section 

959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

are reduced from 100u to 50u pursuant to 

paragraph (e)(2)(ii) of this section as a result 

of the distribution and the 50u distribution 

is excluded from DP’s gross income pursuant 

to § 1.959–1(c)(1). Then, the remaining 50u of 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

are reclassified as section 959(c)(1) earnings 

and profits pursuant to paragraph (e)(2)(iv) of 

this section as a result of FC’s investment in 

United States property and 50u of the 200u 

section 956 amount is excluded from DP’s 

gross income pursuant to § 1.959–1(c)(2). 

Finally, the remaining 150u section 956 

amount equal to $165 (150u × 1.1) is 

included in DP’s gross income pursuant to 

section 951(a)(1)(B) and the section 959(c)(1) 

earnings and profits in DP’s previously taxed 

earnings and profits account are increased 

from 50u to 200u pursuant to paragraph 

(e)(2)(vii) of this section. Pursuant to 

paragraph (e)(4) of this section, at the end of 

year 1, FC has section 959(c)(1) earnings and 

profits of 200u and non-previously taxed 

earnings and profits of 250u. DP’s dollar 

basis in the previously taxed earnings and 

profits account at the end of year 1 is $215 

(the $50 attributable to the reclassified 50u of 

earnings and $165 attributable to the 150u of 

section 956 inclusion). See section 989(b)(4). 

Example 4. Section 956 amount in 

following year. (i) Facts. Assume the same 

facts as in Example 3, except that in year 2, 

DP has an additional section 956 amount of 

200u with respect to its stock in FC and the 

spot exchange rate on December 31, year 2 

is 1u = $1.20. 

(ii) Analysis. As in Example 3, at the end 

of year 1, DP has a section 959(c)(1) earnings 

and profits account with respect to its stock 

in FC of 200u. Although DP has 200u of 

section 959(c)(1) earnings and profits in its 

previously taxed earnings and profits account 

with respect to its stock in FC, section 

959(c)(1) earnings and profits are generated 

by the inclusion of a section 956 amount in 

a United States shareholder’s gross income or 

the reclassification of section 959(c)(2) 

earnings and profits to exclude a section 956 

amount from a United States shareholder’s 

gross income and cannot be used to exclude 

any additional section 956 amounts from a 

United States shareholder’s gross income. 

Consequently, at the end of year 2, the 

section 959(c)(1) earnings and profits in DP’s 

previously taxed earnings and profits account 

are increased from 200u to 400u pursuant to 

paragraph (e)(2)(vii) of this section and the 

200u section 956 amount is included in DP’s 

gross income pursuant to section 

959(a)(1)(B). Pursuant to paragraph (e)(4) of 

this section, at the end of year 2, FC has 

section 959(c)(1) earnings and profits of 400u 

and non-previously taxed earnings and 

profits of 50u. DP’s dollar basis in its 200u 

of year 2 section 959(c)(1) earnings and 

profits is $240. 

Example 5. Section 951(a)(1)(A) inclusion 

and distribution in following year. (i) Facts. 

Assume the same facts as in Example 4, 

except that in year 3, FC derives 250u of 

subpart F income, which is included in DP’s 

income under section 951(a)(1)(A), makes a 

250u distribution to DP, and has 700u of 

current and accumulated earnings and profits 

(before taking into account distributions 

made during year 3). The average exchange 

rate for year 3 is 1u = $1.10, so DP includes 

$275 in income (250u × $1.10/1u). 

(ii) Analysis. As in Example 4, at the end 

of year 2, DP has a previously taxed earnings 

and profits account with respect to its stock 

in FC of 400u of section 959(c)(1) earnings 

and profits. At the end of year 3, adjustments 

are made in the following order. First, DP’s 

section 959(c)(2) earnings and profits are 

increased from 0 to 250u pursuant to 

paragraph (e)(2)(i) of this section as a result 

of the subpart F inclusion. Then the section 

959(c)(1) earnings and profits in DP’s 

previously taxed earnings and profits account 

are reduced from 400u to 150u and the 250u 

distribution to DP is excluded from DP’s 

gross income pursuant to § 1.959–1(c)(1). 

Pursuant to paragraph (e)(4) of this section, 

at the end of year 3, FC has 150u of section 

959(c)(1) earnings and profits, 250u of 

section 959(c)(2) earnings and profits, and 

50u of non-previously taxed earnings and 

profits. If DP has not made the dollar basis 

pooling election described in paragraph 

(b)(3)(ii) of this section, then the 250u 

distribution out of section 959(c)(1) earnings 

is assigned a dollar basis of $293.75 ($240 

basis in 200u of year 2 earnings and $53.75 

basis in 50u of year 1 earnings (50u/200u × 

$215)). DP’s remaining dollar basis in the 

year 1 section 959(c)(1) earnings is $161.25 

($215 ¥ $53.75). If DP elected to maintain 

the dollar basis of its previously taxed 

earnings and profits account on a pooled 

basis as provided in paragraph (b)(3)(ii) of 

this section, then the 250u distribution out of 

section 959(c)(1) earnings is assigned a dollar 

basis of $280.77 (250u/650u × ($215 + $240 

+ $275)), and DP’s dollar basis in its 

remaining 400u previously taxed earnings 

accounts is $449.23 ($730¥$280.77). 

Example 6. Distribution to a United States 

shareholder and a foreign shareholder. (i) 

Facts. DP, a United States shareholder, owns 

70% and FP, a nonresident alien, owns 30% 

of the only class of stock in FC, a CFC that 

uses the U.S. dollar as its functional 

currency. Both DP and FC use the calendar 

year as their taxable year. During year 1, FC 

derives $100x of subpart F income, $70x of 

which is included in DP’s gross income 

under section 951(a)(1)(A). FC’s current and 

accumulated earnings and profits (before 

taking into account distributions made 

during year 1) are $500x. Also, during year 

1, FC distributes $50x of earnings and profits, 

$35x distribution to DP and $15x distribution 

to FP. 

(ii) Analysis. At the end of year 1, the 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

are increased from $0 to $70x, pursuant to 

paragraph (e)(2)(i) of this section as a result 

of the subpart F inclusion. The section 

959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

are then reduced from $70x to $35x, pursuant 

to paragraph (e)(2)(ii) of this section as a 

result of the distribution. Pursuant to 

paragraph (e)(4) of this section, at the end of 

year 1, FC has section 959(c)(2) earnings and 

profits of $35x and non-previously taxed 

earnings and profits of $415x. 

Example 7. Intercorporate Distribution. (i) 

Facts. DP, a United States shareholder, owns 

70% and FP, a nonresident alien, owns 30% 

of the only class of stock in FC, a CFC. FC 

owns 100% of the only class of stock in FS, 

a CFC. FC uses the ‘‘u’’ as its functional 

currency and FS uses the ‘‘y’’ as its 

functional currency. DP, FC, and FS all use 

the calendar year as their taxable year. 

During year 1, FS derives 100y of subpart F 

income. The average y:$ exchange rate for 

year 1 is 1y = $1. On December 31, year 2, 

FS distributes 100y to FC. The y:u exchange 

rate on December 31, year 2, is 1y = 0.5u. 

(ii) Analysis. (A) Year 1. At the end of year 

1, DP’s pro rata share of 70y of subpart F 

income is included in DP’s gross income 

pursuant to section 951(a)(1)(A)(i) and the 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

with respect to the stock it indirectly owns 

in FS are correspondingly increased from 0 

to 70y pursuant to paragraph (e)(2)(i) of this 

section as a result of the subpart F income. 

The dollar basis of the previously taxed 

earnings and profits in DP’s account with 

respect to its stock in FS is $70. At the end 

of year 2, FS has section 959(c)(2) earnings 

and profits of 70y and non-previously taxed 

earnings and profits of 30y. 

(B) Year 2. Upon the distribution of 100y 

= 50u from FS to FC on December 31, year 

2, the section 959(c)(2) earnings and profits 

in DP’s previously taxed earnings and profits 

account with respect to the stock it indirectly 

owns in FS are reduced from 70y to 0 and 

the section 959(c)(2) earnings and profits in 

DP’s earnings and profits account with 

respect to its stock in FC are correspondingly 

increased from 0 to 35u pursuant to 

paragraph (e)(3) of this section. The entire 

100y = 50u distribution is excluded from 

FC’s income for purposes of determining FC’s 

subpart F income under section 951(a) for 

year 2 with respect to DP pursuant to 

§ 1.959–2(a)(1). Pursuant to paragraph (e)(4) 


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of this section, at the end of year 2, FS has 

0 earnings and profits and FC has section 

959(c)(2) earnings and profits of 35u and 

non-previously taxed earnings and profits of 

15u. DP’s dollar basis in its 35u of section 

959(c)(2) earnings and profits in its earnings 

and profits account with respect to its stock 

in FC is $70, carried over from DP’s original 

dollar basis in its 70y of section 959(c)(2) 

earnings and profits in its previously taxed 

earnings and profits account with respect to 

its stock in FS. 

Example 8. Sale of CFC stock. (i) Facts. 

DP1, a United States shareholder, owns 

100% of the only class of stock in FC, a CFC. 

At the beginning of year 1, DP1 has a zero 

basis in its stock in FC. Both DP1 and FC use 

the calendar year as their taxable year. FC 

uses the U.S. dollar as its functional 

currency. During year 1, FC derives $100x of 

subpart F income and $100x of other income. 

On December 31 of year 1, DP1 sells all of 

its stock in FC to DP2, a U.S. person for 

$200x. Year 1 is a year beginning on or after 

December 31, 1962. 

(ii) Analysis. First, DP1 includes the $100x 

of subpart F income in gross income under 

section 951(a)(1)(A). The section 959(c)(2) 

earnings and profits in DP1’s previously 

taxed earnings and profits account with 

respect to its stock in FC are increased from 

$0 to $100x pursuant to paragraph (e)(2)(i) of 

this section and DP1’s basis in its FC stock 

is increased from $0 to $100x pursuant to 

§ 1.961–1(b). FC’s section 959(c)(2) earnings 

and profits are increased from $0 to $100x 

and its non-previously taxed earnings and 

profits are correspondingly increased from $0 

to $100x pursuant to paragraph (e)(4) of this 

section. Then pursuant to section 1248(a), 

because FC has $100x of non-previously 

taxed earnings and profits attributable to 

DP1’s stock that are attributable to a taxable 

year beginning on or after December 31, 1962 

during which FC was a CFC and DP1 owned 

its stock in FC, the $100x of gain recognized 

by DP1 on the sale of its stock ($200x 

proceeds¥$100x basis) is included in DP1’s 

gross income as a dividend. Consequently, 

the section 959(c)(2) earnings and profits in 

DP1’s previously taxed earnings and profits 

account with respect to its stock in FC are 

increased from $100x to $200x pursuant to 

paragraph (e)(2)(i) of this section. Upon the 

sale, DP2 acquires from DP1 a previously 

taxed earnings and profits account with 

respect to the FC stock of $200x of section 

959(c)(2) earnings and profits and takes a cost 

basis of $200x in the FC stock pursuant to 

section 1012. 

(f) Special rule for shareholders with 

more than one previously taxed 

earnings and profits account.—(1) 

Adjustments for distributions. If a 

covered shareholder owns (within the 

meaning of section 958(a)) more than 

one share of stock in a foreign 

corporation as of the last day of the 

foreign corporation’s taxable year, to the 

extent that the total amount of any 

distributions of earnings and profits 

made with respect to any particular 

share for the foreign corporation’s 

taxable year would exceed the 

previously taxed earnings and profits 

account with respect to such share (an 

excess distribution amount), the 

following adjustments shall be made: 

(i) Adjustment of other accounts. The 

covered shareholder’s previously taxed 

earnings and profits accounts with 

respect to the shareholder’s other shares 

of stock in the foreign corporation that 

are owned by the covered shareholder 

as of the last day of the CFC’s taxable 

year shall be decreased, in the aggregate, 

by an amount equal to such excess 

distribution amount, but not below zero. 

