Corporate Alternative Minimum Tax Applicable After 2022

SUPPLEMENTARY INFORMATION:

Authority

This document contains proposed additions and amendments to 26 CFR part 1 (Income Tax Regulations) addressing the application of the corporate alternative minimum tax (CAMT) imposed by section 55 of the Internal Revenue Code (Code), as amended by the enactment of section 10101 of Public Law 117-169, 136 Stat. 1818, 1818-1828 (August 16, 2022), commonly known as the Inflation Reduction Act of 2022 (IRA). The proposed additions and amendments are issued under section 56A, as added to the Code by the IRA, section 59 of the Code, as amended by the IRA, and section 1502 of the Code (proposed regulations), pursuant to the express delegations of authority provided under those sections. The express delegations relied upon are referenced in the parts of the Explanation of Provisions section of this preamble describing the individual sections of the proposed regulations. The proposed regulations are also issued under the express delegation of authority under section 7805 of the Code.

Background

I. Overview

As amended by section 10101 of the IRA, section 55 imposes the CAMT based on the adjusted financial statement income, as determined under section 56A (AFSI), of an applicable corporation, as determined under section 59, for taxable years beginning after December 31, 2022. In general, under section 59(k), a corporation is an applicable corporation subject to the CAMT for a taxable year if it meets an average annual AFSI test for one or more taxable years that (i) are before that taxable year, and (ii) end after December 31, 2021.

Section 55(a) provides that, for the taxable year of an applicable corporation, the amount of CAMT equals the excess (if any) of (i) the tentative minimum tax for the taxable year, over (ii) the sum of the regular tax, as defined in section 55(c), for the taxable year plus the tax imposed under section 59A (commonly referred to as the base erosion and anti-abuse tax, or BEAT). Section 55(b)(2)(A) provides that, in the case of an applicable corporation, the tentative minimum tax for the taxable year is the excess of (i) 15 percent of AFSI for the taxable year, over (ii) the CAMT foreign tax credit, as determined under section 59(l), for the taxable year. In the case of any corporation that is not an applicable corporation, section 55(b)(2)(B) provides that the tentative minimum tax for the taxable year is zero.

II. AFSI Under Section 56A

A. Adjusted Financial Statement Income; Applicable Financial Statement

Section 56A(a) provides that, for purposes of sections 55 through 59 of the Code, the term “AFSI” means, with respect to any corporation for any taxable year, the net income or loss of the taxpayer set forth on the taxpayer's applicable financial statement (AFS) for that taxable year, adjusted as provided in section 56A. For purposes of section 56A, section 56A(b) provides that the term “AFS” means, with respect to any taxable year, an AFS, as defined in section 451(b)(3) of the Code or as specified by the Secretary in regulations or other guidance, that covers that taxable year.

B. Adjustments to AFSI

Section 56A(c) provides general adjustments to be made to AFSI. Section 56A(c)(1) provides that appropriate adjustments are to be made to AFSI in any case in which an AFS covers a period other than the taxable year. Section 56A(c)(2) provides special rules for related entities. Section 56A(c)(2)(A) provides that, if the financial results of a taxpayer are reported on the AFS for a group of entities (financial statement group), rules similar to the rules of section 451(b)(5) apply. Section 451(b)(5) provides that, in such a situation, the consolidated financial statement of the financial statement group is treated as the AFS of the taxpayer. However, for purposes of section 451(b)(5), if the taxpayer's financial results are also reported on a separate financial statement that is of equal or higher priority to the consolidated financial statement, then the taxpayer's AFS is the separate financial statement. See § 1.451-3(h)(1)(i). Section 1.451-3(h)(2) and (3) provide rules under section 451(b)(5) for determining the extent to which income reflected on the consolidated financial statement and the underlying source documents is allocable to the taxpayer for purposes of applying the rules under section 451(b).

Section 56A(c)(2)(B) provides a general rule that, if the taxpayer is part of an affiliated group of corporations that join in filing (or that are required to join in filing) a consolidated return for Federal income tax purposes (tax consolidated group) for any taxable year, AFSI for that group for that taxable year must take into account items on the group's AFS that are properly allocable to members of that group. However, section 56A(c)(2)(B) authorizes the Secretary to prescribe by regulation exceptions to that general rule.

Section 56A(c)(2)(C) provides that, in the case of any corporation that is not included on a consolidated return with the taxpayer, AFSI of the taxpayer with respect to that other corporation is determined by only taking into account dividends received from that other corporation (reduced to the extent provided by the Secretary in regulations or other guidance) and other amounts that are includible in gross income or deductible as a loss under chapter 1 of the Code (chapter 1), other than amounts required to be included under sections 951 and 951A of the Code or such other amounts as provided by the Secretary, with respect to that other corporation.

Section 56A(c)(2)(D)(i) provides that, except as provided by the Secretary, if the taxpayer is a partner in a partnership, the taxpayer's AFSI with respect to such partnership is adjusted to take into account only the taxpayer's distributive share of such partnership's AFSI. Section 56A(c)(2)(D)(ii) provides that, for purposes of sections 55 through 59, the AFSI of a partnership is the partnership's net income or loss set forth on that partnership's AFS (adjusted under rules similar to the rules set forth in section 56A).

Section 56A(c)(3)(A) provides an adjustment to the AFSI of a taxpayer for any taxable year in which the taxpayer is a United States shareholder (within the meaning of section 951(b) or, if applicable, section 953(c)(1)(A) of the Code (each shareholder, a “U.S. shareholder”)) of one or more controlled foreign corporations (each within the meaning of section 957 of the Code or, if applicable, section 953(c)(1)(B)) (CFC). Under this rule, the AFSI of the taxpayer with respect to the CFC (as determined under section 56A(c)(2)(C)) is adjusted to also take into account the taxpayer's pro rata share (determined under rules similar to the rules under section 951(a)(2)) of items taken into account in computing the net income or loss set forth on the AFS (as adjusted under rules similar to those that apply in determining AFSI) of each CFC with respect to which the taxpayer is a U.S. shareholder. Section 56A(c)(3)(B) provides that, if the adjustment determined under section 56A(c)(3)(A) would result in a negative adjustment for the taxable year, (i) no adjustment is made to the taxpayer's AFSI for that year, and (ii) the amount of the adjustment determined under section 56(c)(3)(A) for the succeeding taxable year is reduced by an amount equal to the negative amount from the prior taxable year.

Section 56A(c)(4) provides that, in determining the AFSI of a foreign corporation, the principles of section 882 of the Code (which subjects a foreign corporation to Federal income tax on its taxable income that is effectively connected with the conduct of a trade or business within the United States) apply.

Section 56A(c)(5) provides the general rule that AFSI is appropriately adjusted to disregard any Federal income taxes, or income, war profits, or excess profits taxes (within the meaning of section 901 of the Code) with respect to a foreign country or possession of the United States, which are taken into account on the taxpayer's AFS. To the extent provided by the Secretary, this general rule does not apply to such foreign taxes taken into account on the taxpayer's AFS if the taxpayer does not choose to claim a foreign tax credit (FTC) under section 27 of the Code (regular FTC). Section 56A(c)(5) also authorizes the Secretary to prescribe regulations or other guidance on the proper treatment of current and deferred taxes for purposes of section 56A(c)(5), including the time at which such taxes are properly taken into account.

Section 56A(c)(6) requires AFSI to be adjusted to take into account any AFSI of a disregarded entity owned by the taxpayer. Section 56A(c)(7) and (8) provide special rules for cooperatives and Alaska Native Corporations (within the meaning of section 3 of the Alaska Native Claims Settlement Act (ANCSA) (43 U.S.C. 1602(m))), respectively.

Section 56A(c)(9) requires AFSI to be appropriately adjusted to disregard any amount treated as a payment against the tax imposed by subtitle A of the Code (subtitle A) pursuant to an election under section 48D(d) or 6417 of the Code and included in the net income or loss set forth on the taxpayer's AFS. However, if such amount is otherwise disregarded under the adjustment rule in section 56A(c)(5) (concerning AFSI adjustments for certain taxes), the adjustment in section 56A(c)(9) does not apply.

Section 56A(c)(10)(A) requires AFSI to be adjusted so as not to include any item of income in connection with a mortgage servicing contract any earlier than when the income is included in gross income under any other provision of chapter 1. Section 56A(c)(10)(B) authorizes the Secretary to provide regulations to prevent the avoidance of taxes imposed by chapter 1 with respect to amounts not representing reasonable compensation (as determined by the Secretary) with respect to a mortgage servicing contract.

Section 56A(c)(11)(A) provides that AFSI is (i) adjusted to disregard any amount of income, cost, or expense that otherwise would be included on the AFS in connection with any covered benefit plan, (ii) increased by any amount of income in connection with any such covered benefit plan that is included in the gross income of the corporation under chapter 1, and (iii) reduced by any deductions allowed under any other provision of chapter 1 with respect to any such covered benefit plan. Section 56A(c)(11)(B) defines the term “covered benefit plan” to mean: (i) a defined benefit plan (other than a multiemployer plan described in section 414(f) of the Code) if the trust that is part of such plan is an employees' trust described in section 401(a) of the Code that is exempt from tax under section 501(a) of the Code; (ii) any qualified foreign plan (as defined in section 404A(e) of the Code); or (iii) any other defined benefit plan that provides post-employment benefits other than pension benefits.

Section 56A(c)(12) requires AFSI to be appropriately adjusted, in the case of an organization subject to tax under section 511 of the Code, to take into account only AFSI (i) of an unrelated trade or business of such organization, as defined in section 513 of the Code, or (ii) derived from debt-financed property, as defined in section 514 of the Code, to the extent that income from such property is treated as unrelated business taxable income.

Section 56A(c)(13)(A) requires AFSI to be reduced by depreciation deductions allowed under section 167 of the Code with respect to property to which section 168 of the Code applies, to the extent of the amount allowed as deductions in computing taxable income for the taxable year. In addition, section 56A(c)(13)(B)(i) requires appropriate adjustments to AFSI to disregard any amount of depreciation expense that is taken into account on the taxpayer's AFS with respect to such property. Section 56A(c)(13)(B)(ii) further provides that AFSI is appropriately adjusted to take into account any other item specified by the Secretary in order to provide that such property is accounted for in the same manner as that property is accounted for under chapter 1.

Section 56A(c)(14)(A)(i) requires AFSI to be reduced by amortization deductions allowed under section 197 of the Code with respect to qualified wireless spectrum, to the extent of the amount allowed as deductions in computing taxable income for the taxable year. Section 56A(c)(14)(A)(ii)(I) requires appropriate adjustments to AFSI to disregard any amount of amortization expense that is taken into account on the taxpayer's AFS with respect to such qualified wireless spectrum. Section 56A(c)(14)(A)(ii)(II) further provides that AFSI is appropriately adjusted to take into account any other item specified by the Secretary in order to provide that such qualified wireless spectrum is accounted for in the same manner as that property is accounted for under chapter 1. Section 56A(c)(14)(B) defines the term “qualified wireless spectrum” as wireless spectrum that is used in the trade or business of a wireless telecommunications carrier and that was acquired after December 31, 2007, and before August 16, 2022.

Section 56A(c)(15) authorizes the Secretary to issue regulations or other guidance to provide for such adjustments to AFSI as the Secretary determines necessary to carry out the purposes of section 56A, including adjustments to AFSI (i) to prevent the omission or duplication of any item, and (ii) to carry out the principles of part II of subchapter C (relating to corporate liquidations), part III of subchapter C (relating to corporate organizations and reorganizations), and part II of subchapter K (relating to partnership contributions and distributions) of chapter 1.

C. Financial Statement Net Operating Losses

Section 56A(d)(1) provides that AFSI (determined after the application of section 56A(c), but without regard to section 56A(d)) is reduced by an amount equal to the lesser of (i) the aggregate amount of financial statement net operating loss (FSNOL) carryovers to the taxable year, or (ii) 80 percent of AFSI (determined after the application of section 56A(c), but without regard to section 56A(d)). Section 56A(d)(2) provides that the amount of an FSNOL that can be carried forward to a taxable year is the FSNOL remaining (if any) after reducing AFSI in prior taxable years under section 56A(d)(1). An FSNOL is the net loss set forth on a taxpayer's AFS, adjusted as provided by section 56A(c), but without regard to section 56A(d), for taxable years ending after December 31, 2019. See section 56A(d)(3).

Section 56A(e) authorizes the Secretary to provide such regulations and other guidance as necessary to carry out the purposes of section 56A, including regulations and other guidance relating to the effect of the rules of section 56A on partnerships with income taken into account by an applicable corporation.

III. Applicable Corporations Under Section 59(k)

Section 59(k)(1)(A) provides that, for purposes of sections 55 through 59, the term “applicable corporation” means, with respect to any taxable year, any corporation other than an S corporation (as defined in section 1361(a)(1) of the Code), a regulated investment company (as defined in section 851 of the Code) (RIC), or a real estate investment trust (as defined in section 856 of the Code) (REIT), that meets the average annual AFSI test under section 59(k)(1)(B) (AFSI Test) for one or more taxable years that (i) are prior to that taxable year, and (ii) end after December 31, 2021.

There are two versions of the AFSI Test under section 59(k)(1)(B): one version that applies to corporations that are members of a foreign-parented multinational group (FPMG); and another version that applies to all other corporations. Under section 59(k)(1)(B)(i), a corporation that is not a member of an FPMG meets the AFSI test for a taxable year if the average annual AFSI of that corporation (determined without regard to the adjustment under section 56A(d) for FSNOLs) for the three-taxable-year period ending with that taxable year exceeds $1,000,000,000 (general AFSI test). Under section 59(k)(1)(B)(ii), a corporation that is a member of an FPMG for any taxable year meets the AFSI test for that taxable year if (i) that corporation meets the general AFSI test (determined after applying the rule in section 59(k)(2)) (FPMG $1 billion test), and (ii) the average annual AFSI of that corporation (determined without regard to the rule in section 59(k)(2) and without regard to the adjustment described in section 56A(d) for FSNOLs) for the aforementioned three-taxable-year period is at least $100,000,000.

Solely for purposes of determining whether a corporation is an applicable corporation under section 59(k)(1), section 59(k)(1)(D) provides that all AFSI of persons treated as a single employer with the corporation under section 52(a) or (b) of the Code is treated as AFSI of that corporation.

Section 59(k)(1)(D) also provides that, solely for purposes of determining whether a corporation is an applicable corporation, the AFSI of such corporation must be determined without regard to the partnership distributive share adjustment under section 56A(c)(2)(D)(i) and the adjustments under section 56A(c)(11) pertaining to covered benefit plans (as defined in section 56A(c)(11)(B)). In addition, section 59(k)(2)(A) provides that, solely for purposes of determining whether a corporation that is a member of an FPMG meets the FPMG $1 billion test, (i) the AFSI of such corporation must include the AFSI of all members of the FPMG, and (ii) AFSI is determined without regard to the partnership distributive share adjustment under section 56A(c)(2)(D)(i), the CFC pro rata share adjustment under section 56A(c)(3), the effectively connected income adjustment under section 56A(c)(4), and the adjustments under section 56A(c)(11) pertaining to covered benefit plans.

Section 59(k)(1)(E) provides additional special rules for purposes of determining whether a corporation is an applicable corporation. With regard to a corporation with AFSI for any taxable year of less than 12 months, the AFSI of that corporation (including any predecessor) is annualized by multiplying the AFSI for the short period by 12 and dividing the result by the number of months composing the short period. See section 59(k)(1)(E)(ii) and (iii).

Section 59(k)(1)(E)(i) provides that, if a corporation has been in existence for less than three taxable years, the AFSI tests are applied to that corporation on the basis of the period during which that corporation was in existence. Section 59(k)(1)(E)(iii) provides that a reference in section 59(k)(1)(E) to a corporation includes a reference to any predecessor of such corporation. Accordingly, for purposes of determining whether a corporation was in existence for less than three taxable years and, if so, the period on the basis of which the AFSI Tests are applied to that corporation, the period(s) of existence of any predecessor(s) of such corporation are included. See section 59(k)(1)(E)(i) and (iii).

Section 59(k)(1)(C) excludes a corporation from the definition of “applicable corporation” if the following requirements are satisfied. First, the corporation must have either (i) a change in ownership, or (ii) a specified number of consecutive taxable years (as determined by the Secretary, taking into account the taxpayer's facts and circumstances), including the most recent taxable year, in which the corporation does not meet an AFSI test. See section 59(k)(1)(C)(i). Second, the Secretary must determine that it would not be appropriate to continue to treat that corporation as an applicable corporation (appropriateness determination). See section 59(k)(1)(C)(ii). However, as provided in the last sentence of section 59(k)(1)(C), a corporation that satisfies these two requirements for exclusion from applicable corporation status nonetheless will be treated as an applicable corporation if that corporation subsequently meets an AFSI test for any taxable year beginning after the first taxable year for which an appropriateness determination applies.

For purposes of applying section 59(k)(2)(A), section 59(k)(2)(B) defines an FPMG, with respect to a taxable year, as two or more entities if (i) at least one entity is a domestic corporation and another entity is a foreign corporation, (ii) the entities are included in the same AFS for the year, and (iii) either the common parent of the entities is a foreign corporation or, if there is no common parent, the entities are treated as having a common parent that is a foreign corporation under rules provided by the Secretary under the authority granted by section 59(k)(2)(D) (the common parent or the entity treated as the common parent, the FPMG Common Parent). For purposes of applying section 59(k)(2), if a foreign corporation is engaged in a trade or business in the United States, that trade or business is treated as a separate domestic corporation that is wholly owned by the foreign corporation. See section 59(k)(2)(C).

Section 59(k)(2)(D) authorizes the Secretary to provide regulations or other guidance applying the principles of section 59(k)(2), including rules to determine the entities treated as having an FPMG Common Parent, the entities included in an FPMG, and the FPMG Common Parent.

Section 59(k)(3) authorizes the Secretary to provide regulations or other guidance for purposes of applying section 59(k), including providing a simplified method for determining whether a corporation meets the requirements of section 59(k)(1), and addressing the application of section 59(k) to a corporation that experiences a change in ownership.

IV. CAMT FTC

Section 59(l)(1) provides rules for determining the amount of the CAMT FTC for a taxable year if an applicable corporation chooses to claim the Regular FTC for the taxable year. The CAMT FTC of the applicable corporation for a taxable year is the sum of two amounts. The first amount (CFC Taxes) is equal to the lesser of: (i) the aggregate of the applicable corporation's pro rata share (as determined under section 56A(c)(3)) of the amount of income, war profits, and excess profits taxes (within the meaning of section 901) imposed by any foreign country or possession of the United States that are (A) taken into account on the AFS of each CFC with respect to which the applicable corporation is a U.S. shareholder, and (B) paid or accrued (for Federal income tax purposes) by each such CFC; or (ii) 15 percent of the applicable corporation's adjustment under section 56A(c)(3)(A) (CFC FTC Limitation). See section 59(l)(1)(A). The second amount is equal to the amount of income, war profits, and excess profits taxes (within the meaning of section 901) imposed by any foreign country or possession of the United States that are (i) taken into account on the AFS of the applicable corporation, and (ii) paid or accrued (for Federal income tax purposes) by the applicable corporation. See section 59(l)(1)(B).

Section 59(l)(2) provides that, for any taxable year for which an applicable corporation chooses to claim the Regular FTC, the amount of CFC Taxes for the taxable year in excess of the CFC FTC Limitation for the taxable year is carried forward for up to the five succeeding taxable years and increases the amount of CFC Taxes in any of those succeeding taxable years to the extent not taken into account in a prior taxable year.

Section 59(l)(3) authorizes the Secretary to provide regulations or other guidance as is necessary to carry out the purposes of the CAMT FTC rules in section 59(l).

V. Consolidated Return Regulations

Section 1502 authorizes the Secretary to prescribe regulations to clearly reflect the Federal income tax liability of a tax consolidated group and to prevent avoidance of such tax liability. See § 1.1502-1(h) (defining the term “consolidated group” for Federal income tax purposes). For purposes of carrying out those objectives, section 1502 explicitly permits the Secretary to prescribe rules that may be different from the provisions of chapter 1 that would apply if the corporations composing the tax consolidated group filed separate returns.

VI. Prior Guidance Relating to the CAMT

The Treasury Department and the IRS have issued seven notices with respect to the CAMT (CAMT notices).

A. Notice 2023-7

On January 17, 2023, the Treasury Department and the IRS published Notice 2023-7, 2023-3 I.R.B. 390, which announced the intention of the Treasury Department and the IRS to issue proposed regulations addressing the application of the CAMT. Notice 2023-7 provides interim guidance on certain issues relating to the CAMT, including issues regarding subchapters C and K of chapter 1, troubled corporations, tax consolidated groups, depreciation of property to which section 168 applies, the treatment of certain Federal income tax credits under the CAMT, and the determination of applicable corporation status in circumstances involving certain partnerships. Notice 2023-7 also describes a simplified method for determining whether a corporation is an applicable corporation subject to the CAMT.

B. Notice 2023-20

On March 6, 2023, the Treasury Department and the IRS published Notice 2023-20, 2023-10 I.R.B. 523, to provide interim guidance on the determination of an insurance company's AFSI as it relates to (i) variable contracts (and similar contracts), and (ii) funds withheld reinsurance and modified coinsurance agreements. Notice 2023-20 also provides interim guidance on the determination of AFSI as it relates to the basis of certain assets held by certain previously tax-exempt entities that received a “fresh start” basis adjustment.

C. Notice 2023-42

On June 7, 2023, the Treasury Department and the IRS published Notice 2023-42, 2023-26 I.R.B. 1085, to provide relief from the addition to tax under section 6655 of the Code with respect to the tax imposed under section 55(a) (CAMT liability) for any taxable year that begins after December 31, 2022, and before January 1, 2024.

D. Notice 2023-64

On October 2, 2023, the Treasury Department and the IRS published Notice 2023-64, 2023-40 I.R.B. 974, to provide additional interim guidance on determining a taxpayer's AFS and AFSI, including guidance applicable to tax consolidated groups and certain foreign corporations. Notice 2023-64 also describes guidance related to (i) AFSI adjustments with respect to depreciation of property to which section 168 applies, (ii) the amortization of qualified wireless spectrum, (iii) the treatment of certain taxes, (iv) the prevention of certain duplications and omissions, (v) the determination of applicable corporation status, (vi) the CAMT FTC, and (vii) FSNOLs.

E. Notice 2024-10

On January 16, 2024, the Treasury Department and the IRS published Notice 2024-10, 2024-3 I.R.B., to provide additional interim guidance on determining the AFSI of a U.S. shareholder if a CFC pays a dividend. Notice 2024-10 also modifies and clarifies interim guidance provided in Notice 2023-64 regarding the AFS of a tax consolidated group.

F. Notice 2024-33

On April 15, 2024, the Treasury Department and the IRS issued Notice 2024-33, 2024-18 I.R.B. 959, which provided a limited waiver of the addition to tax under section 6655 to the extent the amount of any underpayment is attributable to a portion of a corporation's CAMT liability. The relief provided in Notice 2024-33 applied only for the purpose of calculating the installment of estimated tax by a corporate taxpayer that was due on or before April 15, 2024, or May 15, 2024 (in the case of a fiscal year taxpayer with a taxable year beginning in February 2024), with respect to a taxable year that began in 2024.

G. Notice 2024-47

On June 13, 2024, the Treasury Department and the IRS issued Notice 2024-47, 2024-27 I.R.B. 1, extending the relief provided in Notice 2024-33. Under Notice 2024-47, the limited waiver of the addition to tax under section 6655 that is attributable to a corporation's CAMT liability was extended to include the calculation of any installment of estimated tax by a corporate taxpayer that was due on or before August 15, 2024, with respect to a taxable year that began in 2024.

H. Reliance on Notices

Except as provided in the next paragraph, pursuant to section 15.02 of Notice 2023-64, a taxpayer may rely on the interim guidance provided in sections 3 through 7 of Notice 2023-7 (as modified and clarified by Notice 2023-64), sections 3 through 5 of Notice 2023-20, and sections 3 through 14 of Notice 2023-64, for taxable years ending on or before September 13, 2024.

Pursuant to section 5.01 of Notice 2024-10, taxpayers may rely on the interim guidance described in section 3 of Notice 2024-10 for Covered CFC Distributions (as defined therein) received on or before September 13, 2024. In addition, pursuant to section 5.02 of Notice 2024-10, taxpayers may rely on the interim guidance described in section 4.02(5)(b) and section 6.02 of Notice 2023-64 (as modified by Notice 2024-10) and section 4.04 of Notice 2024-10 for taxable years ending before September 13, 2024. A taxpayer may not rely on the unmodified text of sections 4.02(5)(b)(i) or 6.02 of Notice 2023-64 for any tax return filed on or after December 15, 2023.

I. Feedback Received

The Treasury Department and the IRS have received feedback from taxpayers, tax professionals, and other stakeholders regarding the CAMT, including feedback received in response to the CAMT notices. Based on the feedback received, and based on further consideration of sections 55, 56A, 59 and 1502, and the CAMT notices, the Treasury Department and the IRS are proposing these regulations under sections 55, 56A, 59, 1502, and 7805 as described in the Authority section. Certain CAMT issues with respect to which stakeholders have provided feedback, as well as issues on which the Treasury Department and the IRS have further reflected after publication of the CAMT notices, are discussed in the following Explanation of Provisions.

Explanation of Provisions

I. Proposed § 1.56A-1: Adjusted Financial Statement Income (AFSI)

Pursuant to the authority granted by section 56A(c)(2)(B), (c)(15), and (e), proposed § 1.56A-1 would provide definitions and general rules for determining the AFSI of a CAMT entity (that is, any entity identified in section 7701 of the Code and the regulations under section 7701 other than a disregarded entity) for purposes of sections 55 through 59 of the Code.

Proposed § 1.56A-1(a) would provide an overview of proposed § 1.56A-1 and clarify the scope of the section 56A regulations, which term is defined to mean proposed §§ 1.56A-1 through 1.56A-27 and § 1.1502-56A. Specifically, proposed § 1.56A-1(a)(2) would provide that the section 56A regulations apply to determine a CAMT entity's AFSI, as defined in proposed § 1.56A-1(b)(1), modified FSI, as defined in proposed § 1.56A-1(b)(32) (in the case of a partnership), or adjusted net income or loss, as defined in proposed § 1.56A-1(b)(2) (in the case of a CFC), for purposes of sections 55 through 59. Proposed § 1.56A-1(a)(2) would also provide that the section 56A regulations apply to any CAMT entity whose AFSI, modified FSI, or adjusted net income or loss, as applicable, is relevant for determining whether that CAMT entity, or any other CAMT entity, is an applicable corporation under section 59(k), or the tentative minimum tax amount under section 55(b)(2)(A) of that CAMT entity, or any other CAMT entity. Significantly, while the definition of “CAMT entity” in proposed § 1.56A-1(b)(8) would include any entity identified in section 7701 of the Code and the regulations under section 7701 other than a disregarded entity, not all such entities are applicable corporations, nor are all relevant to the determination of CAMT liability for an applicable corporation, or to the determination of CAMT status.

Proposed § 1.56A-1(b) would provide definitions that apply for purposes of the section 56A regulations. Proposed § 1.56A-1(b)(1) would provide that the term “adjusted financial statement income” (AFSI) means the CAMT entity's FSI for the taxable year, adjusted as provided in the section 56A regulations.

Proposed § 1.56A-1(b)(20) would provide that the term “financial statement income” (FSI) means the net income or loss of the CAMT entity set forth on the income statement included in the CAMT entity's applicable financial statement (AFS) for the taxable year. FSI includes all the CAMT entity's items of income, expense, gain, and loss reflected in the net income or loss set forth on the income statement for the taxable year, including nonrecurring items and net income or loss from discontinued operations, but does not include items reflected elsewhere in the CAMT entity's AFS, including equity accounts such as retained earnings and other comprehensive income (OCI). OCI is not included in the net income or loss reflected on financial statements prepared in accordance with United States Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). See Accounting Standards Codification (ASC) 220-10-20 and International Accounting Standards (IAS) 1.82A. Accordingly, because the determination of FSI starts with the net income or loss set forth on an AFS, OCI would not be included in that determination.

Proposed § 1.56A-1(b)(4) would provide that the term “AFS consolidation entries” means the financial accounting journal entries that are made in preparing a consolidated financial statement for a financial statement group in order to present the financial results of that financial statement group as though all members of the financial statement group were a single economic entity. Proposed § 1.56A-1(b)(6) would provide that the term “applicable financial statement” (AFS) is defined in proposed § 1.56A-2(b). AFS means a CAMT entity's financial statement from which a CAMT entity's FSI and AFSI is determined. Proposed § 1.56A-1(b)(7) would provide that the term “CAMT basis” means the basis of an item for purposes of determining AFSI. Except as otherwise provided in the section 56A regulations, the CAMT basis of an item would be the AFS basis of the item, adjusted as provided in the section 56A regulations. Proposed § 1.56A-1(b)(22) would provide that the term “for regular tax purposes” means for the purposes of computing a CAMT entity's regular tax liability, as defined under section 26(b) of the Code, or, if the CAMT entity is a pass-through entity or a CFC, the regular tax liability of a direct or indirect owner of the CAMT entity, as applicable.

Proposed § 1.56A-1(c) would provide general rules for determining a CAMT entity's FSI, which is the starting point for determining the CAMT entity's AFSI. The rules in proposed § 1.56A-1(c) generally would be consistent with section 5 of Notice 2023-64 and section 4 of Notice 2024-10.

Proposed § 1.56A-1(c)(1) would provide that FSI includes all items of income, expense, gain, and loss reflected in the net income or loss reported in the CAMT entity's income statement, regardless of the treatment of these items for regular tax purposes. For example, FSI includes gain on a like-kind exchange that qualifies for non-recognition treatment under section 1031.

Proposed § 1.56A-1(c)(2) would set forth rules for determining the FSI of a tax consolidated group and CAMT entities that own disregarded entities. If the AFS of each member of the tax consolidated group is not the same consolidated financial statement (as determined under proposed § 1.56A-2(g)), the financial results of all CAMT entities reflected in the different AFSs of its members are combined to form a single consolidated financial statement that is treated as the AFS of the tax consolidated group. Adjustments are made to avoid duplication of financial results and to record any AFS consolidation entries that would have been made if such a consolidated financial statement actually had been prepared to the extent not already reflected in the financial results of any member. Proposed § 1.56A-1(c)(2)(i) would also provide that additional rules for determining the FSI of a tax consolidated group are under proposed § 1.1502-56A. Proposed § 1.56A-1(c)(2)(ii) would provide that special rules for determining the FSI of a CAMT entity that owns a disregarded entity or branch are under proposed § 1.56A-9.

Proposed § 1.56A-1(c)(3) and (4) would provide the rules for determining the entity-level FSI, AFS basis, and balance sheet account amounts for a CAMT entity whose financial results are included in a single consolidated financial statement. It is necessary for a CAMT entity to determine entity-level FSI, AFS basis, and balance sheet account amounts because section 56A and other CAMT provisions require certain AFSI computations or adjustments to be performed at the entity level. For example, see section 56A(c)(2)(D), which determines the AFSI of a CAMT entity that is a partner in a partnership; section 56A(c)(3), which adjusts the AFSI of a CAMT entity for any taxable year that the CAMT entity is a U.S. shareholder of one or more CFCs; and section 55, which assesses the CAMT liability for each corporate filer notwithstanding that multiple corporations may be part of the same financial statement group.

Proposed § 1.56A-1(c)(3) would set forth rules for determining a CAMT entity's FSI if the CAMT entity's AFS is a consolidated financial statement (consolidated AFS) that reflects FSI for the financial statement group (consolidated FSI). Under the proposed rules, consolidated FSI that is the CAMT entity's FSI must be (i) supported by the CAMT entity's separate books and records, including trial balances, used to create the consolidated AFS, and (ii) generally determined without regard to the financial results of the other financial statement group members. Accordingly, the loss of one member of the financial statement group may not generally offset the income of another member in determining the consolidated FSI that is the CAMT entity's FSI, even though the amounts are reflected in consolidated FSI on a net basis. See proposed § 1.56A-1(c)(3)(ii).

Additionally, under the proposed rules, the consolidated FSI that is the CAMT entity's FSI would be determined without regard to AFS consolidation entries that are made in preparing the consolidated AFS and that either: eliminate the effect of transactions between the CAMT entity and other CAMT entities that are members of the same financial statement group; or eliminate any income, loss, expense, asset, liability, or other item of the CAMT entity with respect to its investment in another CAMT entity that is a member of the same financial statement group. These elimination entries are disregarded due to the statutory requirement for entity-level AFSI computations. Absent the rules in proposed § 1.56A-1(c)(3)(iii), items would be improperly omitted from AFSI because they would not be reflected in FSI. If the CAMT entity has an investment in a partnership or domestic corporation that is a member of the same financial statement group, the CAMT entity's FSI with respect to the investment is determined as though the CAMT entity had prepared a separate financial statement in which the investment was properly accounted for under the relevant accounting standards, for example, the Parent-Entity Financial Statement accounting standards described in ASC 810-10-45-11 (unless the CAMT entity already accounts for the investment in this manner in its separate books and records). Under this approach, parent company financial statements present the parent company's investment in its subsidiaries as a single line item on the balance sheet. The amount recorded as the investment reflects the parent's proportionate share of the subsidiary's net assets. Similarly, the parent company financial statements reflect the result of operations of the subsidiary as a single line item reflecting the parent's proportionate results. See proposed § 1.56A-1(c)(3)(iii). This rule is necessary because the investment account may not be properly maintained in the separate books of the CAMT entity investor, given that the FSI of the partnership or domestic corporation in which it has an investment is already included in the consolidated financial statement.

To prevent amounts from being duplicated or omitted from a CAMT entity's FSI, proposed § 1.56A-1(c)(3)(iv) would provide that AFS consolidation entries, other than elimination entries, that relate to one or more CAMT entities that are members of the financial statement group but are not reflected in the separate books and records of the CAMT entities are appropriately allocated or pushed down (or both), as applicable, to each CAMT entity to which the AFS consolidation entries relate and taken into account in each CAMT entity's FSI.

To ensure all items on a consolidated financial statement are properly accounted for by each CAMT entity that is a member of the financial statement group, proposed § 1.56A-1(c)(3)(v) would require each CAMT entity to maintain books and records sufficient to demonstrate how the CAMT entity's FSI, determined under the rules in proposed § 1.56A-1(c)(3), reconciles to consolidated FSI of the financial statement group.

For reasons similar to those underlying proposed § 1.56A-1(c)(3), proposed § 1.56A-1(c)(4)(i) would provide that, if a CAMT entity's AFS is a consolidated financial statement, and if the CAMT entity's balance sheet accounts or AFS basis in an item is relevant for determining the CAMT entity's AFSI, then the CAMT entity uses the balance sheet accounts or AFS basis reflected in the CAMT entity's separate books and records used to create the CAMT entity's consolidated financial statement, determined under rules similar to the rules in proposed § 1.56A-1(c)(3)(iii) and (iv). Proposed § 1.56A-1(c)(4)(ii) would provide, in part, that any adjustments under purchase accounting (as defined in proposed § 1.56A-1(b)(35)) or push down accounting (as defined in proposed § 1.56A-1(b)(36)) reflected in a CAMT entity's AFS basis, balance sheet accounts, or FSI as a result of the application of proposed § 1.56A-1(c)(4)(i) may be disregarded for purposes of determining the CAMT entity's CAMT basis and AFSI under other sections of the section 56A regulations, for example, under proposed §§ 1.56A-4 and 1.56A-18. See parts IV and XVIII of this Explanation of Provisions.

Because it is necessary to determine a CAMT entity's FSI before determining its AFSI, proposed § 1.56A-1(c)(5) would provide that proposed § 1.56A-1(c) applies before proposed § 1.56A-1(d) and (e) and before all other sections of the section 56A regulations, other than proposed § 1.56A-2. Accordingly, references to AFS basis and FSI in proposed § 1.56A-1(d) and (e) and in proposed §§ 1.56A-3 through 1.56A-27 mean AFS basis and FSI as determined under the proposed § 1.56A-1(c) rules described previously.

Proposed § 1.56A-1(c)(6) would provide examples illustrating these rules.

Proposed § 1.56A-1(d) would provide general rules for determining a CAMT entity's AFSI under the section 56A regulations. The rules in proposed § 1.56A-1(d) for determining AFSI generally would be consistent with section 5 of Notice 2023-64. Accordingly, proposed § 1.56A-1(d)(1) would provide that AFSI includes all items of income, expense, gain, and loss reflected in a CAMT entity's FSI regardless of the treatment of these items for regular tax purposes, unless an exception is provided in another section of the section 56A regulations. For example, if a CAMT entity's FSI reflects gain or loss from a transaction that qualifies for nonrecognition treatment for regular tax purposes, then the gain or loss is included in AFSI except as otherwise provided in the section 56A regulations.

Proposed § 1.56A-1(d)(2) would limit the adjustments allowed in determining a CAMT entity's AFSI to those provided in the section 56A regulations or in IRB guidance (as defined in proposed § 1.56A-1(b)(31)). The section 56A regulations would encompass all statutory AFSI adjustments and any AFSI adjustments provided with the use of the regulatory authority of the Treasury Department and the IRS described in the Authority section. Certain AFSI adjustments are based on the authority granted in section 56A(c)(15), which authorizes “such adjustments to adjusted financial statement income as the Secretary determines necessary to carry out the purposes of this section . . . .” Examples of AFSI adjustments based on section 56A(c)(15) authority are those found in proposed § 1.56A-21 (regarding troubled companies) and proposed § 1.56A-12(b)(2) (regarding the proceeds of certain credit transfers).

Proposed § 1.56A-1(d)(3) generally would provide that the AFSI adjustments described in the section 56A regulations, including those adjustments that affect the CAMT basis of an item, are made for taxable years ending after December 31, 2019. However, a transition rule in proposed § 1.56A-1(d)(3)(ii) generally would provide that, except as otherwise provided in the section 56A regulations (for example, in § 1.56A-15(c)(6) and (e)(2)(ii)(A) for AFSI adjustments for section 168 property), AFSI adjustments that otherwise affect the computation of AFSI in taxable years ending after December 31, 2019, but that arise from a transaction or an event that occurred in a taxable year ending on or before December 31, 2019, are not made. The rules underlying proposed § 1.56A-1(d)(3) are derived from the statute. For example, under section 59(k)(1)(A) and (B), a corporation is an applicable corporation for a taxable year if the average annual adjusted financial statement income of the corporation for a 3-taxable-year period that is prior to such taxable year and that ends after December 31, 2021, exceeds certain thresholds. In addition, section 56A(d)(3) defines a FSNOL as the amount of the net loss on the corporation's AFS for taxable years ending after 2019. The statute generally contemplates that events that occur before 2020 but affect AFSI computations and adjustments in 2020 and later need to be considered in determining AFSI in later years. Such an approach, however, may not be administrable in certain cases. Accordingly, except where it is appropriate to carry out the purposes of section 56A (for example, for section 168 property), the transition rule would neither permit nor require AFSI adjustments with respect to pre-2020 transactions or events.

