This document contains amendments to the income tax regulations (26 CFR part 1) under section 468A of the Code relating to deductions for contributions to trusts maintained for decommissioning nuclear power plants and the use of the amounts in those trusts to decommission nuclear plants.

Section 468A was originally enacted by section 91(c)(1) of the Deficit Reduction Act of 1984, Public Law 98-369 (98 Stat 604) and has been amended several times, most recently by section 1310 of the Energy Policy Act of 2005, Public Law 109-58 (119 Stat 594). Temporary regulations (TD 9374) under section 468A were published in the Federal Register on December 31, 2007 (72 FR 74175). Final regulations finalizing and removing the temporary regulations (TD 9512) were published in the Federal Register on December 23, 2010 (75 FR 80697) (existing regulations). A notice of proposed rulemaking (REG-112800-16) (proposed regulations) was published in the Federal Register (81 FR 95929) on December 29, 2016. The proposed regulations provide additional guidance on deductions for contributions to trusts maintained for decommissioning nuclear power plants and the use of the amounts in those trusts to decommission nuclear plants under section 468A.

The Department of the Treasury (Treasury Department) and the IRS received several written and electronic comments in response to the proposed regulations. All comments are available at www.regulations.gov. The Treasury Department and the IRS held a public hearing on the proposed regulations on October 25, 2017.

After consideration of the comments received, including comments made at the public hearing, the proposed regulations are adopted as final regulations as revised by this Treasury decision. In general, these final regulations follow the approach of the proposed regulations with some modifications based on the recommendations made in the comments. This preamble describes the comments received by the Treasury Department and the IRS and the revisions made.

Section 7805(b)(1)(A) and (B) of the Code generally provides that no temporary, proposed, or final regulation relating to the internal revenue laws may apply to any taxable period ending before the earliest of (A) the date on which such regulation is filed with the Federal Register, or (B) in the case of a final regulation, the date on which a proposed or temporary regulation to which the final regulation relates was filed with the Federal Register.

The proposed regulations provided that the regulations would apply to taxable years ending on or after the date of publication of the Treasury decision adopting the proposed rules as final regulations in the Federal Register. Additionally, the preamble to the proposed regulations provided that, notwithstanding the prospective effective date, taxpayers could take return positions consistent with the proposed regulations for taxable years ending on or after December 29, 2016 (the date the proposed regulations were published in the Federal Register).

One commenter proposed that the effective and applicability dates of these regulations be amended to permit taxpayers to rely on the provisions of the final regulations for taxable years that are open as of the date the proposed regulations were published in the Federal Register. After consideration, the Treasury Department and IRS decline to adopt this comment in the final regulations. As noted in the preceding paragraph, the preamble to the proposed regulations made clear that taxpayers could take return positions consistent with the notice of proposed rulemaking for taxable years ending on or after December 29, 2016 (the date the proposed regulations were published in the Federal Register). This allowed taxpayers to request schedules of ruling amounts from the IRS (as required by section 468A(d)(1) and §1.468A-3) with respect to costs that were treated as nuclear decommissioning costs under the proposed regulations and to deduct those amounts in taxable years ending on or after December 29, 2016. However, for taxpayers that have not requested and obtained a schedule of ruling amounts for taxable years for which the deemed payment deadline date (as defined in §1.468A-2(c)(1)) has passed as of September 4, 2020, under §1.468-3(e)(v), it is impossible to obtain a schedule of ruling amounts (and therefore impossible to contribute any amount to a qualified fund) because the request for the schedule of ruling amounts would be submitted to the IRS after the deemed payment deadline date. Accordingly, while the final regulations apply to taxable years ending on or after September 4, 2020, taxpayers may apply the rules contained in the final regulations to prior taxable years for which a taxpayer’s deemed payment deadline has not passed prior to September 4, 2020. See section 7805(b)(7).

Executive Orders 12866 and 13563 direct agencies to assess costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility.

These final regulations have been designated by the Office of Management and Budget’s (OMB) Office of Information and Regulatory Affairs (OIRA) as subject to review under Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and OMB regarding review of tax regulations. OIRA has determined that the final rulemaking is significant and subject to review under Executive Order 12866 and section 1(b) of the Memorandum of Agreement.

Federal law requires operators of nuclear power plants to dismantle these plants and safely dispose of the fuel when the useful life of the plant has expired. Nuclear Regulatory Commission (NRC) rules require plant owners to demonstrate that sufficient financial resources will be available for decommissioning costs.¹ Additionally, owners are required to report to the NRC at least every two years the status of a plant’s decommissioning funding. The NRC rules allow for various methods to satisfy the requirement for dedicated decommissioning funds. Section 468A of the Code is intended to facilitate these requirements by allowing taxpayers with ownership interests in nuclear power plants to elect to currently deduct the future costs of decommissioning a nuclear power plant.² Funds for which an election has been made under section 468A are widely used in the industry, but not all decommissioning funding vehicles are section 468A funds.

The election is made pursuant to procedures provided in existing regulations under section 468A and allows taxpayers to make contributions to a Nuclear Decommissioning Fund (“Fund”) prior to the time when actual decommissioning costs are incurred.³ When amounts are actually distributed from the Fund the electing taxpayer faces a gross income inclusion. Generally, the income inclusion is offset with a corresponding deduction for the costs of decommissioning activities when they are actually performed. Funds are treated as separate taxable corporations, with investment incomes subject to a fixed 20 percent rate of tax.