Such decrease shall be made on a pro 

rata basis by reference to the amount of 

the previously taxed earnings and 

profits in those other accounts and shall 

be allocated to the section 959(c)(1) and 

(c)(2) earnings and profits in those 

accounts in the same manner as a 

distribution is allocated to such 

earnings and profits pursuant to the 

rules of section 959(c) and paragraph 

(e)(2)(ii)(A) of this section. 

(ii) Adjustment of deficient account. 

The covered shareholder’s previously 

taxed earnings and profits account for 

the first-mentioned share of stock shall 

correspondingly be increased by the 

same amount, and then shall be 

adjusted to zero as provided under 

paragraph (e)(2)(ii)(B) of this section. 

(2) Adjustments for section 956 

amounts. If a United States shareholder, 

who owns more than one share of stock 

in a CFC as of the last day of the CFC’s 

taxable year, has a section 956 amount 

with respect to its stock in the CFC for 

a taxable year, to the extent that the 

section 956 amount with respect to any 

particular share of stock exceeds the 

section 959(c)(2) earnings and profits in 

such shareholder’s previously taxed 

earnings and profits account with 

respect to such share (an excess section 

956 amount), the covered shareholder’s 

section 959(c)(2) earnings and profits in 

its previously taxed earnings and profits 

accounts with respect to its other shares 

of stock that are owned by the United 

States shareholder on the last day of the 

CFC’s taxable year shall be reclassified 

as section 959(c)(1) earnings and profits, 

in the aggregate, by an amount equal to 

such excess section 956 amount. Such 

reclassification shall be made on a pro 

rata basis by reference to the amount of 

the section 959(c)(2) earnings and 

profits in each of the United States 

shareholder’s other previously taxed 

earnings and profits accounts with 

respect to its stock in the CFC prior to 

reclassification under this paragraph 

(f)(2). 

(3) Examples. The application of this 

paragraph (f) is illustrated by the 

following examples: 

Example 1. Two blocks of stock. (i) Facts. 

DP, a United States shareholder, owns two 

blocks, block 1 and block 2, of shares of class 

A stock in FC, a CFC that uses the U.S. dollar 

as its functional currency. Both DP and FC 

use the calendar year as their taxable year. 

Entering year 1, DP has a previously taxed 

earnings and profits account with respect to 

its block 1 shares consisting of $25x of 

section 959(c)(2) earnings and profits and a 

previously taxed earnings and profits account 

with respect to its block 2 shares consisting 

of $65x of section 959(c)(2) earnings and 

profits. Entering year 1, FC has section 

959(c)(2) earnings and profits of $90x and 

non-previously taxed earnings and profits of 

$200x. During year 1, FC makes a 

distribution of earnings and profits on its 

Class A stock of $50x on each of block 1 and 

block 2. 

(ii) Analysis. First, as a result of the 

distribution, the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 1 

are decreased from $25x to $0 and the section 

959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

with respect to block 2 are decreased from 

$65x to $15x pursuant to paragraph (e)(2)(ii) 

of this section. Because there are insufficient 

previously taxed earnings and profits with 

respect to block 1, DP may access its excess 

previously taxed earnings and profits with 

respect to its block 2 stock, after taking into 

account any distributions or section 956 

amounts with respect to block 2. 

Accordingly, the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 2 

are decreased from $15x to $0 pursuant to 

paragraphs (e)(2)(v) and (f)(1)(i) of this 

section and the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 2 

are increased from $0 to $15x and then 

decreased from $15x to $0 pursuant to 

paragraphs (e)(2)(ii)(B) and (f)(1)(ii) of this 

section. The $40x ($25x + $15x) of the 

distribution with respect to block 1 and $50x 

of the distribution with respect to block 2 are 

excluded from DP’s gross income pursuant to 

§ 1.959–1(c)(1). The remaining $10x of the 

distribution of earnings and profits with 

respect to block 1 is included in DP’s gross 

income as a dividend. Pursuant to paragraph 

(e)(4) of this section, at the end of year 1, FC 

has section 959(c)(2) earnings and profits of 

$0 and non-previously taxed earnings and 

profits of $190x. 

Example 2. Multiple classes of stock. (i) 

Facts. Assume the same facts as in Example 

1, except that DP also owns a block, block 3, 

of class B stock in FC. Entering year 1, DP 

has a previously taxed earnings and profits 

account with respect to block 3 consisting of 

$60x of section 959(c)(2) earnings and profits. 

Entering year 1, FC has $150x of section 

959(c)(2) earnings and profits and $200x of 

non-previously taxed earnings and profits. 

(ii) Analysis. First, as in Example 1, the 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

with respect to block 1 are decreased from 

$25x to $0 and the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 2 


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are decreased from $65x to $15x pursuant to 

paragraph (e)(2)(ii) of this section. Because 

there are insufficient previously taxed 

earnings and profits with respect to block 1, 

DP may access its excess previously taxed 

earnings and profits with respect to block 2 

and block 3, after taking into account any 

distributions or section 956 amounts with 

respect to those blocks. In addition, the 

previously taxed earnings and profits from 

blocks 2 and 3 are decreased pro rata based 

on the relative previously taxed earnings and 

profits in the previously taxed earnings and 

profits accounts with respect to both blocks 

after taking into account any distributions or 

section 956 amounts with respect to those 

blocks. Thus, the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 2 

are decreased from $15x to $10x ($15x/$75x 

× $25x) and the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 3 

are decreased from $60x to $40x ($60x/$75x 

× $25x) pursuant to paragraphs (e)(2)(v) and 

(f)(1)(i) of this section. The section 959(c)(2) 

earnings and profits in DP’s previously taxed 

earnings and profits account with respect to 

block 1 are increased from $0 to $25x and 

then decreased from $25x to $0 pursuant to 

paragraphs (e)(2)(ii)(B) and (f)(1)(ii) of this 

section. The entire $50x distribution with 

respect to block 1 and $50x distribution with 

respect to block 2 are excluded from DP’s 

gross income pursuant to § 1.959–1(c)(1). 

Pursuant to paragraph (e)(4) of this section, 

at the end of year 1, FC has section 959(c)(2) 

earnings and profits of $50x and nonpreviously taxed earnings and profits of 

$200x. 

Example 3. Distribution in excess of 

aggregate previously taxed earnings and 

profits. (i) Facts. Assume the same facts as in 

Example 2, except that instead of a total 

distribution of $100x on Class A shares in 

year 1, FC makes a total distribution of $200x 

on its Class A shares in year 1, consisting of 

a $100x distribution to block 1 and a $100 

distribution to block 2. 

(ii) Analysis. First, as a result of the 

distribution, the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 1 

are decreased from $25x to $0 and the section 

959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

with respect to block 2 are decreased from 

$65x to $0 pursuant to paragraph (e)(2)(ii) of 

this section. Because there are insufficient 

previously taxed earnings and profits in DP’s 

previously taxed earning and profits accounts 

with respect to blocks 1 and 2, DP may access 

its excess previously taxed earnings and 

profits in its previously taxed earnings and 

profits account with respect to block3 after 

taking into account any distributions or 

section 956 amounts with respect to block 3. 

Consequently, the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 3 

are decreased from $60x to $0 pursuant to 

paragraphs (e)(2)(v) and (f)(1)(i) of this 

section. Of the total $200x distribution from 

FC to DP, $150x is excluded from DP’s gross 

income pursuant to § 1.959–1(c)(1). The 

remaining $50x of the distribution is 

included in DP’s gross income pursuant to 

section 951(a)(1)(A). Pursuant to paragraph 

(e)(4) of this section, at the end of year 1, FC 

has section 959(c)(2) earnings and profits of 

$0 and non-previously taxed earnings and 

profits of $150x. 

Example 4. Sale. (i) Facts. Assume the 

same facts as in Example 2, except that DP 

sells block 3 before the end of year 1. 

(ii) Analysis. First, as in Example 2, the 

distribution results in a decrease of the 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

with respect to block 1 from $25x to $0 and 

the section 959(c)(2) earnings and profits in 

DP’s previously taxed earnings and profits 

account with respect to block 2 from $65x to 

$15x pursuant to paragraph (e)(2)(ii) of this 

section. Because DP does not own block 3 on 

the last day of year 1, DP cannot use the 

previously taxed earnings and profits account 

with respect to block 3 to exclude a 

distribution in that year to block 1 or 2 from 

gross income. Therefore, the section 959(c)(2) 

earnings and profits in DP’s previously taxed 

earnings and profits account with respect to 

block 2 are decreased from $15x to $0 

pursuant to paragraphs (e)(2)(v) and (f)(1)(i) 

of this section and the section 959(c)(2) 

earnings and profits in DP’s previously taxed 

earnings and profits account with respect to 

block 1 are increased from $0 to $15x and 

then decreased from $15x to $0 pursuant to 

paragraphs (e)(2)(ii)(B) and (f)(1)(ii) of this 

section. The $40x ($25x + $15x) of the 

distribution with respect to block 1 and $50x 

of the distribution with respect to block 2 are 

excluded from DP’s gross income pursuant to 

§ 1.959–1(c)(1). The remaining $10x of the 

distribution with respect to block 1 is 

included in DP’s gross income as a dividend. 

Pursuant to paragraph (e)(4) of this section, 

at the end of year 1, FC has section 959(c)(2) 

earnings and profits of $60x and nonpreviously taxed earnings and profits of 

$190x. 

Example 5. Section 956 amount. (i) Facts. 

Assume the same facts as in Example 2, 

except that, in addition, during year 1, FC 

has a section 956 amount of $30x, $5x of 

which is allocable to each of blocks 1 and 2, 

and $20x of which is allocable to block 3. 

(ii) Analysis. Pursuant to paragraph (f)(2) of 

this section, account adjustments are made 

for the distribution from FC before any 

account adjustments are made for the section 

956 amount. After account adjustments are 

made for the distribution from FC as 

illustrated in Example 2, DP has a previously 

taxed earnings and profits account with 

respect each block as follows: Block 1: $0, 

block 2: $10x of section 959(c)(2) earnings 

and profits, block 3: $40x of section 959(c)(2) 

earnings and profits. As a result of the 

section 956 amount with respect to block 2, 

pursuant to paragraph (e)(2)(vi) of this 

section, $5x of DP’s section 959(c)(2) 

earnings and profits in its previously taxed 

earnings and profits account with respect to 

block 2 is reclassified as section 959(c)(1) 

earnings and profits. Consequently, block 2 is 

left with a previously taxed earnings and 

profits account consisting of $5x of section 

959(c)(1) earnings and profits and $5x of 

section 959(c)(2) earnings and profits. In 

addition, pursuant to paragraph (e)(2)(vi) of 

this section, $20x of DP’s section 959(c)(2) 

earnings and profits in its previously taxed 

earnings and profits account with respect to 

block 3 are reclassified as section 959(c)(1) 

earnings and profits. Consequently, block 3 is 

left with a previously taxed earnings and 

profits account consisting of $20x of section 

959(c)(1) earnings and profits and $20x of 

section 959(c)(2) earnings and profits. The 

total $25x section 956 amount with respect 

to blocks 2 and 3 is excluded from DP’s gross 

income pursuant to § 1.959–1(c)(2). Because 

there are insufficient previously taxed 

earnings and profits in the previously taxed 

earnings and profits account with respect to 

block 1, DP may access its excess previously 

taxed earnings and profits in the previously 

taxed earnings and profits accounts with 

respect to blocks 2 and 3 after taking into 

account any distributions or section 956 

amounts with respect to those blocks. In 

addition, the previously taxed earnings and 

profits in the previously taxed earnings and 

profits accounts with respect to blocks 2 and 

3 are reclassified pro rata based on the 

relative previously taxed earnings and profits 

in those accounts after taking into account 

any distributions or section 956 amounts 

with respect to those blocks. Accordingly, 

pursuant to paragraphs (e)(2)(vi) and (f)(2) of 

this section, an additional $1x ($5x/$25x × 

$5x) of the section 959(c)(2) earnings and 

profits in DP’s previously taxed earnings and 

profits account with respect to block 2 are 

reclassified as section 959(c)(1) earnings and 

profits and an additional $4x ($20x/$25x × 

$5x) of the section 959(c)(2) earnings and 

profits in DP’s previously taxed earnings and 

profits account with respect to block 3 are 

reclassified as section 959(c)(1) earnings and 

profits. The $5x section 956 amount with 

respect to block 1 is also excluded from DP’s 

gross income pursuant to § 1.959–1(c)(2). At 

the end of year 1, DP’s previously taxed 

earnings and profits accounts with respect to 

its various blocks of stock are as follows: 

block 1 has no previously taxed earnings and 

profits, block 2 has $6x ($5x + $1x) of section 

959(c)(1) earnings and profits and $4x 

($5x¥$1x) of section 959(c)(2) earnings and 

profits and block 3 has $24x ($20x + $4x) of 

section 959(c)(1) earnings and profits and 

$16x ($20x¥$4x) of section 959(c)(2) 

earnings and profits. Pursuant to paragraph 

(e)(4) of this section, at the end of year 1, FC 

has $30x of section 959(c)(1) earnings and 

profits, $20x of section 959(c)(2) earnings and 

profits, and $200x of non-previously taxed 

earnings and profits. 