To prevent duplications and omissions, proposed § 1.56A-1(d)(4) generally would provide that, if a gain or loss is reflected in FSI with respect to an item that has a CAMT basis that is different than the item's AFS basis, and if the gain or loss is required to be recognized for AFSI purposes, then the gain or loss reflected in FSI is redetermined for AFSI purposes by reference to the CAMT basis of the item.

Proposed § 1.56A-1(e) would provide that a CAMT entity whose AFSI is not expressed in U.S. dollars must translate its AFSI, after having made all other applicable adjustments under the section 56A regulations except for those adjustments that already are expressed in U.S. dollars, to U.S. dollars using the weighted average exchange rate, as defined in § 1.989(b)-1, for the CAMT entity's taxable year. See part VI.C. of this Explanation of Provisions for a discussion of the separate rules under proposed § 1.56A-6(c)(1) that apply for translating a CFC's adjusted net income or loss to U.S. dollars.

Proposed § 1.56A-1(f) would provide that the classification of an entity for regular tax purposes applies for purposes of the section 56A regulations regardless of whether the entity or arrangement is classified differently for AFS purposes. The proposed regulations would follow regular tax principles for purposes of determining whether an organization or other arrangement is treated as an entity separate from its owners, and whether an unincorporated organization or contractual arrangement is treated as a partnership. Accordingly, regardless of the AFS treatment, a participant in a contractual arrangement that rises to the level of an entity classified as a partnership for Federal income tax purposes is treated as owning a partnership investment to which section 56A(c)(2)(D)(i) adjustments may apply. This interpretation is supported by references in section 56A to entity classifications that do not exist for AFS purposes, such as disregarded entities, and provides for administrative consistency in situations in which the financial accounting rules and the Federal income tax rules provide for disparate structural characterizations. For example, the Treasury and the IRS understand that in certain situations IFRS may treat a CAMT entity that is treated as a partner in a partnership for Federal income tax purposes as owning 100 percent of the partnership's equity, while treating another CAMT entity that is also treated as a partner in the partnership for Federal income tax purposes as a lender to that partnership. Although under IFRS a CAMT entity's partnership investment might be treated as that of a lender, the section 56A(c)(2)(D)(i) adjustment applies if the CAMT entity is treated as a partner in the partnership for Federal income tax purposes.

Proposed § 1.56A-1(g)(1) would require an applicable corporation to maintain books and records sufficient to demonstrate its compliance with the section 56A regulations, including the identification of the corporation's AFS, the determination of the corporation's FSI (including how FSI reconciles to consolidated FSI if determined under proposed § 1.56A-1(c)(3)), the substantiation of any adjustments required by the section 56A regulations, and the substantiation of AFS basis and CAMT basis. Proposed § 1.56A-1(h) would require an annual return on Form 4626, Alternative Minimum Tax-Corporations, setting forth information in the form and manner as the form or instructions prescribe.

II. Proposed § 1.56A-2: Applicable Financial Statement (AFS)

Pursuant to the authority granted by section 56A(b), (c)(15), and (e), proposed § 1.56A-2 would provide rules under section 56A(b) regarding the meaning and identification of an “applicable financial statement” and under section 56A(c)(2)(A) regarding the priority of consolidated financial statements.

A. Defining and Identifying an AFS

Section 56A(b) generally defines an “applicable financial statement” (AFS) for any taxable year as an applicable financial statement as defined in section 451(b)(3) or as specified by the Secretary in regulations or other guidance. Section 451(b)(3) and § 1.451-3(a)(5), which implements section 451(b)(3), generally provide that a taxpayer's AFS is the taxpayer's financial statement listed therein that has the highest priority. The financial statements listed in § 1.451-3(a)(5) are financial statements certified as being prepared in accordance with GAAP or IFRS, or financial statements filed with the Federal or a State government, an agency thereof, or a self-regulatory organization. Under § 1.451-3(a)(5), the financial statements that would take the highest priority are those prepared in accordance with GAAP, followed by those prepared in accordance with IFRS, followed by those filed with certain Federal, State, and foreign governments or agencies thereof.

Consistent with sections 56A(b) and 451(b)(3), proposed § 1.56A-2(b) generally would provide that the term “AFS” means a CAMT entity's financial statement listed in proposed § 1.56A-2(c) that has the highest priority. Proposed § 1.56A-2(c) generally would adopt the list of financial statements and their order of priority set forth in section 451(b)(3) and § 1.451-3(a)(5).

However, proposed § 1.56A-2(c)(3) would expand the list of financial statements to include certain certified financial statements prepared in accordance with accounting standards other than GAAP and IFRS but issued by an accounting standards board charged with developing accounting standards for one or more jurisdictions. Because these statements have been certified, they would take a higher priority than financial statements filed with governments or agencies thereof, which are not subject to a certification requirement. However, these statements would take a lower priority than financial statements certified as being prepared in accordance with GAAP or IFRS.

Additionally, proposed § 1.56A-2(c)(5) and (6) would add two additional categories of financial statements of lower priority: (i) financial statements that are unaudited (or audited but not certified) and that are prepared using accepted accounting standards for an external non-tax purpose; and (ii) the CAMT entity's Federal income tax return or information return. These categories would be added to ensure CAMT entities that do not prepare a financial statement described in any of the other categories can perform the necessary AFSI computations required under sections 56A and 59(k), including for purposes of determining whether a corporation is an applicable corporation under section 59(k) or determining the AFSI of an applicable corporation under section 56A.

As discussed previously, the list of financial statements in proposed § 1.56A-2(c) would include certain certified financial statements that are used for a substantial non-tax purpose. Proposed § 1.56A-2(h) would provide examples illustrating the presence or absence of a substantial non-tax purpose. Comments are requested on whether additional examples are necessary to illustrate other cases in which a financial statement is used for a substantial non-tax purpose.

A stakeholder requested guidance on what it means for a financial statement to be “certified,” as section 451(b)(3) and § 1.451-3(a)(5) do not address this issue. Proposed § 1.56A-2(d) would provide that a financial statement is certified for purposes of proposed § 1.56A-2(c) if it is: (i) certified by an independent financial statement auditor to present fairly the financial position and results of operations of a CAMT entity or financial statement group in conformity with the relevant financial accounting standards (that is, an unqualified or unmodified “clean” opinion); (ii) subject to a qualified or modified opinion by an independent financial statement auditor that the financial statement presents fairly the financial position and results of operations of a CAMT entity or financial statement group in conformity with the relevant financial accounting standards, except for the effects of the matter to which the qualification or modification relates (that is, a qualified or modified “except for” opinion); or (iii) subject to an adverse opinion by an independent financial statement auditor, but only if the auditor discloses the amount of the disagreement with the statement. This definition of the term “certified” generally follows the Public Company Accounting Oversight Board's rules governing an audit opinion of an independent financial statement auditor and the definition of a “certified audited” financial statement in former § 1.56-1(c)(1)(ii) ( see TD 8307, 55 FR 33671, 33679 (August 17, 1990)) (1990 Regulations). See AS 3101, The Auditor's Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion; AS 3105, Departures from Unqualified Opinions and Other Reporting Circumstances; SEC Release No. 34-81916 (October 23, 2017).

Consistent with § 1.451-3(a)(5)(iv), proposed § 1.56A-2(e) and (f) would provide additional rules for prioritizing a restated financial statement over an original financial statement if the restated financial statement is issued prior to the date the CAMT entity files its original Federal income tax return for that taxable year, and for prioritizing annual financial statements over periodic financial statements.

B. Priority of a Consolidated Financial Statement

Section 56A(c)(2)(A) provides that, if a taxpayer's financial results are reported on the AFS for a group of entities (that is, a financial statement group), rules similar to the rules in section 451(b)(5) apply. Section 451(b)(5) provides that, in such a situation, the AFS for the financial statement group is treated as the AFS of the taxpayer. The rules in § 1.451-3(h) generally provide that the AFS for the group is treated as the AFS of the taxpayer, unless the taxpayer has a separate financial statement that is of equal or higher priority than the AFS for the financial statement group.

Proposed § 1.56A-2(g)(1) would provide general rules for determining a CAMT entity's AFS if the financial results of the CAMT entity are included in a consolidated financial statement (that is, a financial statement that consolidates the financial results of more than one CAMT entity to treat such CAMT entities as if they were a single economic unit). This section generally would provide that, if a CAMT entity's financial results are included in one or more consolidated financial statements described in proposed § 1.56A-2(c)(1) through (5) (that is, financial statements other than a tax return), the CAMT entity's AFS is the consolidated financial statement with the highest priority within those sections. However, if the CAMT entity's financial results are also reported on one or more separate financial statements that are of equal or higher priority to the highest priority consolidated financial statement (as determined under proposed § 1.56A-2(c)), then the CAMT entity's AFS is the separate financial statement with the highest priority under proposed § 1.56A-2(c).

Proposed § 1.56A-2(g)(2)(i) through (iv) would provide exceptions to the use of a separate financial statement if the CAMT entity is a member of a tax consolidated group.

Proposed § 1.56A-2(g)(2)(i) generally would require a CAMT entity that is a member of a tax consolidated group that has only one consolidated financial statement described in proposed § 1.56A-2(c)(1) through (5) that contains the financial results of all members of the tax consolidated group to use that consolidated financial statement as the CAMT entity's AFS, even if the CAMT entity's financial results also are reported on a separate financial statement (or a consolidated financial statement that has the financial results of some, but not all, members of the tax consolidated group) that is of equal or higher priority to that consolidated financial statement.

Proposed § 1.56A-2(g)(2)(ii) generally would provide that, if there is more than one consolidated financial statement described in proposed § 1.56A-2(c)(1) through (5) that contains the financial results of all members of a tax consolidated group, then a CAMT entity that is a member of the tax consolidated group uses the consolidated financial statement with the highest priority, even if the CAMT entity's financial results also are reported on a separate financial statement (or a consolidated financial statement that has the financial results of some, but not all, members of the tax consolidated group) that is of equal or higher priority to that consolidated financial statement. Proposed § 1.56A-2(g)(2)(iii) and (iv) would provide additional exceptions that apply if there are no consolidated financial statements that contain the financial results of all members of a tax consolidated group.

As noted previously, if the AFS of each member of a tax consolidated group is not the same consolidated financial statement after the application of proposed § 1.56A-2(g), proposed § 1.56A-1(c)(2) would provide rules for combining the different financial statements of the members of the tax consolidated group to form a single consolidated financial statement that is treated as the AFS of the tax consolidated group for purposes of determining FSI and AFSI of the tax consolidated group under the section 56A regulations.

The foregoing rules would be consistent with the treatment of the members of a tax consolidated group as a single corporation for purposes of the CAMT. See section 56A(c)(2)(B) and proposed § 1.1502-56A(a)(2). In addition, these proposed rules would alleviate the administrative burden of determining the FSI and AFSI of a tax consolidated group by pulling information from financial statements of different members using different accounting standards.

In order to minimize the inconsistent treatment of transactions between FPMG members computing AFSI based on different financial accounting standards, proposed § 1.56A-2(g)(2)(v) would provide an additional exception to the use of a separate financial statement for a CAMT entity that is a member of an FPMG. Proposed § 1.56A-2(g)(2)(v) would provide that, if the FPMG common parent (as defined in proposed § 1.56A-1(b)(25)) prepares a consolidated financial statement (FPMG consolidated AFS) that includes the CAMT entity, the CAMT entity uses the FPMG consolidated AFS as the CAMT entity's AFS, regardless of whether the CAMT entity's financial results also are reported on a separate financial statement that is of equal or higher priority to the FPMG consolidated AFS.

Proposed § 1.56A-9, discussed later, would provide rules for attributing items of a disregarded entity or branch to its CAMT entity owner by treating them as a single CAMT entity. For this purpose, proposed § 1.56A-2(h) would provide that if the financial results of a disregarded entity or branch are reflected in the CAMT entity owner's AFS, the disregarded entity or branch may not determine its own AFS under the rules of § 1.56A-2 as if it were a separate CAMT entity (that is, the CAMT entity owner uses its AFS to determine its FSI and AFSI under the rules in proposed § 1.56A-9). Proposed § 1.56A-2(h) would further provide that if the financial results of a disregarded entity or branch are not reflected in the CAMT entity owner's AFS, the disregarded entity or branch determines its own AFS under the rules of proposed § 1.56A-2, as if it were a CAMT entity (however, see proposed § 1.56A-9(b)(3) for rules for determining the FSI and AFSI of a CAMT entity that owns a disregarded entity or branch that determines its own AFS).

Proposed § 1.56A-2 generally would be consistent with the guidance described in section 4 of Notice 2023-64, as modified and clarified in section 4 of Notice 2024-10.

III. Proposed § 1.56A-3: AFSI Adjustments for AFS Year and Taxable Year Differences

Pursuant to the authority granted by sections 56A(c)(1), (c)(15), and (e), proposed § 1.56A-3 would provide rules under section 56A(c)(1) regarding appropriate adjustments that are made to AFSI if an AFS covers a period other than the taxable year. If a CAMT entity's AFS is prepared on the basis of a financial accounting period that differs from the CAMT entity's taxable year, proposed § 1.56A-3(b) would require the CAMT entity to compute FSI and AFSI as if the financial reporting period were the same as the taxable year by conducting an interim closing of the books using the accounting standards the CAMT entity uses to prepare the AFS.

The Treasury Department and the IRS considered the methods in the 1990 Regulations and in § 1.451-3(h)(4), among other methods, in determining which adjustments are appropriate under section 56A(c)(1). Those methods included (i) performing an interim closing of the books, (ii) using pro rata amounts for each financial accounting year that includes any part of the taxable year, and (iii) in the case of an accounting year ending at least five months after the end of the taxable year, using the amount reported for the financial accounting year ending within the taxable year. The proposed regulations would provide for adjustments based on an interim closing of the books because this method carries out the purposes of the statute by producing an accurate measurement of AFSI for the taxable year.

Proposed § 1.56A-3(b)(2) would provide examples illustrating the application of an interim closing of the books to determine FSI and AFSI when a CAMT entity's AFS is prepared on the basis of a financial accounting period that differs from the taxable year.

IV. Proposed § 1.56A-4: AFSI Adjustments and Basis Determinations With Respect to Foreign Corporations

A. Overview

Section 56A(c)(2)(C) provides that a taxpayer's AFSI with respect to a corporation that is not a member of the taxpayer's tax consolidated group generally only takes into account dividends (reduced to the extent provided by the Secretary in regulations or other guidance) and other amounts that are includible in gross income or deductible as a loss under chapter 1 (other than amounts required to be included under sections 951 and 951A or such other amounts as provided by the Secretary). Section 56A(c)(3)(A) provides that the AFSI of a taxpayer that is a U.S. shareholder of one or more CFCs is adjusted to also take into account the taxpayer's pro rata share of items taken into account in computing the net income or loss set forth on the AFS (as adjusted under rules similar to those that apply in determining AFSI) of each CFC with respect to which the taxpayer is a U.S. shareholder. See proposed § 1.56A-6 (AFSI adjustments with respect to CFCs).

Section 56A(c)(15) authorizes the Secretary to issue regulations or other guidance to provide for such adjustments to AFSI as the Secretary determines necessary to carry out the purposes of section 56A, including: (i) adjustments to prevent the omission or duplication of any item; and (ii) adjustments to carry out the principles of part II of subchapter C of chapter 1 (relating to corporate liquidations) and part III of subchapter C of chapter 1 (relating to corporate organizations and reorganizations). See also section 56A(e).

Pursuant to the authority granted by sections 56A(c)(2)(C), (c)(15), and (e), proposed § 1.56A-4 would provide rules concerning foreign corporations. More specifically, proposed § 1.56A-4 would provide rules under section 56A(c)(2)(C) for determining the amount of AFSI of a CAMT entity that results solely from the CAMT entity's ownership of stock of a foreign corporation. Additionally, proposed § 1.56A-4 would provide (i) rules under section 56A(c)(15)(B) for determining the AFSI and CAMT basis consequences of certain transactions involving foreign corporations (referred to as covered asset transactions); (ii) rules regarding the treatment of elections made under section 338(g) of the Code for acquisitions of stock of foreign corporations; (iii) rules regarding the treatment of purchase accounting and push down accounting with respect to acquisitions of stock of foreign corporations; (iv) rules for adjusting AFSI in certain circumstances when basis in foreign stock received is determined under section 358 of the Code; (v) rules for adjusting modified FSI of a partnership in certain circumstances when the partnership distributes stock of a foreign corporation; and (vi) examples illustrating application of the rules in proposed § 1.56A-4.

The interaction of section 56A(c)(2)(C) and (c)(3) raises unique double-counting issues with respect to distributions by CFCs and transfers of stock of CFCs. For example, absent guidance, distributions by CFCs could result in earnings of CFCs being included in the AFSI of a U.S. shareholder of the CFC more than once. Specifically, a duplication of items may result if the U.S. shareholder includes in AFSI, under section 56A(c)(2)(C), the amount of a dividend received from earnings associated with adjusted net income or loss that the U.S. shareholder also includes in AFSI under section 56A(c)(3). A duplication of items may also result if an upper-tier CFC includes in adjusted net income or loss the amount of a dividend received from a lower-tier CFC from earnings associated with adjusted net income or loss that the U.S. shareholder includes in AFSI under section 56A(c)(3) with respect to the lower-tier CFC. Section 56A grants the Secretary broad authority to address this issue. See section 56A(c)(2)(C), (c)(15)(A), and (e).

The Treasury Department and the IRS considered various approaches to applying section 56A(c)(2)(C) to items that result solely from a CAMT entity's ownership of stock of a CFC. As indicated previously, the interaction of section 56A(c)(2)(C) and (c)(3) raises unique duplication concerns that are not present in the case of a CAMT entity's ownership of stock of a domestic corporation. In the regular tax context, similar duplication concerns relating to U.S. taxpayers owning the stock of CFCs have given rise to complex rules ( see, for example, sections 959 and 961). Creating a similar system for CAMT would be a substantial undertaking and an impediment to releasing timely guidance addressing this issue and would also increase taxpayers' compliance burden and the administrative burden on the IRS. To avoid these issues, the proposed regulations would require taxpayers to rely on existing regular tax rules with respect to CFCs within CAMT. Because the regular tax rules apply to both distributions by CFCs and transfers of stock of CFCs, the proposed regulations would require taxpayers to rely on certain regular tax rules for determining both the earnings and profits of foreign corporations and the basis of the stock of foreign corporations. Additionally, relying on the regular tax rules would be consistent with the statutory language of section 56A(c)(2)(C). See for example, the statutory language of section 56A(c)(2)(C) (referring to “other amounts which are includible in gross income or deductible as a loss under this chapter”).

The Treasury Department and the IRS also are of the view that ownership of stock of all foreign corporations should be subject to the same rules under proposed § 1.56A-4 to avoid the need for, and complexity arising from, rules addressing foreign corporations' transition into and out of CFC status. Accordingly, proposed § 1.56A-4 would apply to the ownership of stock of any foreign corporation, regardless of whether the foreign corporation is a CFC. Compare the discussion in part XVIII of this Explanation of Provisions of the rules under section 56A(c)(2)(C) regarding investments in domestic corporations that are not members of the CAMT entity's tax consolidated group and the rules under section 56A regarding certain transactions involving domestic corporations.

B. General Rule for Ownership of Foreign Stock

Proposed § 1.56A-4(c)(1) would provide for adjustments to a CAMT entity's AFSI as a result of direct ownership of stock of a foreign corporation. Specifically, consistent with Notice 2024-10, proposed § 1.56A-4(c)(1)(i) would require a CAMT entity, in calculating AFSI, to disregard any items of income, expense, gain, and loss resulting from ownership of stock of the foreign corporation, including any such items that result from acquiring or transferring such stock, reflected in the CAMT entity's FSI. Proposed § 1.56A-4(c)(1)(ii) would generally require the CAMT entity to include in AFSI any items of income, deduction, gain, and loss for regular tax purposes resulting from ownership of stock of the foreign corporation, including any items that result from acquiring or transferring such stock (for example, transaction costs). Proposed § 1.56A-4(e) would provide that if a partnership directly owns stock of a foreign corporation, then in determining the AFSI of a CAMT entity that is a partner in the partnership (or an indirect partner, in the case of tiered partnerships), the partner takes into account the tax items described in proposed § 1.56A-4(c)(1)(ii) (described in the preceding sentence) that are allocated to the partner for regular tax purposes. However, proposed § 1.56A-4(c)(1)(i) (disregarding certain items reflected in FSI) would apply at the partnership level because the partnership, as the direct owner of the stock of the foreign corporation, may have reflected certain items resulting from the ownership of stock of the foreign corporation in its FSI.

As one illustration of proposed § 1.56A-4(c)(1), the AFSI of a CAMT entity that is a domestic corporation would not reflect any inclusion with respect to a dividend received from a foreign corporation if the CAMT entity is eligible for a dividends-received deduction under section 245A of the Code for the entire amount of the dividend, because the item of FSI with respect to the dividend would be disregarded, and the regular tax income item with respect to the dividend would be offset by an item of deduction resulting from the receipt of the dividend. As another example, the AFSI of a CAMT entity that is a domestic corporation would generally not reflect any inclusion with respect to a distribution of previously taxed earnings and profits (PTEP) (described in section 959 of the Code) by a foreign corporation to the CAMT entity because the item of FSI with respect to the distribution would be disregarded and section 959(a) excludes the regular tax amount of the distribution of PTEP from the CAMT entity's gross income. See also proposed § 1.56A-6(c)(2) (applying similar rules in the context of dividends received by a CFC from a foreign corporation) and part VI of this Explanation of Provisions (regarding AFSI adjustments with respect to CFCs). Also, under proposed § 1.56A-4(c)(1)(ii), the AFSI of a CAMT entity that is a shareholder of a passive foreign investment company (as defined in section 1297 of the Code) would include regular tax items resulting from the ownership of the stock of the passive foreign investment company, including any amounts under sections 1291, 1293, and 1296 of the Code. The Treasury Department and the IRS are considering whether additional rules should be included in the final regulations to address passive foreign investment companies, including rules that would specifically address adjustments to AFSI with respect to the ownership of stock in a section 1291 fund and the indirect ownership of stock in a lower-tier passive foreign investment company. In addition, the Treasury Department and the IRS are considering whether rules specific to passive foreign investment companies would be appropriate in § 1.59-4 (CAMT foreign tax credit), including rules similar to the rules in section 1291(g)(1)(C)(ii) in respect of foreign taxes paid by section 1291 funds and rules similar to the rules in section 1293(f) in respect of foreign taxes paid by qualifying electing funds. The Treasury Department and the IRS request comments on this topic.

Under proposed § 1.56A-4(c)(1)(ii), no adjustment to AFSI would be made for amounts included in a CAMT entity's gross income under sections 951 and 951A. See section 56A(c)(2)(C). Furthermore, because a deduction under section 250 of the Code arises with respect to a foreign corporation only in connection with an income inclusion under section 951A, no adjustment is made to AFSI for amounts deducted under section 250. Additionally, because adjusted net income or loss of a CFC is computed without regard to foreign income taxes ( see proposed §§ 1.56A-8(b) and 1.56A-6(c)(1)), no adjustment would be made for the gross-up for deemed-paid foreign tax credits under section 78 of the Code.

The items described in proposed § 1.56A-4(c)(1)(ii) are determined under regular tax rules, including subchapter C of chapter 1 (subchapter C), taking into account the CAMT entity's basis in the stock of the foreign corporation for regular tax purposes and the foreign corporation's earnings and profits for regular tax purposes. Accordingly, any AFSI consequences of a distribution in respect of, or transfer of, stock of a foreign corporation would be determined, as applicable, by reference to the earnings and profits of the foreign corporation for regular tax purposes or the basis in such stock for regular tax purposes. See, for example, proposed § 1.56A-4(d)(5) (CAMT basis in foreign stock is equal to its basis for regular tax purposes). Further, CAMT retained earnings are not relevant in determining AFSI in respect of ownership of stock of foreign corporations. Certain earnings and profits of a foreign corporation for regular tax purposes carry over to a domestic corporation under section 381(c)(2) of the Code for purposes of determining that domestic corporation's CAMT retained earnings. See § 1.367(b)-3(f)(1) (providing the extent to which earnings and profits of a foreign corporation carryover to a domestic corporation in an inbound nonrecognition transaction); proposed § 1.56A-4(h)(8) ( Example 8); and proposed § 1.56A-18(c)(7)(i). CAMT retained earnings of a domestic corporation would not carry over to a foreign corporation under section 381(c)(2) because CAMT retained earnings are not relevant in determining AFSI in respect of ownership of stock of foreign corporations. This is the case even though earnings and profits of a domestic corporation may carry over to a foreign corporation under section 381(c)(2) for purposes of determining the foreign corporation's earnings and profits for regular tax purposes.

While proposed § 1.56A-4(c)(1)(ii) would determine the AFSI consequences resulting from ownership of stock of a foreign corporation by reference to the basis in that stock for regular tax purposes and the foreign corporation's earnings and profits for regular tax purposes, the rules in proposed §§ 1.56A-18 and 1.56A-19 generally would determine the AFSI consequences resulting from ownership of stock of a domestic corporation by reference to the CAMT basis in that stock and the domestic corporation's CAMT retained earnings.

C. Covered Asset Transactions

Pursuant to the authority granted by section 56A(c)(15)(B), proposed § 1.56A-4 would incorporate certain rules under subchapter C for determining the AFSI and CAMT basis consequences of certain transactions involving foreign corporations (referred to as covered asset transactions). However, the proposed rules would use the CAMT basis of transferred assets to determine the AFSI consequences of such transfers and that basis may be different than the basis for regular tax purposes, except in the case of foreign stock. Using CAMT basis for assets other than foreign stock is consistent with the general rule in proposed § 1.56A-1 and appropriate because the duplication concerns that exist for foreign stock are not present.

Proposed § 1.56A-4(b), which would provide definitions that apply for purposes of proposed § 1.56A-4, would define the term covered asset transaction. The definition of covered asset transaction uses the concept of a component transaction (within the meaning of proposed § 1.56A-18(b)(6)) to distinguish the fact patterns in which the rules of proposed § 1.56A-4 (which apply to ownership of foreign stock) apply versus the rules of proposed §§ 1.56A-18 and 1.56A-19 (which generally apply to ownership of domestic stock). The rules of proposed §§ 1.56A-18 and 1.56A-19 apply on a component transaction-by-component transaction basis. Covered asset transactions include two categories of transactions.

The first category of covered asset transactions involves a transfer of an asset to, or by, a foreign corporation. More specifically, this first category includes a component transaction in which one or more assets are: (i) transferred by a foreign corporation in a transfer to which section 311 of the Code applies; (ii) transferred by a foreign corporation in a transfer that is part of a complete liquidation to which sections 332 and 337 of the Code apply; (iii) transferred to a foreign corporation in a transfer to which section 351 or section 361 of the Code applies; (iv) transferred by a foreign corporation in a transfer to which section 361 applies; (v) stock, or stock and securities, of a domestic corporation described in section 355(a)(1)(A) of the Code and transferred by a foreign corporation in a transfer to which section 355 applies; or (vi) securities of a foreign corporation that is a party to a reorganization described in section 368(a)(1) and transferred in a transfer to which section 354 or 356 applies.

The second category of covered asset transactions involves a transfer of foreign stock to or by a domestic corporation. That is, this second category includes a component transaction in which one or more assets, at least one of which is stock of a foreign corporation, are: (i) transferred by a domestic corporation in a transfer to which section 311 applies; (ii) transferred by a domestic corporation in a transfer that is part of a complete liquidation to which sections 332 and 337 apply; (iii) transferred to a domestic corporation in a transfer to which section 351 or section 361applies; (iv) transferred by a domestic corporation in a transfer to which section 361 applies; (v) stock, or stock and securities, of a foreign corporation described in section 355(a)(1)(A) and transferred by a domestic corporation in a transfer to which section 355 applies; or (vi) securities of a domestic corporation that is a party to a reorganization described in section 368(a)(1) and transferred in a transfer to which section 354 or 356 applies, provided the securities are exchanged for stock or securities of a foreign corporation that is a party the reorganization.

Proposed § 1.56A-4(c)(2) would provide for adjustments to a CAMT entity's AFSI as a result of a transfer of an asset other than stock of a foreign corporation in a covered asset transaction. Specifically, proposed § 1.56A-4(c)(2)(i) would require a CAMT entity, in calculating AFSI, to disregard any items of income, expense, gain, and loss with respect to the transferred asset resulting from the covered asset transaction reflected in the CAMT entity's FSI. Proposed § 1.56A-4(c)(2)(ii) would require the CAMT entity to include any items of income, deduction, gain, and loss for regular tax purposes with respect to the transferred asset resulting from the covered asset transaction; however, for this purpose, the amount of each such item would be computed by substituting the CAMT entity's CAMT basis in the transferred asset for the CAMT entity's basis in the transferred asset for regular tax purposes.

Proposed § 1.56A-4(d)(1) would provide rules for determining the CAMT basis in an asset that is transferred in a covered asset transaction. The rules for determining CAMT basis would rely on the principles of the Code that apply to these transactions for determining basis for regular tax purposes, but use CAMT basis instead of regular tax basis as applicable. If the asset is transferred in a covered asset transaction described in section 311, the transferee's CAMT basis in the asset would be determined in the manner described in section 301(d) of the Code. If the asset is transferred in a covered asset transaction described in sections 332 and 337, the transferee's CAMT basis in the asset would be determined in the manner described in section 334(b) of the Code, substituting the transferor's CAMT basis in the asset for the transferor's basis in the asset for regular tax purposes. If the asset is transferred in a covered asset transaction described in section 351 or 361, the transferee's CAMT basis in the asset would be determined in the manner described in section 362 of the Code, substituting the transferor's CAMT basis in the asset for the transferor's basis in the asset for regular tax purposes and substituting the amount of gain included in the transferor's AFSI for the amount of gain recognized to the transferor for regular tax purposes. However, if the transferor is not a CAMT entity, the transferee's CAMT basis in the asset would be equal to the transferee's basis in the asset for regular tax purposes. Thus, if an individual transfers an asset to a foreign corporation in a transaction described in section 351, this rule would apply to the extent the individual is not a CAMT entity (that is, an individual that does not operate a trade or business that would not be required to determine AFSI for any purpose under the section 56A regulations).

If the asset transferred is stock or securities of a domestic corporation described in section 355(a)(1)(A) and the asset is transferred by a foreign corporation in a covered asset transaction to which section 355 applies, the transferee's CAMT basis in the transferred stock or securities of the domestic corporation would be equal to the transferee's basis in the stock or securities for regular tax purposes. If the asset transferred is stock or securities of a foreign corporation described in section 355(a)(1)(A) and the asset is transferred by a domestic corporation in a covered asset transaction to which section 355 applies, the transferee's CAMT basis in the stock or securities of the domestic corporation would be determined by applying section 358, substituting the transferee's CAMT basis in the stock or securities of the domestic corporation for the transferee's basis in the stock of the domestic corporation for regular tax purposes. If the asset transferred is securities of a foreign corporation that is a party to a reorganization described in section 368(a)(1) and the asset received in exchange for the securities is not stock of a foreign corporation that is a party to the reorganization, the transferee's CAMT basis in the asset received would be determined by applying section 358, substituting the transferee's CAMT basis in the securities of the foreign corporation for the transferee's basis in such securities for regular tax purposes. If the asset transferred is securities of a domestic corporation that is a party to a reorganization described in section 368(a)(1) and the asset received in exchange for the securities is not stock of a foreign corporation that is a party to the reorganization, the transferee's CAMT basis in the asset received would be determined by applying section 358, substituting the transferee's CAMT basis in the securities of the domestic corporation for the transferee's basis in such securities for regular tax purposes.

D. Section 338(g) Transactions

Proposed § 1.56A-4(c)(3) would provide adjustments to the AFSI of a foreign corporation the stock of which is purchased in a transaction where the purchaser makes an election under section 338(g) (a section 338(g) transaction), consistent with the general principles underlying the rules in proposed § 1.56A-4 to follow regular tax rules for foreign stock and transactions involving foreign corporations. Specifically, proposed § 1.56A-4(c)(3) would require such a foreign corporation, when calculating AFSI, to include any net gain or loss that results for regular tax purposes with respect to all assets the foreign corporation is treated as selling by reason of the section 338(g) transaction; however, for this purpose, the amount of gain or loss with respect to each asset that the foreign corporation is deemed to have sold by reason of the section 338(g) transaction is computed by substituting the foreign corporation's CAMT basis in the asset for the foreign corporation's basis in the asset for regular tax purposes. Proposed § 1.56A-4(d)(2) would provide a parallel rule that if stock of a foreign corporation is acquired in a section 338(g) transaction, immediately after the section 338(g) transaction, the foreign corporation's CAMT basis in the assets it is deemed to have purchased by reason of the section 388(g) transaction is equal to the foreign corporation's basis in those assets for regular tax purposes. See proposed § 1.56A-18(g)(2) and (4) (addressing AFSI consequences to a domestic target corporation and CAMT basis in the target corporation's assets in a transaction where there is an election under section 336(e), 338(g), or 338(h)(10) of the Code).

E. Purchase Accounting and Push Down Accounting Adjustments

Proposed § 1.56A-1(c)(4)(ii) would provide that, except as otherwise provided, any purchase accounting and push down accounting adjustments, as applicable, are required to be reflected in the CAMT entity's AFS basis, balance sheet accounts, and FSI. Proposed § 1.56A-4(c)(4) would provide an exception to this general rule such that any purchase accounting or push down accounting adjustments, as applicable, with respect to an acquisition of the stock of a foreign corporation by a CAMT entity would be disregarded for purposes of determining the CAMT entity's AFSI. Proposed § 1.56A-4(d)(4) would provide a parallel rule that any purchase accounting or push down accounting adjustments, as applicable, with respect to an acquisition of the stock of a foreign corporation by a CAMT entity would be disregarded for purposes of determining the CAMT basis in the foreign corporation's assets. See proposed § 1.56A-18(c)(3) (addressing purchase accounting and push down accounting adjustments where the stock of a domestic corporation is acquired).

F. AFSI Adjustments in Certain Cases in Which Basis in Foreign Stock Is Determined Under Section 358

CAMT basis in stock of a foreign corporation is equal to the basis in the stock for regular tax purposes. See proposed § 1.56A-4(d)(5). If stock of a foreign corporation is received in a transaction subject to section 358, the recipient CAMT entity's basis in the foreign stock received for regular tax purposes is determined in whole or in part by reference to the basis in other property for regular tax purposes, which may be different than the CAMT basis in such property. For example, if the stock of a foreign corporation is received by reason of an asset transferred to the foreign corporation in a transaction described in section 351(a), the transferor's basis in the stock of the foreign corporation received is determined under section 358 by reference to the transferor's basis in the asset transferred. As another example, if the stock of a foreign corporation is received in a distribution described in section 355, the distributee's basis in the stock of the foreign corporation received is determined under section 358 by reference to the distributee's basis in the stock of the distributing corporation.

Proposed § 1.56A-4(f) would provide rules that apply to certain cases in which a CAMT entity receives stock of a foreign corporation in a covered asset transaction and the CAMT entity's basis in the stock of the foreign corporation for regular tax purposes is determined under section 358. These rules compare the CAMT basis in the stock of the foreign corporation (which equals its basis for regular tax purposes) with what the CAMT basis would have been had it been determined under section 358, substituting the CAMT basis for the basis for regular tax purposes in the property by reference to which the basis of the foreign stock for regular tax purposes is determined in whole or in part (such amount, the hypothetical CAMT basis). To the extent a CAMT entity's basis in the stock of the foreign corporation received for regular tax purposes exceeds its hypothetical CAMT basis in that stock (referred to as basis disparity in this part IV of this Explanation of Provisions), the CAMT entity increases its AFSI for the taxable year in which the foreign stock is received if either of two requirements is satisfied.

The first requirement is satisfied if a principal purpose of the covered asset transaction is to avoid treatment of the CAMT entity or another CAMT entity as an applicable corporation or to reduce or otherwise avoid a liability under section 55(a) (principal purpose rule). The second requirement is satisfied if within two years of the date the stock of the foreign corporation is received, the basis in such stock of the foreign corporation is taken into account, in whole or in part, in determining the AFSI of the recipient CAMT entity or another CAMT entity (two-year rule). The principles of the two-year rule apply with respect to any asset whose basis for regular tax purposes is determined in whole or in part by reference to the basis of the foreign stock received. For example, if stock of the foreign corporation received is subsequently transferred in a transaction described in section 351(a) to another foreign corporation in exchange for stock of such other foreign corporation (or if the foreign stock received is exchanged under section 354 of the Code for stock in another foreign corporation), then the two-year rule applies to both the stock of the foreign corporation received in the initial transfer as well as the stock of the other foreign corporation received in the subsequent transfer.

To illustrate the principal purpose rule, consider the following fact pattern. USP, a domestic corporation, owns all the stock of a controlled foreign corporation (CFC1), which has a functional currency of the U.S. dollar. CFC1 owns Asset A, with a basis for regular tax purposes of $10x, a CAMT basis of $4x, and fair market value of $20x. The intent is for CFC1 to sell Asset A. For CAMT purposes, if CFC1 were to sell Asset A, CFC1 would include $16x in adjusted net income or loss under proposed § 1.56A-6 (fair market value of $20x, less CAMT basis of $4x) and USP's pro rata share of CFC1's adjusted net income or loss would take into account the $16x. With a principal purpose of reducing CFC1's adjusted net income or loss and USP's pro rata share, Asset A is contributed to a newly formed foreign corporation (CFC2) in exchange solely for stock of CFC2 in a transaction that qualifies under section 351(a) for regular tax purposes and therefore is a covered asset acquisition (asset transfer). CFC1's CAMT basis in the stock of CFC2 received is equal to $10x (the amount of CFC1's basis in the stock of CFC2 for regular tax purposes), and CFC1's hypothetical CAMT basis in the stock of CFC2 is $4x. In a transaction purported to be separate from the asset transfer for purposes of qualifying the asset transfer under section 351, CFC1 then subsequently sells the stock of CFC2 to a third party in exchange for cash, and the CAMT basis for purposes of determining the amount included in CFC1's adjusted net income or loss is $10x. Under the principal purpose rule, CFC1's adjusted net income or loss is increased by the $6x basis disparity (the excess of the basis in the stock of CFC2 for regular tax purposes and CAMT purposes ($10x) over the hypothetical CAMT basis ($4x)) for the taxable year in which the asset transfer occurs.

The Treasury Department and the IRS considered alternatives to addressing the basis disparity concern. One alternative is to adjust (increase or decrease) the recipient CAMT entity's AFSI in all cases in which there is a basis disparity, including if the basis disparity arises when a CAMT entity's basis in stock of the foreign corporation received for regular tax purposes is less than the hypothetical CAMT basis. However, in this case, if the CAMT entity and the foreign corporation whose stock is received are related, the decrease in AFSI would be allowed only when the recipient CAMT entity and the foreign corporation are no longer related. Another alternative is to implement an account system whereby the basis disparity would be tracked and taken into account as an increase or decrease to AFSI, as applicable, as the basis in the stock of the foreign corporation received is taken into account, for example, upon a taxable sale or a return of basis distribution under section 301. A concern with an account tracking system is that it would introduce complexity, including the need to track the account reflecting stock of each foreign corporation for a potentially significant period and address subsequent transactions that duplicate basis in the foreign stock (transactions in which basis in another asset is determined by reference to the basis in the foreign stock, including section 351 transfers of the foreign stock). The Treasury Department and the IRS welcome comments on the proposed rule and whether alternatives should be further considered.