Section 468A(a) limits the purposes for which amounts can be considered “nuclear decommissioning costs.” The definition of such costs forms the basis for a large portion of the rulemaking that has been issued regarding 468A and furthermore forms the bulk of the basis for the final regulations.⁴ As decommissioning activity increases and technologies change, additional guidance is needed to address withdrawals from the Fund to cover new costs and cost categories that may arise for purposes of decommissioning. For example, the accumulating amounts of spent nuclear fuel and the ongoing lack of a Federal repository for that fuel have led plant owners to store spent nuclear fuel in Independent Spent Fuel Storage Installations (ISFSIs). The need to independently store spent fuel was not anticipated when previous IRS regulations were issued. The final regulations clarify that the costs of an ISFSI and related matters are decommissioning costs for purposes of section 468A.

More generally, the final regulations provide clarifications and updates to existing regulations in response to industry requests for public guidance on this and related issues. These clarifications generally have already been adopted by the IRS in its private letter rulings but stakeholders have requested that the regulations be amended to provide additional certainty.

The regulations provide guidance on deductions for contributions to funds maintained for decommissioning nuclear power plants and the use of the amounts in those funds to decommission nuclear plants under section 468A. Specifically, the regulations (1) broaden the definition of nuclear decommissioning costs in §1.468A-1(b)(6) to include expenses related to spent fuel storage in ISFSIs both on-site and off-site from the nuclear power plant that generates such spent fuel; (2) clarify that the definition of nuclear decommissioning costs in §1.468A-1(b)(6) does not only include currently deductible costs by adding the words “or recoverable through depreciation or amortization” following “otherwise deductible”; (3) broaden the definition of nuclear decommissioning costs in §1.468A-1(b)(6)(i) to include “all land improvements and otherwise deductible expenses to be incurred in connection with the entombment, decontamination, dismantlement, removal, and disposal of the structures, systems and components of a nuclear power plant, whether that nuclear power plant will continue to produce electric energy or has permanently ceased to produce electric energy”; (4) broaden the exemption from the self-dealing rules to include reimbursements to parties related to the electing taxpayer and also expand the types of expenses permitted to be reimbursed as nuclear decommissioning costs under the self-dealing rules to include direct or indirect overhead and a reasonable profit element; and (5) provide that the substantial completion date is the date on which all Federal, state, local, and contractual decommissioning liabilities are fully satisfied.

It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities pursuant to the Regulatory Flexibility Act (RFA) (5 U.S.C. 601). Although a substantial number of small entities may be affected, the economic impact of this rule is unlikely to be significant.

According to the Small Business Administration’s Table of Size Standards (13 CFR 121), utilities, including nuclear electric power generation with 750 or fewer employees (NAICS Code 221113), are considered small entities. According to the 2016 Statistics of U.S. Businesses (SUSB) data, there are at least seven entities with fewer than 750 employees of the 27 entities in the industry, which could be considered a substantial number of small entities for purposes of the RFA.

The economic impact of these regulations on small entities is not likely to be significant. Section 468A of the Code allows taxpayers with ownership interests in nuclear power plants to elect to currently deduct the future costs of decommissioning a nuclear power plant. The procedures for this election are set forth in existing regulations. As discussed earlier in these Special Analyses, the final regulations provide clarifications and updates to the existing regulations in response to industry requests for public guidance. These clarifications generally have already been adopted by the IRS in private letter rulings but stakeholders have requested that the regulations be amended to provide additional certainty. Because the final rule is codifying what is widely understood to be existing policy, the economic impact of this rule is not likely to be significant for any entities affected, regardless of size.

Pursuant to section 7805(f) of the Code, the proposed regulations preceding these final regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business and no comments were received.

There is no new collection of information contained in these regulations. The collection of information contained in the regulations under section 468A has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-2091. Responses to these collections of information are required to obtain a tax benefit.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by section 6103 of the Code.

The principal author of these regulations is Jennifer C. Bernardini, Office of Associate Chief Counsel (Passthroughs and Special Industries). However, other personnel from the IRS and the Treasury Department participated in their development.

Income taxes, Reporting and recordkeeping requirements

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

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

Par. 2. Section 1.468A-1 is amended by adding paragraphs (b)(6)(i) and (ii) to read as follows:

§1.468A-1 Nuclear decommissioning costs; general rules.

* * * * *

(b) * * *

(6) * * *

(i) For the purpose of this title, the term nuclear decommissioning costs or decommissioning costs includes all expenses related to land improvements and otherwise deductible expenses to be incurred in connection with the entombment, decontamination, dismantlement, removal and disposal of the structures, systems and components of a nuclear power plant, whether that nuclear power plant will continue to produce electric energy or has permanently ceased to produce electric energy. Such term includes all expenses related to land improvements and otherwise deductible expenses to be incurred in connection with the preparation for decommissioning, such as engineering and other planning expenses, and all otherwise deductible expenses to be incurred with respect to the plant after the actual decommissioning occurs, such as physical security and radiation monitoring expenses. An expense is otherwise deductible for purposes of this paragraph (b)(6) if it would be deductible or recoverable through depreciation or amortization under chapter 1 of the Internal Revenue Code without regard to section 280B.

(ii) The term nuclear decommissioning costs or decommissioning costs, as applicable to this title, also includes expenses incurred in connection with the construction, operation, and ultimate decommissioning of a facility used solely to store, pending delivery to a permanent repository or disposal, spent nuclear fuel generated by one or more nuclear power plants (for example, an Independent Spent Fuel Storage Installation). Such term does not include otherwise deductible expenses to be incurred in connection with the disposal of spent nuclear fuel under the Nuclear Waste Policy Act of 1982 (Pub. L. 97-425).

* * * * *

Par. 3. Section 1.468A-5 is amended by revising the section heading and paragraphs (b)(2)(i) and (v) and (d)(3)(i) to read as follows:

§1.468A-5 Nuclear decommissioning fund—miscellaneous provisions.