(g) Special rule for shareholder 

included in a consolidated group—(1) 

Adjustments for distributions—(i) In 

general. In the case of a covered 

shareholder who is a member of a 

consolidated group, to the extent that 

the total amount of any distributions of 

earnings and profits with respect to 

such covered shareholder’s stock in a 

foreign corporation during such foreign 

corporation’s taxable year would exceed 

the covered shareholder’s previously 

taxed earnings and profits account with 

respect to all of the covered 

shareholder’s stock of the foreign 


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corporation (an excess distribution 

amount) the previously taxed earnings 

and profits accounts of the covered 

shareholder and of the other members of 

the covered shareholder’s consolidated 

group that own stock in the same 

foreign corporation and are members of 

the covered shareholder’s consolidated 

group on the last day of the foreign 

corporation’s taxable year shall be 

adjusted as follows. 

(A) Adjustment of other members’

accounts. The previously taxed earnings 

and profits accounts of the other 

members of the consolidated group that 

own (within the meaning of section 

958(a)) stock in the same foreign 

corporation and are members of the 

covered shareholder’s consolidated 

group on the last day of the foreign 

corporation’s taxable year shall be 

decreased, in the aggregate, by the 

amount of such excess distribution 

amount, but not below zero. Such 

decrease shall be made on a pro rata 

basis by reference to the amount of such 

other members’ previously taxed 

earnings and profits accounts and shall 

be allocated to the section 959(c)(1) and 

(c)(2) earnings and profits in such 

accounts in the same manner as a 

distribution is allocated to such 

earnings and profits pursuant to section 

959(c) and paragraph (e)(2)(ii)(A) of this 

section. 

(B) Adjustment of the deficient 

account. The deficient previously taxed 

earnings and profits account of such 

covered shareholder shall 

correspondingly be increased by the 

same amount, and then adjusted to zero 

under paragraph (e)(2)(ii)(B) of this 

section. 

(ii) Insufficient previously taxed 

earnings and profits. If more than one 

member of the consolidated group is a 

covered shareholder that has an excess 

distribution amount with respect to all 

of its stock in the foreign corporation 

and there is insufficient previously 

taxed earnings and profits available in 

the previously taxed earnings and 

profits accounts of other consolidated 

group members to exclude the 

combined excess distribution amounts 

of the covered shareholders, the other 

consolidated group members’

previously taxed earnings and profits 

shall be allocated between the covered 

shareholders’ deficient previously taxed 

earnings and profits accounts in 

proportion to each covered 

shareholder’s excess distribution 

amount. 

(2) Adjustments for section 956 

amounts—(i) In general. If a United 

States shareholder, who is a member of 

a consolidated group, has a section 956 

amount with respect to its stock in a 

CFC for a taxable year, to the extent that 

the section 956 amount exceeds the 

section 959(c)(2) earnings and profits in 

such United States shareholder’s 

previously taxed earnings and profits 

accounts with respect to all of its stock 

in the CFC (an excess section 956 

amount), the section 959(c)(2) earnings 

and profits in the previously taxed 

earnings and profits accounts of 

consolidated group members, who are 

members of the United States 

shareholder’s consolidated group on the 

last day of the CFC’s taxable year, with 

respect to their stock in the CFC shall 

be reclassified as section 959(c)(1) 

earnings and profits, in the aggregate, by 

an amount equal to such excess section 

956 amount. The amount that is 

reclassified with respect to each such 

account of such other members shall be 

proportionate to the amount of section 

959(c)(2) earnings and profits in those 

accounts prior to reclassification under 

this paragraph (g). 

(ii) Insufficient section 959(c)(2) 

earnings and profits. If more than one 

member of the consolidated group is a 

United States shareholder that has an 

excess section 956 amount with respect 

to its stock in the CFC for the taxable 

year and there is insufficient aggregate 

section 959(c)(2) earnings and profits in 

other consolidated group members’

previously taxed earnings and profits 

accounts to exclude the combined 

excess section 956 amounts of the 

Untied States shareholders, the amount 

of any consolidated group members’

section 959(c)(2) earnings and profits 

that are reclassified on behalf of each 

United States shareholder shall be 

proportionate to the excess section 956 

amount for each such United States 

shareholder. 

(3) Stock basis adjustments of 

members. See § 1.1502–32 for rules 

addressing investment adjustments 

resulting from the application of this 

paragraph. 

(4) Examples. The application of this 

paragraph (g) is illustrated by the 

following examples: 

Example 1. Two consolidated group 

members. (i) Facts. DP1, a United States 

shareholder, owns one block, block 1, of 

shares of Class A stock in FC, a CFC that uses 

the U.S. dollar as its functional currency. 

DP2, a United States shareholder and a 

member of DP1’s consolidated group, owns 

one block, block 2, of shares of Class A stock 

in FC. DP1, DP2 and FC all use the calendar 

year as their taxable year and FC uses the 

U.S. dollar as its functional currency. 

Entering year 1, DP1 has a previously taxed 

earnings and profits account with respect to 

block 1 consisting of $50x of section 959(c)(2) 

earnings and profits and DP2 has a 

previously taxed earnings and profits account 

with respect to block 2 consisting of $200x 

of section 959(c)(2) earnings and profits. 

Entering year 1, FC has section 959(c)(2) 

earnings and profits of $250x and nonpreviously taxed earnings and profits of 

$100x. In year 1, FC generates no earnings 

and profits and makes a distribution of 

earnings and profits on its stock Class A 

stock, a $100x distribution of earnings and 

profits to block 1 and a $100x distribution of 

earnings and profits to block 2. 

(ii) Analysis. First, pursuant to paragraph 

(e)(2)(ii) of this section, the section 959(c)(2) 

earnings and profits in DP1’s previously 

taxed earnings and profits account with 

respect to block 1 are decreased from $50x 

to $0 and the section 959(c)(2) earnings and 

profits in DP2’s previously taxed earnings 

and profits account with respect to block 2 

are decreased from $200x to $100x. Then, 

pursuant to paragraphs (e)(2)(v) and 

(g)(1)(i)(A) of this section, the section 

959(c)(2) earnings and profits in DP2’s 

previously taxed earnings and profits account 

with respect to block 2 are decreased from 

$100x to $50x and, pursuant to paragraphs 

(e)(2)(ii)(B) and (g)(1)(i)(B) of this section, the 

section 959(c)(2) earnings and profits in 

DP1’s previously taxed earnings and profits 

account with respect to block 1 are increased 

from $0 to $50x and then decreased from 

$50x to $0. Pursuant to section 959(a) and 

§ 1.959–1(c), the entire $100x distribution to 

block 1 and $100x distribution to block 2 are 

excluded from DP1’s and DP2’s gross 

incomes respectively. Pursuant to paragraph 

(e)(4) of this section, at the end of year 1, FC 

has section 959(c)(2) earnings and profits of 

$50x and non-previously taxed earnings and 

profits of $100x. 

Example 2. Two consolidated group 

members; multiple classes of stock. (i) Facts. 

Assume the same facts as in Example 1, 

except that DP1 also owns one block, block 

3, of shares of class B stock in FC. DP1 has 

a previously taxed earnings and profits 

account with respect to block 3 consisting of 

$40x of section 959(c)(2) earnings and profits. 

Entering year 1, FC has section 959(c)(2) 

earnings and profits of $290x and nonpreviously taxed earnings and profits of 

$100x. 

(ii) Analysis. First, pursuant to paragraph 

(e)(2)(ii) of this section, the section 959(c)(2) 

earnings and profits in DP1’s previously 

taxed earnings and profits account with 

respect to block 1 are decreased from $50x 

to $0 and the section 959(c)(2) earnings and 

profits in DP2’s previously taxed earnings 

and profits account with respect to block 2 

are decreased from $200x to $100x. Then, 

pursuant to paragraphs (e)(2)(v) and (f)(1)(i) 

of this section, the section 959(c)(2) earnings 

and profits in DP1’s previously taxed 

earnings and profits account with respect to 

block 3 are decreased from $40x to $0 and, 

pursuant to paragraphs (e)(2)(ii)(B) and 

(f)(1)(ii) of this section, the section 959(c)(2) 

earnings and profits in DP1’s previously 

taxed earnings and profits account with 

respect to block 1 are increased from $0 to 

$40x and then decreased from $40x to $0. 

Finally, pursuant to paragraphs (e)(2)(v) and 

(g)(1)(i)(A) of this section, the section 

959(c)(2) earnings and profits in DP2’s 

previously taxed earnings and profits account 

with respect to block 2 are decreased from 


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$100x to $90x and, pursuant to paragraphs 

(e)(2)(ii)(B) and (g)(1)(i)(B) of this section, the 

section 959(c)(2) earnings and profits in 

DP1’s previously taxed earnings and profits 

account with respect to block 1 are increased 

from $0 to $10x and then decreased from 

$10x to $0. Pursuant to section 959(a) and 

§ 1.959–1(c), the entire $100x distribution to 

block 1 and $100x distribution to block 2 are 

excluded from DP1’s and DP2’s gross 

incomes respectively. Pursuant to paragraph 

(e)(4) of this section, at the end of year 1, FC 

has section 959(c)(2) earnings and profits of 

$90x and non-previously taxed earnings and 

profits of $100x. 

Example 3. Three consolidated group 

members; multiple classes of stock. (i) Facts. 

Assume the same facts as in Example 2, 

except that DP3, a United States shareholder 

and a member of DP1’s consolidated group, 

owns one block, block 4, of shares of class 

B stock in FC. DP3 has a previously taxed 

earnings and profits account with respect to 

block 4 consisting of $25x of section 959(c)(2) 

earnings and profits. Entering year 1, FC has 

section 959(c)(2) earnings and profits of 

$315x and non-previously taxed earnings and 

profits of $100x. 