G. Adjustments to AFSI When Certain Foreign Stock Is Distributed by a Partnership

Proposed § 1.56A-4(g) would provide rules for distributions of certain stock of a foreign corporation by a partnership to a related CAMT entity. If a partnership distributes stock of a foreign corporation and the distributee partner increases its basis in the stock pursuant to section 732(b) of the Code for regular tax purposes, section 734(b)(2)(B) of the Code generally requires the partnership to reduce the basis of its remaining property for regular tax purposes if either the partnership has an election under section 754 of the Code in effect or the distribution results in a substantial basis reduction as defined in section 734(d). There is no similar mechanism under CAMT, however, for the partnership to reduce its basis in remaining property, other than its basis in any remaining foreign stock to the extent the basis in such stock is reduced for regular tax purposes. As a result, if the distributee partner were to subsequently dispose of the foreign stock, there would be an omission from AFSI in the amount of the basis increase under section 732(b) that did not result in a corresponding basis decrease under section 734(b)(2)(B) to any remaining foreign stock held by the partnership.

The Treasury Department and the IRS are concerned that related parties might abuse the rules relating to the CAMT basis of foreign stock distributed by a partnership to create omissions from AFSI. Accordingly, proposed § 1.56A-4(g)(1) would provide that if a partnership distributes stock of a foreign corporation to a partner that is a related CAMT entity, and the basis for regular tax purposes in the foreign stock to the related CAMT entity distributee is increased pursuant to section 732(b) (distributee step-up amount), and the distributee step-up amount is greater than the amount, if any, that the distributing partnership is required to decrease its basis for regular tax purposes in any remaining foreign stock pursuant to section 734(b)(2)(B) (partnership basis decrease amount), the distributing partnership must increase its modified FSI for the taxable year of the distribution by any excess of the distributee step-up amount over the partnership basis decrease amount. For purposes of this rule, a partner would be a related CAMT entity if immediately before the distribution, the partner is related to the distributing partnership or any partner in the distributing partnership within the meaning of sections 267(b) or 707(b)(1) of the Code, without regard to section 267(c)(3).

The proposed rule would be limited to related party partnerships and basis increases in order to address potentially abusive transactions. The Treasury Department and the IRS request comments on proposed § 1.56A-4(g), including whether it is appropriate to limit the rule to related party partnerships and whether rules are needed to prevent duplications to AFSI for distributions of foreign stock by a partnership where the distributee partner decreases the basis for regular tax purposes of the distributed foreign stock pursuant to section 732(a)(2) or (b).

V. Proposed § 1.56A-5: AFSI Adjustments for Partner's Distributive Share of Partnership AFSI

Pursuant to the authority granted by section 56A(c)(2)(D)(i), (c)(15), and (e), proposed § 1.56A-5 would provide rules under section 56A(c)(2)(D) regarding a partner's distributive share of partnership AFSI. Section 56A(c)(2)(D)(i) provides that, except as provided by the Secretary, if the taxpayer is a partner in a partnership, AFSI of the taxpayer with respect to such partnership is adjusted to only take into account the taxpayer's distributive share of AFSI of such partnership. Section 56A(c)(2)(D)(ii) provides that, for the purposes of the CAMT, the AFSI of a partnership is the partnership's net income or loss set forth on the partnership's AFS adjusted under rules similar to the rules of section 56A.

Stakeholders have suggested various approaches to determining a CAMT entity's distributive share of AFSI from a partnership investment (that is, a CAMT entity's interest in a partnership). One suggested approach is a “top-down” method that would start with the FSI amount reported by the CAMT entity on its AFS and adjustments to this amount under section 56A. Under a top-down method, a CAMT entity's distributive share of AFSI from a partnership investment generally would be based on the CAMT entity's method used to account for the investment for AFS purposes.

Another suggested approach is a “bottom-up” method. Under this method, a partnership would calculate its AFSI and allocate each partner a “distributive share” of the partnership's AFSI. Stakeholders have suggested that a partner's “distributive share” of a partnership's AFSI could be based on tax principles (for example, section 704(b) or (c) of the Code) or financial accounting principles (for example, the equity method (as described in proposed § 1.56A-1(b)(15))). Other suggested approaches included allowing CAMT entities to use their regular tax income amounts from a partnership investment as their distributive share amount of AFSI from such investment.

A bottom-up approach is consistent with the statute and is more conducive to taking into account section 56A adjustments. A bottom-up approach supports the framework of section 56A(c)(2)(D)(ii), which suggests that a partnership calculates its AFSI prior to determining the partners' distributive shares of such AFSI. Additionally, a bottom-up approach allows for a consistent methodology to be used to calculate a CAMT entity's distributive share of partnership AFSI regardless of the method used by a CAMT entity to account for its partnership investment for AFS purposes. For example, if a CAMT entity accounts for a partnership investment by using the fair value method for AFS purposes (as described in proposed § 1.56A-1(b)(17)), a top-down approach would require the CAMT entity to report a mark-to-market amount with respect to that partnership investment for purposes of its FSI, although making applicable adjustments to that amount under section 56A in a precise manner might not be possible. As a result, under a top-down approach, multiple methodologies might be required to calculate the applicable adjustments under section 56A, depending on the CAMT entity's method to account for its partnership investment for AFS purposes. Under a bottom-up approach, all CAMT entities would calculate their distributive share amounts of AFSI from a partnership investment using a consistent methodology, which is referred to in proposed § 1.56A-5(c) as the “applicable method.”

Additionally, under a bottom-up approach, a CAMT entity's distributive share of AFSI generally should be based on the income it reports for AFS purposes with respect to its partnership investment rather than the amount of its taxable income with respect to the partnership investment. Accordingly, under proposed § 1.56A-5, a CAMT entity's distributive share of AFSI from a partnership investment generally would be based on the share of the partnership's FSI that the CAMT entity reports on its AFS with respect to such investment, rather than on the CAMT entity's allocations of partnership items for regular tax purposes. This rule comports with the structure of the CAMT, which generally imposes a tax that is based on book income with certain adjustments. Proposed § 1.56A-5 would provide certain exceptions that would be consistent with the statute's adjustments to FSI.

A. General Rule

Proposed § 1.56A-5 would provide rules for the applicable method (that is, a bottom-up approach) to determine a CAMT entity's distributive share of AFSI with respect to its partnership investment. In a tiered partnership structure, each partnership would be a CAMT entity with respect to the partnership in which it is a partner and would be required to compute its distributive share of AFSI with respect to its interest in the lower-tier partnership.

Proposed § 1.56A-5(b) generally would provide that, if a CAMT entity is a partner in a partnership, its AFSI with respect to its partnership investment is adjusted as required under the applicable method in proposed § 1.56A-5(c) and the rules in proposed § 1.56A-20 (concerning AFSI adjustments to apply certain principles of subchapter K of chapter 1 (subchapter K)) to take into account its distributive share of the partnership's AFSI. A CAMT entity must use the applicable method described in proposed § 1.56A-5(c) to determine its AFSI adjustment regardless of the CAMT entity's method used to account for its partnership investment for AFS purposes.

B. Applicable Method

Under the applicable method in proposed § 1.56A-5(c), a CAMT entity would compute its distributive share of AFSI with respect to its partnership investment by first disregarding any amount the CAMT entity reflects in its FSI with respect to that investment for the taxable year (for example, under the fair value method or the equity method), except as provided in proposed § 1.56A-5(d). See proposed § 1.56A-5(c)(1). The CAMT entity then would include its “distributive share amount” (as determined under proposed § 1.56A-5(e)) for the taxable year in its AFSI with respect to its investment in the partnership. See proposed § 1.56A-5(c)(2).

C. Amounts Not Disregarded

The statutory directive in section 56A(c)(2)(D) to take into account only the taxpayer's distributive share of a partnership's AFSI does not mean that a CAMT entity may disregard all amounts with respect to a partnership investment that are outside the scope of the “distributive share amount,” as computed under proposed § 1.56A-5(e), in determining its FSI with respect to that investment. Section 56A(c)(2)(D) and the applicable method implementing this statutory provision address only a CAMT entity's AFSI amount based on a partnership's AFSI. FSI amounts resulting from transactions such as a transfer, sale or exchange, or deconsolidation of a partnership investment are not covered by section 56A(c)(2)(D). Accordingly, proposed § 1.56A-5(d) would clarify the amounts of FSI with respect to the CAMT entity's partnership investment that may not be disregarded in applying the applicable method under proposed § 1.56A-5(c). Under proposed § 1.56A-5(d), a CAMT entity may not disregard any FSI amounts attributable to a transfer, sale or exchange, contribution, distribution, dilution, deconsolidation, change in ownership, or any other transaction between any partners (including the CAMT entity) and the partnership, or between any partners (including the CAMT entity), that are not derived from, and included in, the partnership's FSI. As a result, such amounts are not excluded from a CAMT entity's AFSI under the applicable method. However, these amounts may be subject to adjustment under proposed §§ 1.56A-1(d)(4) (concerning redetermination of FSI gains and losses) and 1.56A-20 (concerning AFSI adjustments to apply certain subchapter K principles). In addition, in the case of a CAMT entity and a partnership that are members of the same financial statement group, proposed § 1.56A-5(d) would provide that the FSI of the CAMT entity with respect to the partnership investment is determined under proposed § 1.56A-1(c)(3)(iii) (concerning elimination journal entries).

D. Distributive Share Amount

The rules for computing the distributive share amount included in a CAMT entity's AFSI with respect to its partnership investment under proposed § 1.56A-5(c)(2) are contained in proposed § 1.56A-5(e). Proposed § 1.56A-5(e)(1) would provide that a CAMT entity's distributive share amount is computed for each taxable year based on the following four steps: (i) the CAMT entity determining its distributive share percentage; (ii) the partnership determining its modified FSI; (iii) the CAMT entity multiplying its distributive share percentage by the modified FSI of the partnership (as reported by the partnership); and (iv) the CAMT entity adjusting the product of the amount determined in (iii) for certain separately stated section 56A adjustments.

Proposed § 1.56A-5(e)(2) would provide rules for how a CAMT entity determines its distributive share percentage. As described previously in this part V of the Explanation of Provisions, determining a CAMT entity's distributive share percentage based on the amount of FSI it reports on its AFS with respect to its partnership investment, and not on its economic interest for regular tax purposes, is appropriate because the CAMT is a tax based on income reported by a CAMT entity for AFS purposes.

Accordingly, proposed § 1.56A-5(e)(2) would provide that a CAMT entity's distributive share percentage is a fraction, the numerator of which is the FSI amount that is disregarded under the applicable method (but redetermined based on the partnership's taxable year if the taxable year of the partnership and the CAMT entity are different), and the denominator of which depends on the method of accounting the CAMT entity uses for AFS purposes, but in each case, as determined by the CAMT entity for AFS purposes.

In the case of a CAMT entity and a partnership that are members of the same financial statement group, or in the case of a CAMT entity that uses the equity method to account for its partnership investment (including the hypothetical liquidation at book value method under the equity method), the denominator would be 100 percent of the partnership's FSI for the partnership's taxable year. See proposed § 1.56A-5(e)(2)(i). In the case of a CAMT entity that uses the fair value method to account for its partnership investment, the denominator would be the total change in the fair value of the partnership during the partnership's taxable year as determined by the CAMT entity for inclusion of its share of the total change in its AFS. See proposed § 1.56A-5(e)(2)(ii). In the case of a CAMT entity that treats its partnership investment as other than equity for AFS purposes (for example, as debt) (a non-AFS partner), the denominator would be 100 percent of the partnership's FSI for the taxable year plus the FSI amount included in the numerator of the distributive share percentage for the taxable year. See proposed § 1.56A-5(e)(2)(iii). In the case of a CAMT entity that treats itself as owning 100 percent of the equity in the partnership for AFS purposes because the CAMT entity treats all other partners as non-AFS partners, the denominator would be 100 percent of the partnership's FSI for the taxable year plus the sum of any amounts reflected in the partnership's FSI that are treated as paid or accrued to the other partners for the partnership's taxable year. See proposed § 1.56A-5(e)(2)(iv). In the case of a CAMT entity that uses any other method of accounting to account for its partnership investment, the denominator would be an amount determined under the principles set forth in proposed § 1.56A-5(e)(2)(i) and (ii) that is reasonable under the facts and circumstances and reflective of the proportionate amount of the partnership's FSI the CAMT entity is reporting for AFS purposes. See proposed § 1.56A-5(e)(2)(v).

It is possible for the distributive share percentage to be a negative number. This situation may arise if a partner is using the equity method to account for its partnership investment and the partnership's FSI is positive but the CAMT entity is reporting a negative FSI amount. In such cases, the negative distributive share percentage is multiplied by the partnership's modified FSI. If the distributive share percentage is negative and the partnership's modified FSI is positive, the result for the CAMT entity's share of modified FSI will be a negative amount. Similarly, if the distributive share percentage is negative and the partnership's modified FSI is negative, the result for the CAMT entity's share of modified FSI will be a positive amount. Examples under proposed § 1.56A-5 would include illustrations on computing the distributive share percentage. See proposed § 1.56A-5(k). The Treasury Department and the IRS appreciate that the calculation methodology provided for in proposed § 1.56A-5(e)(2) may produce imprecise results under certain circumstances, particularly in the case of a CAMT entity that uses the hypothetical liquidation at book value method under the equity method to account for its partnership investment for AFS purposes, treats itself as a non-AFS partner, or treats itself as owning 100 percent of the equity in the partnership because the CAMT entity treats all other partners in the partnership as non-AFS partners. The Treasury Department and the IRS request comments on more precise methods that could be used to calculate a CAMT entity's distributive share percentage, including in the circumstances described in the previous sentence. The Treasury Department and the IRS also request comments on whether AFSI with respect to a non-AFS partner's partnership investment should be determined other than by use of a distributive share percentage and the applicable method, including in situations where more than one CAMT entity is a non-AFS partner in the partnership.

The second step in the distributive share amount computation is for the partnership to determine its modified FSI. To facilitate this computation, proposed § 1.56A-5(e)(3) would provide that a partnership starts with its FSI for its taxable year (as determined under proposed § 1.56A-1(c)) and makes all AFSI adjustments provided for in the section 56A regulations that are applicable to partnerships, with certain enumerated exceptions.

The third step in the distributive share amount computation is for the CAMT entity to multiply its distributive share percentage by the partnership's modified FSI, as reported by the partnership to the CAMT entity. See proposed § 1.56A-5(e)(1)(iii).

The fourth and final step in the distributive share amount computation is for the CAMT entity to adjust the amount determined in the previous sentence (that is, in the third step) by certain AFSI items that are separately stated to the CAMT entity and not taken into account by the partnership in determining its modified FSI. See proposed § 1.56A-5(e)(1)(iv) and (e)(4)(ii). Separately stated AFSI items that adjust a CAMT entity's distributive share amount would include certain AFSI items with respect to basis adjustments under section 743(b) and § 1.1017-1(g)(2) attributable to section 168 property or qualified wireless spectrum and would be based on the CAMT entity's distributive share of the items for regular tax purposes. See proposed §§ 1.56A-15(d)(2)(ii) and (iv) and 1.56A-16(d)(2)(ii) and (iv).

Separately stated AFSI items that adjust a CAMT entity's distributive share amount would also include certain amounts resulting from a disposition of section 168 property or qualified wireless spectrum by a partnership to which the CAMT entity had a basis adjustment under section 743(b) or § 1.1017-1(g)(2) in place, as provided under proposed §§ 1.56A-15(e)(3)(iii) and (iv) and 1.56A-16(e)(3)(iii) and (iv). See proposed §§ 1.56A-15(e)(3)(iii) and (iv) and 1.56A-16(e)(3)(iii) and (iv).

Lastly, separately stated AFSI items that adjust a CAMT entity's distributive share amount would include the CAMT entity's distributive share of deferred distribution gain or loss described in proposed § 1.56A-20(d)(1)(ii), which would be equal to the CAMT entity's allocable share of the items as provided in proposed § 1.56A-20(d)(2)(i), taking into account any acceleration event under proposed § 1.56A-20(d)(1)(iii) and (d)(2)(ii).

Under proposed § 1.56A-5(e)(4)(iii), certain AFSI items would be separately stated by the partnership but would not be taken into account as adjustments to a CAMT entity's distributive share amount. Instead, these AFSI items would be taken into account by a CAMT entity in determining its AFSI. These AFSI items include items described in proposed § 1.56A-4(c)(1)(ii) with respect to stock of foreign corporations owned by the partnership, as provided under proposed § 1.56A-4(e); items described in proposed § 1.56A-6(c)(2)(iii) with respect to stock of foreign corporations owned by the partnership, as provided under proposed § 1.56A-6(c)(2)(iv); items described in proposed § 1.56A-8(c) with respect to creditable foreign tax expenditures of a partnership, as provided under proposed § 1.56A-8(c); and the item described in proposed § 1.56A-21(e)(2)(iii) with respect to discharge of indebtedness income reflected in the partnership's FSI, as provided under proposed § 1.56A-21(e)(2)(ii). Although proposed § 1.56A-5(e)(4)(iii) refers to the items described in § 1.56A-6(c)(2)(iii) as “AFSI items,” these items represent adjustments to the adjusted net income or loss of a CFC. See § 1.56A-6(c)(1) (generally providing that for purposes of determining a CFC's adjusted net income or loss, references to AFSI in other sections of the section 56A regulations are treated as references to adjusted net income or loss).

The adjustment to AFSI described in proposed § 1.56A-6(b) is not included as a separately stated item because, under proposed § 1.56A-6(b)(1) (which incorporates the principles of section 951(a)(2)), a partnership is not treated as owning stock of a CFC for purposes of proposed § 1.56A-6(b)(1), and therefore proposed § 1.56A-6(b) does not result in an adjustment to modified FSI of a partnership. Rather, in the case of a partnership that owns stock of a CFC, a partner that is a U.S. shareholder with respect to the CFC determines its own pro rata share of the adjusted net income or loss of the CFC and makes an appropriate adjustment to its AFSI directly under proposed § 1.56A-6(b)(1). See proposed § 1.56A-6(e)(3) ( Example 3).

Proposed § 1.56A-5(e)(5) would provide rules coordinating the effect of equity method basis adjustments for AFS purposes with a CAMT entity's adjustments to a partnership's modified FSI under the applicable method. If a CAMT entity includes in its FSI amortization of an equity method basis adjustment with respect to a partnership investment that is attributable to section 168 property or qualified wireless spectrum held by the partnership, and if the CAMT entity has a basis adjustment under section 743(b) with respect to the same property that affects the CAMT entity's distributive share amount, then the CAMT entity adjusts its AFSI to disregard any such FSI amortization. The rule in proposed § 1.56A-5(e)(5) is intended to remove the potential for a duplicative reduction to AFSI for an equity method basis adjustment and section 743(b) basis adjustment that relates to the same property.

Proposed § 1.56A-5(e)(6)(i) would provide rules for determining a CAMT entity's distributive share amount if the partnership treats as its AFS its Federal income tax return pursuant to proposed § 1.56A-2(c)(6). In such case, a CAMT entity's distributive share amount with respect to its partnership investment would be equal to the amount of FSI disregarded under proposed § 1.56A-5(c)(1) of the applicable method further adjusted to disregard any items described in proposed §§ 1.56A-4(b)(1) and 1.56A-8(b) that are reflected in such amount. Additionally, the AFSI items described in proposed § 1.56A-5(e)(4)(iii)(A) through (C) would still apply to determine the CAMT entity partner's AFSI, but not the AFSI item described in proposed § 1.56A-5(e)(4)(iii)(D) since the AFSI item in proposed § 1.56A-5(e)(4)(iii)(D) is dependent on the partnership's FSI and, pursuant to § 1.56A-5(e)(6)(i), the partnership effectively does not have an FSI amount if it treats as its AFS its Federal income tax return. See proposed § 1.56A-21(e)(2)(iii).

Proposed § 1.56A-5(f) would provide that, in the case of a tiered entity structure, if a CAMT entity is a partner in a partnership (UTP) that directly or indirectly owns an investment in a lower-tier partnership (LTP), each partnership, starting with the lowest-tier partnership and continuing in order up the chain of ownership, must use the applicable method to determine the distributive share amounts of each CAMT entity partner in the tiered-partnership chain. Because each UTP determines its own distributive share amount, amounts separately stated under proposed § 1.56A-5(e)(4)(ii) to an UTP are included in determining the UTP's modified FSI under the applicable method in proposed § 1.56A-5(c). Under proposed § 1.56A-5(g), the distributive share amount required to be included in a CAMT entity's AFSI for a taxable year with respect to a partnership investment under proposed § 1.56A-5(c)(2) is based on the modified FSI of the partnership for any taxable year of the partnership ending within or with the taxable year of the CAMT entity.

E. Reporting and Filing Requirements—Partner

Proposed § 1.56A-5(h) would provide rules on the reporting and filing requirements for a CAMT entity that is a partner in a partnership. The Treasury Department and the IRS are aware that, in order to compute its distributive share of a partnership's AFSI, a CAMT entity may require information from the partnership. To facilitate information reporting by partnerships, the proposed regulations would require a partnership to provide the information to the CAMT entity if the CAMT entity cannot determine its distributive share of the partnership's AFSI without the information and the CAMT entity makes a timely request for the information.

Under proposed § 1.56A-5(h)(1), if a CAMT entity cannot determine its distributive share of a partnership's AFSI without receiving certain information from the partnership, the CAMT entity would be required to request the information from the partnership by the 30th day after the close of the partnership's taxable year to which the information request relates. The information, and the requests made for the information, would be required to be maintained by the CAMT entity in its books and records. The partnership would be required to continue to provide the information to the CAMT entity for each subsequent taxable year unless the partnership receives written notification from the CAMT entity that the information is not required.

The Treasury Department and the IRS are aware that a CAMT entity might not timely receive the requested information from the partnership. Under proposed § 1.56A-5(h)(2)(i), a CAMT entity that does not timely receive the requested information from the partnership would be required to make a good-faith estimate of its distributive share of the partnership's AFSI. Except as provided in proposed § 1.56A-5(h)(2)(iii)(B), once the CAMT entity receives the information from the partnership, the CAMT entity (if not also an applicable corporation) should report the information to its partners, including any UTP (which would then report the information to its partners), until the information is received by an applicable corporation. See proposed § 1.56A-5(h)(2)(ii) and (iii)(B).

In the case of a partnership subject to the centralized partnership audit regime in subchapter C of chapter 63 of the Code (BBA partnership), if making the required estimate requires the CAMT entity to treat a partnership-related item (PRI) in a manner that is inconsistent with the BBA partnership's treatment of the PRI, the CAMT entity must follow the procedures for filing a notice of inconsistent treatment with respect to the PRI. See proposed § 1.56A-5(h)(2)(iii)(A). If, as part of providing a CAMT entity with information under proposed § 1.56A-5(h)(1), the BBA partnership must change a PRI reported on its partnership return for a taxable year and the due date for filing the return has passed, the BBA partnership must file an administrative adjustment request (AAR) under section 6227 of the Code to adjust the PRI. Pursuant to the centralized partnership audit regime, the adjustment is determined and taken into account under section 6227 and the regulations thereunder. See proposed § 1.56A-5(h)(2)(iii)(B).

F. Reporting and Filing requirements—Partnerships

Proposed § 1.56A-5(i) would provide rules for a partnership that receives a request from a CAMT entity for information to determine the CAMT entity's distributive share amount, including information necessary to determine the denominator for the distributive share percentage as described in proposed § 1.56A-5(e)(2), the partnership's modified FSI as described in proposed § 1.56A-5(e)(3), and for the CAMT entity to make the AFSI adjustments as described in proposed § 1.56A-5(e)(4). The partnership would be required to file the information with the IRS in forthcoming forms, instructions, or other guidance, as described in proposed § 1.56A-5(i)(1).

Proposed § 1.56A-5(i)(2) would provide special rules for tiered partnership structures. These rules would require an UTP that has a reporting and filing requirement under proposed § 1.56A-5(i) to request the information from an LTP, which then must file the requested information with the IRS and furnish it to the UTP as described in proposed § 1.56A-5(i)(1). The information would be required to be requested by the UTP by the later of the 30th day after the close of the taxable year to which the information request relates or 14 days after the date the UTP receives an information request from another UTP.

Under proposed § 1.56A-5(i)(3), the partnership would be required to provide the requested information by the date prescribed under section 6031(b) of the Code. However, under proposed § 1.56A-5(i)(3)(iii) a partnership would not be required to furnish information to a CAMT entity until it has received a notice of request. A partnership would be considered to have received a notice of request when it receives the request either electronically or in the manner agreed to by the parties, or the partnership has an obligation to continue providing information to a CAMT entity due to the CAMT entity's request in a prior taxable year.

Under proposed § 1.56A-5(i)(4), the information would be requested electronically or in the manner agreed to by the parties. Under proposed § 1.56A-5(i)(5), the partnership would be required to retain in its books and records a copy of the information request and the date it was received. Under proposed § 1.56A-5(i)(6), a partnership that fails to furnish the requested information would be subject to penalties under section 6722 of the Code.

The Treasury Department and the IRS request comments on whether exceptions to the reporting requirements should apply for partnerships that meet certain criteria. For example, such criteria may include the fair market value of the partnership's assets or whether the partnership is controlled (either directly or indirectly) by an applicable corporation. If a partnership is exempt from some or all of the reporting requirements outlined in proposed § 1.56A-5(i), the Treasury Department and the IRS request comments on how a partner in the partnership would determine its distributive share of AFSI with respect to its partnership investment. The Treasury Department and the IRS also request comments regarding the application of the requirement in proposed § 1.56A-5(i)(3) that a partnership provide information requested by a partner by the date prescribed under section 6031(b) of the Code for filing its partnership return when the partnership to which the request is made is a UTP or LTP in a tiered partnership structure.

G. Limitation on Allowance of Negative Distributive Share Amount

Proposed § 1.56A-5(j)(1) would provide a rule limiting the amount of a CAMT entity's negative distributive share amount from a partnership investment for a taxable year that can be included in the CAMT entity's AFSI for such taxable year in a manner similar to the rule in section 704(d) that applies for regular tax purposes. This rule would provide that, if a CAMT entity's distributive share amount with respect to a partnership investment for a taxable year, as determined under proposed § 1.56A-5(e), is negative, such distributive share amount for the taxable year would include only the negative distributive share amount that does not exceed the CAMT entity's CAMT basis in its partnership investment as of the end of the partnership's taxable year. Ordering rules similar to the rules in § 1.704-1(d)(2) apply in computing a CAMT entity's CAMT basis in its partnership investment for purposes of applying the loss limitation rule for negative distributive share amounts. The Treasury Department and the IRS request comments regarding the application of the ordering rule in § 1.704-1(d)(2) and whether more specific ordering rules are needed for purposes of applying the loss limitation rule for negative distributive share amounts.

Proposed § 1.56A-5(j)(2) would provide that any excess negative distributive amount that is disallowed for a taxable year under proposed § 1.56A-5(j)(1) is carried forward and may be used by the CAMT entity in a subsequent taxable year to the extent such negative amount does not exceed a CAMT entity's CAMT basis in its partnership investment in the subsequent taxable year.

Proposed § 1.56A-5(j)(3) would provide rules for determining a CAMT entity's CAMT basis in a partnership investment. These rules would be similar to the rules in section 705 of the Code that apply for regular tax purposes.

A CAMT entity's CAMT basis in a partnership investment would start with the basis of the investment for AFS purposes as of the first day of the partnership's first taxable year ending after December 31, 2019 in which the CAMT entity held its interest in the partnership and would reflect certain adjustments for each taxable year of the partnership ending after December 31, 2019 (but not adjustments that would make the CAMT basis less than zero). See proposed § 1.56A-5(j)(3).

VI. Proposed § 1.56A-6: AFSI Adjustments With Respect to Controlled Foreign Corporations

A. General Rule for Adjusting AFSI Under Proposed § 1.56A-6(b)

Pursuant to the authority granted by section 56A(c)(5), (c)(15), and (e), proposed § 1.56A-6 would provide rules under section 56A(c)(3) regarding an adjustment to the AFSI of a CAMT entity for any taxable year in which the CAMT entity is a U.S. shareholder of one or more CFCs. Under proposed § 1.56A-6(b)(1), if a CAMT entity is a U.S. shareholder of a CFC, the CAMT entity's AFSI is generally adjusted for its pro rata share of the CFC's adjusted net income or loss, which generally means the CFC's FSI for the CFC's taxable year, adjusted for all AFSI adjustments provided under the section 56A regulations (except as provided under proposed § 1.56A-6(c)(2) through (5), which are described later in this Explanation of Provisions). More specifically, proposed § 1.56A-6(b)(1) would provide that, except as provided in proposed § 1.56A-6(b)(3) (concerning an aggregate negative adjustment), for any taxable year, a CAMT entity that is a U.S. shareholder of one or more CFCs makes a single adjustment to the CAMT entity's AFSI that is equal to the sum of the CAMT entity's pro rata shares of the adjusted net income or loss of each such CFC, with such aggregate amount reduced as provided in proposed § 1.56A-6(b)(2) (reduction for taxes if an applicable corporation does not claim foreign tax credits) and (4) (reduction for utilization of a CFC adjustment carryover, as defined in proposed § 1.56A-6(b)(6)). The CAMT entity's pro rata share of the adjusted net income or loss of a CFC is determined for the taxable year of the CFC that ends with or within the taxable year of the CAMT entity and is determined under the principles of section 951(a)(2). These principles include, for example, rules similar to those described in section 951(a)(2)(A) and (B) and the aggregation rules in § 1.958-1(d).

A single adjustment under section 56A(c)(3) is consistent with the statutory language. See section 56A(c)(3)(B) (which refers to “the adjustment determined under subparagraph (A)” rather than multiple “adjustments”) and section 59(l) (which refers to “the adjustment under section 56A(c)(3)” in the singular and provides for the aggregation of an applicable corporation's pro rata share of creditable taxes paid or accrued by each CFC). Accordingly, to calculate the adjustment under section 56A(c)(3) for a U.S. shareholder of several CFCs, the net loss of a CFC may offset net income of another CFC in the same taxable year under proposed § 1.56A-6(b). This rule would be consistent with the guidance provided in section 7.02(2) of Notice 2023-64. If the sum of the pro rata share of the adjusted net income or loss of each CFC of which the CAMT entity is a U.S. shareholder produces a negative amount, this amount is carried to the succeeding taxable year, as described subsequently in more detail.

For purposes of determining inclusions of subpart F income and global intangible low-taxed income under sections 951 and 951A, a domestic partnership is not treated as owning stock of a foreign corporation within the meaning of section 958(a) of the Code and therefore has no inclusions under section 951 or 951A with respect to any stock of a CFC it owns. See §§ 1.951-1(a)(4) (directing taxpayers to § 1.958-1(d) for rules regarding the ownership of stock of a foreign corporation through a domestic partnership for purposes of section 951) and 1.958-1(d) (providing generally that for purposes of applying sections 951 and 951A, a domestic partnership is not treated as owning stock of a foreign corporation). Accordingly, because a CAMT entity's pro rata share of the adjusted net income or loss of a CFC is determined under the principles of section 951(a)(2), a domestic partnership would have no pro rata share with respect to the adjusted net income or loss of any stock of a CFC it owns and no adjustment would be made to the partnership's modified FSI under proposed § 1.56A-6(b)(1). However, if a partner in the partnership is a U.S. shareholder with respect to the CFC, the partner would determine its own pro rata share of the adjusted net income or loss of the CFC and would make an appropriate adjustment to its AFSI directly under proposed § 1.56A-6(b)(1). See proposed § 1.56A-6(e)(3) ( Example 3).

B. Additional Mechanics for Adjusting AFSI Under Proposed § 1.56A-6(b)

Solely for purposes of determining AFSI under section 56A (and not under section 59(k)), proposed § 1.56A-6(b)(2) would require an applicable corporation that is not claiming foreign tax credits for the taxable year to reduce the amount of the adjustment determined under proposed § 1.56A-6(b)(1) by its share of eligible current year taxes of CFCs for the taxable year (calculated under proposed § 1.59-4(d)(3) as if the applicable corporation had claimed foreign tax credits for the taxable year). For this purpose, the applicable corporation's share of eligible current year taxes of CFCs is reduced to reflect the suspensions and disallowances described in proposed § 1.59-4(b)(1) that apply at the level of the U.S. shareholder for purposes of determining foreign income taxes eligible for the CAMT FTC. Finally, the proposed regulations would not permit a reduction to the amount of the adjustment under proposed § 1.56A-6(b)(1) for taxes deemed paid by the applicable corporation on distributions of PTEP under section 960(b) (PTEP taxes).

Proposed § 1.56A-6(b)(3) would provide that, if the amount of the adjustment determined under proposed § 1.56A-6(b)(1) with respect to a taxable year of a U.S. shareholder would be negative (after taking into account the tax reduction provided under proposed § 1.56A-6(b)(2) but before taking the CFC adjustment carryovers under proposed § 1.56A-6(b)(4) into account), then there is no adjustment under proposed § 1.56A-6(b)(1) for the taxable year. This would-be negative adjustment amount would give rise to a CFC adjustment carryover generated in the taxable year. Proposed § 1.56A-6(b)(4) would provide that if the adjustment determined under proposed § 1.56A-6(b)(1) with respect to a taxable year of a U.S. shareholder would be positive (after taking into account the tax reduction provided under proposed § 1.56A-6(b)(2) but before taking proposed § 1.56A-6(b)(4) into account), then the adjustment under proposed § 1.56A-6(b)(1) (after taking into account the tax reduction provided under proposed § 1.56A-6(b)(2)) is reduced by the aggregate amount of CFC adjustment carryovers to the taxable year, but not below zero. Proposed § 1.56A-6(b)(5) would provide rules describing the ordering and use of CFC adjustment carryovers, which parallel similar rules for FSNOL carryovers in proposed § 1.56A-23(d).

Proposed § 1.56A-6(b)(7) would provide that members of a tax consolidated group are treated as a single entity for purposes of proposed § 1.56A-6(b). See also proposed § 1.1502-56A(h) for rules regarding the use of CFC adjustment carryovers by a tax consolidated group.

C. Definition of Adjusted Net Income or Loss

Proposed § 1.56A-6(c)(1) generally would define the term adjusted net income or loss with respect to any CFC, for any taxable year of the CFC, as the FSI of the CFC, adjusted for all AFSI adjustments provided under the section 56A regulations, except as provided in proposed § 1.56A-6(c)(2) through (5). Adjusted net income or loss of a CFC must be expressed in U.S. dollars. Accordingly, items not expressed in U.S. dollars that are taken into account in determining the CFC's adjusted net income or loss must be translated to U.S. dollars. This translation may be required where the reporting currency used for a CFC's AFS is not the U.S. dollar, because in that case the CFC's FSI (the starting point in determining the CFC's adjusted net income or loss) will not be expressed in U.S. dollars. It may also be required where an adjustment made in determining the CFC's adjusted net income or loss references an amount as determined for regular tax purposes, because that regular tax amount may be denominated in the CFC's functional currency for regular tax purposes, which may not be the U.S. dollar (and may also be different from the reporting currency used for the CFC's AFS). In any case in which currency translation is required under proposed § 1.56A-6(c)(1), it is undertaken using the weighted average exchange rate, as defined in § 1.989(b)-1, for the CFC's taxable year. For purposes of translating a CFC's adjusted net income or loss to U.S. dollars, the rules described in proposed § 1.56A-6(c)(1) apply in lieu of the rules described in proposed § 1.56A-1(e)(1).

The adjustments in proposed § 1.56A-6(c)(2) are intended to address certain potential duplications of items and would be generally consistent with, but expand upon, the guidance provided in Notice 2024-10. See part IV.A of this Explanation of Provisions describing a potential duplication of items when an upper-tier CFC owns stock of a lower-tier CFC. Proposed § 1.56A-6(c)(2) would provide adjustments to a CFC's adjusted net income or loss relating to the CFC's ownership of stock of a foreign corporation, in lieu of the adjustments described in proposed § 1.56A-4(c)(1). Proposed § 1.56A-6(c)(2)(ii) would exclude from a CFC's adjusted net income or loss any items of income, expense, gain, and loss resulting from ownership of stock of a foreign corporation, including from acquiring or transferring such stock, reflected in the CFC's FSI. Proposed § 1.56A-6(c)(2)(iii) would include in a CFC's adjusted net income or loss any items of income, deduction, gain, and loss resulting from the CFC's ownership of stock of a foreign corporation, including from acquiring or transferring such stock, for regular tax purposes, except for the amount of any dividend received from another foreign corporation to the extent the dividend is a CAMT excluded dividend. Proposed § 1.56A-6(d) would define the term “CAMT excluded dividend” to mean a dividend received by a CFC to the extent the dividend is excluded from (i) the recipient CFC's gross income under section 959(b), or (ii) both (A) the recipient CFC's foreign personal holding company income under section 954(c)(3) or (c)(6) of the Code, and (B) the recipient CFC's gross tested income under § 1.951A-2(c)(1)(iv).

Because a CFC's adjusted net income or loss reflects all AFSI adjustments provided under the section 56A regulations, except as provided in proposed § 1.56A-6(c)(2) through (5), if a CFC is a partner in any partnership or the owner of any disregarded entity, the items taken into account in computing the CFC's adjusted net income or loss generally include the CFC's distributive share amount of modified FSI from any such partnership ( see proposed § 1.56A-5) and the AFSI of any such disregarded entity ( see proposed § 1.56A-9). This would be consistent with the guidance provided in section 7.02(3) of Notice 2023-64. Proposed § 1.56A-6(c)(2)(iv) would further provide that if a partnership directly owns stock of a foreign corporation, then in determining the adjusted net income or loss of a CFC that is a partner in the partnership (or an indirect partner in the case of tiered partnerships), the partner takes into account the items described in proposed § 1.56A-6(c)(2)(iii) (including taking into account the exception for CAMT excluded dividends) that are reported to the partner by the partnership for regular tax purposes.

Section 56A(c)(3)(A) provides that the AFSI of a CAMT entity that is a U.S. shareholder of a CFC should be adjusted to take into account a pro rata share of CFC items under rules similar to the rules under section 951(a)(2). Reading section 56A(c)(3) as limited only to the pro rata share of CFC items that would be taken into account in computing AFSI under section 56A(c)(4) and proposed § 1.56A-7 (that is, items of income that are effectively connected with the conduct of a trade or business within the United States and deductions connected with such income) would be underinclusive. Thus, proposed § 1.56A-6(c)(3) would provide that a CFC's adjusted net income or loss is not limited to amounts taken into account in determining AFSI under proposed § 1.56A-7, which would generally limit the AFSI of a foreign corporation to taxable income that is effectively connected with the conduct of a trade or business within the United States.