* * * * *

(b) * * *

(2) * * *

(i) A payment by a nuclear decommissioning fund for the purpose of satisfying, in whole or in part, the liability of the electing taxpayer for decommissioning costs of the nuclear power plant to which the nuclear decommissioning fund relates, whether such payment is made to an unrelated party in satisfaction of the decommissioning liability or to the plant operator or other otherwise disqualified person as reimbursement solely for actual expenses paid by such person in satisfaction of the decommissioning liability;

* * * * *

(v) Any act described in section 4951(d)(2)(B) or (C). Whether payments under section 4951(c)(2)(C) are not excessive is determined under §1.162-7. See §53.4941(d)-3(c)(1). The fact that the amount of such payments that are not excessive are also more than the disqualified person’s actual expenses for such personal services does not cause the payments to constitute acts of self-dealing, even if the difference is properly characterized as profit, or direct or indirect overhead;

* * * * *

(d) * * *

(3) * * *

(i) The substantial completion of the decommissioning of a nuclear power plant occurs on the date on which all Federal, state, local, and contractual decommissioning requirements are fully satisfied (the substantial completion date). Except as otherwise provided in paragraph (d)(3)(ii) of this section, the substantial completion date is also the termination date.

* * * * *

Par. 4. Section 1.468A-9 is revised to read as follows:

§1.468A-9 Applicability dates.

(a) In general. Except as provided in paragraph (b) of this section, §§1.468A-1 through 1.468A-8 are effective on December 23, 2010, and apply with respect to taxable years ending after such date.

(b) Special rules—(1) Taxable years ending before December 23, 2010. Special rules that are provided for taxable years ending on or before December 23, 2010, such as the special rule for certain special transfers contained in §1.468A-8(a)(4)(ii), apply with respect to such taxable years. In addition, except as provided in paragraph (2) of this section, a taxpayer may apply the provisions of §§1.468A-1 through 1.468A-8 with respect to a taxable year ending on or before December 23, 2010, if all such provisions are consistently applied.

(2) Applicability of §1.468A-1(b)(6) and §1.468A-5(b)(2)(i), (b)(2)(v), and (d)(3)(i). The rules in §§1.468A-1(b)(6) and 1.468A-5(b)(2)(i), (b)(2)(v), and (d)(3)(i) apply to taxable years ending on or after September 4, 2020. Taxpayers may also choose to apply the rules in §1.468A-1(b)(6) and §1.468A-5(b)(2)(i), (b)(2)(v), and (d)(3)(i) to prior taxable years for which a taxpayer’s deemed payment deadline (as defined in §1.468A-2(c)(1)) has not passed prior to September 4, 2020.

Sunita Lough,

Deputy Commissioner for Services and Enforcement.

Approved: March 5, 2020.

David J. Kautter,

Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on September 3, 2020, 8:45 a.m., and published in the issue of the Federal Register for September 4, 2020, 85 F.R. 55185)

¹ A detailed description of nuclear decommissioning and the various Nuclear Regulatory Commission (NRC) rules are beyond the scope of this document.

² See generally Joint Committee on Taxation Staff, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, 98th Cong. 2d Sess. 270 (1984).

³ Electing taxpayers are permitted to contribute to the Fund amounts in accordance with a schedule of ruling amounts, which taxpayers must request and receive from the IRS. Very generally, the schedule of ruling amounts should reflect the total cost for decommissioning the plant over the estimated useful life of the plant. Section 468A(d); §1.468A-3.

⁴ Section 468A was added by the Deficit Reduction Act of 1984. Regulations were first promulgated in 1988 and were amended in 1992, 1994, 2007, and 2010.

Section 951(a) of the Code generally requires a United States shareholder (as defined in § 951(b)) (U.S. shareholder), to include in its gross income its pro rata share of subpart F income (as defined in § 952) of a controlled foreign corporation (as defined in § 957) (CFC) and the amount determined under § 956 with respect to such shareholder for such year (but only to the extent not excluded from gross income under § 959(a)(2)) (subpart F inclusion).

Section 951A(a) requires a U.S. shareholder of any CFC for any taxable year to include in gross income the shareholder’s GILTI for such taxable year (GILTI inclusion amount). The U.S. shareholder’s GILTI inclusion amount is calculated based on certain items – such as tested income, tested loss, and QBAI – of each CFC owned by the U.S. shareholder (tested items). See § 1.951A-1(c) of the Income Tax Regulations. In general, a U.S. shareholder’s GILTI inclusion amount is determined by reference to the U.S. shareholder’s pro rata share of the tested items based on the stock of all the CFCs that the U.S. shareholder owns within the meaning of § 958(a). See § 951A(e)(1) (cross referencing § 951(a)(2)). The GILTI provisions in § 951A, enacted in § 14201(a) of the TCJA, apply to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end. See § 14201(d) of the TCJA.

Section 951(b) defines a U.S. shareholder, with respect to any foreign corporation, as a United States person (U.S. person) that owns (within the meaning of § 958(a)), or is considered as owning by applying the ownership rules of § 958(b), 10 percent or more of the total combined voting power of all classes of stock entitled to vote of such corporation or 10 percent or more of the value of all shares of all classes of stock of the foreign corporation. See also § 1.951-1(g). Section 957(c) generally defines a U.S. person for purposes of subpart F by reference to § 7701(a)(30), which defines a U.S. person as a citizen or resident of the United States, a domestic partnership, a domestic corporation, and certain estates and trusts.

For purposes of subparts A and F of part III (§§ 901 through 909 and §§ 951 through 965, respectively), and part V (§ 999), of subchapter N of chapter 1, § 1373(a) provides that an S corporation is treated as a partnership and the shareholders of the S corporation are treated as partners of the partnership. Section 1373(a) thus causes S corporations, which are domestic corporations, to be treated in the same manner as domestic partnerships for purposes of §§ 951 and 951A.