(ii) Analysis. First, pursuant to paragraph 

(e)(2)(ii) of this section, the section 959(c)(2) 

earnings and profits in DP1’s previously 

taxed earnings and profits account with 

respect to block 1 are decreased from $50x 

to $0 and the section 959(c)(2) earnings and 

profits in DP2’s previously taxed earnings 

and profits account with respect to block 2 

are decreased from $200x to $100x. Then, 

pursuant to paragraphs (e)(2)(v) and (f)(1)(i) 

of this section, the section 959(c)(2) earnings 

and profits in DP1’s previously taxed 

earnings and profits account with respect to 

block 3 are decreased from $40x to $0 and, 

pursuant to paragraphs (e)(2)(ii)(B) and 

(f)(1)(ii) of this section, the section 959(c)(2) 

earnings and profits in DP1’s previously 

taxed earnings and profits account with 

respect to block 1 are increased from $0 to 

$40x and then decreased from $40x to $0. 

Finally, pursuant to paragraphs (e)(2)(v) and 

(g)(1)(i)(A) of this section, the section 

959(c)(2) earnings and profits in DP2’s and 

DP3’s previously taxed earnings and profits 

accounts with respect to blocks 2 and 4 are 

decreased pro rata from $100x to $92x and 

from $25x to $23x respectively, and, 

pursuant to paragraphs (e)(2)(ii)(B) and 

(g)(1)(i)(B) of this section, the section 

959(c)(2) earnings and profits in DP1’s 

previously taxed earnings and profits account 

with respect to block 1 are increased from $0 

to $10x and then decreased from $10x to $0. 

Pursuant to section 959(a) and § 1.959–1(c), 

the entire amounts of the $100x distribution 

to block 1 and the $100x distribution to block 

2 are excluded from DP1’s and DP2’s gross 

incomes respectively. Pursuant to paragraph 

(e)(4) of this section, at the end of year 1, FC 

has section 959(c)(2) earnings and profits of 

$115x and non-previously taxed earnings and 

profits of $100x. 

Example 4. Section 956 Amount. (i) Facts. 

Assume the same facts as in Example 3, 

except that instead of a distribution of 200x 

on its class A stock, FC has a section 956 

amount for year 1 of $180x, 45x of which is 

allocable to each of blocks 1 through 4. 

(ii) Analysis. First, pursuant to paragraph 

(e)(2)(iv) of this section, the section 959(c)(2) 

earnings and profits in each shareholder’s 

previously taxed earnings profits account are 

reclassified as section 959(c)(1) earnings and 

profits leaving each block of stock with the 

following account: Block 1: $45x of section 

959(c)(1) earnings and profits, $5x of section 

959(c)(2) earnings and profits; block 2: $45x 

of section 959(c)(1) earnings and profits and 

$155x of section 959(c)(2) earnings and 

profits; block 3: $40x of section 959(c)(1) 

earnings and profits and $0 of section 

959(c)(2) earnings and profits; block 4: $25x 

of section 959(c)(1) earnings and profits and 

$0 of section 959(c)(2) earnings and profits. 

After the above reclassifications, DP1 has an 

excess section 956 amount of $5x with 

respect to block 3. Therefore, pursuant to 

paragraphs (e)(2)(vi) and (f)(2) of this section, 

the remaining $5x of section 959(c)(2) 

earnings and profits in DP1’s previously 

taxed earnings and profits account with 

respect to block 1 are reclassified as section 

959(c)(1) earnings and profits, leaving DP1 

with $50x of section 959(c)(1) earnings and 

profits and $0 of section 959(c)(2) earnings 

and profits in its previously taxed earnings 

and profits account with respect to block 1. 

The entire $45x section 956 amount with 

respect to blocks 1 and 3 are excluded from 

DP1’s gross income pursuant to paragraph 

(c)(2) of this section. After the above 

reclassifications, DP3 has an excess section 

956 amount of $20x with respect to block 4. 

Therefore, pursuant to paragraphs (e)(2)(vi) 

and (g)(2)(i) of this section, $20x of the 

section 959(c)(2) earnings and profits in 

DP2’s previously taxed earnings and profits 

account with respect to block 2 are 

reclassified as section 959(c)(1) earnings and 

profits, leaving DP2 with $65x of section 

959(c)(1) earnings and profits and $135x of 

section 959(c)(2) earnings and profits. The 

entire $45x section 956 amount with respect 

to blocks 2 and 4 are excluded from DP2’s 

and DP3’s gross incomes, respectively, 

pursuant to § 1.959–1(c)(2). Pursuant to 

paragraph (e)(4) of this section, at the end of 

year 1, FC has section 959(c)(1) earnings and 

profits of $180x, section 959(c)(2) earnings 

and profits of $135x, and non-previously 

taxed earnings and profits of $100x. 

Example 5. Ex-member. (i) Facts. DP1, a 

United States shareholder, owns one block, 

block 1, of shares of Class A stock in FC, a 

CFC that uses the U.S. dollar as its functional 

currency. DP2 and DP3, both United States 

shareholders and members of DP1’s 

consolidated group, own one block each, 

blocks 2 and 3 respectively, of shares of Class 

A stock in FC. DP1, DP2, DP3 and FC all use 

the calendar year as their taxable year. 

Entering year 1, DP1 has a previously taxed 

earnings and profits account with respect to 

block 1 consisting of $50x of section 959(c)(2) 

earnings and profits, DP2 has a previously 

taxed earnings and profits account with 

respect to block 2 consisting of $100x of 

section 959(c)(2) earnings and profits, and 

DP3 has a previously taxed earnings and 

profits account with respect to block 3 

consisting of $200x of section 959(c)(2) 

earnings and profits. Entering year 1, FC has 

section 959(c)(2) earnings and profits of 

$350x and non-previously taxed earnings and 

profits of $100x. On March 15 of year 1, FC 

makes a distribution of earnings and profits 

on its stock Class A stock consisting of a 

$100x distribution of earnings and profits to 

each of blocks 1, 2 and 3. On July 4 of year 

1, DP3 is sold to DP4, a United States person 

who is not a member of the consolidated 

group, and DP3 ceases to be a member of the 

consolidated group. 

(ii) Analysis. First, pursuant to paragraph 

(e)(2)(ii) of this section, the section 959(c)(2) 

earnings and profits in DP1’s previously 

taxed earnings and profits account with 

respect to block 1 are decreased from $50x 

to $0, the section 959(c)(2) earnings and 

profits in DP2’s previously taxed earnings 

and profits account with respect to block 2 

are decreased from $100x to $0, and the 

section 959(c)(2) earnings and profits in 

DP3’s previously taxed earnings and profits 

account with respect to block 3 are decreased 

from $200x to $100x. Because DP3 was not 

a member of DP1’s consolidated group on the 

last day of year 1, the remaining $100x of 

section 959(c)(2) earnings and profits in 

DP3’s previously taxed earnings and profits 

account with respect to its stock in FC cannot 

be used to exclude the remaining $50x 

distribution to DP1 from DP1’s gross income. 

Consequently, pursuant to § 1.959–1(c)(1), 

$50x of the distribution to block 1, the entire 

$100x of the distribution to block 2, and the 

entire $100x of the distribution to block 3 are 

excluded from DP1’s, DP2’s, and DP3’s gross 

incomes respectively. The remaining $50x 

distribution to DP1 is included in DP1’s gross 

income pursuant to section 951(a)(1)(a). 

Pursuant to paragraph (e)(4) of this section, 

at the end of year 1, FC has section 959(c)(2) 

earnings and profits of $150x and nonpreviously taxed earnings and profits of 

$50x. 

Example 6. Insufficient excess previously 

taxed earnings and profits. (i) Facts. DP1, a 

United States shareholder, owns one block, 

block 1, of shares of Class A stock in FC, a 

CFC that uses the U.S. dollar as its functional 

currency. DP2 and DP3, both United States 

shareholders and members of DP1’s 

consolidated group, own one block each, 

blocks 2 and 3 respectively, of shares of Class 

A stock in FC. DP1, DP2, DP3 and FC all use 

the calendar year as their taxable year. 

Entering year 1, DP1 has a previously taxed 

earnings and profits account with respect to 

block 1 consisting of $40x of section 959(c)(2) 

earnings and profits, DP2 has a previously 

taxed earnings and profits account with 

respect to block 2 consisting of $60x of 

section 959(c)(2) earnings and profits, and 

DP3 has a previously taxed earnings and 

profits account with respect to block 3 

consisting of $150x of section 959(c)(2) 

earnings and profits. Entering year 1, FC has 

section 959(c)(2) earnings and profits of 

$250x and non-previously taxed earnings and 

profits of $100x. On March 15 of year 1, FC 

makes a distribution of earnings and profits 

on its Class A stock consisting of a $100x 

distribution of earnings and profits to each of 

blocks 1, 2 and 3. 

(ii) Analysis. First, pursuant to paragraph 

(e)(2)(ii) of this section, the section 959(c)(2) 

earnings and profits in DP1’s previously 

taxed earnings and profits account with 

respect to block 1 are decreased from $40x 


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to $0, the section 959(c)(2) earnings and 

profits in DP2’s previously taxed earnings 

and profits account with respect to block 2 

are decreased from $60x to $0, and the 

section 959(c)(2) earnings and profits in 

DP3’s previously taxed earnings and profits 

account with respect to block 3 are decreased 

from $150x to $50x. Then, pursuant to 

paragraph (g)(1)(i)(A) of this section, the 

section 959(c)(2) earnings and profits in 

DP3’s previously taxed earnings and profits 

account with respect to its stock in FC are 

reduced from $50x to $0 and, pursuant to 

paragraphs (g)(1)(i)(B) and (g)(1)(ii) of this 

section, the section 959(c)(2) earnings and 

profits in DP1’s and DP2’s previously taxed 

earnings and profits accounts with respect to 

their stock in FC are increased from $0 to 

$30x ($60x/$100x × $50x) and $0 to $20x 

($40x/$100x × $50x) respectively and then 

immediately reduce to $0. Pursuant to 

§ 1.959–1(c), $70x ($40x + $30x) of the 

distribution to DP1, $80x ($60x + $20x) of the 

distribution to DP2, and $100x of the 

distribution to DP3 are excluded from gross 

income. The remaining $30x distributed to 

DP1 and $20x distributed to DP2 are 

included in gross income pursuant to section 

951(a)(1)(A). Pursuant to paragraph (e)(4) of 

this section, at the end of year 1, FC has nonpreviously taxed earnings and profits of 

$50x. 

(h) Adjustments in the case of 

redemptions—(1) In general. In the case 

of a foreign corporation’s redemption of 

stock (a redemption distribution), the 

effect on the covered shareholder’s 

previously taxed earnings and profits 

account and on the earnings and profits 

of the redeeming corporation depends 

on whether the distribution is treated as 

a payment in exchange for stock or as 

a distribution of property to which 

section 301 applies. For the treatment of 

deemed redemption distributions in 

transactions described in section 

304(a)(1), see paragraph (h)(4) of this 

section. 

(2) Exchange treatment—(i) Effect on 

foreign corporation’s earnings and 

profits. In the case of a redemption 

distribution that is treated as a payment 

in exchange for stock under section 

302(a) or section 303, the amount of the 

distribution properly chargeable to the 

earnings and profits of the redeeming 

foreign corporation is the amount 

determined under section 312(a), 

subject to the limitation in section 

312(n)(7) and this paragraph (h)(2)(i). 

For purposes of section 312(n)(7), the 

amount properly chargeable to the 

earnings and profits of the redeeming 

foreign corporation shall not exceed the 

sum of—

(A) The amount of the previously 

taxed earnings and profits account with 

respect to the redeemed shares of stock 

(without adjustment for any income 

inclusion under section 1248 resulting 

from the redemption); and 

(B) A ratable portion of the redeeming 

corporation’s non-previously taxed 

earnings and profits. Such chargeable 

amount of earnings and profits shall be 

allocated to earnings and profits in 

accordance with section 959(c) and this 

section. 