Moreover, where an amount is subject to CAMT under section 56A(c)(4) and proposed § 1.56A-7 because a CFC is itself an applicable corporation, such amount should be excluded from a U.S. shareholder's adjustment under 56A(c)(3) to prevent double counting of the same income of the CFC. Thus, proposed § 1.56A-6(c)(3) would provide that, if a CFC is an applicable corporation, the CFC's adjusted net income or loss is reduced by the amount of AFSI of the CFC (with such AFSI determined by taking proposed § 1.56A-7 into account). The rule in proposed § 1.56A-6(c)(3) would be consistent with the guidance provided in section 7.02(5) of Notice 2023-64.

Proposed § 1.56A-6(c)(4) would provide that the AFSI adjustment provided under proposed § 1.56A-8(c) does not apply in computing a CFC's adjusted net income or loss. Proposed § 1.56A-8(c) generally would provide a reduction in the AFSI of an applicable corporation by the amount of foreign income taxes deducted by the applicable corporation, if the applicable corporation does not choose to claim foreign tax credits for the taxable year.

Proposed § 1.56A-6(c)(5) would provide that the AFSI adjustment provided under proposed § 1.56A-23(c) (providing a reduction to AFSI for FSNOL carryovers) does not apply in computing a CFC's adjusted net income or loss. Allowing a CFC to make the adjustment for FSNOL carryovers provided by proposed § 1.56A-23(c) when determining the CFC's adjusted net income or loss, while also allowing for the use of CFC adjustment carryovers to reduce a U.S. shareholder's adjustment to AFSI under proposed § 1.56A-6(b)(1), would lead to an improper double counting of loss carryovers.

VII. Proposed § 1.56A-7: AFSI Adjustments With Respect to Effectively Connected Income

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-7 would provide rules under section 56A(c)(4) for applying the principles of section 882 to determine a foreign corporation's AFSI. As amended by section 10101 of the IRA, section 882(a)(1) provides, in part, that a foreign corporation engaged in a trade or business within the United States during the taxable year is taxable under the CAMT on its taxable income which is effectively connected with the conduct of a trade or business within the United States.

In determining taxable income for purposes of section 882(a)(1), gross income includes only gross income which is effectively connected with the conduct of a trade or business within the United States (ECI). See section 882(a)(2). Deductions are generally allowed for these purposes only if and to the extent they are connected with income which is ECI. See section 882(c)(1)(A). Accordingly, proposed § 1.56A-7(b) would provide that, for purposes of section 56A(c)(4), the AFSI of a foreign corporation is adjusted to include only amounts and items of FSI that would be included in ECI or allowable as a deduction by such corporation for purposes of section 882(c) had such amount or item accrued for regular tax purposes in the taxable year.

Section 7.02(5) of Notice 2023-64 provides guidance under which, for purposes of applying section 56A(c)(4), in the case of a foreign corporation that qualifies for and claims the benefits of the business profits provisions of an applicable income tax treaty, the principles of those provisions would apply in determining the foreign corporation's AFSI. This guidance was intended to clarify that a foreign corporation entitled to benefits under an income tax treaty may apply the treaty to determine its AFSI. After further consideration, the Treasury Department and the IRS are of the view that it is not necessary to make this clarification in the proposed regulations, because section 894(a) of the Code already provides that the Code is applied with due regard to any income tax treaty obligation of the United States that applies to a taxpayer, and nothing in the IRA changes the normal operation of U.S. income tax treaties in this context.

VIII. Proposed § 1.56A-8: AFSI Adjustments for Certain Federal and Foreign Income Taxes

Section 56A(c)(5) provides that AFSI is appropriately adjusted to disregard any Federal income taxes or income, war profits, or excess profits taxes (within the meaning of section 901) with respect to a foreign country or possession of the United States which are taken into account in the taxpayer's AFS. Further, the statute provides a grant of authority to the Secretary to provide an exception to this rule for a taxpayer that does not choose to claim foreign tax credits for a taxable year. Finally, section 56A(c)(5) authorizes the Secretary to prescribe such regulations or other guidance as may be necessary or appropriate to provide for the proper treatment of current and deferred taxes for purposes of section 56A(c)(5), including the time at which the taxes are properly taken into account.

Pursuant to the authority granted by section 56A(c)(5), (c)(15), and (e), proposed § 1.56A-8(b)(1) would adjust AFSI to disregard any applicable income taxes, as defined in proposed § 1.56A-8(b)(2), that are taken into account in a CAMT entity's AFS. The proposed regulations would define applicable income taxes as Federal income taxes and foreign income taxes that are taken into account in a CAMT entity's AFS as current tax expense (or benefit), as deferred tax expense (or benefit), or through increases or decreases to other AFS accounts of the CAMT entity (for example, AFS accounts used to account for FSI from investments in other CAMT entities, AFS accounts used to account for section 168 property, or AFS accounts used to account for other items of income and expense). See proposed § 1.56A-8(b)(2). Additionally, the proposed regulations would define Federal income taxes to mean any taxes imposed by subtitle A of the Code and to include amounts allowed as credits against taxes imposed by subtitle A, including credit amounts that are generated by a partnership and passed through to a partner. See proposed § 1.56A-1(b)(18). Proposed § 1.56A-1(b)(23) would define foreign income tax to have the meaning provided in § 1.901-2.

AFSI is relevant in determining both whether a corporation is an applicable corporation and the amount of an applicable corporation's CAMT liability under section 55(a). For purposes of determining whether a corporation is an applicable corporation, the Treasury Department and the IRS are of the view that AFSI should be determined on a pre-tax basis for all taxpayers, regardless of whether the taxpayer chooses to claim foreign tax credits for the taxable year. This ensures that all taxpayers determine whether a corporation is an applicable corporation using the same metric (pre-tax AFSI) and ensures that the choice of whether to claim foreign tax credits has no effect on the determination of whether a corporation is an applicable corporation.

For purposes of determining the amount of an applicable corporation's CAMT liability under section 55(a), however, the Treasury Department and the IRS are of the view that it is an appropriate exercise of the regulatory authority granted under section 56A(c)(5) to allow a reduction to AFSI (similar to the deduction for regular tax purposes under section 164 of the Code) for foreign income taxes if an applicable corporation does not choose to claim foreign tax credits for the taxable year and thus is not eligible to claim a CAMT FTC under section 59(l).

Accordingly, proposed § 1.56A-8(c) would provide that an applicable corporation that does not choose to claim a foreign tax credit for the taxable year would reduce its AFSI by the amount of foreign income taxes which the applicable corporation deducts for regular tax purposes under section 164 (taking into account all other relevant provisions) for the taxable year, including foreign income taxes of a disregarded entity of which the applicable corporation is the owner for regular tax purposes and any creditable foreign tax expenditures (within the meaning of § 1.704-1(b)(4)(viii)) allocated to the applicable corporation as a partner or indirect partner in a tiered partnership or other type of pass-through entity. This adjustment is disregarded in applying the average annual AFSI tests described in § 1.59-2(c) to determine whether a corporation is an applicable corporation. See § 1.59-2(c)(1)(ii)(B) and (c)(2)(ii)(B).

An applicable corporation that chooses to claim a foreign tax credit for the taxable year, however, would not reduce its AFSI by the amount of foreign income taxes that the applicable corporation deducts in the taxable year (for example, foreign income taxes paid to specified foreign countries under section 901(j)). See proposed § 1.56A-8(e)(2) ( Example 2). The Treasury Department and the IRS are of the view that this approach is consistent with the grant of regulatory authority provided in section 56A(c)(5).

Proposed § 1.56A-6(b)(2) provides a rule similar to proposed § 1.56A-8(c) that would reduce the pro rata share adjustment provided under proposed § 1.56A-6(b)(1) for certain foreign income taxes of CFCs if an applicable corporation does not choose to claim foreign tax credits for the taxable year.

Proposed § 1.56A-8(d) would provide that, for purposes of proposed §§ 1.56A-8(b) and 1.59-4, applicable income taxes are considered taken into account in an AFS of a CAMT entity if any journal entry has been recorded in the books and records used to determine an amount in the AFS of the CAMT entity for any year, or in another AFS that includes the CAMT entity, to reflect such taxes. Applicable income taxes are considered taken into account in an AFS of a CAMT entity even if the taxes do not increase or decrease the CAMT entity's FSI at the time of the journal entry. Further, if applicable income taxes are taken into account in a partnership's AFS, they also are considered taken into account in any AFS of the partnership's partners.

IX. Proposed § 1.56A-9: AFSI Adjustments for Owners of Disregarded Entities or Branches

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-9 would provide rules under section 56A(c)(6) and (15) for determining the AFSI of a CAMT entity that owns a disregarded entity or branch. Section 56A(c)(6) provides that AFSI is adjusted to take into account any AFSI of a disregarded entity owned by the taxpayer.

Proposed § 1.56A-9(b)(1) would provide that, for purposes of the section 56A regulations, a disregarded entity or branch and the CAMT entity that owns the disregarded entity or branch, including through other disregarded entities or branches, (CAMT entity owner) are treated as a single CAMT entity. As a result, the CAMT entity owner would be treated as directly owning the assets of, being directly liable for the liabilities of, and directly earning or incurring any income, expense, gain, loss, or other similar item of the disregarded entity or branch. Further, proposed § 1.56A-9(b)(2) would provide that transactions between the disregarded entity or branch and the CAMT entity owner (or between disregarded entities or branches owned by the same CAMT entity) and any balance sheet account or income statement account that reflects the CAMT entity owner's investment in the disregarded entity or branch (or a disregarded entity's investment in another disregarded entity or branch that is ultimately owned by the same CAMT entity owner) would be disregarded. Proposed § 1.56A-9(b)(3) would provide that if a disregarded entity or branch is required to determine its own AFS under § 1.56A-2(h), the CAMT entity owner of the disregarded entity or branch treats such separate AFS of the disregarded entity or branch as part of the CAMT entity owner's own AFS.

Financial accounting does not have the concept of a disregarded entity. For financial accounting purposes, a single member limited liability corporation, for instance, may have a financial statement (or be a separate member of a financial statement group) and, thus, is treated the same as any other corporation. Section 56A(c)(6) affirms the application of regular tax principles to the treatment of disregarded entities. Accordingly, these proposed rules would apply regular tax principles for the treatment of disregarded entities and branches, rather than treating disregarded entities and branches as independently calculating AFSI and then adding that AFSI to the AFS of the owner.

X. Proposed § 1.56A-10: AFSI Adjustments for Cooperatives

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-10 would provide rules under section 56A(c)(7) regarding the determination of AFSI for a cooperative. Proposed § 1.56A-10(b) would provide that, in the case of a cooperative to which section 1381 of the Code applies, AFSI of the cooperative is reduced by the amounts referred to in section 1382(b) of the Code and the regulations under section 1382(b) (relating to patronage dividends and per-unit retain allocations), but only to the extent such amounts were not otherwise taken into account in determining the AFSI of the cooperative.

XI. Proposed § 1.56A-11: AFSI Adjustments for Alaska Native Corporations

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-11 would provide rules under section 56A(c)(8) regarding Alaska Native Corporations. Section 56A(c)(8) provides for two adjustments to the AFSI of Alaska Native Corporations. First, section 56A(c)(8)(A) provides that cost recovery and depletion attributable to certain property that is allowed for regular tax purposes is allowed in calculating AFSI. Section 21(c) of the ANCSA (43 U.S.C. 1620(c)) describes land and interests in land that Alaska Native Corporations receive pursuant to certain provisions of the ANCSA. Such property interests have a basis equal to their fair market value either at the time the corporation receives the property or at the time the corporation first commercially develops the property. Proposed § 1.56A-11(c) would provide that the AFSI of an Alaska Native Corporation (i) is reduced for cost recovery and depletion attributable to such property to the extent of the amount recovered for regular tax purposes, and (ii) is adjusted to disregard any cost recovery or depletion attributable to such property that is reflected in the corporation's FSI. In other words, proposed § 1.56A-11(c) allows an Alaska Native Corporation to use the basis of such property for regular tax purposes in lieu of the AFS basis of such property for all depletion and cost recovery computations (including gain or loss computations) with respect to such property that apply in determining AFSI.

Second, section 56A(c)(8)(B) provides that deductions for certain amounts payable under the ANCSA are allowed in calculating AFSI only at the time the deductions are allowed for regular tax purposes. Section 7(i) and (j) of the ANCSA (43 U.S.C. 1606(i) and (j)) requires the Regional Corporations (within the meaning of 43 U.S.C. 1606) to divide a portion of their revenues among all Regional Corporations, and to distribute at least a minimum percentage of their revenues to shareholders. Proposed § 1.56A-11(d) would provide that the AFSI of an Alaska Native Corporation (i) is reduced by regular tax deductions for payments under section 7(i) and 7(j) of the ANCSA at the time they are deducted for regular tax purposes, and (ii) is adjusted to disregard expenses for specified payments reflected in the corporation's FSI.

XII. Proposed § 1.56A-12: AFSI Adjustments With Respect to Certain Tax Credits

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-12 would provide rules under section 56A(c)(9) and (c)(15) regarding AFSI adjustments for certain credits. Proposed § 1.56A-12(b)(1) would provide that AFSI is adjusted to disregard any amount treated as a payment against the tax imposed by subtitle A pursuant to an election under section 48D(d) or 6417, provided that this amount is not otherwise disregarded under proposed § 1.56A-8 (concerning taxes). This provision would permit the exclusion of certain credit amounts from AFSI, which would follow their treatment for regular tax purposes.

For regular tax purposes, an eligible taxpayer that elects to transfer an eligible credit, as those terms are defined in section 6418(f) of the Code, excludes from gross income amounts received from the transfer of the credit. Section 6418(b)(2). Pursuant to the Secretary's authority under section 56A(c)(15), and consistent with the treatment of similar credits for which an election under section 6417 (a companion provision to section 6418) is made, proposed § 1.56A-12(b)(2) would provide that AFSI is adjusted to disregard any amount received from the transfer of an eligible credit that is not included in the gross income of the CAMT entity under section 6418(b) or that is treated as tax exempt income under section 6418(c)(1)(A), provided that the amounts are not otherwise disregarded under proposed § 1.56A-8. In addition, proposed § 1.56A-12(b)(3) would provide that AFSI is adjusted to disregard amounts received pursuant to a direct pay election under section 48D(d)(2) or 6417(c) that is treated as tax exempt income for regular tax purposes, provided that the amounts are not otherwise disregarded under proposed § 1.56A-8. The rules in proposed § 1.56A-12(b)(1) through (3) would be consistent with section 6 of Notice 2023-7.

Pursuant to the Secretary's authority under section 56A(c)(15), proposed § 1.56A-12(c) would provide rules for the treatment of purchasers (transferees) of an eligible credit for purposes of determining their AFSI. For regular tax purposes, under section 6418(a) and § 1.6418-2(f)(2), a transferee does not have gross income as a result of utilizing a purchased credit with a value in excess of the amount paid for the purchased credit. Consistent with this regular tax treatment, proposed § 1.56A-12(c)(2) would provide that, to the extent FSI of a transferee reflects income from the utilization of a purchased credit, AFSI is adjusted to disregard the income if it is not otherwise disregarded under proposed § 1.56A-8.

For regular tax purposes, section 6418(b)(3) provides that the transferee cannot deduct the cash payment it makes to purchase the credit. Consistent with that regular tax treatment, proposed § 1.56A-12(c)(1) would provide that, for a transferee taxpayer that is a CAMT entity, AFSI is adjusted to disregard the cash payment the transferee taxpayer made to purchase the credit, if the expense is not otherwise disregarded under proposed § 1.56A-8.

Both the direct pay election provisions and the credit transfer provisions of the Code reference the basis reduction and credit recapture provisions in section 50 of the Code. See sections 48D(d)(5), 6417(g), and 6418(g)(3), respectively. For regular tax purposes, liability for credit recapture would represent nondeductible tax. To ensure that the CAMT treatment of a credit recapture is not more advantageous than the regular tax treatment, proposed § 1.56A-12(d) would provide that, to the extent FSI reflects a decrease for a credit recapture under sections 48D(d)(5), 50(a)(3), 6417(g), or 6418(g)(3) that is not otherwise disregarded under proposed § 1.56A-8, AFSI is adjusted to disregard the decrease to FSI.

XIII. Proposed § 1.56A-13: AFSI Adjustments for Covered Benefit Plans

Pursuant to the authority granted by section 56A(c)(11)(A), (c)(15), and (e), proposed § 1.56A-13 would provide rules under section 56A(c)(11) regarding adjustments to AFSI with respect to covered benefit plans. As defined in proposed § 1.56A-13(c), the term “covered benefit plan” would include: (i) a qualified defined benefit pension plan that is a defined benefit plan described in section 401(a) with a trust that is exempt from tax under section 501(a), and that is not a multiemployer plan described in section 414(f); (ii) a qualified foreign plan described in section 404A(e); or (iii) another plan if, under the accounting standards that apply to the AFS, the plan is treated as a defined benefit plan that provides post-employment benefits other than pension benefits.

The definition of the third type of covered benefit plan in proposed § 1.56A-13(c)(4) would be consistent with a recommendation from stakeholders that a welfare plan providing post-retirement benefits should be treated as a covered benefit plan if it is accounted for on a defined benefit basis. For example, if the accounting standards that apply to the AFS are GAAP, then a plan that provides post-employment benefits other than pension benefits and that is accounted for under the rules of Accounting Standards Codification (ASC) 715-60 would be treated as a covered benefit plan.

A defined benefit pension plan with a trust created or organized in Puerto Rico is a qualified defined benefit pension plan described in proposed § 1.56A-13(c)(2)(i) only if an election described in section 1022(i)(2)(A) of the Employee Retirement Income Security Act of 1974, Public Law 93-406, 88 Stat. 829, and § 1.401(a)-50(a) has been made with respect to the plan for its trust to be treated as created or organized in the United States for purposes of section 401(a) of the Code. A defined benefit pension plan with a trust created or organized in any other possession specified in section 937(a)(1) of the Code is not a qualified defined benefit pension plan under proposed § 1.56A-13(c)(2)(i).

Proposed § 1.56A-13(b) would provide that AFSI: (i) is adjusted to disregard any amount of income, cost, expense, gain, or loss that otherwise would be included on a CAMT entity's AFS in connection with any covered benefit plan; (ii) is increased by any amount of income in connection with any covered benefit plan that is included in gross income for the taxable year under any provision of chapter 1; and (iii) is reduced by deductions allowed for the taxable year under any provision of chapter 1 with respect to any covered benefit plan.

XIV. Proposed § 1.56A-14: AFSI Adjustments for Tax-Exempt Entities

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-14 would provide rules under section 56A(c)(12) regarding tax-exempt entities. Section 56A(c)(12) states that, in the case of an organization subject to tax under section 511 (generally, a tax-exempt entity), AFSI must be appropriately adjusted to only take into account any AFSI (i) of an unrelated trade or business (as defined in section 513) of such organization, or (ii) derived from debt-financed property (as defined in section 514) to the extent that income from such property is treated as unrelated business taxable income.

For most organizations described in section 501(c), unrelated business taxable income (UBTI) is defined in section 512(a)(1) of the Code as the gross income derived by any exempt organization from any unrelated trade or business (as defined in section 513) regularly carried on by it, less the deductions allowed by chapter 1 that are directly connected with the carrying on of such trade or business, both computed with the modifications provided in section 512(b).

The modifications in section 512(b) generally exclude from UBTI income from passive sources, such as dividends, interest, annuities, and certain other items (section 512(b)(1)), royalties (section 512(b)(2)), certain rents (section 512(b)(3)), and certain capital gains (section 512(b)(5)). However, notwithstanding section 512(b)(1), (2), (3), and (5), section 512(b)(4) includes as an item of gross income derived from an unrelated trade or business the amount of income determined under section 514(a)(1) that is derived from debt-financed property, as defined in section 514(b). Section 512(a)(3) provides an alternate definition of UBTI for certain organizations that is computed without regard to the modifications in section 512(b)(1), (2), (3), and (5).

Stakeholders have requested clarification that the modifications in section 512(b) apply for purposes of section 56A(c)(12). One stakeholder stated that section 56A(c)(12)(B), which specifically includes income from debt-financed property, would be unnecessary if section 56A(c)(12)(A) already included such income (as would be the case if section 512(b) did not apply).

For the reason mentioned by the stakeholder, the modifications in section 512(b) should apply for purposes of section 56A(c)(12). Therefore, proposed § 1.56A-14(b) would provide that, in the case of an organization subject to tax under section 511, AFSI is adjusted to take into account any AFSI of an unrelated trade or business of such organization, subject to the applicable modifications to UBTI found in section 512(b), including AFSI derived from debt-financed property to the extent that income from such property is treated as UBTI.

XV. Proposed § 1.56A-15: AFSI Adjustments for Section 168 Property

Pursuant to the authority granted by section 56A(c)(13)(B)(ii), (c)(15), and (e), proposed § 1.56A-15 would provide rules under section 56A(c)(13) for determining the AFSI adjustments for property to which section 168 applies (section 168 property). To implement section 56A(c)(13), the proposed regulations would mimic the regular tax treatment of all section 168 property to the extent of the timing and amount of regular tax basis recovery with respect to the section 168 property, regardless of when the section 168 property is placed in service, whether and how the costs with respect to section 168 property are recognized in FSI, and whether gain or loss with respect to section 168 property is recognized in FSI. As a result, proposed § 1.56A-15 applies the principle that the application of section 56A(c)(13) should not provide the CAMT entity with a better result with respect to section 168 property for AFSI purposes than for regular tax purposes.

Proposed § 1.56A-15(b) would provide definitions that generally follow the definitions in sections 2 and 4 of Notice 2023-7, as modified and clarified by sections 5 and 9.02 of Notice 2023-64. A new defined term, covered book inventoriable depreciation, would be added to explain a simplified method for a CAMT entity to determine depreciation in ending inventory for purposes of determining the tax COGS depreciation and covered book COGS depreciation adjustments, as discussed in part XV.B of this Explanation of Provisions. In addition, new defined terms, tax capitalization method change and tax capitalization method change AFSI adjustment, would be added for changes in methods of accounting for regular tax purposes involving a change from capitalizing and depreciating costs as section 168 property to deducting the costs (or vice versa), as discussed in part XV.B of this Explanation of Provisions. Further, the definition of the term tax depreciation section 481(a) adjustment would be expanded to include an adjustment (or portion thereof) required under section 481(a) for any other change in method of accounting (other than a tax capitalization method change) that impacts the timing of taking into account depreciation of section 168 property in computing taxable income (for example, a change in method of accounting involving a change from deducting depreciation of section 168 property to capitalizing such depreciation under section 263A or another capitalization provision, or vice versa). These additional or expanded definitions for changes in methods of accounting would prevent depreciation of section 168 property from being duplicated in, or omitted from, AFSI.

A. Section 168 Property

1. In General

Proposed § 1.56A-15(c)(1) generally would define section 168 property to mean: (i) MACRS property, as defined in § 1.168(b)-1(a)(2), that is depreciable under section 168; (ii) computer software that is qualified property, as defined in § 1.168(k)-1(b)(1) or 1.168(k)-2(b)(1), and is depreciable under section 168; and (iii) certain other intangible property that is depreciable under section 168, is qualified property as defined in § 1.168(k)-2(b)(1), and is described in § 1.168(k)-2(b)(2)(i)(E), (F), or (G). Property described in § 1.168(k)-2(b)(2)(i)(E), (F), or (G) includes: (i) a qualified film or television production, or a qualified live theatrical production, for which a deduction otherwise would be allowable under section 181 of the Code and which was initially released, broadcast, or staged live, respectively, after September 27, 2017; or (ii) a specified plant for which the taxpayer has properly made an election to apply section 168(k)(5) and that is planted, or grafted to a plant that has already been planted, by the taxpayer in the ordinary course of the taxpayer's farming business, as defined in section 263A(e)(4) of the Code.

As explained previously, section 168 property includes computer software and certain other intangible property that is “qualified property”. The term “qualified property” is defined in § 1.168(k)-1(b)(1) or 1.168(k)-2(b)(1) as depreciable property that meets the following four requirements: (i) the depreciable property is of a specified type; (ii) the original use of the depreciable property commences with the taxpayer, or used depreciable property meets the acquisition requirements of section 168(k)(2)(E)(ii); (iii) the depreciable property is placed in service by the taxpayer within a specified time period or is planted or grafted by the taxpayer before a specified date; and (iv) the depreciable property is acquired by the taxpayer after September 27, 2017.

2. Property Depreciable Under Section 168

The definition of “Section 168 Property” in section 4.04 of Notice 2023-7 includes only property “depreciated” under section 168. The Treasury Department and the IRS have further considered the interim guidance in Notice 2023-7 in response to stakeholder feedback. Accordingly, the proposed regulations would interpret the adjustment under section 56A(c)(13) to include property “depreciable” under section 168 even if the property is not ultimately depreciated under section 168, but only to the extent of the depreciation allowed under section 167. Accordingly, proposed § 1.56A-15(c)(1) would expand the definition of “Section 168 Property” to include property “depreciable” under section 168. As a result, section 168 property would include property that has not yet been placed in service but that would be property “depreciable” under section 168 once placed in service. Additionally, section 168 property would include property eligible for the additional first year depreciation deduction, even if the taxpayer makes the election out under section 168(k)(7). See proposed § 1.56A-15(c)(5). However, proposed § 1.56A-15(c)(2) would clarify that the adjustments under section 56A(c)(13) apply only to the portion of the cost of property depreciable under sections 167 and 168, and not the portion deductible under section 181 or recovered under any other section of the Code.

Proposed § 1.56A-15(c)(3) would provide that the adjustments under section 56A(c)(13) do not apply to deductible expenditures (such as deductible repair expenditures) that are made with respect to section 168 property, and proposed § 1.56A-15(c)(4) would clarify that property that is not depreciable under section 168 for regular tax purposes does not give rise to adjustments under section 56A(c)(13). These items would not be depreciable under section 168, and therefore are not within the scope of section 56A(c)(13). However, stakeholders have recommended that the AFSI adjustments under section 56A(c)(13) with respect to section 168 property take into account repair expenditures with respect to such property that are deductible for regular tax purposes, but which are capitalized and depreciated for AFS purposes. Stakeholders commented that this approach would simplify the computation of AFSI and would reduce the compliance burden on taxpayers. In addition, stakeholders noted that certain industries (for example, regulated utilities) are subject to industry-specific GAAP or IFRS rules that increase the disparity between the amount of repair expenditures expensed for AFS purposes compared to the deductible repair expenditures for regular tax purposes, and, thus, such industries may have increased amounts of AFSI after application of the adjustments under section 56A(c)(13). The Treasury Department and the IRS continue to study this issue. Comments are requested on whether the AFSI adjustments with respect to section 168 property should take into account or otherwise reflect the repair expenditures with respect to section 168 property that are deducted for regular tax purposes but capitalized and depreciated for AFS purposes.

Proposed § 1.56A-15(c)(6) would provide that section 56A(c)(13) applies to property placed in service in any taxable year, including taxable years beginning before January 1, 2023 (that is, the effective date of the CAMT). This rule is based on section 56A(c)(13), which does not limit the depreciation adjustments to property placed in service in certain years or under certain conditions. In contrast, see section 56A(d)(3), which limits the net loss set forth on a taxpayer's AFS to taxable years ending after December 31, 2019.

B. AFSI adjustments for Depreciation

Proposed § 1.56A-15(d)(1) would provide the AFSI adjustments for depreciation that are required under section 56A(c)(13). Proposed § 1.56A-15(d)(2) would provide special rules for section 168 property held by a partnership, and proposed § 1.56A-15(d)(3) would provide special rules for determining the adjustments under proposed § 1.56A-15(d)(1) if depreciation is an inventoriable cost for AFS or regular tax purposes. Finally, proposed § 1.56A-15(d)(4) would provide adjustment periods for tax capitalization method change AFSI adjustments.

More specifically, under proposed § 1.56A-15(d)(1), AFSI of a CAMT entity would be reduced by: (i) tax cost of goods sold (tax COGS) depreciation (that is, tax depreciation capitalized under section 263A to inventory or to the basis of property described in section 1221(a)(1) that is not inventory), but only to the extent of the amount recovered as part of cost of goods sold in computing gross income for the taxable year or as part of the computation of gain or loss from the sale or exchange of non-inventory property described in section 1221(a)(1) of the Code that is included or deducted in computing taxable income for the taxable year; (ii) deductible tax depreciation (that is, depreciation deductions allowed under section 167, or another provision of the Code, with respect to section 168 property), but only to the extent of the amount that is allowed as a deduction in computing taxable income for the taxable year; and (iii) any tax depreciation section 481(a) adjustment (that is, an adjustment for regular tax purposes under section 481(a) of the Code with respect to a change in method of accounting for depreciation for section 168 property or any other change in method of accounting (other than a tax capitalization method change) that impacts the timing of taking into account depreciation with respect to section 168 property in computing taxable income) that is negative, but only to the extent of the amount of such adjustment that is taken into account in computing taxable income for the taxable year.

AFSI of a CAMT entity also would be adjusted to disregard covered book cost of goods sold (book COGS) depreciation, covered book depreciation expense, covered book expense, and any AFS basis recovery with respect to section 168 property that is reflected in FSI following the date such property is disposed of for regular tax purposes. Covered book COGS depreciation includes depreciation expense, other recovery of AFS basis (including from an impairment loss) that occurs prior to the taxable year in which the disposition of section 168 property occurs for regular tax purposes, or impairment loss reversal that is taken into account as cost of goods sold (or as part of the computation of gain or loss from the sale or exchange of property held for sale) in FSI with respect to section 168 property. Covered book depreciation expense includes depreciation expense, other recovery of AFS basis (including from an impairment loss) that occurs prior to the taxable year in which the disposition of section 168 property occurs for regular tax purposes, or impairment loss reversal that is taken into account in FSI with respect to section 168 property and is not included in covered book COGS depreciation. Covered book expense includes an amount other than covered book COGS depreciation and covered book depreciation expense that reduces FSI and is reflected in the unadjusted depreciable basis, as defined in § 1.168(b)-1(a)(3), of section 168 property for regular tax purposes.

AFSI of a CAMT entity (i) would be increased by any tax depreciation section 481(a) adjustment that is positive, but only to the extent of the amount of such adjustment that is taken into account in computing taxable income for the taxable year, and (ii) would be increased or decreased, as appropriate, by any tax capitalization method change AFSI adjustment. The tax capitalization method change AFSI adjustment is determined as of the beginning of the tax year of change and equals the difference between (i) the cumulative amount of adjustments made to AFSI with respect to the cost(s) subject to the tax capitalization method change and (ii) the cumulative amount of adjustments to AFSI that would have been made if the new method of accounting had been applied for those taxable years. As provided in the definition in proposed § 1.56A-15(b)(11), the tax capitalization method change AFSI adjustments include only amounts with respect to taxable years beginning after December 31, 2019, because generally AFSI adjustments are not made for earlier periods. See also proposed § 1.56A-1(d)(3). The IRS may publish IRB guidance that provides for other AFSI adjustments under section 56A(c)(13). See proposed § 1.56A-15(d)(1).

These proposed regulations generally would follow the adjustments described in section 4.03 of Notice 2023-7, as modified by section 9.02(5) and (6) of Notice 2023-64, with certain modifications.

The proposed regulations also would include special rules for section 168 property held by partnerships under proposed § 1.56A-15(d)(2). If section 168 property is held by a partnership, the adjustments provided in proposed § 1.56A-15(d)(1) (excluding the covered book adjustments in proposed § 1.56A- 15(d)(1)(iii)) would include amounts resulting from any basis adjustment under section 734(b) attributable to section 168 property that is treated as an increase or decrease to tax depreciation or a tax depreciation section 481(a) adjustment for regular tax purposes. See proposed § 1.56A-5(e)(3) for the manner in which the adjustments provided for in proposed § 1.56A-15(d)(1) are taken into account by a partnership in computing modified FSI.

However, if section 168 property is held by a partnership, the adjustments provided in proposed § 1.56A-15(d)(1) would not include amounts resulting from any basis adjustment under section 743(b) of the Code. Additionally, the adjustments provided in proposed § 1.56A-15(d)(1) would not include any decreases in tax depreciation or income amounts for regular tax purposes resulting from any basis adjustment under § 1.1017-1(g)(2) attributable to section 168 property held by a partnership (as calculated under § 1.743-1(j)(4)(ii)). Instead, the adjustments provided in proposed § 1.56A-15(d)(2)(ii) and (iv) for amounts resulting from basis adjustments under section 743(b) and § 1.1017-1(g)(2) that would have been included in the adjustments provided in § 1.56A-15(d)(1) would be separately stated to the partnership's CAMT entity partners for inclusion in their distributive amounts. See proposed § 1.56A-5(e)(4) for the manner in which the adjustments provided for in proposed § 1.56A-15(d)(2)(ii) and (iv) are taken into account by a CAMT entity partner.

Stakeholders also requested an adjustment to reduce AFSI for amounts of depreciation that are capitalized under section 263A during the taxable year, regardless of the period in which the capitalized amount is recovered, similar to the methodology under § 1.163(j)-1(b)(1)(iii). This approach is inconsistent with section 56A(c)(13)'s directive to mimic the regular tax treatment of all section 168 property to the extent of the timing and amount of regular tax basis recovery with respect to the section 168 property, and therefore the application of section 56A(c)(13) should not provide the taxpayer with a better result for AFSI than for regular tax purposes. However, the Treasury Department and the IRS continue to study the viability of this and other simplifying safe harbors. In addition, the proposed regulations would include special rules to determine tax COGS depreciation and covered book COGS depreciation adjustments, as well as simplifying methods for FIFO and LIFO method taxpayers to determine depreciation in ending inventory for purposes of computing the tax COGS depreciation and covered COGS depreciation adjustments to AFSI. See proposed § 1.56A-15(d)(3).

In addition, stakeholders requested guidance on potential adjustments to AFSI to account for a change in method of accounting made for regular tax purposes from deducting a cost as an expense to capitalizing and depreciating that cost under sections 167 and 168, and vice versa (proposed § 1.56A-15(b)(10) would define this type of change in method of accounting as a tax capitalization method change). As a result of a tax capitalization method change, the cost at issue would be reclassified to or from section 168 property beginning with the taxable year the tax capitalization method change is effective (depending on the particular tax capitalization method change), and therefore the CAMT entity would be required to begin or cease making adjustments under section 56A(c)(13) beginning in that year of change. Accordingly, proposed § 1.56A-15(d)(1)(vi) would require adjustments to AFSI to prevent any omission or duplication that would otherwise result from the CAMT entity being required to begin or cease making adjustments under section 56A(c)(13) as a result of a tax capitalization method change (proposed § 1.56A-15(b)(11) would define these adjustments as the “tax capitalization method change AFSI adjustment”). For example, if a CAMT entity changes its method of accounting for regular tax purposes from capitalizing and depreciating a cost under sections 167 and 168 to deducting that cost as a repair under section 162, adjustments under section 56A(c)(13) would no longer be required beginning in the year of change as the cost would no longer constitute section 168 property and a tax capitalization method change AFSI adjustment would be made to adjust the cumulative amount of AFSI as of the beginning of the year of change to reflect the cumulative amount of adjustments to AFSI that would have been made in prior years under the new method of accounting. Proposed § 1.56A-15(d)(4) would provide that, in general, a negative tax capitalization method change AFSI adjustment reduces AFSI in the tax year of change by the full amount of the adjustment, and a positive tax capitalization method change AFSI adjustment increases AFSI ratably over four taxable years beginning with the tax year of change. For purposes of proposed § 1.56A-15(d)(4), a short taxable year would be treated as if it were a full 12-month taxable year. If, in any taxable year, a CAMT entity ceases to engage in the trade or business to which the tax capitalization method change AFSI adjustment relates, proposed § 1.56A-15(d)(4) would require the CAMT entity to include in its AFSI for such taxable year any portion of the adjustment not included in AFSI for a previous taxable year.

Examples in proposed § 1.56A-15(d)(5) would illustrate the adjustments to AFSI that would be required by proposed § 1.56A-15(d).

C. Disposition of Section 168 Property

1. In General

To prevent duplications or omissions of AFSI, proposed § 1.56A-15(e)(1) generally would provide that, if a CAMT entity disposes of section 168 property for regular tax purposes, the CAMT entity must adjust AFSI for the year of the disposition to redetermine the gain or loss taken into account in the CAMT entity's FSI on the disposition by reference to the CAMT basis in the property (in lieu of the AFS basis). For this purpose, the CAMT basis in the property would be determined by adjusting the AFS basis in the property on the disposition date by the amounts described in proposed § 1.56A-15(e)(2). Proposed § 1.56A-15(e)(1) would clarify that, to the extent the CAMT basis of section 168 property is negative (for example, if regular tax basis exceeds AFS basis), such negative amount is recognized as AFSI gain upon disposition of the section 168 property. Proposed § 1.56A-15(e)(7) would provide that, in the case of a disposition for regular tax purposes in an intercompany transaction defined in § 1.1502-13(b)(1)(i), the timing of taking into account the AFSI adjustment under proposed § 1.56A-15(e)(1) is deferred until the taxable year in which the FSI of the tax consolidated group includes the selling member's FSI gain or loss. The calculation of FSI of a tax consolidated group is further discussed in part XXXI.C of this Explanation of Provisions, and the treatment of tax items relating to intercompany transactions is further discussed in part XXXI.G of this Explanation of Provisions.

Proposed § 1.56A-15(e)(2)(i) would provide that the CAMT basis of the section 168 property as of the disposition date is the AFS basis of the section 168 property as of that date: (i) decreased by the full amount of the tax depreciation with respect to such property (regardless of whether any amount of the tax depreciation was capitalized for regular tax purposes and not yet taken into account as a reduction to AFSI through an adjustment described in proposed § 1.56A-15(d)(1)(i) or (ii) as tax COGS depreciation or deductible tax depreciation); (ii) increased by the amount of any covered book expense with respect to the property; (iii) increased by the amount of any covered book COGS depreciation and covered book depreciation expense that reduced the AFS basis of such property as of the date of disposition, including covered book COGS depreciation and covered book depreciation expense with respect to AFS basis that are otherwise disregarded for AFSI and CAMT basis purposes (for example, AFS basis increases that are disregarded for AFSI and CAMT basis purposes under proposed § 1.56A-18 or 1.56A-19 (concerning corporate transactions)); (iv) decreased by any reductions to the CAMT basis of such property under proposed § 1.56A-21(c)(4) and (5) (concerning CAMT attribute reductions for troubled companies); (v) decreased by any amount allowed as a credit against tax imposed by subtitle A with respect to such property, but only to the extent of the amount that reduces the tax basis of such property for regular tax purposes; and (vi) increased or decreased, as appropriate, by the amount of any adjustments to AFS basis that are disregarded for AFSI and CAMT basis purposes under other sections of the section 56A regulations with respect to such property (for example, AFS basis decreases that are disregarded for AFSI and CAMT basis purposes under § 1.56A-8 and AFS basis adjustments that are disregarded for AFSI and CAMT basis purposes under § 1.56A-18 or 1.56A-19).