(1) Entity Treatment of Domestic Partnerships and S Corporations

Historically, a domestic partnership or S corporation was generally treated as a U.S. shareholder that had a subpart F inclusion with respect to a CFC owned under § 958(a) by the partnership or S corporation (entity treatment). Under entity treatment, an S corporation determines its subpart F inclusion at the entity level. An S corporation shareholder takes into account the shareholder’s pro rata share of the S corporation’s subpart F inclusion, regardless of whether the S corporation shareholder itself is a U.S. shareholder of the CFC under § 951(b). See generally § 1366(a). A similar approach applied to domestic partnerships under entity treatment.

(2) Aggregate Treatment of Partners of Foreign Partnerships

Under § 958(a)(2), a partner in a foreign partnership is treated as owning proportionately the stock of a CFC owned by the foreign partnership (aggregate treatment) for purposes of subpart F, which includes § 951A. Accordingly, if a partner in a foreign partnership is a U.S. shareholder with respect to a CFC owned by the partnership, the U.S. shareholder-partner will directly include in gross income the pro rata share of subpart F income of the CFC and directly determine the partner’s GILTI inclusion amount by reference to the pro rata share of tested items of the CFC. See §§ 951(a) and 951A(e)(1).

(3) Hybrid Treatment for GILTI Purposes Under 2018 Proposed Regulations

On October 10, 2018, the Treasury Department and the IRS published a notice of proposed rulemaking (REG-104390-18) in the Federal Register (83 FR 51072) under § 951A (2018 proposed regulations). Section 1.951A-5 of the 2018 proposed regulations (proposed § 1.951A-5) provided a “hybrid approach” to a domestic partnership that is a U.S. shareholder (U.S. shareholder partnership) of a CFC (partnership-owned CFC). Under the hybrid approach, a U.S. shareholder partnership would determine its GILTI inclusion amount, and the partners of the partnership that were not also U.S. shareholders of the partnership-owned CFC would take into account their distributive share of the partnership’s GILTI inclusion amount. See proposed § 1.951A-5(b). Partners that also were U.S. shareholders of a partnership-owned CFC would not take into account their distributive share of the partnership’s GILTI inclusion amount. Instead, such partners would be treated as proportionately owning the stock of the partnership-owned CFC within the meaning of § 958(a) as if the domestic partnership were a foreign partnership. See proposed § 1.951A-5(c).

Because § 1373(a) treats S corporations as partnerships for purposes of subpart F, the hybrid approach in the 2018 proposed regulations also applied to S corporations that held stock of a CFC. For example, proposed § 1.951A-5(g)(5) (Example 5) applied entity treatment (outlined in section 2.02(1) of this notice) to an S corporation shareholder that was not a U.S. shareholder of a CFC owned by the S corporation (S corporation-owned CFC), and aggregate treatment (outlined in section 2.02(2) of this notice) to an S corporation shareholder that was a U.S. shareholder of the S corporation-owned CFC.

(4) Aggregate Treatment for GILTI Purposes under 2019 Final Regulations

On June 21, 2019, the Treasury Department and the IRS published final regulations (T.D. 9866) in the Federal Register (84 FR 29288) under § 951A (final regulations). The final regulations did not adopt the hybrid approach included in the 2018 proposed regulations and instead adopted aggregate treatment for domestic partnerships. Accordingly, under the final regulations, a domestic partnership does not have a GILTI inclusion amount, and therefore no partner of the partnership has a distributive share of a GILTI inclusion amount. See § 1.951A-1(e)(1). Rather, for purposes of determining the GILTI inclusion amount of any partner of a domestic partnership, each partner is treated as proportionately owning the stock of a CFC owned by the partnership within the meaning of § 958(a) in the same manner as if the domestic partnership were a foreign partnership. Because only a U.S. person that is a U.S. shareholder can have a GILTI inclusion amount, a partner that is not a U.S. shareholder of a partnership-owned CFC does not have a GILTI inclusion amount determined by reference to the partnership-owned CFC. Section 1.951A-1(e)(1) applies to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end. See § 1.951A-7.

(5) Aggregate Treatment for Subpart F and GILTI Purposes Under 2019 Proposed Regulations

On June 21, 2019, concurrent with the final regulations, the Treasury Department and the IRS published a notice of proposed rulemaking (REG-101828-19) in the Federal Register (84 FR 29114) under § 958 (2019 proposed regulations). Section 1.958-1 of the 2019 proposed regulations (proposed § 1.958-1) mirrored the aggregate treatment of domestic partnerships for purposes of GILTI inclusions as set forth in the final regulations, and also extended it to apply for purposes of subpart F inclusions. See proposed § 1.958-1(d)(1). Accordingly, subject to certain exceptions in proposed § 1.958-1(d)(2), for purposes of §§ 951 and 951A and any other provision that applies by reference to § 951 or 951A, the 2019 proposed regulations provided that a domestic partnership is not treated as owning stock of a foreign corporation within the meaning of § 958(a); instead, a domestic partnership is treated in the same manner as a foreign partnership for purposes of determining the persons that own stock of the foreign corporation within the meaning of § 958(a). See proposed § 1.958-1(d)(1). Under proposed § 1.958-1(d)(2), a domestic partnership is treated as an entity for purposes of determining whether any U.S. person (including the domestic partnership) is a U.S. shareholder, whether any U.S. shareholder is a controlling domestic shareholder (as defined in § 1.964-1(c)(5)), or whether any foreign corporation is a CFC.

