Helpful IRS guidance regarding midyear PTEP distributions: PwC

Helpful IRS guidance regarding midyear PTEP distributions

March 2023

In brief

The IRS’s Office of Chief Counsel released an Advice Memorandum (AM), AM 2023-002, on March 10, 2023, that addresses the interplay between ‘controlled foreign corporation’ (CFC) stock basis adjustments (due to subpart F income, Section 956, and ‘global intangible low-taxed income’ (GILTI) inclusions) in a tax year and previously taxed earnings and profits (PTEP) distributions that occur before the last day of the same tax year (a midyear PTEP distribution). The issue stems from the uncertain interaction between the timing of basis increases and reductions under the existing Section 961 regulations. The AM concludes that increases in basis that would occur for a given CFC tax year under Section 961(a) are taken into account when applying Section 961(b)(2) to determine if gain must be recognized on a distribution of PTEP during such CFC tax year. By allowing current year CFC stock basis increases to be taken into account in determining gain, if any, that would arise from midyear PTEP distributions, the AM’s analysis reduces the risk of gain being triggered on such distributions.

The takeaway: The AM is consistent with a recently issued private letter ruling (PLR), PLR 202304008, addressing this issue and confirming the Service’s taxpayer-favorable view. While the AM and PLR are not binding guidance, they are the first IRS statements regarding the impact of midyear PTEP distributions on CFC stock gain determinations outside of the Section 965 context, a relatively common issue since the enactment of the 2017 Tax Cuts and Jobs Act.

Sections 961(a) and 961(b)

Sections 961(a) and (b)(1) provide for basis increases and decreases, respectively, in certain CFC stock. Section 961(a) increases a US shareholder’s basis in a top-tier CFC stock by any amounts included in the shareholder’s gross income under Sections 951(a) and 951A with respect to the top-tier CFC and any lower-tier CFC the shareholder is considered to own by reason of Section 958(a)(2). Section 961(b)(1), on the other hand, decreases such US shareholder’s basis in the top-tier CFC stock by any amounts of PTEP distribution it receives from such CFC, but excludes from income under Section 959(a). Further, if the amount of PTEP excluded from income under Section 959(a) exceeds the shareholder’s basis in the CFC’s stock, Section 961(b)(2) requires the US shareholder to recognize gain to the extent of such excess amount.

Sections 961(a) and (b) do not themselves describe the timing of such basis adjustments. However, regulations issued under Section 961 provide that the basis increase under Section 961(a) occurs “as of the last day in the taxable year of such corporation on which it is a [CFC].” Treas. Reg. sec. 1.961-1(a)(1). Conversely, the regulations provide that the basis decrease under Section 961(b) occurs “as of the time” the US shareholder receives the PTEP distribution. Treas. Reg. sec. 1.961-2(a)(1). The regulations do not, however, specify the time at which gain must be recognized under Section 961(b)(2) where a PTEP distribution exceeds tax basis. This ambiguity presented a potential issue for distributions during a CFC’s tax year of amounts that ultimately would be determined to be PTEP.

AM 2023-002

The AM involves a single CFC (FS) wholly owned by its US shareholder (USP). At the beginning of Year 1, USP has a $0 basis in its FS stock and a $0 PTEP account with respect to FS. In Year 1, USP includes $100x in its income under Sections 951(a) and 951A with respect to FS’s subpart F income and GILTI. Halfway through Year 1, FS distributed $100x to USP which, at the end of FS’s tax year, is determined to be entirely a distribution of PTEP and is thus excluded from USP’s income under Section 959(a).

The AM emphasizes that Sections 959 and 961 are “companion provisions the purpose of which is to prevent double taxation…” The AM acknowledges that the Section 961 regulations do not specifically address midyear PTEP distributions and could be read to require the Section 961(b)(1) basis decrease prior to the Section 961(a) basis increase for the same CFC earnings.

Again pointing to the purpose of these Code sections to prevent double taxation, the AM states that, “in light of the fact that the final amount of PTEP for the taxable year can be determined only at the end of the year,” the “better interpretation” is that the basis increase under Section 961(a) is “taken into account” when determining whether gain must be recognized under Section 961(b)(2) on a midyear PTEP distribution. The AM also notes that this timing of the required basis adjustments is consistent with the “gain reduction rule” in the Section 965 regulations. The rule allowed taxpayers to take into account basis attributable to any Section 965 PTEP amounts when determining if any distributions received in the year of the Section 965 inclusion resulted in gain under Section 961(b)(2).

Observation: The AM is consistent with similar guidance issued by the IRS in the form of a PLR earlier this year. Importantly, PLRs are issued with respect to a specific taxpayer and its specific facts. Therefore, other taxpayers may not rely on guidance in PLRs as precedent. While this AM likewise is not binding, it is signed by the IRS Associate Chief Counsel (International) and will be considered by IRS agents in auditing PTEP and Section 961 issues.