These proposed regulations generally would follow the adjustments described in section 4.07 of Notice 2023-7, as modified by section 9.02(5) and (7) of Notice 2023-64, with certain modifications for Federal tax credits that reduce the basis of section 168 property for regular tax purposes. Proposed § 1.56A-15(e)(2)(i)(E) would provide for an adjustment to decrease CAMT basis upon disposition by any amount allowed as a Federal tax credit to the extent of the amount that reduces the basis of section 168 property for regular tax purposes. Because Federal tax credits can offset an applicable corporation's CAMT liability under section 55(a), this adjustment would provide parity with the regular tax rules that generally apply a “no excess benefit” principle such that the adjusted basis of property is reduced, in whole or in part, if a Federal tax credit is determined with respect to such property. Accordingly, this adjustment would prevent an applicable corporation from obtaining an excess benefit for CAMT purposes upon disposition through a recovery of additional CAMT basis equal to the amount of the credit. This adjustment is also consistent with the implementation of section 56A(c)(13) in these proposed regulations by mimicking the regular tax treatment of all section 168 property to the extent of the timing and amount of regular tax basis recovery.

Proposed § 1.56A-15(e)(2)(ii) and (e)(3) would provide special rules regarding adjustments to the AFS basis of section 168 property. Proposed § 1.56A-15(e)(2)(ii)(A) would provide that, for section 168 property placed in service prior to the effective date of CAMT (that is, January 1, 2023), the adjustments in proposed § 1.56A-15(e)(2)(i) include amounts attributable to all taxable years beginning before January 1, 2023. This would be consistent with the implementation of section 56A(c)(13) in these proposed regulations by mimicking the regular tax treatment of all section 168 property to the extent of the timing and amount of regular tax basis recovery such that unrecovered pre-effective date AFS basis is not recovered upon disposition when regular tax basis recovery already occurred. In the case of section 168 property acquired in a transaction that is a covered recognition transaction, as defined in proposed § 1.56A-18, with respect to at least one party to the transaction, or in a partnership transaction described in proposed § 1.56A-20, proposed § 1.56A-15(e)(2)(ii)(B) would provide that the adjustments in proposed § 1.56A-15(e)(2)(i) include only amounts attributable to the period following the transaction. The adjustments in proposed § 1.56A-15(e)(2)(i) are not required for the period prior to a covered recognition transaction or a partnership transaction described in proposed § 1.56A-20 because gain or loss was included in AFSI at the time of the transaction (using CAMT basis in lieu of AFS basis). Accordingly, for a subsequent disposition of section 168 property after a covered recognition transaction or a partnership transaction described in proposed § 1.56A-20, the adjustments in proposed § 1.56A-15(e)(2)(i) that pre-date the transaction are not needed to determine the CAMT basis and redetermine gain or loss for purposes of adjusting AFSI for the subsequent disposition.

Proposed § 1.56A-15(e)(2)(ii)(C), which contains a special rule for coordination with section 56A(c)(5), would provide that the adjustment for tax credits described in proposed § 1.56A-15(e)(2)(i)(E) applies regardless of the treatment of the tax credit for AFS purposes. In addition, proposed § 1.56A-15(e)(2)(ii)(D) would provide a rule for determining CAMT basis of section 168 property following a change in method for depreciation or a tax capitalization method change. Under the rule, adjustments under § 1.56A-15(e)(2)(i) would be determined as though the CAMT entity used the method of accounting to which it changed under the corresponding method change when making the adjustments under § 1.56A-15(d)(1) in all taxable years prior to the taxable year in which the disposition of the section 168 property occurs. This special rule would be needed to prevent income or deductions from being duplicated or omitted because of the accounting method change.

Proposed § 1.56A-15(e)(2)(ii)(E) would provide that the adjustments described in proposed § 1.56A-15(e)(2)(i)(B) (covered book expense) and (C) (covered book COGS depreciation and covered book depreciation expense) would include only the covered book expense, covered book COGS depreciation, and covered book depreciation expense amounts that were actually disregarded by the CAMT entity under proposed § 1.56A-15(d)(1)(iii) in computing its AFSI, modified FSI, or adjusted net income or loss for the relevant taxable years. However, for a taxable year ending on or before December 31, 2019, or for a taxable year in which the CAMT entity satisfies the simplified method under proposed § 1.59-2(g) (including a taxable year included in the relevant three-taxable-year period), the CAMT entity is deemed to have disregarded the appropriate amounts under proposed § 1.56A-(d)(1)(iii). This rule prevents a CAMT entity that did not disregard the appropriate amounts in prior years from receiving a double benefit on disposition given that the rules in proposed § 1.56A-15(e)(2) otherwise would include these amounts in the CAMT basis of the section 168 property disposed of.

Proposed § 1.56A-15(e)(3) would provide special rules for section 168 property disposed of by a partnership. If a partnership disposes of section 168 property, the partnership must adjust its modified FSI (described in proposed § 1.56A-5(e)(3)) for the taxable year in which the disposition occurs to redetermine any gain or loss taken into account in the partnership's FSI by reference to the CAMT basis (in lieu of the AFS basis) of the section 168 property. For purposes of this calculation, adjustments to a partnership's AFS basis of section 168 property disposed of by the partnership include any tax depreciation (including any reduction in tax depreciation) relating to a section 734(b) basis adjustment. Accordingly, tax depreciation relating to a section 734(b) basis adjustment would be required in all cases to be recaptured upon a disposition of the section 168 property by a partnership unless a corresponding adjustment was made to the AFS basis of the property as a result of the transaction that gave rise to the section 734(b) basis adjustment.

Adjustments to a partnership's AFS basis of section 168 property disposed of by a partnership do not include any tax depreciation (including any reduction in tax depreciation) or adjustments to the partnership's AFS basis in the section 168 property with respect to a basis adjustment under § 1.1017-1(g)(2). However, if a partner in the partnership is subject to the attribute reduction rules under proposed § 1.56A-21(c)(4) and (5) for discharge of indebtedness income realized through the partnership, the partner must increase its distributive share amount (under proposed § 1.56A-5(e)(4)(ii)(A)) for the taxable year of the disposition of the section 168 property by the amount of any remaining basis adjustment under § 1.1017-1(g)(2) with respect to the section 168 property that has not yet been taken into account for regular tax purposes. See § 1.1017-1(g)(2)(v) and proposed § 1.56A-5(e)(4)(ii)(A).

Adjustments to a partnership's AFS basis of section 168 property disposed of by a partnership also do not include any tax depreciation (including any reduction in tax depreciation) or adjustments to the partnership's AFS basis in the section 168 property with respect to a basis adjustment under section 743(b). However, if a partner in the partnership has a section 743(b) adjustment with respect to section 168 property held by the partnership that is disposed of by the partnership for regular tax purposes, the partner must increase its distributive share amount (under proposed § 1.56A-5(e)(4)(ii)(B)) for the taxable year of the disposition of the section 168 property by an amount equal to the total amount of any tax depreciation or tax depreciation section 481(a) adjustments (including negative amounts) with respect to a section 743(b) basis adjustment that decreased the partner's distributive share amount under proposed § 1.56A-5(e)(1)(iv) and (e)(4)(ii)(A) for taxable years prior to the disposition. Likewise, the partner must decrease its distributive share amount (under proposed § 1.56A-5(e)(4)(ii)(B)) for the taxable year of the disposition of the section 168 property by an amount equal to the total amount of any tax depreciation or tax depreciation section 481(a) adjustments with respect to a section 743(b) basis adjustment that increased the partner's distributive share amount under proposed § 1.56A-5(e)(1)(iv) and (e)(4)(ii)(A) for taxable years prior to the disposition. Thus, tax depreciation or tax depreciation section 481(a) adjustments relating to a section 743(b) basis adjustment that adjusted a partner's distributive share amount would be required in all cases to be recaptured by the partner upon a disposition of the section 168 property by the partnership.

Section 56A(a) provides that the term “AFSI” means, for any corporation for any taxable year, the net income or loss of the taxpayer set forth on its AFS for the taxable year, adjusted as provided in section 56A. Section 56A(c)(13) does not expressly include an adjustment to AFSI to apply nonrecognition or gain deferral provisions that apply to certain dispositions of section 168 property for regular tax purposes. However, under the authority granted by section 56A(c)(15), the Secretary may provide for such an adjustment in certain situations (for example, see proposed §§ 1.56A-18 and 1.56A-19, which would provide for an adjustment to AFSI if section 168 property is disposed of in a covered nonrecognition transaction).

Accordingly, proposed § 1.56A-15(e)(4) would provide that except as otherwise provided in other sections of the section 56A regulations, the nonrecognition and gain deferral rules of the Code would not apply when a CAMT entity recognizes gain or loss from the disposition of section 168 property in its FSI, regardless of whether or when any gain or loss on the disposition is taken into account for regular tax purposes. These rules would be consistent with sections 9.02 and 9.03 of Notice 2023-64 and with section 56A(c)(13)'s directive to mimic the regular tax treatment of all section 168 property to the extent of the timing and amount of regular tax basis recovery, which does not extend to the timing and amount of disposition proceeds received upon the disposition of section 168 property that are taken into account in determining gain or loss in FSI (unless otherwise provided in other sections of the section 56A regulations).

Proposed § 1.56A-15(e)(6) also follows the principle applied in interpreting section 56A(c)(13) by providing a special rule that, if section 168 property is disposed of for regular tax purposes before it is treated as disposed of for AFS purposes, the CAMT entity continues to make AFSI adjustments under proposed § 1.56A-15(d)(1)(iii) to disregard any AFS basis recovery that is reflected in FSI following the disposition of the section 168 property for regular tax purposes. Finally, proposed § 1.56A-15(e)(5) would provide that the unit of property determination under § 1.263(a)-3(e) does not apply for purposes of determining the appropriate asset to ascertain whether section 168 property has been disposed of. Instead, CAMT entities would be required to follow section 168 and the regulations under section 168. See § 1.168(i)-8(c)(4).

Proposed § 1.56A-15(e)(7) would provide examples to illustrate these rules.

XVI. Proposed § 1.56A-16: AFSI Adjustments for Qualified Wireless Spectrum

Pursuant to the authority granted by section 56A(c)(14)(A)(ii)(II), (c)(15), and (e), proposed § 1.56A-16 would provide rules under section 56A(c)(14) regarding qualified wireless spectrum. The principles of interpretation and rules applied would be consistent with the principles and rules for section 168 property discussed in part XV of this Explanation of Provisions, except for certain rules that are not applicable to qualified wireless spectrum (for example, the definition of section 168 property and the rules for tax depreciation that is capitalized under section 263A to inventory or to the basis of property under section 1221(a)(1) that is not inventory). Therefore, section 56A(c)(14) would be interpreted to mimic the regular tax treatment of all qualified wireless spectrum to the extent of the timing and amount of regular tax basis recovery with respect to the qualified wireless spectrum, regardless of when placed in service and regardless of whether gain or loss with respect to qualified wireless spectrum is recognized in FSI.

The definitions, rules for adjusting AFSI for amortization and other amounts with respect to qualified wireless spectrum, and rules upon disposition of qualified wireless spectrum are therefore not discussed. Instead, only rules or definitions within proposed § 1.56A-16 that differ or are unique from the section 168 property rules (that is, the definition of qualified wireless spectrum) are discussed in this section. Proposed § 1.56A-16(c)(1) would define “qualified wireless spectrum” as wireless spectrum that: (i) is used in the trade or business of a wireless telecommunications carrier; (ii) is an amortizable section 197 intangible under section 197(c)(1) and (d)(1)(D); and (iii) was acquired after December 31, 2007, and before August 16, 2022. This definition would be consistent with the definition in section 10.02(4) of Notice 2023-64.

XVII. Proposed § 1.56A-17: AFSI Adjustments To Prevent Certain Duplications and Omissions

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-17 would provide rules under section 56A(c)(15) to prevent certain duplications and omissions.

A. Only Specified Adjustments to AFSI Are Allowed

Section 56A(c)(15)(A) authorizes the Secretary to issue regulations or other guidance to provide for adjustments to AFSI that the Secretary determines necessary to carry out the purposes of section 56A, including adjustments to prevent the duplication or omission of any item. Consistent with Notice 2023-64 and proposed § 1.56A-1(d)(2), proposed § 1.56A-17(b) would provide that, to prevent duplications or omissions of items of income, expense, gain or loss, AFSI is adjusted for those items identified in proposed § 1.56A-17(c) through (e) and any other items identified in the section 56A regulations. Accordingly, CAMT entities would not be allowed to self-identify items they believe to be duplications or omissions and make AFSI adjustments for such items. The Treasury Department and the IRS request comments on whether additional adjustments are necessary to prevent duplications or omissions of items under section 56A.

B. Adjustment for Changes in Accounting Principles

New accounting standards commonly are implemented retrospectively through an adjustment to the beginning balance of a CAMT entity's retained earnings in the AFS for the year in which the new standards are implemented, which may result in a duplication of AFSI or an omission from AFSI. For example, a duplication would arise if a new accounting standard were to recognize income or expense in a later year than the prior standard (as that amount would be taken into account in FSI under both the prior standard and the new standard, thus necessitating an offsetting adjustment to retained earnings). Conversely, an omission would arise if the new standard were to recognize income or expense in a prior year whereas the old standard would have recognized such amount in a future year (as that amount would not be taken into account in FSI under either standard, thus necessitating an adjustment to retained earnings to account for the economic effect of that amount in the financial statements).

To prevent these duplications or omissions, and consistent with Notice 2023-64, proposed § 1.56A-17(c)(1) generally would require a CAMT entity to adjust its AFSI by the “accounting principle change amount,” as described in proposed § 1.56A-17(c)(2)(i), if the CAMT entity implements a change in accounting principle in its AFS. Under proposed § 1.56A-17(c)(2)(i), the accounting principle change amount would be equal to the net cumulative adjustment to the CAMT entity's beginning retained earnings resulting from the change in accounting principle. The accounting principle change amount would also be subject to further adjustment if any portion of the amount relates to any FSI items to which other AFSI adjustments apply, such as taxes under section 56A(c)(5) and proposed § 1.56A-8, and to disregard any portion of the cumulative adjustment attributable to taxable years beginning on or before December 31, 2019.

Proposed § 1.56A-17(c)(2)(ii) also provides rules for determining the accounting principle change amount when a CAMT entity is treated as having a change in accounting principle under proposed § 1.56A-1(c)(5) because the priority of the CAMT entity's AFS for the taxable year (as determined under proposed § 1.56A-2(c)) is different from the priority of the CAMT entity's AFS for the immediately preceding taxable year. In such a case, the accounting principle change amount would be equal to the difference between the CAMT entity's beginning retained earnings reflected on the current AFS as of the beginning of the taxable year and the ending retained earnings reflected on the former AFS as of the end of the immediately preceding taxable year. The accounting principle change amount would also be subject to further adjustment if any portion of the amount relates to any FSI items to which other AFSI adjustments apply, such as taxes under section 56A(c)(5) and proposed § 1.56A-8, and to disregard any portion of the cumulative adjustment attributable to taxable years beginning on or before December 31, 2019.

Proposed § 1.56-17(c)(3) would provide rules consistent with Notice 2023-64 for spreading accounting principle change amounts across multiple taxable years. Different spread period rules would apply depending on whether a net adjustment to AFSI prevents the duplication or prevents the omission of an amount. Because the same accounting principle change amount could prevent a duplication of an item and prevent the omission of another item, proposed § 1.56-17(c)(3) would require a CAMT entity to determine the appropriate spread period rules based on whether the accounting principle change amount prevents a net duplication or a net omission due to the accounting principle change.

Proposed § 1.56A-17(c)(3)(i)(A) generally would provide that, if an accounting principle change adjustment prevents a net duplication for AFSI purposes, the adjustment must be taken into account in the CAMT entity's AFSI ratably over four taxable years, beginning with the taxable year the change in accounting principle is implemented in the CAMT entity's AFS. However, stakeholders have observed that duplicated items could be taken into account in FSI over a shorter or longer period of time. Moreover, a distortion could occur if the duplicated items were significant and taken into account in FSI over a different period than the corresponding AFSI adjustment. A spread period other than four years may be appropriate to prevent such distortions but have abuse and administrability concerns associated with allowing excessively long spread periods. Accordingly, proposed § 1.56A-17(c)(3)(i)(B) would provide that the spread period is capped at 15 years, which should be sufficient to prevent undue distortions. If a CAMT entity can demonstrate that a net duplication is reasonably anticipated to be taken into account in FSI over a period other than 4 years, proposed § 1.56A-17(c)(3)(i)(B) would allow such CAMT entity to take the AFSI adjustment into account ratably over a spread period, not to exceed 15 years, that matches the period that the net duplication is taken into account in the AFS under the new accounting principle (regardless of whether the duplicated amount is taken into account ratably over that period). The Treasury Department and the IRS request comments about whether a spread period greater than 15 years is necessary for an accounting principle change amount that prevents duplication.

In contrast, if an adjustment prevents a net omission for AFSI purposes, proposed § 1.56A-17(c)(3)(ii) would require (i) adjustments that result in an increase to AFSI to be taken into account in AFSI ratably over four taxable years, beginning with the taxable year that the change in accounting principle is implemented in the CAMT entity's AFS, and (ii) adjustments that result in a decrease to AFSI to be taken into account in AFSI in full in the taxable year the change in accounting principle is implemented in the CAMT entity's AFS. Unlike items that were duplicated in AFSI, items that would be omitted from AFSI (but for the accounting principle change adjustment) already would have been taken into account in FSI under the new accounting principle. Accordingly, there is no need to defer any portion of the AFSI adjustment to future taxable years in order to match its timing with the related FSI items, as the omitted item would have already been taken into account in FSI in a prior period under the new accounting principle. Nonetheless, the spread period rules for amounts omitted from AFSI would follow the spread period rules used for section 481(a) adjustments for regular tax purposes, consistent with the description immediately preceding.

Proposed § 1.56A-17(c)(4) would provide, consistent with Notice 2023-64, that any portion of an accounting principle change amount not included in AFSI for a previous taxable year must be taken into account in AFSI in the taxable year the CAMT entity ceases to engage in the trade or business that is the subject of the change in accounting principle. The Treasury Department and the IRS request comments on proposed § 1.56A-17(c)(4) and whether and to what extent the rules and concepts provided in Rev. Proc. 2015-13, 2015-5 I.R.B. 419, that accelerate the recognition of a section 481(a) adjustment in certain circumstances should apply to accelerate the recognition of an accounting principle change amount (without suggesting that an accounting principle change is inherently also a tax accounting method change).

C. Adjustment for Restatement of a Prior Year's AFS

Proposed § 1.56A-2(e) would provide rules for the restatement of FSI for a taxable year on a CAMT entity's restated AFS (restatement) issued prior to the date that the CAMT entity files its original Federal income tax return for such taxable year. Proposed § 1.56A-17(d) would provide rules for a restated AFS issued on or after the date that the CAMT entity files its original Federal income tax return. Consistent with Notice 2023-64, proposed § 1.56A-17(d)(1) generally would require the CAMT entity to adjust its AFSI to account for the restatement (AFSI restatement adjustment). Unlike Notice 2023-64, which required the adjustment to be taken into account in the first taxable year for which the CAMT entity had not filed an original return as of the restatement date, proposed § 1.56A-17(d)(1)(i) would require that the adjustment be made for the taxable year during which the restated AFS is issued. This change was made because of a concern that the rule in Notice 2023-64 might not provide CAMT entities with enough time to take into account the restatement if it were issued shortly before the next due date for filing an original return. Providing an adjustment for the taxable year during which the restated AFS is issued is intended to minimize the instances in which a CAMT entity would file an amended return or an administrative adjustment request (AAR) under section 6227 of the Code as a result of a restatement. However, proposed § 1.56A-17(d)(2) would require a CAMT entity that has a restatement, and that files an amended return or AAR to adjust taxable income as a result of the restatement, to use the restated AFS to determine AFSI on the amended return or AAR instead of making the AFSI restatement adjustment.

The AFSI restatement adjustment would be equal to the cumulative effect of the restatement on the CAMT entity's FSI for the restatement year, including any restatement of the CAMT entity's beginning retained earnings. The AFSI restatement adjustment would also be subject to further adjustment if any portion of the amount relates to any FSI items to which other AFSI adjustments apply, such as taxes under section 56A(c)(5) and proposed § 1.56A-8, and to disregard any portion of the cumulative adjustment attributable to taxable years beginning on or before December 31, 2019. A spread period for the adjustment, as in the case of an adjustment for a change in accounting principle, was not considered appropriate in the case of restatements, which are corrections in the application of such principles.

Proposed § 1.56A-17(d)(3) would provide that a CAMT entity is treated as if it restated its AFS for the preceding taxable year, and subject to the AFSI restatement adjustment rules discussed previously, if (i) a CAMT entity adjusts the beginning balance of retained earnings on its AFS for the current taxable year to be different from the ending balance of retained earnings on its AFS for the preceding taxable year without restating the AFS (for example, as the result of a prior period adjustment), (ii) the difference is attributable to items that otherwise would be reflected in the CAMT entity's FSI under the relevant accounting standards used to prepare the CAMT entity's AFS, and (iii) the CAMT entity is not otherwise subject to § 1.56A-17(c), (d)(1) or (2).

D. Adjustment for Amounts Disclosed in an Auditor's Opinion

Auditors' opinions that are described in proposed § 1.56A-2(d)(2) (a qualified or modified “except for” opinion) or (d)(3) (an adverse opinion in which the auditor discloses the amount of the disagreement) identify situations in which a CAMT entity's accounting treatment of an item diverges from the relevant accounting standard. Consistent with Notice 2023-64, proposed § 1.56A-17(e) would require AFSI to be adjusted to take into account amounts disclosed in such a qualified or adverse auditor's opinion if those amounts would have increased the CAMT entity's FSI had the amounts been reported in the CAMT entity's AFS. However, no AFS adjustment would be required if the disclosed amount were already included in FSI for a prior year. If FSI for a subsequent year includes amounts included in AFSI due to an adjustment under proposed § 1.56A-17(e), AFSI for the subsequent year is adjusted to prevent any duplication of income. These proposed rules would follow the rules for such adjustments in the 1990 Regulations.

E. No Adjustment for Timing Differences

Stakeholders requested an adjustment to prevent perceived distortions caused by timing differences, particularly in situations in which items are included in FSI before the effective date of the CAMT but included in taxable income thereafter, or vice versa. These timing differences do not create a duplication or omission of AFSI within the meaning of section 56A(c)(15) of the Code and are precisely the types of financial accounting and taxable income differences that the CAMT was intended to capture. Although proposed § 1.56A-17(b) prevents such adjustments, for the avoidance of doubt and consistent with Notice 2023-64, proposed § 1.56A-17(f) would not permit any adjustment to account for differences between the period an item is taken into account in FSI and the period it is taken into account for regular tax purposes. This proposed regulation would adopt the approach taken in the 1990 Regulations, which was upheld in CSX Corp. v. United States, 124 F.3d 643 (4th Cir. 1997).

XVIII. Proposed §§ 1.56A-18 and 1.56A-19: AFSI, CAMT Basis, and CAMT Retained Earnings Resulting From Certain Corporate Transactions Involving Domestic Corporations

Pursuant to authority granted by section 56A(c)(2)(C), (c)(15), and (e), proposed § 1.56A-18 would provide rules regarding investments in domestic corporations that are not members of the CAMT entity's tax consolidated group. Pursuant to authority granted by sections 56A(c)(15) and 56A(e), proposed §§ 1.56A-18 and 1.56A-19 also would provide rules under section 56A regarding transactions involving domestic corporations. The rules in proposed §§ 1.56A-18 and 1.56A-19 would not apply to investments in stock in foreign corporations and transactions involving foreign corporations described in proposed § 1.56A-4.

A. Overview

1. Equity Investments in Domestic Corporations That Are Not Members of the Shareholder's Tax Consolidated Group

Section 56A(c)(2)(C) provides, in part, that a taxpayer's AFSI with respect to a corporation that is not a member of the taxpayer's tax consolidated group only takes into account dividends received from that corporation (reduced to the extent provided by the Secretary) and other amounts that are includible in gross income or deductible as a loss under chapter 1 (other than amounts provided by the Secretary) with respect to that corporation.

The financial accounting consequences of an investment in a domestic corporation differ considerably from the Federal income tax consequences of such an investment. Under the Code, a shareholder generally has income or deductions upon the occurrence of a realization event with respect to the shareholder's stock (typically, a distribution from the corporation or an exchange of the stock). The Code specifies the shareholder's tax consequences when such an event occurs, including capital gain or loss, dividend income, a dividends received deduction, or some other result.

In contrast, financial statement income often includes gain or loss with respect to stock even if there has been no realization event for Federal income tax purposes. For example, financial statement income may include unrealized appreciation or depreciation in stock prices, a proportionate share of the corporation's income or loss, or loss from impairment.

2. Subchapter C Transactions

Section 56A(c)(15) authorizes the Secretary to issue regulations or other guidance to provide for such adjustments to AFSI as the Secretary determines necessary to carry out the purposes of section 56A, including adjustments to carry out the principles of part II of subchapter C (relating to corporate liquidations) and part III of subchapter C (relating to corporate organizations and reorganizations) of chapter 1. See section 56A(c)(15)(B).

For Federal income tax purposes, a taxpayer generally recognizes gain or loss on the exchange of property if the property received differs in material kind or extent from the property exchanged. The purpose of the corporate liquidation, organization, and reorganization provisions in parts II and III of subchapter C is to provide nonrecognition treatment for certain specifically described distributions or exchanges incident to certain readjustments of corporate structures made in one of the particular ways specified in the Code that are required by business exigencies and that effect only a readjustment of a continuing interest in property in modified corporate form. See, for example, § 1.368-1(b).

Parties to nonrecognition transactions under subchapter C generally take the acquired assets with a carryover basis (that is, the assets' basis in the hands of the party from whom the assets were acquired) and take the qualifying property (that is, property that is permitted to be received under section 354 or 355 without the recognition of gain or loss) received in the transaction with an exchanged basis (that is, the basis in the property exchanged for qualifying property). If the assets being transferred include stock of another corporation, the basis in the assets of that other corporation generally is not affected by the transaction.

Business combinations and dispositions are treated differently under financial accounting principles than under Federal income tax principles. Under financial accounting principles, acquisitions of entities or lines of business generally are recorded on the AFS at fair value, with the acquiring corporation (acquiror) valuing the assets and liabilities of the acquired entity or line of business at their fair value as of the acquisition date (that is, purchase accounting). See, for example, ASC 805-20-25-1. Additionally, an acquired CAMT entity may elect to adjust the carrying value of its assets and liabilities and the assets and liabilities of any lower-tier entities to fair value as of the date the entity is acquired (that is, push-down accounting). See, for example, ASC 805-20-25-4. In contrast, Federal income tax principles generally preclude adjustments to the basis in the assets of acquired corporations, whether or not gain or loss was recognized in the transaction.

Additionally, although entities generally have separate books and records for financial accounting purposes, financial consolidation generally eliminates the effects of multiple tiers of ownership and disregards the ownership of stock of lower-tier entities as such. Instead, financial consolidation looks through separate legal entities in order to present the financial results as if all of the items of income, expense, gain, and loss of the members of the financial consolidation were the items of a single corporation. In contrast, domestic corporations that are not members of a tax consolidated group generally are treated as separate entities for Federal income tax purposes.

Certain non-pro rata distributions also result in financial accounting gain or loss ( see ASC 845-10-30-12), regardless of whether such transactions would be eligible for nonrecognition treatment under subchapter C.

B. Section 3 of Notice 2023-7

Section 3 of Notice 2023-7 provides guidance under section 56A(c)(15) by describing adjustments to carry out the principles underlying the corporate liquidation, organization, and reorganization provisions of subchapter C. Section 2.01(3)(a) of Notice 2023-7 provides that the financial accounting treatment of corporate transactions controls the determination of AFSI resulting from a transaction unless the treatment is modified as described in Notice 2023-7. For example, under Notice 2023-7, the treatment of a disposition of property that results in gain or loss for Federal income tax purposes (that is, a covered recognition transaction) would be governed by financial accounting principles. As a result, the acquired entities or lines of business generally would be recorded on the AFS at fair value.

However, section 3.03 of Notice 2023-7 further provides, in part, that if a transaction results in no gain or loss for Federal income tax purposes to the party to a transaction under sections 332, 337, 351, 354, 355, 357, 361, 368, or 1032 of the Code (that is, a covered nonrecognition transaction), (i) the party does not take into account the financial accounting gain or loss resulting from the transaction to compute its AFSI, and (ii) to the extent the party does not take into account AFSI resulting from the transaction under Notice 2023-7, any increase or decrease in the financial accounting basis of the assets transferred to the party in the transaction is not taken into account to compute that party's AFSI. In determining whether a transaction is a covered nonrecognition transaction, section 3.02(5)(b) of Notice 2023-7 provides that each component transaction of a larger transaction is evaluated separately.

C. Proposed Regulations

1. In General

Section 56A(a) generally requires AFSI to be determined based on the taxpayer's AFS unless an adjustment provided in section 56A applies. Accordingly, except as otherwise provided in the section 56A regulations, the section 56A regulations generally implement the CAMT by following financial accounting principles. For example, see proposed § 1.56A-1(d)(1) (generally providing that Federal income tax treatment is not relevant for determining a CAMT entity's AFSI except as otherwise provided in the section 56A regulations).

a. Section 56A(c)(2)(C) and Investments in Domestic Corporations

Section 56A(c)(2)(C) constitutes an exception to the general rule in section 56A(a) concerning the determination of AFSI by a CAMT entity with respect to a corporation that is not included on a tax consolidated return with the CAMT entity. In the context of a CAMT entity that is a shareholder in a domestic corporation, section 56A(c)(2)(C) is implemented by providing that, if a CAMT entity's role in a transaction is purely as a shareholder of a domestic corporation (and not as a party to the transaction), regular tax rules govern the CAMT entity's determination of its AFSI, using CAMT inputs (such as CAMT earnings and CAMT basis) where applicable. In other words, in the context of a CAMT entity that is a shareholder in a domestic corporation, section 56A(c)(2)(C) should apply with respect to situations in which the CAMT entity holds stock in the domestic corporation. Such situations include, for example, dividend distributions ( see section 301), redemptions ( see sections 302 and 303 of the Code), stock distributions ( see section 305 of the Code), or certain distributions and exchanges as part of a corporate reorganization ( see sections 354 through 356 of the Code)). In contrast, taking into account the structure of the statute and the grant of regulatory authority in section 56A(c)(15)(B), section 56A(c)(2)(C) generally should not apply if the CAMT entity is a party to a transaction involving the stock of the domestic corporation (such as a section 351 exchange, a disposition or acquisition of stock, or a transfer of property by a distributing corporation to a controlled corporation in a transaction to which sections 355 and 368(a)(1)(D) apply). Proposed § 1.56A-18(c) would provide guidance regarding investments in domestic corporations that are not members of the CAMT entity's tax consolidated group.

In the case of a domestic corporation that is not included in a CAMT entity's tax consolidated group, section 56A(c)(2)(C) is implemented to mean that it applies solely to transactions with respect to holding the corporation's stock (and not to transactions to which the CAMT entity is a party), for several reasons. First, this approach would give effect to the statutory exception in section 56A(c)(2)(C) with due regard for the broad statutory requirement in section 56A(a) that a corporate CAMT entity's AFSI must be determined starting with financial accounting net income or loss. Second, construing section 56A(c)(2)(C) so broadly as to result in the general application of regular tax rules to all transactions involving corporations that are not members of the same tax consolidated group is inconsistent with Congress's grant of authority to the Secretary in section 56A(c)(15)(B) to incorporate the principles of parts II and III of subchapter C.

While this approach is an appropriate implementation of section 56A(c)(2)(C) in the context of investments in domestic corporations, additional considerations are present in the case of investments in foreign corporations that call for a different application of section 56A(c)(2)(C) in that context (for instance, the interaction of section 56A(c)(2)(C) and (c)(3), which raises unique double-counting issues with respect to distributions by CFCs and transfers of stock of CFCs). See the discussion of the application of section 56A(c)(2)(C) with respect to investments in foreign corporations in part IV.A of this Explanation of Provisions.

b. Section 56A(c)(15)(B) and Certain Transactions Involving Domestic Corporations

Proposed §§ 1.56A-18 and 1.56A-19 would clarify and expand the guidance in Notice 2023-7 concerning covered recognition transactions and covered nonrecognition transactions (collectively, covered transactions). Under proposed §§ 1.56A-18 and 1.56A-19, a CAMT entity would use financial accounting rules to determine its AFSI resulting from a corporate transaction unless the entity qualifies for an exception under proposed § 1.56A-18 or 1.56A-19. See proposed § 1.56A-18(c)(2)(ii)(A). This rule reflects, and would be consistent with, the general rule in section 56A(a). The rules for covered transactions described in this part XVIII of the Explanation of Provisions do not apply to determine the CAMT consequences of either a corporate transaction involving domestic corporations that are members of the same tax consolidated group while those corporations remain members of the group or a corporate transaction involving a foreign corporation described in proposed § 1.56A-4. For ease of discussion, the remainder of this part XVIII of the Explanation of Provisions does not repeat these exclusions when discussing the rules for covered transactions.

More specifically, under proposed §§ 1.56A-18 and 1.56A-19, the CAMT consequences of corporate transactions would be determined under financial accounting principles (using CAMT inputs, such as CAMT retained earnings) unless the CAMT entity qualifies solely for nonrecognition treatment under the relevant Code section. In other words, if a transaction results in the recognition of any amount of gain or loss for regular tax purposes with regard to that CAMT entity (the so-called “cliff effect”), the CAMT entity would apply the relevant financial accounting principles (and not the applicable section of the Code) to the covered recognition transaction. See the definition of a “covered recognition transaction” in proposed § 1.56A-18(b)(10).

In contrast, if the CAMT entity qualifies solely for nonrecognition treatment with respect to a transaction, the CAMT entity would determine its AFSI from the transaction by applying regular tax rules with CAMT inputs. Accordingly, the transaction would result in a deferral of AFSI to the CAMT entity, but a stepped-up basis in the assets transferred in the transaction would be prohibited to ensure that such AFSI could be recognized in the future. See the definition of a “covered nonrecognition transaction” in proposed § 1.56A-18(b)(9).

The proposed approach to covered transactions is based upon the following principles. First, the grant of authority in section 56A(c)(15)(B) to provide for such adjustments as the Secretary determines necessary to carry out the principles of parts II and III of subchapter C is an exception to the general rule requiring a CAMT entity's AFSI to be computed based on financial accounting principles. However, section 56A(c)(15)(B) does not refer to, or consequently require, the wholesale importation of Federal income tax rules from, or tax items computed under, parts II and III of subchapter C. In contrast, see section 56A(c)(13)(A), which expressly requires AFSI to be reduced by depreciation deductions allowed under section 167 with respect to section 168 property to the extent of the amount allowed as deductions in computing taxable income for the taxable year. In the case of covered transactions, the Treasury Department and the IRS are of the view that wholly replacing financial accounting principles with the subchapter C rules is not “necessary to carry out the purposes of” section 56A. See section 56A(c)(15).

Second, the proposed approach reflects the long-standing principle of parts II and III of subchapter C that a taxpayer should not recognize gain or loss on its investment unless it “cashes out” its investment. See section 202 of the Revenue Act of 1918 (1918); see also the discussion in part XVIII.A.2 of this Explanation of Provisions. Accordingly, the proposed approach distinguishes between transactions in which the CAMT entity has wholly retained its investment (that is, covered nonrecognition transactions) and transactions in which the CAMT entity has not (that is, covered recognition transactions).

The Treasury Department and the IRS considered several alternatives to the proposed “cliff effect” approach with respect to covered transactions. Under one alternative, the regular tax rules of parts II and III of subchapter C would be incorporated wholesale, using CAMT inputs (such as CAMT basis) in lieu of regular tax inputs. However, as noted previously, section 56A(c)(15)(B) does not compel the wholesale importation of the regular tax rules of parts II and III of subchapter C with respect to covered transactions. Additionally, this alternative approach would not adequately implement section 56A(a), which generally requires the use of financial accounting net income or loss.

Under another alternative, financial accounting principles would be incorporated in proportion to the amount of “boot” (that is, money or property received in a corporate transaction other than stock and securities permitted to be received without the recognition of gain or loss under the applicable Code section(s)) in a transaction that otherwise qualifies for nonrecognition treatment to the CAMT entity. However, such a “proportionate” approach would be inappropriate because many aspects of the financial accounting treatment of corporate transactions are not easily proportioned. For example, under GAAP, a corporate transaction may be recharacterized to reverse the identity of the acquiror and the target corporation, or the direction of a spin-off may be reversed such that the parent corporation is the one whose stock is treated as distributed for GAAP purposes. These types of characterizations are binary in effect (that is, they are either applied or not applied).

Proposed § 1.56A-18(b) and (c) would provide definitions and operating rules, respectively, for purposes of proposed §§ 1.56A-18 and 1.56A-19. Proposed §§ 1.56-18(d) through (h) and 1.56A-19 would provide rules to determine the CAMT consequences of various types of covered transactions.

2. Equity Ownership in Domestic Corporations That Are Not Members of the Shareholder's Tax Consolidated Group

a. In General

As discussed in part XVIII.C.1.a of this Explanation of Provisions, section 56A(c)(2)(C) conforms the treatment of investments in the stock of domestic corporations for purposes of section 56A to Federal income tax principles during the period in which the shareholder holds the stock. Accordingly, proposed § 1.56A-18(c)(2) would provide that, in computing AFSI, CAMT entities disregard any FSI resulting from equity ownership of domestic corporations that are not members of the CAMT entity's tax consolidated group, except with respect to amounts that result from a transaction described in proposed § 1.56A-18 or 1.56A-19. For example, a shareholder CAMT entity would disregard FSI that otherwise would result from applying the equity method or the fair value method to the CAMT entity's investment in stock of the subsidiary domestic corporation. Instead, CAMT entities would be required to follow Federal income tax principles to determine AFSI resulting from equity ownership of subsidiary domestic corporations.

Proposed § 1.56A-18(c)(2) also would provide that a CAMT entity disregards any adjustments to carrying values or retained earnings on the CAMT entity's AFS, and instead adjusts CAMT basis in the stock and adjusts CAMT retained earnings as provided in proposed § 1.56A-18 or 1.56A-19. In other words, CAMT entities would adjust the CAMT basis in stock when required by the applicable provision of the Code, and CAMT entities would adjust the CAMT retained earnings based on AFSI. Compare part IV of this Explanation of Provisions, describing AFSI adjustments and basis determinations with respect to foreign corporations.

b. Alternative Approach Considered

The Treasury Department and the IRS considered an alternative approach under which Federal income tax principles would determine whether there is an inclusion in AFSI for purposes of section 56A(c)(2)(C) (as in proposed §§ 1.56A-18 and 1.56A-19), but financial accounting principles would determine the amount of the inclusion (that is, unadjusted financial accounting carrying values would be used in AFSI computations). However, because of the significant differences in timing and amount of inclusions for Federal income tax and financial accounting purposes, such an approach would risk the omission or duplication of items of income, deduction, gain, and loss.

