TITLE: IRS Form 5471 Schedule E: New CFC Foreign Tax Allocation Rules for the Repealed Section 898(c)(2) Election
IRS Updates Form 5471 Schedule E Reporting for CFCs After Repeal of the Section 898(c)(2) One-Month Deferral Election
The IRS has updated the Form 5471 Schedule E reporting process for controlled foreign corporations affected by the repeal of the section 898(c)(2) one-month deferral election.
The changes matter if your international seller group operates through a US parent and a foreign subsidiary in the UK, EU, Canada, Australia, or another market. You may need to allocate foreign income taxes between the CFC’s first required year and its succeeding taxable year.
This update also affects foreign tax credit tracking, PTEP distributions, election statements, and the supporting records attached to Form 5471.
Act now: the proposed regulation comment deadline is 17 September 2026
The IRS and Treasury published proposed regulations under REG-115145-25 addressing:
- The repeal of the section 898(c)(2) one-month deferral election.
- Allocation of foreign taxes between two taxable years.
- The section 960(d)(4) foreign tax credit disallowance.
- Reporting and election procedures for affected US shareholders.
Comments are due by 17 September 2026. That is tomorrow, based on the publication date of this update.
Comments should be submitted through Regulations.gov, referencing IRS and REG-115145-25.
Understand the first required year before preparing Schedule E
The One Big Beautiful Bill Act repealed the one-month deferral election under section 898(c)(2) for taxable years of specified foreign corporations beginning after 30 November 2025.
An affected CFC must now generally align its taxable year with the required year of its majority US shareholder under section 898(c)(1).
This creates a transition period.
The CFC’s first required year is the first taxable year beginning after 30 November 2025 under the new required-year rules. Its next full accounting period is the succeeding taxable year.
For example:
- A US parent uses a calendar tax year.
- Its foreign CFC previously used a November 30 year-end under the one-month deferral election.
- The CFC’s first required year may run from 1 December 2025 to 31 December 2025.
- The succeeding taxable year then runs from 1 January 2026 to 31 December 2026.
This short first required year can create a mismatch. Foreign tax law may impose tax on a full foreign taxable year, while US tax reporting may recognise only one month of the CFC’s income in the first required year.
That is why foreign tax allocation is now central to Schedule E compliance.
Complete the new Schedule E column (j) reporting
The updated IRS Form 5471 instructions require affected CFCs to report allocated foreign income taxes in Schedule E, Part I, Section 1, column (j).
The amount entered in column (j) should reflect the foreign income tax amount allocated to the CFC’s first required year under the transition rules.
You must not simply report the full foreign tax liability without considering the allocation requirement. Doing so may distort:
- Foreign tax credit calculations.
- Current-year earnings and profits.
- Section 951 and section 951A income groups.
- Taxes deemed paid under section 960.
- PTEP tracking and future distributions.
Maintain a clear reconciliation between the total foreign tax accrued under local law and the amount reported in column (j). This will help you support the filing if the IRS requests additional information.
Attach a detailed foreign tax allocation table
The Form 5471 support should include a statement or table for each foreign income tax subject to allocation.
Your working table should identify at least:
| Required information | What to record |
|---|---|
| Payor entity | The foreign corporation, branch, QBU, partnership, or disregarded entity that paid or accrued the tax |
| EIN or reference ID | The entity’s EIN or consistent Form 5471 reference ID number |
| Total tax accrued | The total foreign income tax accrued for the relevant foreign tax year |
| Amount allocated to the first required year | The portion allocated to the short or transitional first required year |
| Amount allocated to the succeeding year | The remaining portion allocated to the succeeding taxable year |
| Allocation method used | The standard allocation percentage, income-group-specific method, or another permitted method under the proposed rules |
Label any amount allocated to the succeeding taxable year clearly. Use a notation such as “succeeding year tax” or “relevant succeeding year tax” where appropriate.
The IRS worksheet for Schedule E column (j) requests payor details, identification numbers, total tax, the amount allocated to the first required year, and the allocation method. Your supporting statement should also preserve the succeeding-year amount so that the total reconciles completely.
This recordkeeping will save time when preparing the succeeding-year Schedule E and reviewing foreign tax credit balances.
Apply the correct allocation method
The proposed regulations generally use an allocation percentage based on foreign-law taxable income.
The basic calculation is:
Foreign-law taxable income attributable to the first required year ÷ total foreign-law taxable income for the relevant foreign taxable year
You then apply that percentage to the foreign tax assigned to each relevant income group.
The proposed rules also provide an election to use an income-group-specific allocation method. This may be important where income types are unevenly distributed between the first required year and the succeeding taxable year.
For example, a CFC may earn ordinary tested income during the first required year but recognise a capital gain only in the succeeding year. A single percentage may not accurately reflect the tax associated with each income group.
Keep the following evidence:
- Foreign tax returns.
- Tax computations.
- Trial balances for the short year.
- Income-group calculations.
- Foreign-law taxable income schedules.
- Exchange-rate calculations.
- Reconciliations to Schedule E and Schedule E-1.
Review the controlling domestic shareholder elections
The proposed section 1.898(c)-1 rules allow certain elections to be made by the affected corporation’s controlling domestic shareholders.
Election statements may apply to:
- Specified distributive shares of creditable foreign tax expenditures.
- Income-group-specific allocation.
- Non-allocation of specified foreign income taxes.
- Allocation of relevant succeeding-year taxes.
The election statement must be attached to the relevant Form 5471 and use the applicable title specified in the proposed rules, such as:
- “Section 898 Income Group Specific Election Statement.”
- “Section 898 Non-Allocation Election Statement.”
- “Section 898 Relevant Succeeding Year Tax Election Statement.”
Do not assume that one shareholder’s election applies automatically to every entity in the group. The election must be reviewed for consistency across all affected CFCs and controlling domestic shareholders.