Consistent with the final regulations with respect to GILTI, under the 2019 proposed regulations a partner that is not a U.S. shareholder with respect to a partnership-owned CFC does not take into account a subpart F inclusion or GILTI inclusion amount by reference to the partnership-owned CFC.

The 2019 proposed regulations are proposed to apply to taxable years of foreign corporations beginning on or after the date of publication of the Treasury decision adopting the rules as final regulations in the Federal Register. See proposed § 1.958-1(d)(4). Subject to a consistency requirement, however, the 2019 proposed regulations provide that a domestic partnership may apply the regulations, once finalized, to taxable years of a foreign corporation beginning after December 31, 2017, and to taxable years of the domestic partnership in which or with which such taxable years of the foreign corporation end. See id.

(6) Applicability to S Corporations

Under § 1373(a), an S corporation is treated as a partnership and its shareholders as partners for purposes of §§ 951 and 951A, among other provisions. Therefore, for purposes of determining a GILTI inclusion amount under § 1.951A-1(e), as well as determining a subpart F inclusion or GILTI inclusion amount under proposed § 1.958-1(d), an S corporation is not treated as owning stock of a foreign corporation within the meaning of § 958(a) but instead is treated in the same manner as a foreign partnership (each S corporation shareholder is treated as proportionately owning the stock of the S corporation-owned CFC). Under this aggregate treatment, § 961(a) applies to increase a U.S. shareholder’s basis in the shares of the S corporation when the U.S. shareholder has a subpart F inclusion or GILTI inclusion amount attributable to the S corporation-owned CFC. The preamble to the final regulations stated that the Treasury Department and the IRS are studying the application of § 1373(a) with respect to § 951A, as well as the broader implications of treating S corporations as partnerships for purposes of subpart F, and requested comments. See 84 FR 29317.

(7) Distribution Rules Regarding S Corporations

Paragraphs (b) and (c) of § 1368 provide for the annual treatment of distributions of property made by an S corporation with respect to its stock to which (but for § 1368(a)) § 301(c) would apply. Section 1368(b) addresses the treatment of such distributions by an S corporation that does not have AE&P. Specifically, § 1368(b)(1) provides that a distribution by an S corporation is not included in the gross income of the shareholder to the extent that the amount of the distribution does not exceed the adjusted basis of the S corporation’s stock. Section 1368(b)(2) provides that, if the amount of the distribution exceeds the adjusted basis of the S corporation’s stock, that excess is treated as gain from the sale or exchange of property.

Section 1368(c) addresses the treatment of distributions by an S corporation that has AE&P (for example, if the S corporation had generated earnings and profits during its prior status as a C corporation) and therefore has an accumulated adjustments account (AAA), as defined by § 1368(e)(1). AE&P does not include amounts that would increase an S corporation’s AAA. See § 1371(c). The S corporation’s AAA achieves dual congressional purposes by ensuring that (i) distributions of income already taxed to its shareholders will be tax-free and (ii) distributions of AE&P generated by a former C corporation will be taxed as dividends (as defined in § 316) when ultimately distributed. See S. Rept. 97-354, at 3258, 97th Cong. 2nd Sess. (Sept. 29, 1982). Accordingly, to achieve the first-described congressional purpose, an S corporation’s AAA functions similarly to the basis-adjustment rules set forth in § 1367 and is adjusted positively to account for income taxed to its shareholders. See § 1368(e)(1). AAA is limited to income generated by the corporation during its status as an S corporation and preserves the single-level-of-tax treatment to S corporation shareholders that is fundamental to subchapter S of chapter 1 of the Code (subchapter S).

With regard to distributions of property by S corporations with AE&P (relating to the second-described congressional purpose), § 1368(c) first applies the distribution to the S corporation’s AAA. Specifically, § 1368(c)(1) provides that the treatment of the portion of the distribution that does not exceed the S corporation’s AAA is governed by § 1368(b), and not included in a shareholder’s gross income if that amount does not exceed the shareholder’s adjusted basis in the S corporation’s stock. See also § 1368(b)(1). For the portion of the distribution that does not exceed the S corporation’s AAA, but which exceeds the shareholder’s adjusted basis in the S corporation’s stock, that amount is treated as gain from the sale or exchange of property. See §§ 1368(c)(1) and 1368(b)(2). After the application of § 1368(c)(1), any remaining portion of that distribution that exceeds the amount of the S corporation’s AAA is treated as a dividend (as defined in § 316) to the extent of the S corporation’s remaining AE&P. See § 1368(c)(2). Lastly, the portion of the distribution remaining after the application of § 1368(c)(1) and (2) is governed by § 1368(b) (that is, either not included in gross income or treated as gain depending on the shareholder’s basis in the S corporation’s stock). See § 1368(c)(3).

(8) Application of Aggregate Treatment to S Corporations with AE&P

The aggregate treatment provided in the final regulations, as applied to S corporations with AE&P, does not result in a positive adjustment of AAA because the GILTI inclusion amount arises at the shareholder level, rather than at the S corporation level. See § 1.951A-1(e). If an S corporation with AE&P distributes property to its shareholders, for example, to provide its shareholders with funds to pay the resulting federal income tax arising from their GILTI inclusion amount with respect to stock of CFCs owned by the S corporation, the S corporation would need an amount of AAA equal to the amount of that distribution to prevent the distribution from being included in such shareholders’ gross income to the extent of AE&P. See generally § 1368(c). Although the S corporation could generate additional AAA as needed through a distribution from a CFC, comments have asserted that such an approach could result in foreign withholding taxes or undesired reductions in working capital that otherwise would be devoted to the CFC’s businesses.