The Treasury Department and the IRS request comments on whether additional guidance is needed under proposed §§ 1.56A-18 and 1.56A-19 for shareholders in corporations that appear on the same consolidated AFS as the shareholder but that do not file a consolidated Federal income tax return with the shareholder.

3. Purchase Accounting and Push-Down Accounting

The proposed regulations would provide that purchase accounting and push-down accounting adjustments are disregarded in computing any aspect of AFSI resulting from covered transactions that are stock acquisitions, including for purposes of determining the acquiror corporation's CAMT basis and CAMT earnings. See proposed § 1.56A-18(c)(3). In other words, the proposed regulations would treat stock in lower-tier corporations as an asset, and covered nonrecognition transactions generally would not affect the inside basis of a lower-tier corporation's assets. See proposed § 1.56A-18(c)(1) and (c)(4)(ii). Respecting tiers of stock ownership and eliminating purchase accounting and push-down accounting (and thereby preserving two-levels of tax—one at the corporate level, and another at the shareholder level) is consistent with the principles of parts II and III of subchapter C.

4. CAMT Basis in Domestic Stock

Proposed § 1.56A-18(c)(6) would provide that a CAMT entity's CAMT basis in domestic corporate stock is equal to the CAMT entity's adjusted basis in the stock for regular tax purposes as of the first day of the CAMT entity's first taxable year beginning after December 31, 2019, adjusted as required by proposed § 1.56A-18 or 1.56A-19, rather than the carrying value of the stock on the CAMT entity's AFS on that day. Because the carrying value of the stock reflects adjustments under financial accounting principles that do not require a realization event, adopting the carrying value as the CAMT basis may lead to the duplication or omission of income with respect to domestic corporate stock. Additionally, the Treasury Department and the IRS understand that the carrying value of stock is not always maintained for financial accounting purposes because it is not relevant for the preparation of the AFS (for example, if the shareholder and the corporation appear on the same consolidated AFS).

5. Covered Transactions

a. Overview

As discussed in part XVIII.C.1 of this Explanation of Provisions, the proposed regulations would provide that financial accounting treatment governs the computation of a domestic corporation's AFSI with respect to a covered transaction, but that the AFSI computation is modified if the covered transaction qualifies as a covered nonrecognition transaction. This proposed approach would be consistent with Notice 2023-7. Additionally, in certain cases, the proposed regulations would provide modified rules for computing AFSI from covered recognition transactions.

Under Notice 2023-7, the determination of whether a transaction qualifies as a covered nonrecognition transaction is made on a party-by-party and transaction-by-transaction basis. To clarify the treatment of the various parties to covered transactions, proposed §§ 1.56A-18(d) through (h) and 1.56A-19 would significantly expand the covered transaction guidance described in Notice 2023-7 to provide separate rules for the following types of covered transactions: (i) non-liquidating distributions; (ii) distributions for which an election under section 336(e) is made; (iii) corporate liquidations; (iv) taxable sales of stock and assets; (v) stock reorganizations; (vi) asset reorganizations; (vii) divisive transactions to which section 355 applies; (viii) single-corporation reorganizations; and (ix) corporate formations to which section 351 applies. The proposed rules for certain of these covered transactions are described in the remainder of this part XVIII.C.5 of the Explanation of Provisions.

The proposed regulations generally would require a CAMT entity that is a party to a covered nonrecognition transaction: (i) to disregard any gain or loss reflected in FSI resulting from the transaction; (ii) to determine AFSI resulting from the transaction by applying the relevant Code section (that is, no AFSI is recognized); (iii) to determine the basis consequences of the transaction by applying the relevant Code section (using CAMT basis in lieu of AFS basis); and (iv) to adjust CAMT earnings (in lieu of AFS retained earnings) by applying section 312 (and, if applicable, section 381(c)(2)). In other words, for covered nonrecognition transactions, proposed §§ 1.56A-18 and 1.56A-19 would provide that financial accounting gain or loss with respect to such transactions is not taken into account in computing AFSI, and that the parties to the transaction take a carryover or exchange basis (rather than a fair value basis) in the assets or stock received.

In contrast, the proposed rules generally would require a CAMT entity that is a party to a covered recognition transaction: (i) to determine its AFSI by recomputing any gain or loss reflected in its FSI using the CAMT basis of any property transferred in the transaction (in lieu of AFS basis); (ii) to determine the CAMT basis in any property received in the transaction to be its AFS basis; and (iii) to adjust CAMT earnings (in lieu of AFS earnings) by the amount of AFSI resulting from the transaction. In other words, financial accounting principles generally would apply to covered recognition transactions, using CAMT inputs in lieu of financial accounting inputs.

For CAMT entities that are shareholders, the same general rules would apply to both covered nonrecognition transactions and covered recognition transactions. The proposed regulations would require such a CAMT entity: (i) to determine its AFSI by disregarding any gain or loss reflected in its FSI and applying the relevant Code section, using the distribution amount and CAMT basis, if relevant; (ii) to determine the characterization of the transaction by applying the relevant Code section based on CAMT earnings (in lieu of earnings and profits); (iii) to determine CAMT basis in stock or other property received by applying the relevant Code section, using CAMT basis; and (iv) to adjust CAMT earnings (in lieu of AFS retained earnings) by applying section 312 based on AFSI.

b. Non-Liquidating Distributions

Proposed § 1.56A-18(d) reflects the application of the general approach described in part XVIII.C.5.a of this Explanation of Provisions to non-liquidating distributions by a CAMT entity, including the treatment of CAMT entity shareholders that receive such distributions. Under proposed § 1.56A-18(d), the distributing corporation in a transaction that is a covered nonrecognition transaction with respect to the distributing corporation generally would be required (i) to disregard any FSI resulting from the non-liquidating distribution, (ii) to compute AFSI by applying the relevant Code section (section 311(a)) (that is, no AFSI would be recognized), and (iii) to adjust CAMT earnings (in lieu of AFS retained earnings) resulting from the distribution by applying the relevant Code section (section 312). In contrast, if the distribution is a covered recognition transaction with respect to the distributing corporation, the distributing corporation would be required (i) to determine its AFSI by recomputing any gain or loss reflected in its FSI using the CAMT basis in the distributed property, and (ii) to adjust CAMT earnings (in lieu of AFS earnings) by the amount of AFSI resulting from the transaction.

Regardless of whether the non-liquidating distribution is a covered nonrecognition transaction or a covered recognition transaction, CAMT entities that are shareholders of the distributing corporation would be required (i) to disregard any FSI resulting from the non-liquidating distribution, (ii) to compute AFSI by applying the relevant Code section, using CAMT basis and CAMT earnings, and (iii) to adjust CAMT earnings resulting from the distribution by applying the relevant Code section (section 312). However, for administrability and to limit the burden on smaller entities, the proposed regulations would provide that the character of any distribution is determined based on regular tax earnings and profits of the distributing corporation or the target corporation unless the shareholder receiving the distribution owns more than 25 percent by vote or value of the distributing corporation or the target corporation and the distributing corporation or the target corporation itself would not qualify for the safe harbor for determining applicable corporation status in proposed § 1.59-2(g). See proposed § 1.56A-18(c)(2)(iii).

c. Taxable Stock and Asset Sales

Proposed § 1.56A-18(g) would address the treatment of taxable sales of domestic stock. Proposed § 1.56A-18(g)(1)(i) generally would require a target corporation shareholder in a taxable stock sale (that is, a covered recognition transaction), including a transaction to which section 304 applies, (i) to determine gain or loss resulting from the sale for AFSI purposes by using CAMT basis in lieu of AFS basis, (ii) to determine its CAMT basis in the property received in the transaction to be equal to the shareholder's AFS basis in that property (that is, the financial accounting treatment is unmodified), and (iii) to determine its CAMT current earnings based on its AFSI. Proposed § 1.56A-18(g)(3) would provide analogous rules for the acquiror corporation.

However, proposed § 1.56A-18(g)(1)(ii) would provide that, if an election is made for a disposition or purchase of domestic stock under sections 336(e) or 338, respectively, then the transfer of stock is disregarded, and the target corporation shareholder adjusts its CAMT current earnings to reflect the deemed liquidation of the target corporation. Proposed § 1.56A-18(g)(2) and (4) would further provide that, if an election is made for a sale or purchase, as applicable, of stock of a domestic target corporation under section 336(e), 338(g), or 338(h)(10), the target corporation's AFSI is computed under regular tax rules, using the CAMT basis in its assets, and the new target corporation's CAMT basis in the property deemed to be received from the target corporation equals the new target corporation's regular tax basis in that property as a result of that election.

Proposed § 1.56A-18(h) would address the treatment of taxable asset sales by a domestic corporation. Under these proposed rules, each of the acquiror corporation and the target corporation would (i) determine its AFSI resulting from the transaction by redetermining any gain or loss reflected in its FSI by reference to its CAMT basis (in lieu of AFS basis) in the transferred property, (ii) determine its CAMT basis in the property received to be equal to its AFS basis in that property, and (iii) adjust (to the extent applicable) its CAMT current earnings (in lieu of AFS retained earnings) based on its AFSI.

d. Acquisitive Reorganizations

In the case of covered nonrecognition transactions described in section 368(a)(1)(B) (B reorganizations), proposed § 1.56A-19(b)(1) would require the target corporation shareholder or security holder: (i) to determine its AFSI by disregarding any resulting gain or loss reflected in its FSI and applying the relevant Code section (section 354) to the transfer (that is, no AFSI would be recognized by the target corporation shareholder or security holder); (ii) to determine its CAMT basis in the stock received from the acquiror corporation by applying the relevant Code section (section 358), using CAMT basis (in lieu of AFS basis); and (iii) to adjust its CAMT earnings (in lieu of AFS retained earnings) resulting from the transaction by applying section 312. Proposed § 1.56A-19(b)(3) would provide analogous rules for the acquiror corporation in a B reorganization.

If a stock acquisition fails to qualify as a B reorganization, the rules applicable to taxable stock sales or section 351(b) transactions would apply, as appropriate. See proposed § 1.56A-19(b)(2) and (4); see also parts XVIII.C.5.c and f, respectively, of this Explanation of Provisions. Proposed § 1.56A-19(b)(5) and (6) also would provide rules regarding the acquiror corporation parent in covered nonrecognition transactions and covered recognition transactions, respectively.

In the case of acquisitive reorganizations other than B reorganizations, proposed § 1.56A-19(c) would expand upon the approach described in Notice 2023-7. In a transaction that is a covered nonrecognition transaction with respect to the target corporation, proposed § 1.56A-19(c)(1) would require the target corporation: (i) to disregard any FSI resulting from the exchange of target corporation property for acquiror stock; (ii) to apply section 361(a) and (b) to the transfer (that is, the transaction would not result in AFSI to the target corporation); (iii) to determine the CAMT basis of the property received by applying section 358, using CAMT basis in lieu of AFS basis; and (iv) to adjust its CAMT earnings (in lieu of AFS retained earnings) resulting from the transaction by applying section 312. See proposed § 1.56A-19(c)(1)(i).

An additional rule would apply if the target corporation purges all “boot” received in the transaction (that is, if the target corporation distributes or transfers all non-qualifying property) and qualifies solely for nonrecognition treatment under section 361(c). See proposed § 1.56A-19(c)(1)(ii). Under this proposed rule, the target corporation would disregard any FSI resulting from gain or loss with respect to the boot and determine its AFSI by applying section 361(c) (that is, no AFSI would be recognized by the target corporation). In other words, the aforementioned “cliff effect” (that is, the application of financial accounting principles rather than regular tax rules) would be inapplicable if the target corporation distributes all of the boot received to its shareholders in a manner that qualifies the target corporation solely for nonrecognition treatment under the regular tax rules.

Conversely, if the target corporation recognizes any gain or loss on the distribution or transfer of the boot to its shareholders or security holders, then the transaction would be a covered recognition transaction, and the target corporation would determine any gain or loss resulting from the distribution or transfer in its AFSI by reference to its CAMT basis (in lieu of AFS basis) in the distributed or transferred property. See proposed § 1.56A-19(c)(2).

Proposed § 1.56A-19(c)(3)(i) would provide that, in an acquisitive reorganization that is a covered nonrecognition transaction with respect to the domestic acquiror corporation, the acquiror corporation disregards any FSI resulting from the exchange of acquiror corporation stock or other property for target corporation assets, and instead applies section 1032(a) in determining AFSI (that is, the transaction would not result in AFSI to the acquiror corporation). Proposed § 1.56A-19(c)(3)(ii) would provide that the acquiror corporation takes a carryover basis in the assets acquired ( see section 362(b)) using CAMT basis in lieu of AFS basis. Proposed § 1.56A-19(c)(3)(iii) and (iv) would further provide that the acquiror corporation adjusts CAMT retained earnings (in lieu of AFS retained earnings) resulting from the transaction by applying sections 312 and 381(c)(2), and succeeds to the target corporation's attributes under CAMT by applying section 381.

In contrast, if an acquisitive reorganization is a covered recognition transaction with respect to the acquiror corporation, the transaction would be treated in the same manner as a taxable asset sale. See proposed § 1.56A-18(h). Similarly, if an acquisitive reorganization is a covered recognition transaction with respect to a target corporation shareholder or security holder, the transaction would be treated in the same manner as a taxable stock sale or a section 351(b) transaction, as appropriate. See parts XVIII.C.5.c and f, respectively, of this Explanation of Provisions. Proposed § 1.56A-19(c)(5) and (6) also would provide rules regarding the acquiror corporation parent in covered nonrecognition transactions and covered recognition transactions, respectively.

e. Divisive Transactions

In the case of divisive transactions, proposed § 1.56A-19(d) would retain the general approach described in Notice 2023-7, with certain clarifications and other revisions. Proposed § 1.56A-19(d)(1) generally would provide that, in a divisive transaction that is solely a covered nonrecognition transaction with respect to the distributing corporation, the distributing corporation disregards any FSI resulting from (i) the transfer of assets and liabilities to the controlled corporation, (ii) the receipt of any controlled corporation securities or other consideration in the transaction, and (iii) the distribution of controlled corporation stock to the distributing corporation's shareholders in the transaction. The distributing corporation would compute its AFSI with respect to the transaction by applying sections 355 and 361 (that is, the transaction would not result in AFSI to the distributing corporation), would determine its basis in any property received from the controlled corporation by applying section 358 (using CAMT basis in lieu of AFS basis), and would adjust CAMT retained earnings (in lieu of AFS retained earnings) by applying section 312.

Proposed § 1.56A-19(d)(1)(ii) would further provide that, if all qualified property (within the meaning of section 355(c)(2)(B) or section 361(c)(2)(B), as appropriate) is distributed in a transaction that qualifies the distributing corporation solely for nonrecognition treatment under section 361(c), then the distributing corporation computes AFSI by disregarding any FSI relating to the distribution of the qualified property. In other words, the aforementioned “cliff effect” would be inapplicable if the distributing corporation distributes all of the boot received to its shareholders and security holders in a manner that qualifies the distributing corporation solely for nonrecognition treatment under the regular tax rules.

However, proposed § 1.56A-19(d)(2) would provide that, if a section 355 transaction causes the distributing corporation to recognize gain or loss, then the section 355 transaction is a covered recognition transaction to the distributing corporation, which would be required to determine its gain or loss resulting from the transaction by using CAMT basis in lieu of AFS basis. Similarly, if the distributing corporation recognizes any gain or loss on the distribution or transfer of property under section 361(c), then the distribution or transfer would be a covered recognition transaction, and the distributing corporation would determine any gain or loss resulting from the distribution or transfer in its AFSI by reference to its CAMT basis (in lieu of AFS basis) in the distributed or transferred property.

As reflected in the foregoing paragraph, a distributing corporation that transfers property to a controlled corporation in a section 355 transaction is treated as a party to the transaction. Therefore, the rule for shareholders in proposed § 1.56A-18(c)(2)—under which Federal income tax principles rather than financial accounting principles would apply—is inapplicable. However, as mentioned previously, the applicable Code provision(s) would govern the transaction so long as the distributing corporation “purges” all of the boot received in the transaction to its shareholders and securities (that is, if the transaction qualifies as a covered nonrecognition transaction to the distributing corporation).

Under proposed § 1.56A-19(d)(3), the treatment of the distributing corporation's shareholders or security holders generally would follow the regular tax treatment, except that basis consequences would be determined using CAMT basis in lieu of AFS basis, and CAMT retained earnings would be adjusted using AFSI.

Proposed § 1.56A-19(d)(4) would provide that, if a controlled corporation transfers solely its stock to the distributing corporation in a transaction that qualifies as a covered nonrecognition transaction with respect to the controlled corporation, the controlled corporation does not include in AFSI any FSI with respect to the transfer. Instead, the controlled corporation would apply section 1032(a) to the transfer (that is, no AFSI would be recognized by the controlled corporation), would determine the basis of any property received from the distributing corporation using CAMT basis (in lieu of AFS basis), and would adjust CAMT earnings by applying section 312. In contrast, if a controlled corporation transfers money or other property (in addition to stock) to a distributing corporation as part of a section 355 transaction, proposed § 1.56A-19(d)(5)(i)(A) would treat the transfer as a covered recognition transaction to the controlled corporation, unless the distributing corporation purges all boot received in the transfer and qualifies solely for nonrecognition treatment under section 361(b). See proposed § 1.56A-19(d)(5).

Proposed § 1.56A-18(e) would clarify the AFSI computation for a distributing corporation and a target corporation if a distributing corporation makes an election under section 336(e), as described in § 1.336-2(b)(1).

f. Corporate Formations

Proposed § 1.56A-19(g) would address the treatment of covered transactions to which section 351 applies. For purposes of proposed § 1.56A-19(g), a section 351 transferor is treated as a party to the section 351 exchange. Therefore, the rule for shareholders in proposed § 1.56A-18(c)(2)—under which Federal income tax principles rather than financial accounting principles would apply—is inapplicable. Additionally, unlike the target corporation in an acquisitive reorganization or the distributing corporation in a section 355 transaction, the section 351 transferor cannot preclude the recognition of gain or loss (and, thus, the aforementioned “cliff effect”) by distributing any non-stock consideration to its shareholders as part of the transaction, because such an outcome is not permitted under the regular tax rules. Cf. section 361.

Proposed § 1.56A-19(g)(1) would clarify that a section 351 exchange can be a covered nonrecognition transaction with respect to the section 351 transferee and certain section 351 transferors and also be a covered recognition transaction with respect to the section 351 transferee and other section 351 transferors. Treatment of the component transactions of the section 351 exchange as a covered nonrecognition transaction or a covered recognition transaction would be tested separately with respect to each party to the section 351 exchange. Each component transaction of the section 351 exchange in which the section 351 transferee transfers solely stock (including nonqualified preferred stock described in section 351(g)(2) (NQPS)) to a section 351 transferor would be a covered nonrecognition transaction with respect to the section 351 transferee. Each component transaction of the section 351 exchange in which the section 351 transferee transfers money or other property in addition to its stock to a section 351 transferor would be a covered recognition transaction with respect to the section 351 transferee. A component transaction of a section 351 transferor that is a party to the section 351 exchange would be a covered nonrecognition transaction with respect to the section 351 transferor if section 351(a) would apply to the section 351 transferor and would be a covered recognition transaction with respect to the section 351 transferor if section 351(b) would apply to the section 351 transferor, including by reason of section 351(g).

Proposed § 1.56A-19(g)(2) and (4) would provide the CAMT consequences of A component transactions of a section 351 exchange that are covered nonrecognition transactions with respect to section 351 transferors and section 351 transferees, respectively. Proposed § 1.56A-19(g)(2) would provide that, if a section 351 exchange is a covered nonrecognition transaction with respect to the section 351 transferor, then the section 351 transferor disregards any FSI resulting from the exchange, computes its AFSI by applying section 351 to the exchange (that is, the transaction would not result in AFSI to the section 351 transferor), and determines its CAMT basis in the stock received by applying section 358, using CAMT basis in lieu of AFS basis. Similarly, if a component transaction of a section 351 exchange is a covered nonrecognition transaction with respect to the section 351 transferee, then proposed § 1.56A-19(g)(4) would provide that the section 351 transferee would disregard any FSI resulting from the exchange, would compute its AFSI by applying section 1032(a) to the exchange (that is, the transaction would not result in AFSI to the section 351 transferee), and generally would determine CAMT basis in the property received by applying section 362(a)(1), using CAMT basis in lieu of AFS basis and CAMT recognized gain (relevant only if the exchange involves NQPS, which is “stock” for purposes of section 1032 but is treated as “other property” for purposes of section 351(b)), subject to the special CAMT basis rule in proposed § 1.56A-19(g)(4)(iii).

The special CAMT basis rule in proposed § 1.56A-19(g)(4)(iii) is an application of the authority granted in section 56A(c)(15)(A) to adjust CAMT basis to prevent the duplication or omission of CAMT items through the receipt of a relatively small amount of NQPS by a CAMT-irrelevant section 351 transferor to increase the section 351 transferor's CAMT basis in the transferred property that could result under proposed § 1.56A-19(g)(4)(ii). Under proposed § 1.56A-19(g)(4)(iii), a section 351 transferee would determine its CAMT basis in the property received from a section 351 transferor by redetermining the amount of any CAMT gain recognized by the section 351 transferor to include only the amount, if any, by which the fair market value of the portion of the property transferred by the section 351 transferor in exchange for NQPS exceeds the section 351 transferor's CAMT basis in that portion of the transferred property. This special CAMT basis rule would apply if (i) the section 351 transferor is not an applicable corporation and its AFSI otherwise is not required to be taken into account by any applicable corporation for the taxable year in which qualification of the component transaction as a covered recognition transaction with respect to the section 351 transferor otherwise would be determined under the section 56A regulations, (ii) the section 351 transferee solely transfers its stock to that section 351 transferor, and (iii) the fair market value of the NQPS is 10 percent or less of the aggregate fair market value of the stock (including the NQPS) transferred by the section 351 transferee to the section 351 transferor in the section 351 exchange.

However, if a section 351 transferor receives money or other property from the section 351 transferee in a section 351 exchange, then the section 351 exchange would be a covered recognition transaction with respect to both the section 351 transferor under proposed § 1.56A-19(g)(3) and the section 351 transferee under proposed § 1.56A-19(g)(5) (unless no money is received and the “other property” is solely NQPS, in which case the exchange would be a covered recognition transaction with respect to the section 351 transferor under proposed § 1.56A-19(g)(3) but a covered nonrecognition transaction with respect to the section 351 transferee under proposed § 1.56A-19(g)(4)). Proposed § 1.56A-19(g)(3) would provide that the section 351 transferor (i) determines its gain or loss on the exchange for AFSI purposes by using CAMT basis in lieu of AFS basis, (ii) determines its CAMT basis in the property received as equal to its AFS basis in the property transferred, and (iii) adjusts its CAMT retained earnings based on its AFSI. Proposed § 1.56A-19(g)(5) would provide analogous rules for the section 351 transferee, subject to the special CAMT basis rule in proposed § 1.56A-19(g)(5)(iii).

The special CAMT basis rule in proposed § 1.56A-19(g)(5)(iii) is an application of the authority granted in section 56A(c)(15)(A) to adjust CAMT basis to prevent the duplication or omission of CAMT items through the transfer of a relatively small amount of money or other property by a section 351 transferee to increase the section 351 transferee's CAMT basis in the transferred property that could result under proposed § 1.56A-19(g)(5)(ii). Under proposed § 1.56A-19(g)(5)(iii), a section 351 transferee would determine its CAMT basis in the property received from a section 351 transferor by redetermining the section 351 transferee's AFS basis in that property to not exceed the sum of the amount of the section 351 transferor's CAMT basis in the transferred property immediately before the section 351 exchange and the amount, if any, by which the fair market value of the portion of the property other than stock of the section 351 transferee that the section 351 transferee transfers to the section 351 transferor exceeds the section 351 transferee's CAMT basis in that portion of the transferred property. This special CAMT basis rule would apply if (i) the section 351 transferor is not an applicable corporation and its AFSI otherwise is not required to be taken into account by any applicable corporation for the taxable year in which qualification of the component transaction as a covered recognition transaction with respect to the section 351 transferee otherwise would be determined under the section 56A regulations, (ii) the section 351 transferee transfers its stock and money or other property to that section 351 transferor, and (iii) the amount of money and fair market value of other property is 10 percent or less of the sum of the money and the aggregate fair market value of the stock and other property transferred by the section 351 transferee to the section 351 transferor in the section 351 exchange.

g. Complete liquidations

Proposed § 1.56A-18(f) would address the treatment of complete liquidations under section 331 or section 332 of the Code and other corporate dissolutions. In the case of a complete liquidation that is a covered nonrecognition transaction with respect to the liquidating corporation, proposed § 1.56A-18(f)(1) would provide that the liquidating corporation disregards any gain or loss in its FSI resulting from the liquidation and instead applies section 337(a) to the liquidating distributions (that is, the transaction would not result in AFSI to the liquidating corporation). In the case of a complete liquidation that is a covered recognition transaction with respect to the liquidating corporation, proposed § 1.56A-18(f)(2) would provide that the liquidating corporation determines any gain or loss from the liquidation or dissolution for AFSI purposes by using CAMT basis in lieu of AFS basis.

Proposed § 1.56A-18(f)(4) would provide that a liquidation recipient receiving a distribution in a covered nonrecognition transaction (i) disregards any gain or loss resulting from the distribution in its FSI, (ii) applies section 332 to the liquidating distributions received (that is, the transaction would not result in AFSI to the liquidation recipient), (iii) determines the CAMT basis of any property received from the liquidating corporation under section 334(b) using CAMT basis in lieu of AFS basis, (iv) adjusts CAMT retained earnings by applying sections 381(c)(2) and 312 of the Code, and (v) succeeds to the liquidating corporation's attributes under CAMT by applying section 381. Proposed § 1.56A-18(f)(5) would provide that a liquidation recipient in a covered recognition transaction determines any gain or loss resulting from the distribution for AFSI purposes using its CAMT basis in lieu of AFS basis.

Proposed § 1.56A-18(f)(3) would clarify that a single liquidation or other corporate dissolution can be a covered nonrecognition transaction with respect to the liquidating corporation and one liquidation recipient and also be a covered recognition transaction with respect to the liquidating corporation and other liquidation recipients.

XIX. Proposed § 1.56A-20: AFSI Adjustments to Apply Certain Subchapter K Principles

Pursuant to the authority granted by section 56A(c)(2)(D)(i), (c)(15), and (e), proposed § 1.56A-20 would provide rules under section 56A(c)(15)(B), which authorizes the Secretary to issue regulations or other guidance to provide for such adjustments to AFSI as the Secretary determines necessary to carry out the purposes section 56A, including adjustments to carry out the principles of part II of subchapter K.

The guidance concerning Covered Nonrecognition Transactions and Covered Recognition Transactions described in section 3 of Notice 2023-7 apply to certain partnership transactions. For contributions of property by a partner to a partnership to which nonrecognition treatment under section 721 of the Code applies in whole, section 3 of Notice 2023-7 provides that any FSI resulting for AFS purposes to a partnership or a contributing partner is not taken into account in the partnership's or the partner's AFSI (partnership contribution rule). For distributions of property by a partnership to a partner to which nonrecognition treatment under section 731 of the Code applies in whole, section 3 of Notice 2023-7 provides that any FSI resulting for AFS purposes to a partnership or a partner to a transaction is not taken into account in the partnership's or the partner's AFSI (partnership distribution rule; together with the partnership contribution rule, the partnership covered nonrecognition rules).

A. Scope of Rules and General Operating Rule

Proposed § 1.56A-20(a)(2) would provide that the rules in proposed § 1.56A-20 apply to contributions to or distributions from a partnership, but not with respect to stock of a foreign corporation except in the limited circumstance of the effect on the CAMT basis of a partnership investment for a distribution of foreign stock that is distributed in the same transaction as other property. Proposed § 1.56A-20(b) would provide a general operating rule for transactions between a CAMT entity and a partnership in which it holds an investment. This general operating rule would require each of the CAMT entity, any other partners in that partnership, and the partnership itself to include in its AFSI any income, expense, gain, or loss reflected in its FSI as a result of the transaction, except as otherwise provided in proposed § 1.56A-20 (which would apply after the application of § 1.56A-1(c) and (d)).

B. Contributions of Property

According to stakeholders, one possible approach to the partnership contribution rule would be to import certain rules into the CAMT that apply to partnership contributions for regular tax purposes, such as section 704(c) or the so-called “mixing bowl” rules under sections 704(c)(1)(B) and 737 of the Code, to prevent the shifting of built-in gains or losses inherent in contributed property from contributing partners subject to the CAMT to partners that are not subject to the CAMT. Some stakeholders proposed incorporating section 704(c) principles in their entirety, while other stakeholders proposed alternative methods of preventing the shifting of gains or losses between partners without incorporating the complexity of section 704(c) into the CAMT.

One alternative proposed by stakeholders as a means of avoiding much of the complexity associated with incorporating the existing section 704(c) methodologies, including the ceiling rule described in § 1.704-3(b)(1), into the CAMT, is a deferred sale approach based on former proposed § 1.704-3(d) ( see57 FR 61353 (December 24, 1992)). Under this approach, a contribution of property that results in a gain or loss in the contributing partner's FSI would be deferred by the contributing partner and included in its AFSI over time. This approach would differ from the treatment of partnership Covered Nonrecognition Transactions under Notice 2023-7. However, according to stakeholders, this approach would be more consistent with financial accounting principles and would reduce the administrative and compliance burdens on partnerships and the IRS by having all gains or losses resulting from a contribution of property to which section 721(a) applies accounted for by the contributing partner rather than by the partnership.

Rules are needed to prevent the shifting of built-in gain or loss away from the contributing partner. However, the Treasury Department and the IRS believe that importing section 704(c) as well as sections 704(c)(1)(B) and 737 in their entirety into the CAMT would create significant complexity and administrative burden for taxpayers, partnerships, and the IRS.

Pursuant to the authority granted by section 56A(c)(15) and (e), as an alternative to importing these subchapter K rules in their entirety into the CAMT, the proposed regulations would adopt a deferred sale method. More specifically, proposed § 1.56A-20(c)(1) generally would provide that, if property (other than stock in a foreign corporation) is contributed by a CAMT entity (contributor) to a partnership in a transaction to which section 721(a) applies (subject to special rules in proposed § 1.56A-20(e) and (f) for determining section 721(a) treatment), any gain or loss reflected in the contributor's FSI from the property transfer is included in the contributor's AFSI in accordance with the deferred sale approach set forth in proposed § 1.56A-20(c)(2). The deferred sale approach would not apply to disregard any other FSI amount resulting to the contributor or the partnership from the transaction (for example, FSI gain or loss resulting from a deconsolidation or a dilution) for purposes of determining AFSI. See proposed § 1.56A-20(c)(1).

Under proposed § 1.56A-20(c)(2)(i), a contributor would be required to include the amount of gain or loss reflected in its FSI (deferred sale gain or loss) resulting from the contribution of the property to a partnership in a transaction described in proposed § 1.56A-20(c)(1) (deferred sale property) in its AFSI ratably, on a monthly basis, over the applicable recovery period beginning on the first day of the month that the deferred sale property is contributed to the partnership, unless the special rule in proposed § 1.56A-20(c)(2)(i)(E) would apply to the timing of the inclusion. If the contribution is treated as a sale for AFS purposes, the gain or loss resulting from the transaction would be redetermined by reference to the contributor's CAMT basis in the deferred sale property at the time of the contribution rather than the contributor's AFS basis in the deferred sale property. See proposed § 1.56A-20(c)(2)(i)(A). For example, if the FSI resulting from the contribution is calculated for AFS purposes by subtracting the AFS basis of the deferred sale property from its fair market value, the result would be redetermined by reference to the CAMT basis of the deferred sale property rather than the contributed property's AFS basis.

The applicable recovery period for the deferred sale property would depend on the type of deferred sale property contributed to a partnership. For deferred sale property that is section 168 property or qualified wireless spectrum and placed in service by the contributor in a taxable year prior to the taxable year in which the property becomes deferred sale property, the applicable recovery period would be the full recovery period that was assigned to the property by the contributor in the taxable year such property was placed in service for purposes of depreciating or amortizing the property for regular tax purposes. See proposed § 1.56A-20(c)(2)(i)(B). For deferred sale property that is section 168 property or qualified wireless spectrum and that is either placed in service and contributed to the partnership in the same taxable year it is placed in service, or is contributed and placed in service by the partnership in the same taxable year as the contribution, the applicable recovery period would be the recovery period used by the partnership to depreciate or amortize the deferred sale property for regular tax purposes. See proposed § 1.56A-20(c)(2)(i)(C).

For deferred sale property subject to depreciation or amortization for AFS purposes that is not section 168 property or qualified wireless spectrum in the hands of the contributor or the partnership, the applicable recovery period would be the recovery period used by the partnership to depreciate or amortize the deferred sale property for AFS purposes. See proposed § 1.56A-20(c)(2)(i)(D). For deferred sale property that is section 168 property or qualified wireless spectrum but is not subject to depreciation because it has not been placed in service before it is contributed to the partnership, but is placed in service by the partnership in the immediately subsequent taxable year and thus is subject to depreciation in that year, the applicable recovery period would be the recovery period for regular tax purposes used by the partnership in the immediately subsequent taxable year, and the inclusion of the deferred sale gain or loss by the contributor would begin in the first month of that subsequent taxable year. See proposed § 1.56A-20(c)(2)(i)(E). For property that is not described in proposed § 1.56A-20(c)(2)(i)(B) through (E), the applicable recovery period would be 15 years. See proposed § 1.56A-20(c)(2)(i)(F).

Under proposed § 1.56A-20(c)(2)(ii), a contributor would accelerate a portion of its deferred sale gain or loss into its AFSI upon the occurrence of certain events. If a contributor's distributive share percentage in the partnership decreases by more than one-third following its contribution of the deferred sale property (whether by sale or exchange, liquidation of all or a part of the contributor's interest in the partnership, dilution, deconsolidation, or otherwise), the contributor would include in its AFSI for the taxable year in which the decrease occurs an amount of the remaining deferred sale gain proportionate to the percentage change in the contributor's distributive share percentage. Any remaining deferred sale gain would continue to be included in the contributor's AFSI ratably on a monthly basis over the remaining applicable recovery period of the deferred sale property. See proposed § 1.56A-20(c)(2)(ii)(D). Under proposed § 1.56A-20(c)(2)(ii), a contributor's deferred sale loss would not be accelerated into its AFSI upon a decrease in its distributive share percentage unless the decrease is the result of the contributor disposing of its entire investment in the partnership. In contrast, if the partnership sells, distributes, or otherwise disposes of the deferred sale property (including by distribution to the contributor or the partnership's contribution of the deferred sale property to another CAMT entity in a recognition or nonrecognition transaction), the contributor would accelerate all of the remaining deferred sale gain or loss into its AFSI for the taxable year of the disposition. See proposed § 1.56A-20(c)(2)(iii).

If the contributor defers gain upon a contribution to which section 721(c) applies in accordance with the gain deferral method described in § 1.721(c)-3, and if the deferred sale approach under proposed § 1.56A-20(c)(2) applies, then additional acceleration rules would apply. Under proposed § 1.56A-20(c)(2)(iv), if an acceleration event described in § 1.721(c)-4(b) occurs, the contributor must include in its AFSI for the contributor's taxable year of the event the amount of any deferred sale gain with respect to the deferred sale property that has not yet been included in the contributor's AFSI as of the date of the acceleration event. If a partial acceleration event described in § 1.721(c)-5(d) occurs, then the contributor would include in its AFSI in the taxable year of the event an amount of deferred sale gain that bears the same ratio to the total amount of any deferred sale gain that has yet to be included in the contributor's AFSI immediately before the event, that the taxable gain required to be recognized under § 1.721(c)-5(d)(2) or (3) bears to the total amount of remaining built-in gain (as defined in § 1.721(c)-1(b)(13)) with respect to section 721(c) property, as computed for regular tax purposes. The amount (if any) of deferred sale gain with respect to deferred sale property remaining after application of proposed § 1.56A-20(c)(2)(iv) would continue to be included in the contributor's AFSI ratably on a monthly basis over the remaining applicable recovery period of the deferred sale property.

If a contribution of property to a partnership would result in section 721(a) not applying (and, thus, would result in the recognition of gain or loss for regular tax purposes (for example, under section 721(b) or (c)), then the CAMT entity would include in its AFSI in the taxable year of contribution all FSI resulting from the contribution. However, if the CAMT entity defers gain upon a contribution to which section 721(c) applies in accordance with the gain deferral method described in § 1.721(c)-3, then the deferred sale approach in proposed § 1.56A-20(c)(2) would apply.

If the contributor is a partnership for Federal tax purposes, the deferred sale gain or loss included in the AFSI of the contributor partnership (that is, the UTP) for a taxable year in accordance with the deferred sale approach would be included in the distributive share amounts of the partners of the contributor partnership (whether or not they were partners at the time of contribution) in proportion to their distributive share percentages for that taxable year, as determined under proposed § 1.56A-5(e)(2). See proposed § 1.56A-20(c)(2)(v).

Proposed § 1.56A-20(c)(3) would provide basis rules for contributions of property. Proposed § 1.56A-20(c)(3)(i) would provide that the partnership's initial CAMT basis in contributed property would be the partnership's initial AFS basis in the contributed property at the time of contribution, regardless of whether section 721(a) applies, in whole or in part, to the contribution.

Proposed § 1.56A-20(c)(3)(ii) would provide that the contributor's initial CAMT basis in its partnership investment upon a contribution of property to the partnership to which section 721(a) applies is the contributor's AFS basis in the acquired partnership investment, decreased by any deferred sale gain or increased by any deferred sale loss that is required to be included in the contributor's AFSI in accordance with the deferred sale approach. The contributor's initial CAMT basis in the acquired partnership investment would be subsequently increased or decreased: (i) on the last day of each taxable year during the applicable recovery period by an amount equal to the deferred sale gain or loss, respectively, required to be included in AFSI in such year in accordance with the deferred sales approach (without duplication of any increases or decreases to CAMT basis described in the following clause (ii)); or (ii) immediately prior to an event causing all or a portion of the deferred sale gain to be accelerated into AFSI in accordance with proposed § 1.56A-20(c)(2)(ii) by an amount equal to the sum of (A) the deferred sale gain that accrued during the taxable year prior to the acceleration event, and (B) the amount required to be included in AFSI under proposed § 1.56A-20(c)(2)(ii).

C. Distributions of Property

A stakeholder recommended that section 731 generally should apply upon a distribution of property to prevent the recognition of gain or loss by the partnership or partners for purposes of the CAMT if gain or loss would not be recognized for regular tax purposes. Likewise, if a partner would have a stepped-up basis in distributed assets for AFS purposes, stakeholders recommended the inclusion of CAMT rules similar to the carryover basis rules of section 732 to prevent the omission of gains. Stakeholders also suggested that it may be appropriate to import other rules from subchapter K into the CAMT, such as basis adjustments under section 734(b) or the mixing bowl rules under sections 704(c)(1)(B) and 737 (as previously discussed), to prevent the omission of gains or losses or to prevent the shifting of built-in gains or losses among partners. However, given the complexity of importing basis adjustment or mixing bowl rules into the CAMT, the stakeholder also proposed either turning off section 731 entirely for purposes of the CAMT or adopting a deferred sales method at the partnership level.