(ii) Cessation of previously taxed 

earnings and profits account. In the case 

of a redemption distribution that is 

treated as a payment in exchange for 

stock, the redeemed covered 

shareholder’s previously taxed earnings 

and profits account with respect to the 

redeemed shares ceases to exist and is 

not transferred to any other previously 

taxed earnings and profits account. In 

such a case, any previously taxed 

earnings and profits in the redeemed 

covered shareholder’s previously taxed 

earnings and profits account, after being 

reduced under paragraph (h)(2)(i) of this 

section, become non-previously taxed 

earnings and profits of the foreign 

corporation. 

(iii) Examples. The application of this 

paragraph (h)(2) is illustrated by the 

following examples: 

Example 1. Complete redemption treated 

as exchange; previously taxed earnings and 

profits account is depleted. (i) Facts. DP, a 

United States shareholder, owns 70% and 

FP, a nonresident alien who is unrelated to 

DP under section 318, owns 30% of the only 

class of stock in FC, a CFC that uses the U.S. 

dollar as its functional currency. Both DP and 

FC use the calendar year as their taxable year 

and both DP and FC are wholly owned by the 

same domestic corporation, USP. DP has a 

previously taxed earnings and profits account 

consisting of $50x of section 959(c)(2) 

earnings and profits with respect to its stock 

in FC and DP has a $50 basis in its FC stock 

pursuant to section 961(a). FC has $50x of 

section 959(c)(2) earnings and profits and 

$50x of non-previously taxed earnings and 

profits attributable to taxable years of FC 

beginning on or after December 31, 1962 

during which FC was a CFC and during 

which DP held its shares of stock in FC. FC 

redeems all of DP’s stock for $100x in a 

redemption that is treated as a payment in 

exchange for the stock under section 302(a). 

(ii) Analysis. DP includes $35x ($50x × 

70%) in gross income as a dividend pursuant 

to section 1248(a) as a result of the deemed 

exchange. FC adjusts its earnings and profits 

as a result of the exchange under paragraph 

(h)(2)(i) of this section in the following 

manner: first, FC’s section 959(c)(2) earnings 

and profits are reduced from $50x to $0; 

then, FC’s non-previously taxed earnings and 

profits are decreased from $50x to $15x to 

reflect DP’s $35x ratable share of FC’s nonpreviously taxed earnings and profits. DP’s 

previously taxed earnings and profits account 

ceases to exist and is not transferred to any 

other previously taxed earnings and profits 

account. 

Example 2. Complete redemption treated 

as exchange; previously taxed earnings and 

profits account is not depleted. (i) Facts. 

Assume the same facts as Example 1, except 

that the amount of the redemption 

distribution by FC to DP is $25x. 

(ii) Analysis. DP recognizes a $25x loss as 

a result of the deemed exchange. FC’s section 

959(c)(2) earnings and profits are decreased 

from $50x to $25x, pursuant to paragraph 

(h)(2)(i) of this section. DP’s previously taxed 

earnings and profits account ceases to exist, 

and the remaining $25x of section 959(c)(2) 

earnings and profits in such account is not 

transferred to any other previously taxed 

earnings and profits account. However, 

pursuant to paragraph (h)(2)(ii) of this 

section, the $25x of previously taxed 

earnings and profits is converted to nonpreviously taxed earnings and profits of DC. 

(3) Distribution treatment—(i) 

Adjustment of shareholder previously 

taxed earnings and profits accounts and 

foreign corporation’s earnings and 

profits. In the case of a redemption 

distribution by a foreign corporation 

that is treated as a distribution of 

property to which section 301 applies, 

§§ 1.959–1 and this section shall apply 

in the same manner as they would apply 

to any distribution of property to which 

section 301 applies. 

(ii) Transfer to remaining shares. To 

the extent that the previously taxed 

earnings and profits account with 

respect to stock redeemed in a 

transaction described in paragraph 

(h)(3)(i) of this section exceeds the 

amount chargeable to the earnings and 

profits of the corporation under the 

rules of that paragraph, the excess 

previously taxed earnings and profits 

shall be reallocated to the previously 

taxed earnings and profits accounts with 

respect to the remaining stock in the 

foreign corporation in a manner 

consistent with, and in proportion to, 

the proper adjustments of the basis in 

the remaining shares pursuant to 

§ 1.302–2(c). 

(iii) Examples. The application of this 

paragraph (h)(3) is illustrated by the 

following examples: 

Example 1. Redemption in exchange for 

cash that is treated as a distribution. (i) Facts. 

DP, a United States shareholder, owns 100% 

of the stock in FC, a CFC that uses the U.S. 

dollar as its functional currency. Both DP and 

FC use the calendar year as their taxable year. 

DP owns two blocks of stock in FC, block 1 

and block 2. At the beginning of year 1, DP 

has a previously taxed earnings and profits 

account with respect to block 1 consisting of 

$50x of section 959(c)(2) earnings and profits 

and FC has section 959(c)(2) earnings and 

profits of $50x and non-previously taxed 

earnings and profits of $100x. In year 1, FC 

redeems block 1 for $100x in a redemption 

that is treated as a distribution of property to 

which section 301 applies under section 

302(d). 

(ii) Analysis. The section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 1 

are reduced from $50x to $0 and FC’s section 

959(c)(2) earnings and profits are 


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correspondingly reduced from $50x to $0. 

The remaining $50x is included in DP’s gross 

income as a dividend under section 301(c)(1) 

and FC’s non-previously taxed earnings and 

profits are reduced from $100x to $50x. 

Example 2. Redemption in exchange for 

cash that is treated as a distribution. (i) Facts. 

Assume the same facts as Example 1, except 

that DP is redeemed for $25x. 

(ii) Analysis. The section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 1 

are reduced from $50x to $25x and FC’s 

section 959(c)(2) earnings and profits are 

correspondingly reduced from $50x to $25x. 

FC’s non-previously taxed earnings and 

profits remain at $100x. Pursuant to 

paragraph (h)(3)(ii) of this section the 

remaining $25x of section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to block 1 

are reallocated with respect to the remaining 

stock in FC in a manner consistent with, and 

in proportion to, the proper adjustments of 

the basis of the remaining FC shares pursuant 

to § 1.302–2(c). 

(4) Section 304 transactions—(i) 

Deemed redemption treated as a 

distribution. In the case of a stock 

acquisition described in section 

304(a)(1), that is treated as a distribution 

of property to which section 301 

applies, a covered shareholder receiving 

an amount treated as a distribution of 

earnings and profits shall have a 

previously taxed earnings and profits 

account with respect to stock in each 

foreign corporation treated as 

distributing its earnings and profits 

under section 304(b)(2), even if such 

person did not otherwise have a 

previously taxed earnings and profits 

account with respect to stock in such 

corporation or corporations. In such a 

case, §§ 1.959–1 and this section shall 

apply in the same manner as these 

regulations would apply to any 

distribution to which section 301 

applies. 

(ii) The application of this paragraph 

(h)(4) is illustrated by the following 

example: 

Example. Cross-chain acquisition of firsttier CFC. (i) Facts. DP, a domestic 

corporation, owns all of the stock in DS, a 

domestic corporation, and F1, a CFC. DP and 

DS are members of the same consolidated 

group. DS owns all of the stock in F2, a CFC. 

DP, DS, F1 and F2 all use the calendar year 

as their taxable year and F1 and F2 each use 

the U.S. dollar as its functional currency. 

During year 1, F1 purchases all the stock in 

F2 from DS for $80x in a transaction 

described in section 304(a)(1). At the end of 

year 1, before taking into account the 

purchase of F2’s stock, DP has a previously 

taxed earnings and profits account consisting 

of $20x of section 959(c)(2) earnings and 

profits with respect to its stock in F1, and F1 

has previously taxed earnings and profits 

consisting of $20x of section 959(c)(2) 

earnings and profits and non-previously 

taxed earnings and profits of $10x. At the end 

of year1, before taking into account the 

purchase of F2’s stock, DS has a previously 

taxed earnings and profits account consisting 

of $50x of section 959(c)(2) earnings and 

profits with respect to its stock in F2, and F2 

has section 959(c)(2) earnings and profits of 

$50x and non-previously taxed earnings and 

profits of $0. 

(ii) Analysis. Under section 304(a)(1), DS is 

deemed to have transferred the F2 stock to 

F1 in exchange for F1 stock in a transaction 

to which section 351(a) applies, and F1 is 

treated as having redeemed, for $80x, the F1 

stock deemed issued to DS. The payment of 

$80x is treated as a distribution of property 

to which section 301 applies. Under section 

304(b)(2), the determination of the amount 

which is a dividend is made as if the 

distribution were made, first, by F1 to the 

extent of its earnings and profits ($30x), and 

then by F2 to the extent of its earnings and 

profits ($50x). Before taking into account the 

deemed distributions, DS had a previously 

taxed earnings and profits account consisting 

of $50x of section 959(c)(2) earnings and 

profits with respect to its stock in F2, and DP 

had a previously taxed earnings and profits 

account consisting of $20x of section 

959(c)(2) earnings and profits with respect to 

its stock in F1. Under paragraph (h)(4)(i) of 

this section, DS has a previously taxed 

earnings and profits account with respect to 

the stock in F1. Under paragraph (g)(1)(i) of 

this section, the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to the F1 

stock are reduced from $20x to $0 and the 

section 959(c)(2) earnings and profits in DS’s 

previously taxed earnings and profits account 

with respect to the F1 stock are increased 

from $0 to $20x. The distribution by F1 

causes the section 959(c)(2) earnings and 

profits in DS’s previously taxed earnings and 

profits account with respect to F1 stock to be 

reduced from $20x to $0, and causes F1’s 

section 959(c)(2) earnings and profits to be 

reduced from $20x to $0 and its nonpreviously taxed earnings and profits to be 

reduced from $10x to $0. The deemed 

distribution by F2 causes the section 

959(c)(2) earnings and profits in DS’s 

previously taxed earnings and profits account 

with respect to F2 stock to be reduced from 

$50x to $0, and causes F2’s section 959(c)(2) 

earnings and profits to be reduced from $50x 

to $0. Of the distribution of $80x, $70x is 

excluded from DS’s gross income pursuant to 

§ 1.959–1(c)(1), and $10x is included in DS’s 

gross income as a dividend. 

Par. 5. Section 1.959–4 is revised to 

read as follows: 

§ 1.959–4 Distributions of amounts 

excluded under section 959(a). 

Except as provided in section 

960(a)(3) and § 1.960–1, any distribution 

excluded from gross income of a 

covered shareholder under section 

959(a)(1) and § 1.959–1(c)(1) shall be 

treated, for purposes of chapter 1 

(relating to normal taxes and surtaxes) 

of subtitle A (relating to income taxes) 

of the Internal Revenue Code as a 

distribution which is not a dividend, 

except such a distribution shall 

immediately reduce earnings and 

profits. 

Par. 6. Section 1.961–1 is revised to 

read as follows: 

§ 1.961–1 Increase in basis of stock in 

CFCs and of other property. 

(a) Definitions. See § 1.959–1(b) for a 

list of defined terms applicable to 

§ 1.961–1 through § 1.961–4. 

(b) Increase in basis—(1) In general. 

Except as provided in paragraphs (b)(2) 

and (b)(3) of this section, the adjusted 

basis of a United States shareholder’s 

stock in a CFC or property (as defined 

in paragraph (c)(1) of this section) by 

reason of the ownership of which such 

United States shareholder is considered 

under section 958(a) as owning stock in 

a CFC shall be increased under section 

961(a) each time, and to the extent that, 

such United States shareholder’s 

previously taxed earnings and profits 

account with respect to the stock in that 

CFC is increased pursuant to the steps 

outlined in § 1.959–3(e)(2). 

(2) Limitation on amount of increase 

in case of election under section 962. 

[Reserved]. 

(3) Deemed inclusions under sections 

1293(c) and 959(e). Paragraph (b)(1) of 

this section shall not apply in the case 

of a deemed section 951(a) inclusion 

pursuant to section 1293(c) or 959(e). 