As stated in section 2.02(7) of this notice, § 1368(c)(1) provides that tax-free distribution treatment to shareholders of an S corporation with AE&P results only to the extent the S corporation has sufficient AAA to support the distribution. In the absence of enough AAA, § 1368(c)(2) requires the distribution to be taxed as a dividend (as defined in § 316) to the S corporation’s shareholders to the extent of the S corporation’s AE&P. In other words, if an S corporation has no AAA, the amount of the adjusted basis in a shareholder’s S corporation stock—including any positive basis adjustment under § 961(a) resulting from a shareholder’s GILTI inclusion—does not affect dividend treatment. Once the S corporation exhausts its AE&P, distributions are once again applied to shareholder stock basis. Comments regarding the application of the final regulations to S corporations and their shareholders focused on these interactions between the aggregate treatment and the distribution rules for AE&P under subchapter S.

(9) Notice 2019-46 – Domestic Partnerships and S Corporations Filing Under Proposed GILTI Regulations

Following the June 21, 2019, publication of the final regulations, the Treasury Department and the IRS became aware that certain domestic partnerships and S corporations had furnished Schedules K-1 to their partners and shareholders for the 2018 taxable year on or before the publication date of the final regulations and had relied on proposed §1.951A-5. See section 2.04 of Notice 2019-46, 2019-37 I.R.B. 695 (Aug. 23, 2019). To reduce compliance and processing burdens resulting from the need to issue corrected Schedules K-1 consistent with the final regulations, Notice 2019-46 announced the intent of the Treasury Department and the IRS to issue regulations that would permit certain domestic partnerships or S corporations to apply the 2018 proposed regulations, including the hybrid approach in proposed § 1.951A-5, in their entirety, for taxable years that ended before June 22, 2019. See section 3 of Notice 2019-46.

For purposes of applying § 951A, a U.S. shareholder has to determine its “net CFC tested income” and “net deemed tangible income return.” Net CFC tested income is generally defined as the excess (if any) of the aggregate of the shareholder’s pro rata share of the tested income of each CFC with respect to which such shareholder is a U.S. shareholder for the taxable year of the shareholder over the aggregate of the shareholder’s pro rata share of the tested loss of each such CFC. See § 951A(c) and § 1.951A-1(c)(2). The U.S. shareholder’s GILTI inclusion amount is then determined by reducing net CFC tested income by net deemed tangible income return. See § 951A(b)(1). Section 951A(b)(2) and § 1.951A-1(c)(3) define the term “net deemed tangible income return” as the excess of 10 percent of the aggregate of such U.S. shareholder’s pro rata share of the QBAI of each CFC with respect to which the shareholder is a U.S. shareholder for the taxable year, over a certain amount of interest expense.

Section 951A(d)(1) and § 1.951A-1(b) define QBAI, with respect to any CFC for any taxable year, as the quarterly average of the aggregate adjusted bases in specified tangible property used in the CFC’s trade or business and of a type for which a depreciation deduction is allowable under § 167.

The definition of QBAI in § 951A(d) also applies for purposes of determining deemed tangible income return under § 250. See § 250(b)(2)(B) and § 1.250(b)-2(b). Section 250 generally allows a domestic corporation a deduction equal to 37.5 percent (21.875 percent for taxable years after 2025) of its FDII (as defined in § 250(b)(1) and § 1.250(b)-1(b)). For purposes of FDII, QBAI is used to determine the deemed tangible income return of a corporation, which in turn reduces the amount of foreign-derived intangible income of a corporation. See § 250(b)(1)-(2). Section 250(b)(2)(B) and § 1.250(b)-2 incorporate the definition of QBAI in § 951A(d)(3), with some modifications.

(1) Adjusted Basis for Purposes of QBAI

Section 951A(d)(3)¹ requires a taxpayer to calculate QBAI by determining the adjusted basis of property using the ADS under § 168(g) “notwithstanding any provision of this title (or any other provision of law) which is enacted after the date of the enactment of [§ 951A].”

ADS depreciation under § 168(g) is determined by using the straight-line method (without regard to salvage value), the applicable convention determined under § 168(d), and the applicable recovery period as determined under the table in § 168(g)(2)(C). On December 22, 2017, the date of enactment of the TCJA, § 168(g)(2)(C) provided that the recovery period for purposes of ADS depreciation for nonresidential real property, as defined in § 168(e)(2)(B), was 40 years. Nonresidential real property is defined under § 168(e)(2)(B) as “section 1250 property” (that is, any depreciable real property not described in § 1245) that is not residential rental property, as defined in § 168(e)(2)(A), or property with a class life of less than 27.5 years. Section 168(g)(2)(C)(i) provided that the recovery period for property not described in § 168(g)(2)(C)(ii) or (iii) is the property’s class life. Class life is generally determined under Rev. Proc. 87-56, 1987-2 C.B. 674; however, § 168(g)(3) specifies class lives for certain types of property for ADS purposes.

(2) Qualified Improvement Property

Effective for property placed in service after December 31, 2017, § 13204 of the TCJA amended § 168(e) by removing references to qualified leasehold improvement property, qualified restaurant improvement property, and qualified retail improvement property, and adding a definition for QIP. Under § 168(e)(6), as amended by the TCJA, QIP generally is defined as certain improvements to an interior portion of a building that is nonresidential real property if such improvements are placed in service after the date the building was first placed in service. See § 1.168(b)-1(a)(5)(i)(A) and (ii).