If section 731(a) and (b) were imported into the CAMT in their entirety, then other rules that apply to partnership distributions for regular tax purposes also would need to be imported into the CAMT to prevent the omission of certain gains or losses or the shifting of built-in gains or losses. However, the Treasury Department and the IRS believe that importing sections 731, 732, 734, 704(c)(1)(B), and 737 into the CAMT in their entirety would create significant complexity and an administrative burden.

Accordingly, pursuant to the authority granted by section 56A(c)(15) and (e), these proposed regulations would adopt a deferred distribution gain or loss approach (similar to the rules for contributions of property in proposed § 1.56A-20(c)(2)) to the gain or loss recognized by the partnership on a distribution of property to which section 731(b) applies. The proposed regulations would not alter the AFS results to a partner using the principles of section 731(a) because importing section 731(a) into the CAMT also would require importing the carryover basis rules under section 732(a)(2) and (b) and, thus, the basis adjustment rules under section 734(b). As such, the timing or amount of any FSI resulting to a CAMT entity partner from a distribution of partnership property would not be affected by these rules, except to the extent of the CAMT entity's distributive share amount of any deferred distribution gain or loss resulting from the distribution.

Proposed § 1.56A-20(d)(1)(i) generally would provide that, except as provided in proposed § 1.56A-20(f), if a partnership distributes property to a partner in a transaction to which section 731(b) applies, any gain or loss reflected in the partnership's FSI resulting from the distribution of property is disregarded for purposes of determining the partnership's modified FSI (as defined in proposed § 1.56A-5(e)(3)). Instead, any such gain or loss would be included by the partners in their distributive share amounts (as defined in proposed § 1.56A-5(e)) in accordance with the deferred distribution gain or loss approach in proposed § 1.56A-20(d)(1)(ii) and (iii) and (d)(2). The deferred distribution gain or loss approach would not apply to disregard any other FSI amount resulting from the transaction (for example, FSI gain or loss to a partner resulting from a deconsolidation or dilution) for purposes of determining AFSI. See proposed § 1.56A-20(d)(1)(i).

Under proposed § 1.56A-20(d)(1)(ii), the amount of gain or loss reflected in the partnership's FSI (deferred distribution gain or loss) resulting from the distribution of property (deferred distribution property) (i) would be allocated among the partners in proportion to their distributive share percentages for the taxable year in which the distribution occurs (as determined under proposed § 1.56A-20(d)(2)(i)) (a partner's allocable share of deferred distribution gain or loss), and (ii) would be included by each partner in their respective distributive share amounts ratably, on a monthly basis, over the applicable recovery period for the deferred distribution property beginning on the first day of the month in which the distribution occurs.

If the distribution is treated as a sale for AFS purposes, the partnership would redetermine the amount of deferred distribution gain or loss by reference to the partnership's CAMT basis in the deferred distribution property at the time of the distribution rather than its AFS basis in the deferred distribution property. See proposed § 1.56A-20(d)(1)(ii)(A). For example, if the FSI resulting from the distribution is calculated for AFS purposes by subtracting the AFS basis of the deferred distribution property from its fair market value, the AFS basis would be replaced with the CAMT basis of the deferred distribution property.

The applicable recovery period for the deferred distribution property would depend on the type of property. For deferred distribution property that is section 168 property or qualified wireless spectrum and that was placed in service by the partnership in a taxable year prior to the taxable year in which the property becomes deferred distribution property, the applicable recovery period would be the full recovery period that was assigned to the property by the partnership in the taxable year such property was placed in service for purposes of depreciating or amortizing the property for regular tax purposes. See proposed § 1.56A-20(d)(1)(ii)(B). For deferred distribution property that is section 168 property or qualified wireless spectrum and that is either placed in service by a partnership and distributed by the partnership to a partner in the same taxable year it is placed in service, or is distributed by the partnership to a partner and placed in service by the partner in the same taxable year as the distribution, the applicable recovery period would be the recovery period used by the partner to depreciate or amortize the property for regular tax purposes. See proposed § 1.56A-20(d)(1)(ii)(C).

For deferred distribution property subject to depreciation or amortization for AFS purposes that is not section 168 property or qualified wireless spectrum, the applicable recovery period would be the recovery period for newly placed in service property that was used by the partnership to depreciate or amortize the deferred distribution property for AFS purposes. See proposed § 1.56A- 20(d)(1)(ii)(D). For deferred distribution property that is section 168 property or qualified wireless spectrum that is not placed in service in the same taxable year it is distributed to the partner but is placed in service by the partner in the immediately subsequent taxable year, the applicable recovery period would be the recovery period for regular tax purposes that is used by the partner for the deferred distribution property in the immediately subsequent taxable year. See proposed § 1.56A-20(d)(1)(ii)(E). For deferred distribution property that is not described in proposed § 1.56A-20(d)(1)(ii)(B) through (E), the applicable recovery period would be 15 years. See proposed § 1.56A-20(d)(1)(ii)(F).

Under proposed § 1.56A-20(d)(1)(iii), a partner would accelerate the remaining amount of its allocable share of deferred distribution gain or loss into its AFSI upon the occurrence of certain events. If a partnership (i) terminates under section 708(b)(1) of the Code as a result of a dissolution or liquidation, (ii) sells or exchanges all or substantially all of its assets, or (iii) merges or consolidates with one or more partnerships and is not the resulting partnership for regular tax purposes (as determined under § 1.708-1(c)), then for the taxable year in which the acceleration event occurs, each partner must include in its distributive share amount the amount of the partner's allocable share (if any) of deferred distribution gain or loss that has yet to be included in its distributive share amount as of the date immediately before the acceleration event. Similarly, if a partner disposes of its entire investment in the partnership, including through a liquidating distribution by the partnership, the partner must include in its distributive share amount for the partner's taxable year in which the disposition occurs the amount of the partner's allocable share (if any) of deferred distribution gain or loss that has yet to be included in the partner's distributive share amount as of the disposition date. See proposed § 1.56A-20(d)(2)(ii). The Treasury Department and IRS request comments on the events in the proposed regulations that require an acceleration of a partner's remaining deferred distribution gain or loss and whether additional rules are needed to determine whether a partnership has sold or exchanged substantially all of its assets.

If a distribution of property or money from a partnership to a partner results in any gain, loss, or other amount being reflected in the partner's FSI, that amount would be redetermined using the relevant CAMT basis, if applicable, and included in the partner's AFSI in the year of the distribution. If the relevant CAMT basis is the partner's CAMT basis in its partnership investment, proposed § 1.56A-20(d)(2)(iii) would provide that (A) money distributed in the same transaction as property is treated as reducing CAMT basis, if applicable, prior to any distribution of property, (B) stock in a foreign corporation distributed in the same transaction is treated as reducing CAMT basis prior to any distribution of property other than stock in a foreign corporation, and (C) principles similar to § 1.731-1(a)(1)(ii) apply for purposes of calculating the effect of the distribution on the CAMT entity's AFSI.

If any partner of the distributing partnership is a partnership for Federal tax purposes, then proposed § 1.56A-20(d)(2)(iv) would provide that the deferred distribution gain or loss included in the partner's distributive share amount under proposed § 1.56A-20(d)(2)(i) is included in its partners' respective distributive share amounts (whether or not the partners were partners in the partnership at the time of the distribution) in proportion to their distributive share percentages for the taxable year, as determined under proposed § 1.56A-5(e)(2).

Proposed § 1.56A-20(d)(3) would provide basis rules for distributions of property. Proposed § 1.56A-20(d)(3)(i) would provide that a partner's initial CAMT basis of property distributed by a partnership is the partner's initial basis of the property for AFS purposes, determined immediately after the distribution. Proposed § 1.56A-20(d)(3)(ii) would provide that the CAMT basis of a partner's investment in a partnership following the partnership's distribution of property is increased or decreased (i) at the end of each taxable year during the applicable recovery period, by the amount required to be included in the partner's distributive share amount in each taxable year in accordance with proposed § 1.56A-20(d)(1)(ii), and (ii) immediately prior to an acceleration event described in proposed § 1.56A-20(d)(1)(iii) or (d)(2)(ii), by the amount of deferred distribution gain or loss not previously included in the partner's distributive share amount.

D. Treatment of Liabilities

One stakeholder suggested that, as part of importing sections 721 and 731 into the CAMT, section 752 of the Code should be fully imported into the CAMT to better align the treatment of contributions to and distributions from a partnership under the CAMT with their treatment for regular tax purposes, to prevent resulting distortions, and to reduce the potential for tax avoidance. Another stakeholder suggested an alternative approach that would not import any aspect of section 752 into the CAMT, on the grounds that the alternative approach would provide administrative simplicity and be consistent with how liabilities are treated for financial accounting purposes.

Importing section 752 into the CAMT would create significant administrative complexity and generally would be inconsistent with how partner and partnership liabilities are treated for AFS purposes. Accordingly, proposed § 1.56A-20(e)(1) generally would provide that the treatment of partner and partnership liabilities for purposes of determining a partner's or partnership's AFSI is based on the treatment of such liabilities for AFS purposes and not how such liabilities are treated under section 752.

With regard to the treatment of liabilities upon a contribution or distribution of property to or from a partnership, proposed § 1.56A-20(e)(2) would provide that section 752 is inapplicable in determining the amount of gain or loss to be included in the AFSI of the partner or partnership. Accordingly, any rules relating to liabilities for regular tax purposes, such as those under §§ 1.707-5 and 1.707-6, would not apply for purposes of the CAMT. For example, if section 707 or section 752 of the Code would provide that gain or loss is not recognized for regular tax purposes upon a contribution of encumbered property, that rule would be disregarded in determining whether section 721(a) or 731(b) applies to a transaction for purposes of the CAMT.

E. Proportionate Deferred Sale Approach for Partial Nonrecognition Transactions Under Sections 721(a) and 731(b)

As previously described, the partnership Covered Nonrecognition Transaction guidance described in Notice 2023-7 applies only if no gain or loss is recognized on the transaction for regular tax purposes. Stakeholders recommended that these rules also apply to partnership contributions and distributions that are afforded partial nonrecognition treatment for regular tax purposes, and that AFSI generally should result from the transaction in proportion to the amount of gain or loss that is recognized for regular tax purposes.

As discussed in parts XIX.B and C of this Explanation of Provisions, proposed § 1.56A-20(c) and (d) would adopt a deferred sale approach and a deferred distribution gain or loss approach that provides for the deferral of AFSI resulting from a contribution of property to, or a distribution of property from, a partnership. These proposed rules would differ from the partnership Covered Nonrecognition Transaction guidance described in Notice 2023-7 by providing for the deferral of gain or loss. However, because the deferred sale approach and the deferred distribution gain or loss approach would require FSI resulting from a partnership contribution or distribution to be included in AFSI over a definite period of time, and because a “cliff effect” rule for partnership contributions and distributions could result in selective recognition of losses for purposes of the CAMT, it is appropriate to apply the deferred sale approach to a partial nonrecognition transaction to the extent section 721(a) or 731(b) applies to the transaction (after applying the special rules in proposed § 1.56A-20(e)).

Accordingly, proposed § 1.56A-20(f) would provide that, if a transfer of property by a partner to a partnership, or by a partnership to a partner, is not a nonrecognition transaction for regular tax purposes, in whole or in part, under section 721(a) or section 731(b), respectively (or would not be a nonrecognition transaction under these Code sections for regular tax purposes considering the application of proposed § 1.56A-20(e)), then the partner or partnership, as applicable, must include an amount in its AFSI for the taxable year of the transfer. The amount to be included is an amount (if any) of the FSI reflected on the partner's or partnership's AFS resulting from the transaction that (i) bears the same ratio to the total amount of gain or loss reflected in the partner's or partnership's FSI resulting from the transaction, as (ii) the taxable gain or loss that would be recognized on the transfer without the application of section 752 and the exceptions in §§ 1.707-5 and 1.707-6 bears to the taxable gain or loss realized on the transfer for regular tax purposes. Any FSI resulting from the transaction must be calculated using the CAMT basis of the property and not the AFS basis of the property. Any resulting FSI that is not included in AFSI in the taxable year of the transfer under the rule described in proposed § 1.56A-20(f) would be subject to the deferred sale approach or the deferred distribution gain or loss approach.

F. Maintenance of Books and Records and Reporting Requirements

Proposed § 1.56A-20(g) would provide rules relating to the maintenance of books and records and reporting requirements for a partnership and each CAMT entity that is a partner in the partnership. The Treasury Department and the IRS are aware that, for a CAMT entity partner to determine the timing of inclusion in its AFSI of any deferred sale gain or loss resulting from its contribution of deferred sale property, the CAMT entity partner will require information from the partnership. Similarly, a partnership may require information from a partner receiving a distribution of deferred distribution property to determine the timing of inclusion of deferred distribution gain or loss in the CAMT entities' distributive share amounts. To facilitate compliance with the rules of proposed §§ 1.56A-20 and 1.56A-5, the proposed regulations would require partnerships and CAMT entity partners in such partnership to maintain certain information in their respective books and records and to report that information as appropriate.

Proposed § 1.56A-20(g)(1) would require a partnership and each CAMT entity that is a partner in the partnership to include in its respective books and records all information necessary for the partnership and each CAMT entity to comply with the rules of proposed §§ 1.56A-20 and 1.56A-5. As applicable for partnerships and CAMT entities to comply with their respective requirements under these proposed regulations, the information to be maintained in their separate books and records includes, without limitation, (i) the recovery periods used to depreciate deferred sale property and deferred distribution property for regular tax purposes; (ii) the properties contributed to the partnership that had a built-in gain or loss at the time of contribution and the amount of the built-in gain or loss with respect to each property for AFSI purposes; (iii) the CAMT basis of any property contributed to or distributed from the partnership; and (iv) the amount of deferred distribution gain or loss to be allocated among, and included in the distributive share amounts of, the partners of the partnership.

Proposed § 1.56A-20(g)(2)(i) would provide that partnerships must report to a CAMT entity the information required for the CAMT entity to comply with the rules of proposed §§ 1.56A-20 and 1.56A-5. The information to be reported to CAMT entities that are partners in a partnership to facilitate compliance with these sections includes, without limitation, (A) the recovery periods used to depreciate deferred sale property, (B) the date on which the partnership sold, distributed, or otherwise disposed of deferred sale property; (C) the date on which an acceleration event described in § 1.721(c)-4(b) occurred; and (D) the amount of deferred distribution gain or loss resulting from a distribution of property that is included in the CAMT entity partner's distributive share amount under proposed § 1.56A-20(d).

A partnership may report information to a CAMT entity partner in any reasonable manner sufficient for a CAMT entity to comply with the rules of proposed § 1.56A-20. However, if any information relates to the determination of a CAMT entity's distributive share amount with respect to its investment in the partnership, the proposed regulations would require the partnership to report the information consistently with the rules of proposed § 1.56A-5(h). See proposed § 1.56A-20(g)(2)(ii).

XX. Proposed § 1.56A-21: AFSI Adjustments for Troubled Companies

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-21 would provide rules under section 56A regarding financially troubled companies.

A. Overview

The U.S. Bankruptcy Code (11 U.S.C. 101-1532) governs bankruptcies in the United States. The Bankruptcy Code and related authorities give debtors relief from debts they cannot repay to allow them to reorder their affairs and enjoy a “fresh start.” For example, bankruptcy gives otherwise viable business enterprises a chance to continue intact, thereby preserving jobs for employees and the availability of products and services for customers, and enhancing market competition and stability.

The Internal Revenue Code plays an important role in implementing the foregoing objective. Section 61(a)(11) of the Code provides that, except as otherwise provided in subtitle A, gross income includes income from the discharge of indebtedness in the year of the discharge. However, section 108(a)(1) of the Code provides that gross income does not include any amount that otherwise would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer, if the discharge occurs under circumstances specified in section 108(a)(1)(A) through (E), including in a title 11 case and if the taxpayer is insolvent. See section 108(a)(1)(A) and (B), respectively.

Section 108(b) requires taxpayers that exclude income under section 108(a) to reduce certain specified tax attributes, including net operating losses (NOLs) and the minimum tax credit under section 53(b) of the Code. Section 108(b)(1) provides that the amount of income excluded under section 108(a) (excluded COD income, also referred to as discharge of indebtedness income) is applied to reduce the tax attributes of the taxpayer as provided in section 108(b)(2). Thus, section 108 effectively defers rather than excludes tax on excluded COD income.

Section 108(b)(2) generally provides that the following tax attributes are reduced in the following order: (i) any NOL; (ii) amounts used to determine the general business credit under section 38 of the Code; (iii) the minimum tax credit available under section 53(b); (iv) any net capital losses and any capital loss carryover under section 1212 of the Code; (v) the basis of the property of the taxpayer ( see section 1017 of the Code for provisions for making this reduction); (vi) any passive activity loss or credit carryover of the taxpayer under section 469(b) of the Code; and (vii) any carryover to or from the taxable year of the discharge for purposes of determining the amount of the foreign tax credit allowable under section 27.

Any amount of excluded COD income that remains after attribute reduction under section 108(b) (so-called “black hole COD”) is not includible in income. See H.R. Rep. 96-833 at 11 (1980); S. Rep. No. 96-1035 at 12 (1980).

As under section 61(a)(11) of the Code, financial accounting principles generally require debtors to recognize gain on debt discharges. If debts are extinguished, GAAP requires gain to be recognized on the difference between the price at which the debt is satisfied and the carrying value of the debt. See ASC 470-50-40-2. Outside of bankruptcy, troubled companies recognize gain for financial accounting purposes upon the satisfaction of debt to the extent that the carrying value of the debt exceeds the fair value of the assets transferred to the creditor in satisfaction of the debt. See ASC 470-60-35-1. If a company enters bankruptcy, the carrying value of pre-petition debt is adjusted to the probable amount of the allowed claims for the debt, and gain is recognized in cases in which the former is higher than the latter. See ASC 852-10-45-6 and 852-10-45-9. (There is no corresponding income inclusion under section 61 to be excluded under section 108 because no realization event has occurred.) When liabilities subsequently are settled in accordance with the plan of reorganization approved by the bankruptcy court, the difference between the fair value of the consideration a creditor receives and the allowed claim of the debt is recognized in the income statement. See ASC 405-20-40-1.

Both the Code and financial accounting principles also address a corporation's emergence from bankruptcy. Section 368(a)(1)(G) provides nonrecognition treatment for the transfer by a corporation of its assets to another corporation in a title 11 or similar case, so long as certain requirements are satisfied. Taxpayers also may emerge from bankruptcy in a taxable transaction, with favorable rules that permit the use of tax attributes to offset gain prior to the attribute reduction required by section 108(b). See § 1.108-7(b).

Under GAAP, “fresh-start reporting” requires eligible companies to adjust the carrying values of assets and liabilities immediately before the emergence from bankruptcy. See ASC 852-10-45-21. Assets are marked to their fair value, with gain or loss reported in the amount of the change. See id. The settlement of liabilities for an amount different than that previously recorded on the company's books and records results in gain or loss. Any retained earnings on the books of a company in bankruptcy are also eliminated upon its emergence. See id. Fresh-start reporting places the emerging company, which is treated as the successor to the bankrupt company under financial accounting principles, on a similar footing to that of a new company that acquired the bankrupt company's assets.

B. CAMT and Troubled Companies

Section 56A does not specifically address the treatment of troubled companies for purposes of the CAMT. However, absent adjustments to AFSI for income from debt discharges and fresh-start reporting, troubled companies would have additional tax liabilities under the CAMT that could impede the companies from achieving solvency or emerging from bankruptcy. Avoiding this unnecessary harm also would protect the interests of the government in its tax collection efforts. Authority for such adjustments is provided in section 56A(c)(15) and (e).

C. Notice 2023-7 and Troubled Companies

Sections 3.06 and 3.07 of Notice 2023-7 provide guidance for the exclusion of discharge of indebtedness income and gain resulting from fresh-start reporting, respectively. Under section 3.06(1) of Notice 2023-7, financial accounting gain equal to the amount of discharge of indebtedness income excluded under section 108(a) is not taken into account for purposes of calculating the AFSI of a financial statement group for the year in which the discharge of indebtedness occurs. Under section 3.06(2) of Notice 2023-7, financial statement groups with excluded income under section 3.06(1) reduce CAMT attributes to the extent of the reduction of regular tax attributes under section 108(b) using the principles and ordering rules of sections 108(b) and 1017. Section 3.07 of Notice 2023-7 provides that financial accounting gain or loss resulting from a financial statement group's emergence from bankruptcy, and resulting changes to the financial accounting basis of property, are not taken into account for purposes of calculating the financial statement group's AFSI.

D. Proposed Regulations

Proposed § 1.56A-21 would provide rules for determining AFSI with respect to events relating to the bankruptcy or insolvency of a CAMT entity. Proposed § 1.56A-21 also would provide rules for determining AFSI with respect to the receipt of Federal financial assistance (within the meaning of section 597(c) of the Code and § 1.597-1(b)).

1. Proposed Rules for Bankruptcy Exclusion

Consistent with section 3.06 of Notice 2023-7, proposed § 1.56A-21(c)(1)(i) would exclude from AFSI income from the discharge of indebtedness for CAMT entities in a title 11 case. This exclusion is intended to cover all FSI otherwise includible in AFSI that arises from an extinguishment or modification of a debt instrument during bankruptcy of the CAMT entity, regardless of the timing of the reporting of the item under financial accounting principles. The language of the proposed rule is similar to that of the bankruptcy exclusion in section 108(a)(1)(A), with modifications reflecting differences in the timing of the recognition of income for tax and financial accounting purposes.

2. Proposed Rules for Insolvency Exclusion

Consistent with section 3.06 of Notice 2023-7 and section 108(a)(1)(B), proposed § 1.56A-21(c)(2)(i) would exclude from AFSI income from the discharge of indebtedness for insolvent CAMT entities (including foreign corporations), but only to the extent of their insolvency. However, stakeholders have indicated that the amount of insolvency ordinarily is not measured as part of the financial reporting process. Therefore, proposed § 1.56A-21(b)(6) would provide that the amount by which a CAMT entity is insolvent is determined under section 108(d)(3).

3. Disregarded Entities and Partnerships

Special rules would address the application of the bankruptcy and insolvency exclusions to disregarded entities and partnerships. Disregarded entities would be eligible for these exclusions only if their regarded owner is eligible. See proposed § 1.56A-21(c)(3) and (d)(5). For partnerships, eligibility for these exclusions would be determined at the partner level. See proposed § 1.56A-21(e).

4. Attribute Reduction

Consistent with section 3.06 of Notice 2023-7, proposed § 1.56A-21(c) would require CAMT entities that exclude income from a discharge of indebtedness under proposed § 1.56A-21(c)(1)(i) or (c)(2)(i) to reduce CAMT-specific assets in the order listed in proposed § 1.56A-21(c)(4)(iii). Under proposed § 1.56A-21(c)(4)(iii), the tax attributes subject to reduction (but not below zero) would be: (i) the CAMT basis of covered property, but only to the extent the basis of the covered property is reduced by the CAMT entity under section 108 for regular tax purposes; (ii) FSNOLs; (iii) CFC adjustment carryovers; (iv) the CAMT basis of property (other than covered property) that is depreciated or amortized for AFS purposes; (v) the CAMT basis of property (other than covered property) that is not depreciated or amortized for AFS purposes; (vi) CAMT foreign tax credits; and (vii) any remaining CAMT basis of covered property. For purposes of proposed § 1.56A-21, the term “covered property” would mean section 168 property, qualified wireless spectrum, and property whose regular tax basis is determined under section 21(c) of the ANCSA. See proposed § 1.56A-21(b)(2).

The attributes listed in clauses (i) through (v) and (vii) of the prior paragraph would be reduced by one dollar for each dollar excluded under proposed § 1.56A-21(c)(1)(i) and (c)(2)(i), subject to specified limitations for basis reductions. CAMT FTCs would be reduced under a conversion formula that takes into account the differing economic values of deductions and credits. See proposed § 1.56A-21(c)(5).

The proposed order and amount of the reduction of CAMT attributes generally would parallel the order and amount of tax attribute reductions in section 108(b). However, reductions to the CAMT basis of covered property would be prioritized over reductions to other CAMT attributes to the extent the basis of such property has been reduced under section 108(b)(1) (proposed prioritization rule). Under section 56A(c)(8), (13), and (14), depreciation deductions claimed for regular tax purposes with respect to property whose basis is determined under section 21(c) of the ANCSA, Section 168 Property, and qualified wireless spectrum, respectively, are carried over into the CAMT. The proposed prioritization rule would align reductions to the CAMT basis of these three categories of property with the section 108(b)(1) reductions to the same property for regular tax purposes. This proposed rule is intended to minimize regular tax and CAMT basis mismatches in these categories that would make the CAMT harder to administer and enforce.

The proposed prioritization rule also would address a stakeholder's concern that, absent such a rule, taxpayers that have a reduction in depreciable basis in Section 168 Property under section 108(b)(1) would incur a double detriment if they also were required to reduce attributes other than the CAMT basis of the same property. This double detriment would result because AFSI is computed with regular tax depreciation taken on Section 168 Property. See section 56A(c)(13) and proposed § 1.56A-15. Reducing depreciable basis for regular tax purposes has the effect of not only increasing future regular taxable income, but also increasing future AFSI (because basis eligible for depreciation is no longer available). Therefore, if CAMT entities were required to reduce CAMT attributes other than depreciable basis after regular tax depreciable basis already has been reduced, their future AFSI would rise $2 for every $1 of excluded COD income: (i) the first $1 increase in future AFSI would result from the loss of the depreciation deduction against AFSI that the CAMT entity otherwise would have received; and (ii) the second $1 increase in future AFSI would result from the loss of an attribute other than CAMT depreciable basis.

To prevent this double detriment, the proposed prioritization rule would tie reductions in CAMT depreciable basis to the same reductions for regular tax purposes, just as depreciation and amortization deductions for purposes of the CAMT are aligned with regular tax depreciation and amortization deductions under section 56A(c)(13) and (14), respectively. Only when all other attributes have been reduced to zero would the basis of section 168 property (and other covered property) be reduced more than the basis of that property is reduced under section 108(b)(1).

Under section 3.06(2) of Notice 2023-7, the amount of the CAMT attribute reduction is limited to the amount of tax attributes reduced under section 108(b). Stakeholders recommended eliminating this limitation because CAMT attributes are separate from, and arise out of, a different measure of income than the regular tax, and the attribute reduction limitation in Notice 2023-7 does not take this difference into account. Under these proposed regulations, the CAMT attribute reduction would be limited to the amount of CAMT attributes subject to reduction rather than to the amount of tax attributes reduced under section 108(b). See proposed § 1.56A-21(c)(4)(ii)(B).

5. Timing of Attribute Reduction

Proposed § 1.56A-21(c)(4)(iv)(A) would specify that attribute reductions for FSNOLs, CFC net loss carryforwards, and CAMT FTCs are made after the determination of CAMT liability in the taxable year of a discharge. This provision is similar to § 1.108-7(b), which provides an ordering rule for attribute use and reduction under section 108(b). Similarly, proposed § 1.56A-21(c)(4)(iv)(B) would specify that CAMT basis reductions are made immediately before the close of the taxable year of the discharge of indebtedness of the CAMT entity solely with regard to assets of the CAMT entity under that section that the CAMT entity will hold at the beginning of the immediately subsequent taxable year. Proposed § 1.56A-21(c)(4)(iv)(C) would provide that a CAMT entity must make CAMT basis reductions in the same manner as basis reductions for regular tax purposes.

6. Exclusion of Income From Fresh-Start Reporting

Proposed § 1.56A-21(d) would provide rules for the computation of AFSI for CAMT entities emerging from bankruptcy. Under proposed § 1.56A-21(d)(2)(i), gain or loss reflected in FSI resulting from a CAMT entity's emergence from bankruptcy would be disregarded, with corresponding adjustments to CAMT basis and CAMT earnings to eliminate financial accounting changes from the excluded gain or loss. This proposed rule would be consistent with section 3.07 of Notice 2023-7, with additional clarifications as to the scope of its application.

For example, stakeholders expressed uncertainty as to whether section 3.06 of Notice 2023-7 (concerning discharge of indebtedness income) or, rather, section 3.07 of Notice 2023-7 (concerning emergence from bankruptcy) applies to debt discharges that occur upon a debtor's emergence from bankruptcy. Stakeholders also expressed uncertainty over whether section 3.06 of Notice 2023-7 is intended to cover all transactions in bankruptcy, including sales of assets prior to the emergence from bankruptcy and covered nonrecognition transactions prior to, or concurrent with, the emergence from bankruptcy. Some of these transactions may not give rise to income under fresh-start reporting even though they occur in bankruptcy and otherwise may increase a debtor's FSI.

To clarify that the discharge of indebtedness provisions take priority in cases involving the emergence from bankruptcy, proposed § 1.56A-21(d)(2)(ii) would provide that, in such cases, a CAMT entity would rely on proposed § 1.56A-21(c) to determine the CAMT consequences of a discharge of indebtedness. Proposed § 1.56A-21(d)(2)(iii) and (d)(3) would provide that, in the case of an emergence from bankruptcy in a covered transaction, the rules of §§ 1.56A-18 and 1.56A-19 would apply to determine the CAMT consequences of the emergence transaction.

7. Investments in Partnerships

Proposed § 1.56A-21(e) provides rules for determining the AFSI of a CAMT entity that is a partner in a partnership that realizes discharge of indebtedness income. Proposed § 1.56A-21(e)(2)(i) provides that any discharge of indebtedness income reflected in a partnership's FSI is disregarded for determining the partnership's AFSI. Instead, any exclusion from AFSI for a partnership's discharge of indebtedness income, and any resulting CAMT attribute reductions, are applied at the partner level in the manner as the rules in section 108(a) and section 108(b) are applied at the partner level for regular tax purposes. For purposes of applying the attribute reduction rules, proposed § 1.56A-21(e)(2)(ii)(B) provides that a CAMT entity treats its partnership investment as covered property to the extent the basis of covered property held by the partnership is reduced by the partnership for regular tax purposes under § 1.1017-1(g)(2). Additionally, if a CAMT entity that is a partner in a partnership treats its partnership investment as covered property, the basis adjustment rules under § 1.1017-1(g)(2) with respect to covered property held by the partnership apply for purposes of determining the CAMT entity's distributive share amount under proposed § 1.56A-5. Proposed § 1.56A-21(e)(2)(iii) provides that discharge of indebtedness income reflected in a partnership's FSI is separately stated to the partners in accordance with their distributive share percentages for the taxable year in which the income is realized for AFS purposes. For purposes of determining whether a CAMT entity that is a partner in a partnership is insolvent, proposed § 1.56A-21(e)(3) provides that the CAMT entity includes its share of partnership's liabilities under section 752 of the Code in the same manner as its share of partnership liabilities would be included for regular tax purposes.

8. Exclusion of Financial Accounting Gain From Federal Financial Assistance

Stakeholders have expressed concern over the inclusion in AFSI of financial accounting gain attributable to amounts that constitute “Federal financial assistance” (FFA), as defined in proposed § 1.56A-21(b)(4), for regular tax purposes. FFA may arise in the context of an acquisition of a troubled financial institution. Financial accounting principles may require gain attributable to these amounts to be reported as gain on a CAMT entity's AFS and included in FSI when the relevant transaction is entered into (for example, as a result of bargain purchase gain). In contrast, for regular tax purposes, the recognition of gross income attributable to FFA may be deferred over multiple taxable years under section 597 and the regulations under section 597.

Stakeholders stated that this mismatch in timing of recognition of amounts attributable to FFA for AFSI purposes and regular tax purposes may cause or increase CAMT tax liability solely because of a CAMT entity's participation in transactions involving troubled financial institutions that the provision of FFA is otherwise intended to encourage. To address this mismatch in timing, proposed § 1.56A-21(f) would provide adjustments to AFSI so as not to include any financial accounting gain attributable to FFA any earlier than when the gain is included in gross income for purposes of section 597 and the regulations under section 597.

XXI. Proposed § 1.56A-22: AFSI Adjustments for Certain Insurance Companies and Other Specified Industries

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-22 would provide rules under section 56A regarding insurance companies and other specified industries.

A. AFSI Adjustments for Covered Variable Contracts

Some insurance companies issue insurance contracts (including variable contracts, as defined in section 817(d) of the Code) for which the insurance company's obligations to the contract holders (and the company's corresponding reserves) reflect (in whole or in part) the change in value of a designated pool of investment assets supporting the contracts. These contracts generally are accounted for on the insurance company's financial statements by including in its FSI both (i) the change in the unrealized gain or loss in the supporting assets, and (ii) the offsetting change in liability resulting from the related change in the company's obligation to the contract holders. See section 2.02 of Notice 2023-20.

In the absence of a special rule for insurance companies issuing this type of contract, AFSI would be determined by disregarding (i) the change in unrealized gain or loss on certain stock under section 56A(c)(2)(C) and proposed §§ 1.56A-4, 1.56A-18, and 1.56A-19, and (ii) the change in unrealized gain or loss on certain partnership interests (in whole or in part) under section 56A(c)(2)(D) and proposed §§ 1.56A-5 and 1.56A-20, even though the offsetting change in liabilities would be taken into account. This outcome would result in a mismatch that could significantly overstate or understate AFSI for these insurance companies relative to both taxable income and economic income.

Section 3 of Notice 2023-20 provides interim guidance that addresses this mismatch. Under section 3 of Notice 2023-20, for purposes of determining an insurance company's AFSI, the change in the obligation to holders of “Covered Variable Contracts”, as defined in section 2.05(2) of Notice 2023-20, is disregarded to the extent the related gains or losses on assets supporting the contracts are both (i) taken into account in determining FSI, and (ii) excluded from AFSI under section 56A(c)(2)(C) or (c)(2)(D)(i).

A stakeholder suggested that “turning off” section 56A(c)(2)(C) and (c)(2)(D)(i) could achieve the same result as under Notice 2023-20 and would be simpler to administer, because no adjustments to an insurance company's AFSI would be needed to eliminate the mismatch. In contrast, the approach described in Notice 2023-20 requires two adjustments: first, section 56A(c)(2)(C) or (c)(2)(D)(i) is applied to exclude from AFSI certain gains and losses in the assets supporting the contracts; and second, section 3.02 of Notice 2023-20 is applied to exclude from AFSI the offsetting change in the obligations to the contract holders.

To address the foregoing mismatch in a manner that is simple to administer, proposed § 1.56A-22(c)(1) generally would provide that proposed §§ 1.56A-4, 1.56A-5, and 1.56A-18 through 1.56A-20 (and, thus, any statutory AFSI adjustments implemented by these provisions) would not apply to exclude from an insurance company's AFSI any gains or losses on assets supporting covered variable contracts, as defined in proposed § 1.56A-22(b)(5), to the extent that (i) the gains and losses result in a change in the amount of the obligations to the contract holders, and (ii) this change is included in the insurance company's FSI.

A stakeholder also suggested that the definition of Covered Variable Contracts in Notice 2023-20 be broadened. Accordingly, proposed § 1.56A-22(b)(5) would define this term more generally rather than by including in the definition only specific types of identified contracts.

B. AFSI Adjustments for Covered Reinsurance Agreements

In certain types of reinsurance arrangements (namely, funds withheld reinsurance and modified coinsurance agreements), the ceding company retains the investment assets that support the obligations to the holders of the underlying insurance contracts. Under these agreements, the reinsurance operates like conventional reinsurance, but from a legal title and financial accounting perspective, the ceding company retains these investment assets as security for the reinsurer's obligations under the reinsurance agreement (and for modified coinsurance, the ceding company also retains the reserves). See Credit for Reinsurance Model Law (MO-785), NAIC Model Laws, Regulations, Guidelines, & Other Resources, section 3 (2019); NAIC, Accounting Practice & Procedures Manual, SSAP 61R, Life, Deposit-Type and Accident and Health Reinsurance (2023). The ceding company records a liability to the reinsurer to reflect the assets it has retained.

Under GAAP and IFRS, the change in unrealized gains and losses on certain of these retained assets generally is accounted for in the ceding company's OCI, and the change in a related and offsetting payable to the reinsurer is accounted for in the ceding company's FSI. See section 2.03 of Notice 2023-20. The definition of FSI in proposed § 1.56A-1(b)(20) would exclude OCI from AFSI. Accordingly, without a special rule, the change in the payable would be included in the determination of AFSI, but the offsetting change in the unrealized gain or loss in the retained assets generally would not be included.

Section 4 of Notice 2023-20 provides interim guidance that addresses this mismatch. Section 4 of Notice 2023-20 also provides related guidance to the reinsurer, guidance in the case of a retrocession, and guidance if the insurance company elects to account for parts of the reinsurance arrangement at fair value.

The rules in proposed § 1.56A-22(d) generally would be consistent with section 4 of Notice 2023-20. Proposed § 1.56A-22(d)(1) generally would provide that (i) the ceding company in a “covered reinsurance agreement”, as defined in proposed § 1.56A-22(b)(4), excludes from AFSI any changes in the amount of the payable to the reinsurer that correspond to the unrealized gains and losses in the withheld assets to the extent the unrealized gains and losses are not included in AFSI, and (ii) the reinsurer in a covered reinsurance agreement excludes from AFSI any changes in the amount of the receivable from the ceding company that correspond to the unrealized gains and losses in the assets withheld by the ceding company.

However, the rule in proposed § 1.56A-22(d)(3), related to accounting for the reinsurance arrangement at fair value, would “turn off” the general rule in proposed § 1.56A-22(d)(1) if the insurance company either (i) makes an election for AFS purposes to account for the covered reinsurance agreement at fair value in its FSI, or (ii) otherwise accounts for both the payable (for the ceding company) or the receivable (for the reinsurer) and the covered reinsurance agreement at fair value in its FSI. Accordingly, proposed § 1.56A-22(d)(3) would apply only if the covered reinsurance agreement is accounted for at fair value in FSI. Comments are requested on whether the rule in proposed § 1.56A-22(d)(3) appropriately describes the circumstances (under GAAP, IFRS, and other generally accepted accounting standards) in which the general rule in proposed § 1.56A-22(d)(1) should not apply.

C. Use of Fresh Start Basis

Various Acts of Congress fully subjected to Federal taxation certain entities that previously had been exempt from Federal taxation (in whole or in part). See section 2.04 of Notice 2023-20. These Acts provided special rules for determining the adjusted basis of an asset held by any of these entities on the day it became fully subject to Federal taxation. These rules generally provided that, for certain purposes, the adjusted basis of any asset held by the entity on the day it became fully subject to Federal taxation is equal to the fair market value of the asset on that day, providing a “fresh start” for these entities.

Consistent with section 5 of Notice 2023-20, proposed § 1.56A-22(e) would provide that, for purposes of determining AFSI, the adjusted basis of any asset held by the entity since the date it became fully taxable is determined in accordance with the particular Act that fully subjected the entity to Federal taxation.

XXII. Proposed § 1.56A-23: AFSI Adjustments for Financial Statement Net Operating Losses and Other Attributes

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-23 would provide rules under section 56A(d) for determining the AFSI adjustment for financial statement net operating loss (FSNOL) carryovers, built-in losses, and other attributes.