(c) Rules of application—(1) Property 

defined. The property of a United States 

shareholder referred to in paragraph 

(b)(1) of this section shall consist of—

(i) Stock in a foreign corporation; 

(ii) An interest in a foreign 

partnership; or 

(iii) A beneficial or ownership interest 

in a foreign estate or trust (as defined in 

section 7701(a)(31)). 

(2) Increase with respect to each share 

or ownership unit. Any increase under 

paragraph (b) of this section in the basis 

of a United States shareholder’s stock in 

a foreign corporation or property (as 

defined in paragraph (c)(1) of this 

section) by reason of the ownership of 

which such United States shareholder is 

considered under section 958(a) as 

owning stock in a foreign corporation 

shall be made on a pro rata basis with 

respect to each share of such stock or 

each ownership unit of such property. 

(3) Translation rules. For purposes of 

determining an increase in basis under 

this section, in cases in which the 

previously taxed earnings and profits 

account is maintained in a non-United 

States dollar functional currency, 

section 951(a) inclusions shall be 

translated into United States dollars at 

the appropriate exchange rate as 

described in section 989(b). Any other 

increase in basis pursuant to paragraph 


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(b) of this section (for example, a basis 

increase resulting from the application 

of § 1.959–3(f) or (g)) shall be in the 

amount of the transferor’s dollar basis 

attributable to the previously taxed 

earnings and profits transferred. 

(c) Examples. The application of this 

section is illustrated by the following 

examples: 

Example 1. Basis adjustment for income 

inclusion. (i) Facts. DP, a United States 

shareholder, owns 800 of the 1,000 shares of 

the one class of stock in FC and has a basis 

of $50 in each of its shares. DP and FC use 

the calendar year as a taxable year and FC is 

a CFC. FC uses the u as its functional 

currency. The average exchange rate for year 

1 is 1u = $1. In year 1, its first year of 

operation, FC has 100,000u of subpart F 

income after the payment of 11,250u of 

foreign income taxes. DP is required to 

include in gross income 80,000u (800/1,000 

× 100,000u) equal to $80,000 under section 

951(a), and 9,000u (80,000u/100,000u × 

11,250u) equal to $9,000 under section 78. 

(ii) Analysis. On December 31, of year 1, 

DP increases the section 959(c)(2) earnings 

and profits in its previously taxed earnings 

and profits account with respect to its stock 

in FC by 80,000u pursuant to § 1.959–

3(e)(2)(i) to reflect the inclusion of 80,000u, 

or $80,000, in DP’s gross income pursuant to 

section 959(a), and correspondingly increases 

the basis of each share of its stock in FC by 

$100 ($80,000/800) from $50 to $150 

pursuant to paragraphs (b)(1) and (c)(2) of 

this section. 

Example 2. Sale of CFC stock. (i) Facts. 

Assume the same facts as in Example 1, 

except that in year 2, DP sells all of its stock 

in FC to DP2, a United States person that is 

DP’s successor in interest (as defined in 

§ 1.959–1(b)(5)), for $200 per share. At the 

time of sale, the exchange rate is 1u = $1 and 

DP has a basis of $150 per share in its FC 

stock and a previously taxed earnings and 

profits account with respect to its FC stock 

consisting of 80,000u of section 959(c)(2) 

earnings and profits with a dollar basis of 

$80,000. Also, at the time of sale, FC has 

50,000u of non-previously taxed earnings 

and profits, attributable to taxable years of FC 

beginning on or after December 31, 1962 

during which FC was a CFC and DP held its 

shares of stock in FC. 

(ii) Analysis. Pursuant to section 1248(a), 

because FC has 40,000u of non-previously 

taxed earnings and profits attributable to DP’s 

stock (50,000u × 800/1,000), the $40,000 of 

gain, equal to 40,000u, recognized by DP on 

the sale of it stock (($200¥$150) × 800) is 

included in DP’s gross income as a dividend. 

Consequently, the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to its stock 

in FC are increased from 80,000u to 120,000u 

pursuant to § 1.959–3(e)(2)(i). DP’s basis in 

each share of its stock in FC is not adjusted, 

pursuant to paragraph (b)(3) of this section, 

because the adjustment to DP’s previously 

taxed earnings and profits account results 

from a deemed section 951(a) inclusion 

pursuant to section 959(e). Upon the sale, 

DP2 acquires a previously taxed earnings and 

profits account with respect to the FC stock 

of 120,000u pursuant to § 1.959–1(d)(2)(i) 

and can utilize the account if it qualifies as 

a successor in interest under § 1.959–1(b)(5). 

DP2 takes a cost basis of $200 per share in 

the FC stock pursuant to section 1012. 

Par. 7. Section 1.961–2 is revised to 

read as follows: 

§ 1.961–2 Reduction in basis of stock in 

foreign corporations and of other property. 

(a) Reduction in basis—(1) In general. 

Except as provided in paragraph (a)(2) 

of this section, the adjusted basis of a 

covered shareholder’s stock in a foreign 

corporation or property (as defined in 

§ 1.961–1(c)) by reason of the ownership 

of which such covered shareholder is 

considered under section 958(a) as 

owning stock in a foreign corporation 

shall be reduced under section 961(b) 

each time, and to the extent, that such 

covered shareholder’s dollar basis in a 

previously taxed earnings and profits 

account with respect to the stock in 

such foreign corporation is decreased 

pursuant to the steps outlined in 

§ 1.959–3(e)(2) and shall also be reduced 

by the dollar amount of any foreign 

income taxes allowed as a credit under 

section 960(a)(3) with respect to the 

earnings and profits accounted for by 

that decrease. 

(2) Limitation on amount of reduction 

in case of election under section 962. 

[Reserved]. 

(b) Rules of application—(1) 

Reduction with respect to each 

ownership unit. Any reduction under 

paragraph (a) of this section in the 

adjusted basis of a covered 

shareholder’s stock in a foreign 

corporation or property (as defined in 

paragraph (b)(1) of this section) by 

reason of the ownership of which it is 

considered under section 958(a) as 

owning stock in a foreign corporation 

shall be made on a pro rata basis with 

respect to each share of such stock or 

each ownership unit of such property. 

(2) Translation rules. For purposes of 

determining a decrease in basis under 

this section, in cases in which the 

previously taxed earnings and profits 

account is maintained in a non-United 

States dollar functional currency, 

distributions of previously taxed 

earnings and profits shall be translated 

using the dollar basis of the earnings 

distributed. See § 1.959–3(b)(1) and 

(b)(3)(ii) for rules regarding the dollar 

basis of previously taxed earnings and 

profits. If the covered shareholder elects 

to maintain dollar basis accounts of 

previously taxed earnings and profits as 

described in § 1.959–3(b)(3)(ii), the 

dollar basis of the earnings distributed 

shall be determined according to the 

following formula: (functional currency 

distributed/total functional currency 

previously taxed earnings and profits) × 

total dollar basis of previously taxed 

earnings and profits. See section 

989(b)(1) for the appropriate exchange 

rate applicable to distributions for 

purposes of section 986(c). 

(c) Amount in excess of basis. To the 

extent that the amount of the reduction 

in the adjusted basis of property 

provided by paragraph (a) of this section 

exceeds such adjusted basis, the amount 

shall be treated as gain from the sale or 

exchange of property. 

(d) Examples. The application of this 

section is illustrated by the following 

examples: 

Example 1. Successor in interest. (i) Facts. 

DP, a United States shareholder, owns all of 

the 1,000 shares of the one class of stock in 

FC, which owns all of the 500 shares of the 

one class of stock in FS. Each share of DP’s 

stock in FC has a basis of $200. DP, FC, and 

FS use the calendar year as a taxable year and 

FC and FS are CFCs throughout the period 

here involved. FC and FS both use the u as 

their functional currency. In year 1, FS has 

100,000u of subpart F income after the 

payment of 50,000u of foreign income taxes. 

The average exchange rate for year 1 and year 

2 is 1u = $1. For year 1, DP includes 

100,000u in gross income under section 

951(a) with respect to FS. In accordance with 

the provisions of § 1.961–1, DP increases the 

basis of each of its 1,000 shares of stock in 

FC to $300 ($200 + $100,000/1,000) as of 

December 31, of year 1. On July 31 of year 

2, DP sells 250 of its shares of stock in FC 

to domestic corporation DT at a price of $350 

per share. DT satisfies the requirements of 

paragraph (d) of § 1.959–1 so as to qualify as 

DP’s successor in interest. On September 30 

of year 2, the earnings and profits attributable 

to the 100,000u included in DP’s gross 

income under section 951(a) for year 1 are 

distributed to FC which incurs a withholding 

tax of 10,000u on such distribution (10% of 

100,000u) and an additional foreign income 

tax of 331⁄3% or 30,000u by reason of the 

inclusion of the net distribution of 90,000u 

(100,000u ¥ 10,000u) in its taxable income 

for year 2. On June 30 of year 3, FC 

distributes the remaining 60,000u of such 

earnings and profits to DP and DT: DP 

receives 45,000u (750/1,000 × 60,000u) and 

excludes such amount from gross income 

under section 959(a) and § 1.959–1(c); DT 

receives 15,000u (250/1,000 × 60,000u) and, 

as DP’s successor in interest, excludes such 

amount from gross income under section 

959(a) and § 1.959–1(c). 

(ii) Analysis. As of June 30 of year 3, DP 

must reduce the adjusted basis of each of its 

750 shares of stock in FC to $200 ($300 

minus ($45,000/750 + $10,000/1,000 + 

$30,000/1,000)); and DT must reduce the 

basis of each of its 250 shares of stock in FC 

to $250 ($350 minus ($15,000/250 + $10,000/ 

1,000 + $30,000/1,000)). 

Example 2. Sale of lower-tier CFC. (i) Facts. 

Assume the same facts as in Example 1, 

except that in addition, on July 31 of year 2, 

FC sells its 500 shares of stock in FS to 

domestic corporation DT2 at a price of $600 

per share. DT2 satisfies the requirements of 


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§ 1.959–1(b)(5) so as to qualify as DP’s 

successor in interest. On September 30 of 

year 2, FS distributes 100,000u of earnings 

and profits to DT2, which earnings and 

profits are attributable to the 100,000u 

included in DP’s gross income under section 

951(a) for year 1. As DP’s successor in 

interest, DT2 excludes the 100,000u it 

receives from gross income under section 

959(a) and § 1.959–1(c). 

(ii) Analysis. As of September 30 of year 2, 

DT2 must reduce the basis of each of its 500 

shares of stock in FS to $400 ($600 minus 

($100,000/500)). 

Example 3. Section 956 amount. (i) Facts. 

DP, a United States shareholder, owns all of 

the 1,000 shares of the one class of stock in 

FC, which owns all of the 500 shares of the 

one class of stock in FS. Each share of DP’s 

stock in FC has a basis of $200. DP, FC, and 

FS use the calendar year as a taxable year and 

FC and FS are CFCs throughout the period 

here involved. FC and FS both use the u as 

their functional currency. In year 1, FS has 

100,000u of subpart F income after the 

payment of 50,000u of foreign income taxes. 

The average exchange rate for year 1 and year 

2 is 1u = $1. For year 1, DP includes 

100,000u in gross income under section 

951(a) with respect to FS. In accordance with 

the provisions of § 1.959–3(e)(2)(i) and 

§ 1.961–1, DP increases the section 959(c)(2) 

earnings and profits in its earnings and 

profits account with respect to its FC stock 

by 100,000u and correspondingly adjusts the 

basis of each of its 1,000 shares of stock in 

FC to $300 ($200+$100,000/1,000) as of 

December 31, of year 1. In year 2, DP has a 

section 956 amount with respect to its stock 

in FC of 100,000u. 