(3) QIP’s 20-year ADS Recovery Period

Section 2307(a) of the Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136, 134 Stat. 281 (March 27, 2020) (CARES Act), titled “Technical Amendments Regarding Qualified Improvement Property” amended the TCJA rules regarding the treatment of QIP under § 168(e) and (g) (technical amendment). Under the technical amendment, § 2307(a)(1)(A) of the CARES Act amended § 168(e) by adding clause (vii) to paragraph (3)(E), providing that QIP is classified as 15-year property, § 2307(a)(1)(B) of the CARES Act amended the definition of QIP in § 168(e)(6) by providing that the improvement must be “made by the taxpayer,” and § 2307(a)(2) of the CARES Act amended the table in § 168(g)(3)(B) to provide a class life of 20 years for QIP for purposes of the ADS. Under § 2307(b) of the CARES Act, the technical amendment is effective as if its provisions had been included in § 13204 of the TCJA and, therefore, applies to property placed in service after December 31, 2017. According to the Description of the Tax Provisions of Public Law 116-136, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, prepared by the Staff of the Joint Committee on Taxation and published on April 23, 2020 (JCX-12R-20), when Congress enacted § 13204(a)(4)(b)(i) of the TCJA to add the definition of QIP in § 168(e)(6), it intended for QIP to be classified as 15-year property under § 168(e)(3)(E), with a 15-year recovery period under the general depreciation system in § 168(a) and a 20-year ADS recovery period but inadvertently omitted such language from the statute. See JCX-12R-20 at 69-70. The conference report under the TCJA also states that Congress intended QIP to be classified as 15-year property under the general depreciation system and be assigned a 20-year ADS recovery period. See Conference Report to Accompany H.R. 1, H.R. Rept. 115-466, at 366-367, 115th Cong. 1st Sess. (Dec. 15, 2017).

The Treasury Department and the IRS intend to issue the forthcoming S corporation regulations under § 958 of the Code to ease the transition of S corporations with AE&P on September 1, 2020, from the historic entity treatment and the hybrid treatment under proposed §1.951A-5 (and illustrated in § 1.951A-5(g)(5) (Example 5)) to the aggregate treatment required under the final regulations (transition rules). The forthcoming S corporation regulations will ensure that distributions of income already taxed to S corporation shareholders will be tax-free, and AE&P generated by a former C corporation will be taxed as dividends when distributed.

The Treasury Department and the IRS intend the transition rules to assist S corporations with AE&P and their shareholders by allowing them to recognize the GILTI inclusion amount at the entity level so it is treated as an item of income, thereby increasing its AAA before allocation to the shareholders. This increase in AAA will allow S corporations to distribute property to shareholders and avoid dividend treatment. To achieve this result, the Treasury Department and the IRS expect to provide rules and examples consistent with those set forth in sections 3.02 and 3.03, respectively, of this notice. These transition rules are expected to apply solely to S corporations with “transition AE&P,” as defined in section 3.02(3) of this notice.

(1) Elective Entity Treatment

With respect to a taxable year, an S corporation is subject to entity treatment if (a) it (and its shareholders, if applicable) makes an election described in section 3.02(2) of this notice, (b) it has elected S corporation status before June 22, 2019, (c) it would be treated as owning stock of a CFC on June 22, 2019, within the meaning of § 958(a) if entity treatment applied,² (d) it has transition AE&P (as defined in section 3.02(3) of this notice) on September 1, 2020, or on the first day of any subsequent taxable year, and (e) it maintains records to support the determination of the transition AE&P amount. Entity treatment means that an S corporation that owns stock of a CFC is treated as owning within the meaning of § 958(a) the CFC stock for purposes of applying § 951A. Thus, the S corporation determines its GILTI inclusion amount, and its shareholders take into account their distributive share of that GILTI inclusion amount. See section 2.02(1) of this notice.

(2) Time and Manner of Making an Election.

With respect to the first taxable year ending on or after September 1, 2020, an S corporation may irrevocably elect to apply entity treatment on a timely filed (including extensions) original Form 1120-S, U.S. Income Tax Return for an S Corporation. For taxable years of an S corporation ending before September 1, 2020, and after June 21, 2019, the S corporation and all of its shareholders may irrevocably elect the entity treatment provided in section 3.02(1) of this notice on timely filed (including extensions) original returns or on amended returns filed by March 15, 2021, by attaching a statement thereto.

The election is made by attaching a statement to the Federal tax return. The election statement must identify the election being made, include the amount of transition AE&P as described in section 3.02(3) of this notice, and, where applicable, be signed by a person authorized to sign the return required to filed under § 6037. Form 1120-S, Schedules K-1 (Form 1120-S), and Form 8892, U.S. Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI), must be prepared consistent with the S corporation’s election for shareholders to comply with § 6037(c).

(3) Transition AE&P

For purposes of this notice, the term “transition AE&P” means, with respect to an S corporation and its shareholders, the amount of AE&P of the S corporation calculated as of September 1, 2020, reduced as described in section 3.02(5) of this notice. Transition AE&P is not increased as a result of transactions occurring (or entity classification elections described in § 301.7701-3 filed) after September 1, 2020.

(4) Transition AE&P Not Transferable

For purposes of this notice, transition AE&P of an S corporation is not transferrable to another person under any provision of the Code (for example, under §§ 312(h) or 381 by reason of § 1371(a)). In other words, the transferee of the transition AE&P would receive AE&P not transition AE&P.

(5) Reduction Solely by Distributions

An S corporation with transition AE&P is treated as having no transition AE&P if, beginning after September 1, 2020, the S corporation distributes in one or more distributions a cumulative amount of AE&P equal to or greater than the amount of the S corporation’s transition AE&P as of September 1, 2020.