(ii) Analysis. On December 31 of year 2, DP 

reclassifies 100,000u of section 959(c)(2) 

earnings and profits as section 959(c)(1) 

earnings and profits pursuant to § 1.959–

3(e)(2)(iv). DP’s basis in each of its 1,000 

shares of stock in FC remains unchanged at 

$300 per share. 

Par. 8. Section 1.961–3 is added to 

read as follows: 

§ 1.961–3 Basis adjustments in stock held 

by foreign corporation. 

(a) Where the upper-tier entity is 

100% owned by a single United States 

shareholder—(1) In general. If a United 

States shareholder is treated under 

section 958(a) as owning stock in a CFC 

(lower-tier CFC) by reason of owning, 

either directly or pursuant to the 

application of section 958(a), stock in 

one or more other CFCs (each an 

‘‘upper-tier CFC’’), any increase to such 

United States shareholder’s basis in 

stock or other property under § 1.961–1 

of this section resulting from an 

adjustment to such United States 

shareholder’s previously taxed earnings 

and profits account with respect to its 

stock in the lower-tier CFC shall also be 

made to each upper-tier CFC’s basis in 

either the stock in the lower-tier CFC or 

the property by reason of which it is 

considered to own stock in the lowertier CFC under section 958(a), but only 

for purposes of determining the amount 

included under section 951 in the gross 

income of such United States 

shareholder or its successor in interest. 

In addition, any downward adjustment 

to such United States shareholder’s (or 

its successor in interest’s) previously 

taxed earnings and profits account with 

respect to its stock in a distributor under 

§ 1.959–3(e)(3) shall result in a 

corresponding reduction of the basis of 

the distributee’s stock in the distributor 

for purposes of determining the amount 

included in such United States 

shareholders gross income under 

section 951(a). 

(2) Examples. The application of this 

paragraph (a) is illustrated by the 

following examples: 

Example 1. Intercorporate dividend from 

lower-tier CFC to upper-tier CFC. (i) Facts. 

DP, a United States shareholder, owns all of 

the stock in FC, a CFC, and FC owns all of 

the stock in FS, a CFC. DP, FC and FS all use 

the calendar year as their taxable year and FC 

and FS both use the U.S. dollar as their 

functional currency. In year 1, FS has $100x 

of subpart F income that is included in DP’s 

gross income under section 951(a)(1). In year 

2, FS pays a dividend of $100x to FC. 

(ii) Analysis. On December 31 of year 1, the 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

with respect to its stock in FS are increased 

by $100x pursuant to § 1.959–3(e)(2)(i) to 

reflect the inclusion of $100x in DP’s gross 

income under section 951(a)(1)(A). DP’s basis 

in its stock in FC is correspondingly 

increased by $100x pursuant to § 1.961–1(b). 

FC’s basis in its stock in FS is also increased 

by $100x pursuant to paragraph (a) of this 

section, but only for purposes of determining 

the amount included in DP’s gross income 

under section 951. At the end of year 2, the 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

with respect to its stock in FS are decreased 

by $100x and its previously taxed earnings 

and profits account with respect to its stock 

in FC are increased by $100x pursuant to 

§ 1.959–3(e)(3) to reflect the transfer of the 

previously taxed earnings and profits from 

FS to FC. The $100x distribution is excluded 

from FC’s income for purposes of 

determining the amount included in DP’s 

gross income pursuant to § 1.959–2(a). FC’s 

basis in its stock in FS, for purposes of 

determining the amount included in DP’s 

gross income under section 951, is decreased 

by $100x pursuant to paragraph (a) of this 

section. 

Example 2. Sale of upper-tier CFC stock. (i) 

Facts. DP, a United States shareholder, owns 

all of the stock in FC, a CFC. FC owns all of 

the stock in FS1, a CFC, and FS1 owns all 

of the stock in FS2, a CFC. DP, FC, FS1, and 

FS2 all use the calendar year as their taxable 

year and FC, FS1 and FS2 all use the U.S. 

dollar as their functional currency. In year 1, 

FS2 has $100x of subpart F income which is 

included in DP’s gross income under section 

951(a)(1)(A). In year 2, FC sells FS1 to FT, 

a nonresident alien, and recognizes $100x of 

gain on the sale. 

(ii) Analysis. On December 31 of year 1, the 

section 959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

with respect to its stock in FS2 are increased 

by $100x pursuant to § 1.959–3(e)(2)(i) to 

reflect the inclusion of $100x in DP’s gross 

income under section 951(a)(1). DP’s basis in 

its stock in FC is correspondingly increased 

by $100x under § 1.961–1(b). FC’s basis in its 

stock in FS1 and FS1’s basis in its stock in 

FS2 are also each increased by $100x under 

paragraph (a) of this section, but only for 

purposes of determining the amount 

included in the gross income of DP under 

section 951. In year 2, the $100x of gain on 

FC’s sale of FS1 stock would be subpart F 

income that would be includible in DP gross 

income under section 951(a)(1)(A). However, 

since FC has an additional $100x of basis in 

its stock in FS1 for purposes of determining 

the amount included in DP’s gross income 

under section 951, the sale of FS1 by FC does 

not generate any subpart F income to DP. 

(b) Exception where the upper-tier 

entity is less than 100 percent owned by 

a single United States shareholder—(1) 

In general. If United States shareholders 

are treated, under section 958(a), as 

owning stock in a CFC (lower-tier CFC) 

by reason of owning, either directly or 

pursuant to the application of section 

958(a), stock in one or more other CFCs 

(each an ‘‘upper-tier CFC’’), and if, in 

the aggregate, the lower-tier CFC is less 

than wholly owned by a single United 

States shareholder, any increase to any 

United States shareholder’s basis in 

stock or other property under § 1.961–

1(b) of this section resulting from an 

increase to such United States 

shareholder’s previously taxed earnings 

and profits account with respect to its 

stock in such lower-tier CFC shall result 

in an increase to each upper-tier CFC’s 

basis in either the stock in the lower-tier 

CFC or the property by reason of which 

such upper-tier CFC is considered to 

own stock in the lower-tier CFC under 

section 958(a), but only for purposes of 

determining the amount included under 

section 951 in the gross income of such 

United States shareholder or its 

successor in interest. The amount of the 

increase to each upper-tier CFC’s basis 

in either the stock in the lower-tier CFC 

or the property by reason of which such 

upper-tier CFC is considered to own 

stock in the lower-tier CFC under 

section 958(a) shall be equal to the 

amount that would be excluded from 

the gross income of such upper-tier CFC 

pursuant to section 959(b) and § 1.959–

2(a) if the amount that gave rise to the 

adjustment to the United States 

shareholder’s previously taxed earnings 

and profits account with respect to its 

stock in the lower-tier CFC were 

actually distributed through a chain of 

ownership to such upper-tier CFC. In 


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addition, any decrease to such United 

States shareholder’s (or successor in 

interest’s) previously taxed earnings and 

profits account with respect to its stock 

in a distributor under § 1.959–3(e)(3) 

shall result in a corresponding 

reduction of the basis of the 

distributee’s stock in the distributor. 

The reduction of the basis of the 

distributee’s stock in the distributor 

shall be equal to the amount that would 

be excluded from the gross income of 

the distributee pursuant to section 

959(b) and § 1.959–2(a). 

(2) Example. The application of this 

paragraph (b) is illustrated by the 

following example: 

Example. Less than wholly owned CFC. (i) 

Facts. DP, a United States shareholder, owns 

70%, and FP, a nonresident alien, owns 30% 

of the stock in FC, a CFC. FC in turn owns 

100% of the stock in FS, a CFC. Each of DP, 

FC, FN and FS use the calendar year as their 

taxable year and both FC and FS use the U.S. 

dollar as their functional currency. Entering 

year 1, DP has a basis of $50x in FC and FC 

has a basis of $50x in FS. In year 1, FS earns 

$100x of subpart F income. In year 2, FC sells 

FS for $150x. 

(ii) Analysis. On December 31 of year 1, DP 

includes $70x of the $100x of subpart F 

income earned by FS in gross income under 

section 951(a)(1)(A). DP increases its section 

959(c)(2) earnings and profits in its earnings 

and profits account with respect to its stock 

in FS by $70x pursuant to § 1.959–3(e)(2)(i). 

DP increases its basis in FC from $50x to 

$120x pursuant to § 1.961–1(b). FC increases 

its basis in FS from $50× to $150× pursuant 

to paragraph (b)(1) of this section (but only 

for purposes of determining FC’s subpart F 

income with respect to DP) because if the 

$100x amount of subpart F income of FS that 

caused the $70x increase to DP’s previously 

taxed earnings and profits account with 

respect to its stock in FS had been distributed 

to FC, the entire $100x would be excluded 

from FC’s gross income pursuant to section 

959(b) and § 1.959–2(a) for purposes of 

determining DP’s inclusion under section 

951(a)(1)(A). In year 2, when FC sells FS, for 

purposes of determining DP’s subpart F 

inclusion, FC is treated as recognizing $0 on 

the sale ($150x sale proceeds¥$150x basis). 

Therefore, DP includes $0 in income under 

section 951(a)(1)(A) as a result of the sale. 

Although the sale does not generate gain for 

purposes of determining DP’s subpart F 

inclusion, it does cause FC’s non-previously 

taxed earnings and profits to be increased by 

$100x ($150x sale proceeds¥$50x basis). 

(c) Translation rules. Rules similar to 

those provided in § 1.961–1(c)(3) and 

§ 1.961–2(b)(3) shall apply for purposes 

of determining the exchange rates used 

to reflect any change to the basis of 

stock or other property under this 

section. 

Par. 9. Section 1.961–4 is added to 

read as follows: 

§ 1.961–4 Section 304 transactions. 

(a) Deemed redemption treated as a 

distribution—(1) In general. In the case 

of a stock acquisition described in 

section 304(a)(1) that is treated as a 

distribution of earnings and profits of a 

foreign acquiring corporation or a 

foreign issuing corporation or both, 

basis adjustments shall be made in 

accordance with the rules of §§ 1.961–

1, 1.961–2, and 1.961–3. 

(2) Examples. The application of this 

section is illustrated by the following 

examples: 

Example 1. Cross-chain acquisition of firsttier CFC. (i) Facts. DP, a domestic 

corporation, owns all of the stock in DS, a 

domestic corporation, and F1, a CFC. DS 

owns all of the stock in F2, a CFC. DP, DS, 

F1 and F2 all use the calendar year as their 

taxable year and F1 and F2 use the U.S. 

dollar as their functional currency. During 

year 1, F1 purchases all of the stock in F2 

from DS for $80x in a transaction described 

in section 304(a)(1). At the end of year 1, 

before taking into account the purchase of 

F2’s stock, DP has a previously taxed 

earnings and profits account consisting of 

$20x of section 959(c)(2) earnings and profits 

with respect to its stock in F1, and F1 has 

section 959(c)(2) earnings and profits of $20x 

and non-previously taxed earnings and 

profits of $10x. At the end of year 1, before 

taking into account the purchase of F2’s 

stock, DS has a previously taxed earnings and 

profits account consisting of $50x of section 

959(c)(2) earnings and profits with respect to 

its stock in F2 and F2 has section 959(c)(2) 

earnings and profits of $50x and nonpreviously taxed earnings and profits of $0. 

Before taking into account the purchase of 

F2’s stock, DP’s basis in F1’s stock is $30x 

and DS’s basis in F2’s stock is $60x. 

(ii) Analysis. Under section 304(a)(1), DS is 

deemed to have transferred the F2 stock to 

F1 in exchange for F1 stock in a transaction 

to which section 351(a) applies, and F1 is 

treated as having redeemed, for $80x, the F1 

stock hypothetically issued to DS. The 

payment of $80x is treated as a distribution 

to which section 301 applies. Under section 

304(b)(2), the determination of the amount 

which is a dividend is made as if the 

distribution were made, first, by F1 to the 

extent of its earnings and profits ($30x), and 

then by F2 to the extent of its earnings and 

profits ($50x). Before taking into account the 

deemed distributions, DS had a previously 

taxed earnings and profits account of $50x 

with respect to its stock in F2, and DP had 

a previously taxed earnings and profits 

account of $20x with respect to its stock in 

F1. Under § 1.959–3(h)(4)(i), DS is deemed to 

have a previously taxed earnings and profits 

account with respect to stock in F1. Under 

§ 1.959–3(g)(1), the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account with respect to F1 stock 

are reduced from $20x to $0. As a result, DP’s 

basis in F1’s stock is reduced from $30x to 

$10x under § 1.961–2(a). The deemed 

distribution of earnings and profits by F2 

causes the section 959(c)(2) earnings and 

profits in DS’s previously taxed earnings and 

profits account with respect to F2 stock to be 

reduced from $50x to $0. Under § 1.961–2(a) 

and § 1.961–3(a), F1’s basis in its newly 

acquired F2’s stock is reduced from $60x to 

$10x. F1 has a transferred basis of $10x in 

F2’s stock. 

Example 2. Cross-chain acquisition of 

lower-tier CFC. (i) Facts. DP, a domestic 

corporation, owns all of the stock in two 

CFCs, FX and FY. FX owns all of the stock 

in FZ, a CFC. FX, FY and FZ use the U.S. 

dollar as their functional currency. During 

year 1, FY purchases all of the stock in FZ 

from FX for $80x in a transaction described 

in section 304(a)(1). On December 31 of year 

1, before taking into account the purchase of 

FZ’s stock, FY has section 959(c)(2) earnings 

and profits of $20x and non-previously taxed 

earnings and profits of $10x, and FZ has 

section 959(c)(2) earnings and profits of $50x 

and non-previously taxed earnings and 

profits of $0. Before taking into account FX’s 

purchase of FZ’s stock, DP’s basis in FX’s 

stock is $60×; DP’s basis in FY’s stock is 

$30x; and FX’s basis in FZ’s stock, for 

purposes of determining the amount 

includible in DP’s gross income under 

section 951(a), is $60x. 

(ii) Analysis. Under section 304(a)(1), FX is 

deemed to have transferred the FZ stock to 

FY in exchange for FY stock in a transaction 

to which section 351(a) applies, and FY is 

treated as having redeemed, for $80x, the FY 

stock hypothetically issued to FX. The 

payment of $80x is treated as a distribution 

of property to which section 301 applies. 

Under section 304(b)(2), the determination of 

the amount which is a dividend is made as 

if the distribution were made, first, by FY to 

the extent of its earnings and profits, $30x, 

and then by FX to the extent of its earnings 

and profits, $50x. Under § 1.959–2(b), FX is 

deemed to receive the distributions from FY 

and FZ through a chain of ownership 

described in section 958(a), and $70x is 

excluded from FX’s gross income under 

section 959(b) and § 1.959–2(a). Under 

§ 1.959–3(e)(3), the section 959(c)(2) earnings 

and profits in DP’s previously taxed earnings 

and profits account for the stock in FY are 

reduced from $20x to $0; the section 

959(c)(2) earnings and profits in DP’s 

previously taxed earnings and profits account 

for the stock in FZ are reduced from $50x to 

$0; and the section 959(c)(2) earnings and 

profits in DP’s previously taxed earnings and 

profits account for the stock in FX are 

increased from $0 to $70x (and such account 

is further increased to $80x due to the 

inclusion of $10x of subpart F income in DP’s 

gross income under section 951(a)). Under 

§ 1.961–2(a), DP’s basis in the stock in FY is 

reduced from $30x to $10x. DP’s basis in the 

stock in FX is first reduced by $50x under 

§ 1.961–2(a), and then increased by $80x 

under § 1.961–1(b), for a net increase of $30x, 

to $90x. Under § 1.961–3(a), FY’s basis in the 

stock in FZ, for purposes of determining the 

amount includible in DP’s gross income 

under section 951(a), is reduced by $50× to 

$10x. 

Par. 10. Section 1.1502–12 as 

amended by adding paragraph (s) to 

read as follows: 


jlentini on PROD1PC65 with PROPOSAL
Federal Register / Vol. 71, No. 167 / Tuesday, August 29, 2006 / Proposed Rules 51179 

§ 1.1502–12 Separate taxable income. 

* * * * * 

(s) The exclusion from gross income 

of previously taxed earnings and profits 

shall be determined by the rules of 

§ 1.959–3(g). 

Par. 11. In § 1.1502–32, add a 

sentence after the second sentence in 

paragraph (b)(3)(ii)(D), add a sentence 

after the fourth sentence in paragraph 

(b)(3)(iii)(B), and add Example 11 in 

paragraph (b)(5)(ii) to read as follows: 

§ 1.1502–32 Investment adjustments. 

* * * * * 

(b) * * * 

(3) * * * 

(ii) * * * 

(D) * * * Further, an increase to a 

member’s previously taxed earnings and 

profits account under § 1.959–

3(g)(1)(i)(B) that pursuant to section 

961(a) and § 1.961–1(b) results in an 

increase to a member’s basis in the stock 

in a CFC shall be treated as the receipt 

of tax exempt income. * * * 

(iii) * * * 

(B) * * * Also included as a 

noncapital, nondeductible expense is a 

decrease to a member’s previously taxed 

earnings and profits account under 

§ 1.959–3(g)(1)(i)(A) that results in a 

decrease to a member’s basis in the 

stock in a CFC pursuant to section 

961(b) and § 1.961–2(a). * * * 

* * * * * 

(5) * * * 

(ii) * * * 

Example 11. (a) Facts. P owns all of the 

stock of S and S1. S, a United States 

shareholder, owns 50 percent of the stock in 

FC, a CFC that uses the U.S. dollar as its 

functional currency. S1, a United States 

shareholder owns the remaining 50 percent 

of the stock in FC. Entering year 1, S has a 

previously taxed earnings and profits account 

with respect to its stock in FC consisting of 

$50x of section 959(c)(2) earnings and profits 

and S1 has a previously taxed earnings and 

profits account with respect to its stock in FC 

consisting of $200x of section 959(c)(2) 

earnings and profits. Entering year 1, FC has 

section 959(c)(2) earnings and profits of 

$250x and non-previously taxed earnings and 

profits of $100x. In year 1, FC generates no 

earnings and profits and makes a $100x 

distribution of earnings and profits on FC 

stock held by S and a $100x distribution of 

earnings and profits on the FC stock held by 

S1. 

(b) Analysis. First, pursuant to § 1.959–

3(e)(2)(ii), the section 959(c)(2) earnings and 

profits in S’s previously taxed earnings and 

profits account with respect to its FC stock 

are decreased from $50x to $0 and the section 

959(c)(2) earnings and profits in S1’s 

previously taxed earnings and profits account 

with respect to its FC stock are decreased 

from $200x to $100x. Then, pursuant to 

§ 1.959–2(e)(2)(v) and (g)(1)(i)(A), the section 

959(c)(2) earnings and profits in S1’s 

previously taxed earnings and profits account 

with respect to its FC stock are decreased 

from $100x to $50x and, pursuant to § 1.959–

3(e)(2)(ii)(B) and (g)(1)(i)(B), the section 

959(c)(2) earnings and profits in S’s 

previously taxed earnings and profits account 

with respect to its FC stock are increased 

from $0 to $50x and then decreased from 

$50x to $0. Pursuant to § 1.959–1(c) of this 

section, the entire $100x distribution to S 

and $100x distribution to S1 are excluded 

from S’s and S1’s gross incomes. Pursuant to 

paragraph (b)(3)(ii)(D) of this section, the 

$50x increase to the section 959(c)(2) 

earnings and profits in S’s previously taxed 

earnings and profits account with respect to 

its FC stock pursuant to § 1.959–3(g)(1)(i)(B) 

is treated as the receipt of $50x of tax-exempt 

income by S. Pursuant to paragraph (b)(2)(ii) 

of this section, P’s basis in S’s stock is 

increased by $50x. Pursuant to paragraph 

(b)(3)(iii)(B) of this section, the $50x decrease 

to the section 959(c)(2) earnings and profits 

in S1’s previously taxed earnings and profits 

account with respect to its FC stock pursuant 

to § 1.959–3(g)(1)(i)(A) is treated as a 

noncapital nondeductible expense to S1. 

Pursuant to paragraph (b)(2)(iii) of this 

section, P’s basis in S1’s stock is decreased 

by $50x. 

* * * * * 

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. 06–7195 Filed 8–28–06; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 300 

[REG–145154–05] 

RIN 1545–BF68 

User Fees Relating to Enrollment 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Notice of proposed rulemaking 

and notice of public hearing. 

SUMMARY: This document contains 

proposed amendments to the 

regulations relating to user fees for the 

special enrollment examination to 

become an enrolled agent, the 

application for enrollment of enrolled 

agents, and the renewal of this 

enrollment. The charging of user fees is 

authorized by the Independent Offices 

Appropriations Act (IOAA) of 1952. 

This document also contains a notice of 

public hearing on these proposed 

regulations. 

DATES: Written or electronicallygenerated comments must be received 

by September 28, 2006. Outlines of 

topics to be discussed at the public 

hearing scheduled for September 29, 

2006, must be received by September 

28, 2006. 

ADDRESSES: Comments are encouraged 

to be submitted to: CC:PA:LPD:PR 

(REG–145154–05), room 5203, Internal 

Revenue Service, P.O. Box 7604, Ben 

Franklin Station, Washington, DC 

20044. Submissions may be sent 

electronically via the IRS Internet site at 

http://www.irs.gov/regs or via the 

Federal eRulemaking Portal at http:// 

www.regulations.gov (IRS–REG–

145154–05). 

FOR FURTHER INFORMATION CONTACT: 

Concerning submissions of comments 

and/or to be placed on the building 

access list to attend the hearing, Richard 

Hurst at 

Richard.A.Hurst@irscounsel.treas.gov or 

at (202) 622–7180; concerning cost 

methodology, Eva Williams at (202) 

622–6400; concerning the proposed 

regulations, Matthew Cooper at (202) 

622–4940 (not toll-free numbers). 

SUPPLEMENTARY INFORMATION: 

Background 

Section 330 of Title 31 of the United 

States Code authorizes the Secretary of 

the Treasury to regulate practice before 

the Treasury Department. Pursuant to 

section 330 of Title 31, the Secretary has 

published regulations governing 

practice before the IRS in 31 CFR part 

10 and reprinted them as Treasury 

Department Circular No. 230 (Circular 

230). These regulations are administered 

by the IRS Office of Professional 

Responsibility (OPR). 

Section 10.3 of Circular 230 generally 

authorizes attorneys, certified public 

accountants, enrolled agents and 

enrolled actuaries to practice before the 

IRS. An enrolled agent is defined as an 

individual enrolled as an agent pursuant 

to the provisions of Circular 230. The 

provisions of Circular 230 provide that 

an individual desiring to become an 

enrolled agent is eligible for enrollment 

through either the successful passing of 

a written examination or through 

demonstration of sufficient expertise in 

tax administration based on former 

employment with the IRS. Specifically, 

section 10.4(a) authorizes the Director of 

OPR to grant enrollment to an applicant 

who demonstrates special competence 

in tax matters by passing a written 

examination administered by, or 

administered under the oversight of, the 

Director of OPR and who has not 

engaged in any conduct that would 

justify the censure, suspension, or 

disbarment of any practitioner under the 

provisions of Circular 230. Accordingly, 

every year OPR develops and 

administers a Special Enrollment 


jlentini on PROD1PC65 with PROPOSAL