(6) Required Aggregate Treatment

Except as provided in Notice 2019-46, aggregate treatment applies to an S corporation if the S corporation has not made an election described in section 3.02(1) of this notice to apply the transition rules. In the case of an S corporation that has made an election to apply entity treatment as described in section 3.02(1) of this notice, aggregate treatment applies beginning with the S corporation’s first taxable year for which the S corporation has no transition AE&P on the first day of that year, and to each subsequent taxable year of the S corporation. For purposes of this section 3.02(6), aggregate treatment means the treatment of an S corporation provided under § 1.951A-1(e).

The following examples illustrate the rules set forth in section 3.02 of this notice.

(1) Example 1 – S corporation with transition AE&P—(a) Facts. Individual A and Individual B, each U.S. citizens, respectively own 5% and 95% of the single class of stock of SCX, an S corporation. SCX’s sole asset is 100% of the single class of stock of FC, a CFC, which SCX has held since June 1, 2019. Neither Individual A or Individual B own shares, directly or indirectly, in any other CFC. Individual A, Individual B, SCX, and FC all use the calendar year as their taxable year. On January 1, 2021, SCX has transition AE&P of $100x and AAA of $0. SCX elects to apply the transition rules under section 3.02(1) of this notice. During the 2021 taxable year, FC has $200x of tested income (within the meaning of § 1.951A-2(b)(1)) and $0 of QBAI (within the meaning of § 1.951A-3(b)).

(b) Analysis—(i) S corporation-level. As an S corporation with transition AE&P on the first day of the taxable year (here, January 1, 2021), SCX is treated as owning (within the meaning of § 958(a)) all the stock of FC for purposes applying § 951A. Accordingly, SCX, a U.S. shareholder of FC, determines its GILTI inclusion amount under § 1.951A-1(c)(1) for its 2021 taxable year. SCX’s pro rata share of FC’s tested income is $200x, and its pro rata share of FC’s QBAI is $0. SCX’s net CFC tested income (within the meaning of § 1.951A-1(c)(2)) is $200x, and its net deemed tangible income return (within the meaning of § 1.951A-1(c)(3)) is $0. As a result, SCX’s GILTI inclusion amount for 2021 is $200x. At the end of 2021, SCX increases its AAA by $200x to reflect the GILTI inclusion amount. Because SCX computes its income as an individual under § 1363(b), it cannot take a § 250 deduction for any GILTI inclusion amount. See § 1.250(a)-1(c)(1).

(ii) S corporation shareholder-level. Neither Individual A nor Individual B is treated as owning the stock in FC within the meaning of § 958(a). Accordingly, Individual A and Individual B include in gross income their pro rata shares of SCX’s GILTI inclusion amount as described in § 1366(a), which is $10x ($200x x 5%) for Individual A and $190x ($200x x 95%) for Individual B.

(2) Example 2 – Effect of distribution on transition AE&P—(a) Facts. The facts are the same as in Example 1 of this section 3.03, except that, on December 31, 2021, SCX distributes $300x to its shareholders. In addition, FC has an additional $200x of tested income (within the meaning of § 1.951A-2(b)(1)) and $0 of QBAI (within the meaning of § 1.951A-3(b)) during the 2022 taxable year.

(b) Analysis—(i) Determination of transition AE&P. Before taking into account the distribution on December 31, 2021, the results for taxable year 2021 are the same as set forth in paragraphs (b)(i) and (b)(ii) of Example 1 of this section 3.03. $200x, the portion of SCX’s $300x distribution that does not exceed AAA, is subject to § 1368(c)(1). The remaining distribution of $100x is treated as a dividend under § 316 to the extent of SCX’s AE&P. As of January 1, 2022, SCX has $0 of transition AE&P under section 3.02(5) of this notice because the cumulative amount of SCX’s distributions out of AE&P after September 1, 2020, equals or exceeds the amount of SCX’s transition AE&P as of September 1, 2020.

(ii) S corporation-level. Because SCX has no transition AE&P as of January 1, 2022, aggregate treatment applies to SCX for its taxable year 2022 and for each subsequent taxable year. As a result, for purposes of determining a GILTI inclusion amount in its taxable year 2022, SCX is not treated as owning (within the meaning of § 958(a)) the FC stock; instead, SCX is treated in the same manner as a foreign partnership for purposes of determining the FC stock owned by Individual A and Individual B under § 958(a)(2). See § 1.951A-1(e)(1). Accordingly, SCX does not have a GILTI inclusion amount for its 2022 taxable year (or for any subsequent taxable year) and therefore will not increase its AAA as a result of its ownership of FC stock for its taxable year 2022 (or for any subsequent taxable year).

(iii) S corporation shareholder-level—(A) Individual A. For purposes of determining the GILTI inclusion amount of Individual A for taxable year 2022, Individual A is treated as owning 5% of the FC stock under § 958(a). Individual A is not, however, a U.S. shareholder of FC because Individual A owns (within the meaning of § 958(a) and (b)) less than 10% (that is, only 5%) of the FC stock. Accordingly, Individual A does not have a GILTI inclusion amount for taxable year 2022.

(B) Individual B. For purposes of determining the GILTI inclusion amount of Individual B for taxable year 2022, Individual B is treated as owning 95% of the FC stock under § 958(a). In addition, Individual B is a U.S. shareholder of FC because Individual B owns (within the meaning of § 958(a) and (b)) at least 10% (that is, 95%) of the FC stock. Accordingly, Individual B’s pro rata share of FC’s tested income is $190x ($200x x 0.95), and Individual B’s pro rata share of FC’s QBAI is $0. Individual B’s net CFC tested income is $190x, and Individual B’s net deemed tangible income return is $0. As a result, Individual B’s GILTI inclusion amount for taxable year 2022 is $190x.

The Treasury Department and the IRS expect to amend the regulations under §§ 959 and 961 concerning previously taxed earnings and profits to provide rules to address the transition of S corporations from entity treatment to aggregate treatment.