A. General FSNOL Rules

Section 56A(d)(1) provides that AFSI is reduced by an amount equal to the lesser of (i) the aggregate amount of FSNOL carryovers to the taxable year, or (ii) 80 percent of AFSI computed without regard to the FSNOL adjustment. Section 56A(d)(2) provides that an FSNOL for any taxable year is a financial statement net operating loss carryover to each taxable year following the taxable year of the loss. The portion of the FSNOL carried to subsequent taxable years is the amount of the FSNOL remaining after subtracting the adjustments under section 56A(d)(1) for previous years. Section 56A(d)(3) defines an “FSNOL” as the amount of the net loss set forth on a corporation's applicable financial statement as adjusted by section 56A(c), and without regard to the FSNOL deduction, for taxable years ending after December 31, 2019.

Proposed § 1.56A-23(c) would provide that, if the AFSI of a corporation for a taxable year is positive (determined after application of the section 56A regulations), the corporation's AFSI is reduced by an amount equal to the lesser of (i) the aggregate amount of FSNOL carryovers to the taxable year, or (ii) 80 percent of the AFSI of the corporation (determined after application of the section 56A regulations and without regard to proposed § 1.56A-23). Proposed § 1.56A-23(d)(1) would provide that an FSNOL for any taxable year is carried forward to each taxable year following the taxable year of the loss, and that any remaining FSNOL is carried forward to the subsequent taxable year. An example in proposed § 1.56A-23(d)(2) would clarify that the rules in proposed § 1.56A-23(d) apply even if the corporation was not an applicable corporation in a prior taxable year. The statute generally requires AFSI adjustments related to pre-effective date years that affect post-effective date years to be made. This is consistent with the rules described in proposed § 1.56A-1(d)(3), which provides that the AFSI adjustments described in the section 56A regulations are made for taxable years ending after December 31, 2019. Proposed § 1.56A-23(c) and (d) would be consistent with the rules described in section 12 of Notice 2023-64.

The section 56A(d) rules regarding the use of FSNOLs generally match the rules regarding the use of NOLs applicable to most corporations for regular tax purposes under section 172 in that both FSNOLs and NOLs generally (i) may be carried forward for an indefinite number of years but may not be carried back and (ii) may be used to reduce only 80 percent of AFSI (as described in section 56A(d)(1)) or taxable income (as described in section 172(a)(2)), respectively. However, section 172 provides exceptions to the general rule for nonlife insurance companies that are not in section 56A(d). In particular, section 172 provides that a nonlife insurance company's NOLs may be carried back for two years and carried forward 20 years and also that the NOLs are not subject to the 80 percent limit described in section 172(a)(2). See section 172(b)(1)(C) and (f). Stakeholders have observed that this disparity could create a substantial mismatch between AFSI and regular taxable income for nonlife insurance companies that does not exist for other corporations. The Treasury Department and the IRS request comments on how substantial this mismatch may be and the severity of the economic effects of such mismatch, whether rules should be provided to address this potential mismatch, and how the rules might operate.

B. Limitation on FSNOLs and Built-in Losses Acquired in Successor Transactions

The existence of FSNOLs and built-in losses may incentivize acquisitions for Federal income tax reasons in a manner inconsistent with the purposes of section 56A. Accordingly, proposed § 1.56A-23(e) and (f) would limit the use of FSNOLs and built-in losses, respectively, to which an applicable corporation succeeds (i) in a reorganization or liquidation described in section 381(a), or (ii) after a stock acquisition (including a stock acquisition in which the target corporation becomes a member of a tax consolidated group) (collectively, successor transactions, as defined in proposed § 1.56A-23(e)(3)). The proposed limitation is intended to replicate the target corporation's ability to use the CAMT attributes prior to the transaction.

Proposed § 1.56A-23(e) would limit the use of FSNOLs after a successor transaction. Under proposed § 1.56A-23(e)(2), a successor corporation or successor group could use the FSNOLs of an acquired business to offset the successor's AFSI only if the acquired business is separately tracked in the successor's books and records, and only to the extent of the AFSI generated by the separately tracked business after the successor transaction (separately tracked income). Proposed § 1.56A-23(e)(2)(ii) would provide rules for determining separately tracked income for purposes of proposed § 1.56A-23(e), proposed § 1.56A-23(e)(3)(iii) would provide rules regarding the separation of an acquired business from the associated acquired FSNOLs, and proposed § 1.56A-23(e)(3)(iv) would provide rules regarding the integration of an acquired business with the successor's business.

Proposed § 1.56A-23(f) would provide rules regarding the use of built-in losses after a successor transaction. Under proposed § 1.56A-23(f), built-in losses that are recognized after a successor transaction would be treated as if they were acquired FSNOLs for purposes of proposed § 1.56A-23(e). This rule is intended to ensure that acquired built-in losses are treated similarly to acquired FSNOLs. For this purpose, “built-in losses” would be defined by reference to certain specified provisions in section 382 of the Code. See proposed § 1.56A-23(f)(2).

The foregoing limitations are modeled after the separate return limitation year rules in §§ 1.1502-15 and 1.1502-21(c). Stakeholders also had recommended applying section 382 to limit the use of FSNOLs and other CAMT attributes after an acquisition. However, the Treasury Department and the IRS are not proposing to apply the limitation in section 382 to FSNOLs or other CAMT attributes due to complexities that would arise from importing the section 382 limitation into the CAMT system. Additionally, applying section 382 and the regulations under section 382 to the use of FSNOLs and other CAMT attributes is not necessary to carry out the purposes of section 56A for two reasons: (i) the SRLY-like limitation in proposed § 1.56A-23(e) would operate to deter acquisitions undertaken to acquire FSNOLs and other CAMT attributes, and (ii) the administrative burden of applying section 382 and the regulations under section 382 to FSNOLs and other CAMT attributes would outweigh the benefits of applying the section 382 limitation to FSNOLs.

XXIII. Proposed § 1.56A-24: AFSI Adjustments for Hedging Transactions and Hedged Items

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-24 would provide rules under section 56A regarding hedging transactions and hedged items.

A. Overview

Depending on the relevant accounting standards, certain categories of assets and liabilities (for example, derivatives) may be required to be periodically measured and reflected in the AFS at fair value. Stakeholders expressed concern regarding the inclusion in a CAMT entity's AFSI of these periodic measurements of fair value, referred to by certain stakeholders as book or financial statement “mark-to-market” adjustments.

More specifically, some stakeholders expressed concern about situations in which an asset or a liability is periodically measured at fair value and reflected in FSI in a CAMT entity's AFS, but a related asset or liability is not. For example, in the case of a hedging transaction and the related item, the hedging transaction may be required to be periodically measured at fair value, but the related item may not. As a result, in situations involving hedging transactions, CAMT entities may have AFS mismatches between the hedging transaction and the related item, despite the hedging transaction and the related item offsetting each other economically. This mismatch may give rise to distortions in the determination of AFSI that should be alleviated with an adjustment to FSI to avoid the non-economic results that would arise absent an adjustment. The Joint Committee on Taxation has stated that Congress intended for mismatches involving certain hedging transactions to be addressed in the regulations.

These situations also may cause volatility in the determination of a CAMT entity's AFSI due to unrealized gain and loss on a hedging transaction or the related item in cases in which there may not be corresponding economic volatility for the hedging transaction and the related item. For example, a CAMT entity may manage risk with respect to price fluctuations of commodities for future customer delivery obligations by entering into hedging transactions with similar terms as those customer delivery obligations. The delivery obligations may not be periodically measured at fair value, but the hedging transaction generally would be required to be periodically measured at fair value. As a result, a CAMT entity could have volatility in the determination of AFSI attributable to fluctuations in commodities prices even if those fluctuations are hedged as an economic matter. Stakeholders have expressed concern that absent an adjustment for these hedging transactions used to manage business risks, there may be unintended cashflow constraints due to the inclusion of unrealized gain or loss in FSI in the context of hedging transactions in which there generally are not meaningful economic gains or losses.

Some stakeholders also expressed concern about the AFSI treatment of a hedging transaction entered into to manage the foreign currency exposure of a net investment in a foreign operation. In particular, stakeholders expressed concern that changes in the fair value of these hedges are included in equity accounts, such as retained earnings or OCI, and as a result not included in FSI. However, these hedges may be marked to market for regular tax purposes, resulting in a divergence between FSI and regular taxable income due to the manner in which changes in values with respect to these particular hedging transactions are required to be reported under applicable financial accounting principles.

B. Proposed Regulations

To address the mismatches and distortions described in part XXIII.A of this Explanation of Provisions, proposed § 1.56A-24 would provide certain adjustments to AFSI (determined without regard to proposed §§ 1.56A-23 and 1.56A-24, but after giving effect to all other sections of the section 56A regulations) for an AFSI hedge or the related item. Under proposed § 1.56A-24(b)(1), an “AFSI hedge” generally would include hedging transactions for regular tax purposes (for example, those defined in § 1.1221-2(b), whether or not the character of gain or loss from the transaction is determined under § 1.1221-2) as well as hedging transactions for financial accounting purposes. However, an AFSI hedge would not include a hedging transaction entered into by an insurance company to hedge obligations to holders of life insurance or annuity contracts that take into account the value of one or more specified assets or indices (for example, contracts that have guaranteed minimum benefits or crediting rates), because the amount of the liabilities that corresponds to the hedging transaction is also included in the insurance company's FSI. See proposed § 1.56A-24(b)(1)(ii)(A). Under proposed § 1.56A-24(b)(4), the term “hedged item” would mean an asset or a liability that is reflected in a CAMT entity's AFS for which there is a risk of interest rate or price changes, currency fluctuations, or other risk that is eligible to be managed by an AFSI hedge and that is managed by one or more AFSI hedges.

Proposed § 1.56A-24(b)(3) would provide that the term “fair value measurement adjustment” means a change in the value of an asset or a liability due to required periodic determinations at least annually of the increases or decreases in fair value of that asset or liability included in a CAMT entity's FSI, regardless of whether the determinations are required due to the type of asset or liability or an election by the CAMT entity. A fair value measurement adjustment would not include an impairment loss or impairment loss reversal within the meaning of proposed § 1.56A-1(b)(29) and (30), respectively. Under the definition of the term fair value measurement adjustment, changes in the value of an asset or liability not included in a CAMT entity's FSI, such as those generally resulting from a cash flow hedge (as defined in Accounting Standards Codification paragraph 815-30-20 or IFRS 9 Chapter 6.5.11), do not constitute fair value measurement adjustments.

Under proposed § 1.56A-24(c)(2), a fair value measurement adjustment for an AFSI hedge or a hedged item for a taxable year would be disregarded by a CAMT entity for purposes of determining the CAMT entity's AFSI if the CAMT entity (i) has a fair value measurement adjustment with respect to an AFSI hedge but not the hedged item or (ii) has a fair value measurement adjustment with respect to a hedged item but not the AFSI hedge. However, in either situation, the fair value measurement adjustment would not be disregarded if either the AFSI hedge or hedged item is marked to market for regular tax purposes. In these cases, the book and regular tax treatment of the AFSI hedge or hedged item are likely to correspond (for example, the hedged item may be marked-to-market for both book and regular tax purposes), so that no adjustment to AFSI is needed.

The adjustments to AFSI in proposed § 1.56A-24(c)(2) would delay the inclusion in AFSI of unrealized gain or loss attributable to fair value measurement adjustments for an AFSI hedge or a hedged item until the earlier of when the gain or loss on the corresponding hedged item or AFSI hedge (as applicable) is recognized for FSI purposes, or an “AFSI subsequent adjustment date” (as defined in proposed § 1.56A-24(b)(2)) otherwise occurs. These adjustments to AFSI are intended to address certain financial accounting mismatches between an AFSI hedge and a hedged item by coordinating the timing of recognition between AFSI hedges and hedged items in a manner similar to other rules involving economically integrated transactions, such as § 1.446-4.

The rules in proposed § 1.56A-24(c)(2) are intended to avoid the inclusion of unrealized gain or loss in AFSI that is offset economically by a hedged item or AFSI hedge (as applicable) but for which there are timing differences for recognition for financial accounting purposes. By doing so, these proposed rules also are intended to avoid situations in which a CAMT entity would have volatility in the determination of AFSI (and, potentially, in the determination of whether the CAMT entity is subject to the CAMT) because only one of an AFSI hedge or a hedged item is subject to fair value measurement adjustments included in net income, and there is no corresponding difference for regular tax purposes. In the commodities hedging example described in part XXIII.A of this Explanation of Provisions, if the requirements of proposed § 1.56A-24(c)(2) were satisfied, the hedging transaction would be an AFSI hedge for which fair value measurement adjustments would be disregarded until an AFSI subsequent adjustment date occurs, resulting in similar timing for the inclusion of gain or loss in AFSI between the AFSI hedge and the hedged item.

Proposed § 1.56A-24(d) would apply in situations in which a CAMT entity marks to market a “net investment hedge,” as defined in proposed § 1.56A-24(b)(5), for regular tax purposes. Under proposed § 1.56A-24(d), the CAMT entity would include the amount of mark-to-market gain or loss for regular tax purposes in AFSI. This proposed rule is intended to result in greater conformity between the timing of the net investment hedge for financial accounting purposes and for regular tax purposes by including the unrealized gain or loss for the net investment hedge in AFSI.

Proposed § 1.56A-24(e)(1) would provide operative rules for the inclusion of certain taxable amounts in AFSI for fair value measurement adjustments disregarded from a CAMT entity's AFSI under proposed § 1.56A-24(c)(2). Under proposed § 1.56A-24(e)(1), if the fair value measurement adjustment includes items corresponding to items of income, gain, deduction, or loss for regular tax purposes, such as the accrual of original issue discount on a bond, those items would be taken into account for AFSI purposes.

Proposed § 1.56A-24(e)(2) would provide for subsequent adjustments for an AFSI hedge or a hedged item (as applicable) in the taxable year in which there is an AFSI subsequent adjustment date. In general, proposed § 1.56A-24(e)(2) would provide for the inclusion in AFSI of the cumulative fair value measurement adjustments previously disregarded in determining AFSI under proposed § 1.56A-24(c)(2) and for certain adjustments to CAMT basis. Proposed § 1.56A-24(e)(3) would provide for subsequent adjustments for a net investment hedge in the taxable year in which a net investment hedge matures or is sold, disposed of, or otherwise terminated, or the asset or liability that was a net investment hedge subject to § 1.56A-24(d) otherwise ceases to constitute a net investment hedge.

These proposed rules address the situations described by stakeholders in which one component of a transaction is periodically measured at fair value and reflected in FSI in a CAMT entity's AFS, but a related asset or liability is not, without a corresponding mismatch in treatment for regular tax purposes. The Treasury Department and the IRS invite comments on whether there are other similar situations potentially giving rise to a substantial mismatch for which a similar adjustment to AFSI may be appropriate.

XXIV. Proposed § 1.56A-25: AFSI Adjustments for Mortgage Servicing Income

Pursuant to the authority granted by section 56A(e), proposed § 1.56A-25 would provide rules under section 56A(c)(10)(A) regarding mortgage servicing income. CAMT entities that hold contracts to service mortgage assets (mortgage servicing contracts) may have servicing assets or servicing liabilities related to those mortgage servicing contracts. For mortgage servicing contracts that are servicing assets, the relevant accounting standards (for example, ASC 860-50-35) generally require a CAMT entity to determine FSI by taking into account either changes in fair value of the mortgage servicing contracts or the amortization of the value of those contracts.

In general, for regular tax purposes, the treatment of certain sales of mortgages originated by a taxpayer and the income from related mortgage servicing contracts is determined under Rev. Rul. 91-46, 1991-2 C.B. 358 (for example, if the contract entitles the taxpayer to receive amounts that exceed reasonable compensation for the services to be performed, the income attributable to this excess is taken into account under the timing rules for stripped coupons in section 1286 of the Code). In addition, if the taxpayer is a dealer in securities under section 475 of the Code, the mark-to-market method of accounting generally applies to any securities, including any excess mortgage servicing rights treated as stripped coupons. As a result, the timing for the inclusion of items related to mortgage servicing contracts for financial accounting purposes may be different than the timing for the inclusion of items related to mortgage servicing contracts for regular tax purposes.

Consistent with section 56A(c)(10)(A), proposed § 1.56A-25 would provide that AFSI is adjusted so as not to include any item of income in connection with a mortgage servicing contract any earlier than the period in which such income is included in gross income under chapter 1. This proposed rule implements the statutory provision, which results in consistent treatment of items of income in connection with a mortgage servicing contract of a taxpayer for purposes of the CAMT and for regular tax purposes.

Section 56A(c)(10)(B) authorizes the Secretary to provide regulations to prevent the avoidance of taxes imposed by chapter 1 of subtitle A of the Code for amounts not representing reasonable compensation (as determined by the Secretary) with respect to a mortgage servicing contract. While this NPRM does not include proposed regulations under section 56A(c)(10)(B), the Treasury Department and the IRS continue to study the issue and invite comments concerning whether regulations should be issued pursuant to this specific grant of regulatory authority.

XXV. Proposed § 1.56A-26: AFSI Adjustments for Certain Related-Party Transactions and CAMT Avoidance Transactions

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-26 would provide rules regarding certain related-party transactions and CAMT avoidance transactions. The Treasury Department and the IRS are concerned that taxpayers may enter into transactions with related parties or enter into other transactions or arrangements in order to avoid the application of CAMT or to improperly reduce CAMT liability. Proposed § 1.56A-26(b) would defer AFSI losses resulting from transactions between related parties. Proposed § 1.56A-26(c) would provide an anti-abuse rule for arrangements undertaken with a principal purpose of avoiding CAMT, including avoiding treatment as an applicable corporation or reducing or otherwise avoiding a liability under section 55(a). Proposed § 1.56A-26(c) permits the Commissioner to disregard or recharacterize such arrangements to the extent necessary to carry out the purposes of CAMT. An arrangement includes, for example, the filing of a financial statement with the SEC or with an agency of a foreign government that is equivalent to the SEC, where such filing is not required and is made for the purpose of affecting which financial accounting standard is considered the applicable financial accounting standard under the FPMG rules in proposed § 1.59-3.

Proposed § 1.56A-26(d) would require income, expense, gain, or loss arising from transactions between commonly controlled CAMT entities to be clearly reflected for purposes of the CAMT, consistent with the principles of section 482 of the Code. More specifically, proposed § 1.56A-26(d) would require any item of income, expense, gain, or loss reflected in the FSI of a CAMT entity with respect to a controlled transaction or controlled transfer (as defined in § 1.482-1(i)(8)) between two or more CAMT entities to be adjusted to reflect the principles of section 482 and the regulations under section 482, regardless of whether section 482 otherwise is considered to apply. This proposed rule would clarify that the principles of section 482 apply to determine the effect of controlled transactions and controlled transfers on AFSI. No inference is intended regarding how section 482 applies to affect any amount required for the calculation of AFSI without regard to this proposed rule.

XXVI. Proposed § 1.56A-27: AFSI Adjustments for Foreign Governments

Pursuant to the authority granted by section 56A(c)(15) and (e), proposed § 1.56A-27 would provide rules under section 56A regarding AFSI adjustments for income of foreign governments. These proposed rules would provide for an adjustment to AFSI of a foreign government for any amount that, if it were properly treated as gross income for regular tax purposes, would be excluded from gross income and exempt from taxation under subtitle A pursuant to section 892 of the Code.

Under proposed § 1.56A-1(d)(2), except as provided in the section 56A regulations, a CAMT entity may not make any adjustments to its FSI in determining its AFSI. The Treasury Department and the IRS are of the view that any amount of FSI, if it were properly treated as gross income for regular tax purposes and would qualify for the exemption under section 892 for that person, should be excluded from that person's FSI when determining its AFSI only for purposes of determining CAMT liability. Therefore, proposed § 1.56A-27(b) would provide for an adjustment to AFSI for income of foreign governments that qualifies for treatment under section 892.

The adjustment in proposed § 1.56A-27 would apply only for purposes of determining CAMT liability, and not for purposes of determining whether a corporation is an applicable corporation under section 59(k). See, for example, proposed § 1.59-2(c)(1)(ii)(B).

XXVII. Proposed § 1.59-2: General Rules for Determining Applicable Corporation Status

Pursuant to the authority granted by section 59(k)(1)(C) and (k)(3), proposed § 1.59-2 would provide rules under section 59(k) for determining whether a corporation is an applicable corporation for purposes of sections 55 through 59. Proposed § 1.59-2(b) would provide definitions that apply for purposes of section 59, including the definition of an “applicable corporation.” For purposes of the special rules provided in proposed § 1.59-2(f) ( see discussion in part XXVII.C of this Explanation of Provisions), proposed § 1.59-2(b) would provide definitions for “relevant relationship criteria,” “test group,” and “test group parent.” Proposed § 1.59-2(b)(4) would define “relevant relationship criteria” to mean the relationship criteria set forth in the rules for the average annual AFSI tests under proposed § 1.59-2(c)(1)(ii)(A), (c)(2)(ii)(A), or (c)(2)(iii)(A), as applicable. See discussion of the average annual AFSI tests in part XXVII.A of this Explanation of Provisions. Proposed § 1.59-2(b)(5) would provide that the term “test group” means, with respect to a corporation, the corporation and all persons that are treated as related to such corporation under the relevant relationship criteria. Proposed § 1.59-2(b)(6) would provide that the term “test group parent” means the relevant person(s) as described in proposed § 1.59-2(b)(6)(i) through (vii). Terms used in proposed §§ 1.59-2 through 1.59-4 that are not defined in those sections have the meaning provided in proposed § 1.56A-1(b).

A. Average Annual AFSI Test

1. Corporation Is Not a Member of an FPMG

Proposed § 1.59-2(c)(1) describes the average annual AFSI test applied to a corporation that is not a member of an FPMG to determine whether such a corporation is an applicable corporation. Such a corporation meets the average annual AFSI test for a taxable year if its average annual AFSI for the 3-taxable-year period ending with such taxable year exceeds $1,000,000,000. For this purpose, the AFSI of the corporation and the AFSI of all persons treated as a single employer with the corporation under section 52(a) or (b) would be treated as the AFSI of the corporation. See proposed § 1.59-2(c)(1)(ii)(A). Moreover, if a person treated as a single employer with a corporation has a taxable year that differs from the taxable year of the corporation, then the corporation's AFSI would include such person's AFSI for the taxable year of such person that ends with or within the taxable year of the corporation. See proposed § 1.59-2(c)(1)(ii)(A).

Consistent with section 59(k)(1), the AFSI of a corporation described in proposed § 1.59-2(c)(1)(i) and the AFSI of any person treated as a single employer with the corporation under section 52(a) or (b) would be determined without regard to certain specified AFSI adjustments. See proposed § 1.59-2(c)(1)(ii)(B). Certain of the specified adjustments would be disregarded according to the terms of the statute. These are the adjustment for FSNOLs in proposed § 1.56A-23, the adjustment for distributive share of partnership AFSI in proposed § 1.56A-5, and the adjustment for covered benefit plans in proposed § 1.56A-13. See section 59(k)(1)(B)(i) and (k)(1)(D)(i). In addition, the adjustments in proposed §§ 1.56A-6(b)(2) and 1.56A-8(c), which would decrease AFSI for foreign income taxes when the foreign tax credit is not claimed for regular tax purposes, would be disregarded so that, for testing purposes, there is equal treatment of those choosing to claim, and those not choosing to claim, the foreign tax credit. The adjustment to apply certain subchapter K principles provided in proposed § 1.56A-20 would be disregarded to permit testing without the burden of determining that adjustment. Finally, the adjustment with respect to certain income of foreign governments provided in proposed § 1.56A-27 would be disregarded because it would be inappropriate to disregard the income for testing purposes.

To avoid the duplication of AFSI, if a partnership is treated as a single employer with a corporation under section 52(a) or (b), then the AFSI of any partner in the partnership that is either that corporation or treated as a single employer with that corporation would be determined without regard to any amounts reflected in the partner's FSI that is derived from, and included in, the FSI of the partnership. See proposed § 1.59-2(c)(1)(ii)(C).

To provide for the application of the rules relating to discharge of indebtedness income with respect to partnership investments, if a partnership is treated as a single employer with a corporation under section 52(a) or (b), then the exclusions from AFSI for discharge of indebtedness income in proposed § 1.56A-21(c) apply to the partnership's AFSI, but are based on a determination of whether the relevant partner meets any of the exclusions provided in proposed § 1.56A-21(c)(1) and (2), including the application of any resulting CAMT attribute reductions provided in proposed § 1.56A-21(c)(4) and (5). See proposed § 1.59-2(c)(1)(ii)(D).

2. Corporation is a Member of an FPMG

Proposed § 1.59-2(c)(2) describes the average annual AFSI test applied to a corporation that is a member of an FPMG for purposes of determining whether such corporation (FPMG corporation) is an applicable corporation. The FPMG corporation is subject to the two-prong average annual AFSI test described in proposed § 1.59-2(c)(2) if it is a member of an FPMG at the beginning or end of its taxable year. See proposed § 1.59-2(b)(3). Under the first prong, the average annual AFSI of the FPMG corporation for the 3-taxable-year period ending with such taxable year must exceed $1,000,000,000. See proposed § 1.59-2(c)(2)(i)(A). For this purpose, the combined AFSI of the FPMG corporation and all relevant aggregation entities (as defined in proposed § 1.59-2(b)(4)) is treated as the AFSI of the FPMG corporation. The relevant aggregation entities for an FPMG corporation are all members of the FPMG, other than the FPMG corporation itself, and any other person that is treated as a single employer with the FPMG corporation under section 52(a) or (b). If a relevant aggregation entity has a taxable year that differs from the taxable year of the FPMG corporation, then the FPMG corporation's AFSI includes such relevant aggregation entity's AFSI for the taxable year that ends with or within the taxable year of the FPMG corporation. If such relevant aggregation entity does not have a taxable year for regular tax purposes, its AFS reporting year is treated as its taxable year. See proposed § 1.59-2(c)(2)(ii)(A).

Certain specified AFSI adjustments would be disregarded in applying the first prong of this test. In addition to those AFSI adjustments disregarded when applying the average annual AFSI test to corporations that are not members of an FPMG, the adjustments for income of CFCs and income effectively connected with a U.S. trade or business ( see §§ 1.56A-6 and 1.56A-7, respectively) also would be disregarded, pursuant to section 59(k)(2)(A). See proposed § 1.59-2(c)(2)(ii)(B).

For purposes of applying the $1,000,000,000 average AFSI threshold test in proposed § 1.59-2(c)(2)(i)(A), an FPMG corporation that is a foreign corporation and any relevant aggregation entity that is not a United States person (as defined in section 7701(a)(30)) would not make any AFSI adjustment described in the section 56A regulations that is dependent on the treatment of an item for regular tax purposes, such as for depreciation ( see section 56A(c)(13) and proposed § 1.56A-15), if the FPMG corporation or relevant aggregation entity, as applicable, does not take such item into account for regular tax purposes. See proposed § 1.59-2(c)(2)(ii)(C). If an AFSI adjustment provides for disregarding an FSI item and replacing it with an amount taken into account for regular tax purposes, neither would be taken into account, with the result that the FSI amount is included in AFSI. To illustrate, assume the following facts: A foreign corporation (FP) directly owns all the stock of another foreign corporation (FC) and the stock of a domestic corporation (DC); FP and FC are not CFCs and do not have U.S. shareholders that own (within the meaning of section 958(a)) stock of FP or FC; FP and FC are not engaged in a U.S. trade or business; and FP is the FPMG common parent of an FPMG, the members of which are FP, FC, and DC. Under this rule, with respect to FP's ownership of the stock of FC, the AFSI of FP is determined without regard to the adjustments described in proposed § 1.56A-4 (concerning AFSI adjustments with respect to stock of a foreign corporation). However, this rule does not preclude any adjustments described in proposed § 1.56A-26.

This rule is intended to lessen the burden of determining AFSI when there is no regular tax treatment of an item while ensuring that the item is taken into account. Absent such a rule, it would be necessary to determine the regular tax treatment of an item solely for CAMT purposes. This would present an added compliance burden while not achieving the purpose of conforming the CAMT treatment of an item to the regular tax treatment of an item, since there is no regular tax treatment of such item. Moreover, specifically in the context of the AFSI adjustments with respect to stock of a foreign corporation in proposed § 1.56A-4, the double counting concerns that support applying regular tax rules are not necessarily present in the case of a foreign corporation that does not take the item into account for regular tax purposes (such as a foreign corporation that is not a CFC that has U.S. shareholders that own (within the meaning of section 958(a)) stock of the foreign corporation). The Treasury Department and the IRS invite comment on the rule.

To avoid the duplication of AFSI, if a partnership is a relevant aggregation entity with respect to an FPMG corporation, then the AFSI of any partner in the partnership that is either the FPMG corporation or a relevant aggregation entity would be determined without regard to any amount reflected in the partner's FSI that is derived from, and included in, the FSI of the partnership. See proposed § 1.59-2(c)(2)(ii)(D).

To provide for the application of the rules relating to discharge of indebtedness income with respect to partnership investments, if a partnership is a relevant aggregation entity with respect to an FPMG corporation, then the exclusions from AFSI for discharge of indebtedness income in proposed § 1.56A-21(c) apply to the partnership's AFSI, but are based on a determination of whether the relevant partner meets any of the exclusions provided in proposed § 1.56A-21(c)(1) and (2), including the application of any resulting CAMT attribute reductions provided in proposed § 1.56A-21(c)(4) and (5). See proposed § 1.59-2(c)(2)(ii)(E).

The proposed regulations provide a rule to avoid the duplication of AFSI in certain cases in which AFSI of a shareholder of a foreign corporation and AFSI of the foreign corporation would both be taken into account under the aggregation rules. See proposed § 1.59-2(c)(2)(ii)(F). Specifically, for purposes of the $1,000,000,000 average AFSI threshold test in proposed § 1.59-2(c)(2)(i)(A), the AFSI of a shareholder of a foreign corporation that is the FPMG corporation or a relevant aggregation entity with respect to the FPMG corporation (corporate aggregation entity) would be determined without regard to any item reflected in the FSI of the shareholder that is attributable to FSI of the FPMG corporation or corporate aggregation entity and that, under proposed § 1.59-2(c)(2)(ii)(C) (concerning items that are not taken into account for regular tax purposes), is not disregarded, if either of two conditions is satisfied. First, the shareholder is the FPMG corporation and is a foreign corporation. Second, the shareholder is a relevant aggregation entity with respect to the FPMG corporation and is not a United States person (as defined in section 7701(a)(30) of the Code). Thus, proposed § 1.59-2(c)(2)(ii)(F) would apply only to the extent that, absent application of this rule, items would be included in the AFSI of multiple persons for purposes of applying the $1,000,000,000 average AFSI threshold test in proposed § 1.59-2(c)(2)(i)(A) to the FPMG corporation. To illustrate, assume the following facts: A foreign corporation (FP) directly owns all the stock of another foreign corporation (FC) and the stock of a domestic corporation (DC); FP and FC are not CFCs that have U.S. shareholders that own (within the meaning of section 958(a)) stock of FP or FC; FP and FC are not engaged in a U.S. trade or business; FP is the FPMG common parent of an FPMG, the members of which are FP, FC and DC; FC has $100x of FSI and AFSI; and for financial accounting purposes, FP accounts for its interest in FC under the equity method. Under proposed § 1.59-2(c)(2)(i)(C) (concerning items of certain foreign persons not taken into account for regular tax purposes), FP's AFSI is determined without regard to the adjustments described in proposed § 1.56A-4 (rules for foreign stock). Absent the application of this rule, FC's $100x of FSI would be included in FC's AFSI and FP's FSI under the equity method of accounting and therefore FP's AFSI for purposes of the $1,000,000,000 average AFSI threshold test in proposed § 1.59-2(c)(2)(i)(A). Under proposed § 1.59-2(c)(2)(ii)(F), the AFSI of FP is determined without regard to the $100x of FSI of FC that is included in the FSI of FP in order to prevent double counting of the $100x.

The Treasury Department and the IRS are studying whether additional guidance is needed to carry out the purposes of proposed § 1.59-2(c)(2)(ii)(F), including guidance on determining when an item is attributable to FSI. The Treasury Department and the IRS welcome comments on this matter.

Under the second prong, the average annual AFSI of an FPMG corporation for the 3-taxable-year period ending with the taxable year must be $100,000,000 or more. See proposed § 1.59-2(c)(2)(i)(B). For this purpose, rules similar to those applicable to a corporation that is not a member of an FPMG with respect to aggregating AFSI, disregarding certain specified AFSI adjustments, avoiding the duplication of partnership income, and accounting for adjustments applicable to discharge of indebtedness income with respect to partnership investments, would apply. See proposed § 1.59-2(c)(2)(iii).

3. Corporation in Existence for Less Than Three Taxable Years

Proposed § 1.59-2(d) would implement the special rules in section 59(k)(1)(E) for applying the average annual AFSI test. If a corporation has been in existence for less than three taxable years, the average annual AFSI tests would be applied on the basis of the period during which the corporation, or any predecessor, was in existence. See proposed § 1.59-2(d)(1) and (3). Under proposed § 1.59-2(d)(2)(i), the AFSI for any taxable year of less than 12 months would be annualized by multiplying the AFSI for the short period by 12 and dividing the result by the number of months in the short period.

A stakeholder recommended that extraordinary items in a short taxable year be disregarded in annualizing income for a short period. Proposed § 1.59-2(d)(2)(ii) would provide that, in annualizing the income for a short period, items described as extraordinary items in § 1.6655-2(f)(3)(ii)(A) are disregarded, but the items are included in AFSI for the annualized 12-month period after the AFSI for the short period has been annualized.

B. Single Employer

Proposed § 1.59-2(e) would provide rules under section 59(k)(1)(D) for determining whether a corporation and another person are treated as a single employer under section 52(a) or (b). Under these proposed rules, solely for purposes of determining whether a corporation is an applicable corporation, all AFSI of persons treated as a single employer with the corporation under section 52(a) or (b) would be treated as AFSI of that corporation.

In accordance with section 52(a), proposed § 1.59-2(e)(1) generally would provide that corporations that are members of a controlled group of corporations are treated as a single employer. Section 52(a) and proposed § 1.59-2(e)(1) would define a “controlled group of corporations” by reference to section 1563(a), except that “more than 50 percent” is substituted for “at least 80 percent” each place it appears in section 1563(a)(1). Section 1563(a)(1), (2), and (3) provide that a controlled group of corporations may be a parent-subsidiary controlled group, a brother-sister controlled group, or a combined group of corporations. Proposed § 1.59-2(e)(1)(iii) would provide the definition of brother-sister controlled group in accordance with section 1563(f)(5). A controlled group of corporations is determined by taking into account the ownership interests described in section 1563(d)(1) and (2), as applicable.

In accordance with section 52(b), proposed § 1.59-2(e)(2) generally would provide that trades or businesses that are under common control are members of a controlled group and are treated as a single employer. Section 52(b), which applies to partnerships, trusts, estates, corporations, and sole proprietorships, provides that the regulations under section 52(b) are to be based on principles similar to the principles that apply under section 52(a). Section 52(b) and § 1.52-1 provide rules similar to the rules under section 52(a), but with certain modifications to account for different types of ownership interests. The constructive ownership rules under section 1563(d) that apply for purposes of section 52(a) also apply for purposes of section 52(b).

Section 1018(s)(3)(A) of the Technical and Miscellaneous Revenue Act of 1988 amended section 1563(d)(1)(B) to expand the constructive ownership rules of section 1563(e) that apply for purposes of section 1563(d)(1) to include section 1563(e)(2) relating to attribution from partnerships and section 1563(e)(3) relating to attribution from estates or trusts.

A controlled group of corporations under section 52(a), which cross-references section 1563, is determined based on all of the applicable constructive ownership rules of section 1563(e), including section 1563(e)(2) and (e)(3). By contrast, a group of trades or businesses under common control under section 52(b) is determined based on the constructive ownership rules in § 1.52-1(b) and (c). The constructive ownership rules in § 1.52-1(c)(1) were proposed to be revised to conform with the statutory amendment to section 1563(d)(1)(B) by a proposed regulation published in the Federal Register (88 FR 84770) on December 6, 2023. Specifically, that proposed regulation would revise § 1.52-1(c)(1) to include a reference to the constructive ownership rules in § 1.414(c)-4(b)(2), as revised by the same proposed regulation, that attribute ownership of stock directly or indirectly owned by or for a partnership, and a reference to the constructive ownership rules in § 1.414(c)-4(b)(3) that attribute ownership of stock directly or indirectly owned by or for an estate or trust.

These proposed regulations would apply the constructive ownership rules under section 52(b) that are set forth in § 1.52-1(c)(1) as revised by the proposed regulation published in the Federal Register at 88 FR 84770, and all references to § 1.52-1(c) should be understood to include those changes. Proposed § 1.59-2(e)(3) would provide that, in determining whether persons are treated as a single employer under section 52(a) or (b), section 1563(b) and § 1.1563-1(b) (relating to component members of a controlled group of corporations) are not taken into account. Therefore, a foreign corporation subject to income tax under section 881 of the Code may be a member of a controlled group of corporations or a group of trades or businesses that are under common control and treated as a single employer under section 59(k)(1)(D) for purposes of proposed § 1.59-2(c)(1)(ii)(A), (c)(2)(ii)(A), and (c)(2)(iii)(A).

Proposed § 1.59-2(e)(4) would provide that, although an S corporation, a RIC, or a REIT is excluded from the definition of an “applicable corporation,” the S corporation, RIC, or REIT is not excluded from being treated as a single employer under section 52(a) or (b) for purposes of proposed § 1.59-2(c)(1)(ii)(A), (c)(2)(ii)(A), and (c)(2)(iii)(A).

C. Aggregation Group

The Treasury Department and the IRS considered two approaches for applying the relevant aggregation rules necessary to determine a corporation's AFSI for purposes of the average annual AFSI test. The first approach would require the corporation to determine its test group as of the beginning of the taxable year for which the corporation is determining applicable corporation status and compute the AFSI of such test group for the relevant three-taxable-year period. Under this approach, the corporation would include in its AFSI for the three-taxable-year period the AFSI of the persons that were members of such test group regardless of whether the corporation was related to those persons under the relevant relationship criteria during the three-taxable-year-period. The second approach would require the corporation to include in its AFSI for the three-taxable-year period only the AFSI of persons it was related to under the relevant relationship criteria during the three-taxable-year period (and for the period in which they were related). The Treasury Department and the IRS are of the view that the second approach better implements the language of the statute, as it would decrease the instances in which a person's AFSI is duplicated in more than one corporation's AFSI for the same three-taxable-year testing period. This approach is also consistent with rules provided by the Treasury Department and the IRS to determine the applicability of other sections of the Code, where such applicability is determined based on the size of the taxpayer.

Accordingly, proposed § 1.59-2(f)(1) would provide special rules for applying the average annual AFSI test if a corporation's test group changes. These rules generally would require that a corporation include in its AFSI for a taxable year the AFSI of all persons treated as related to the corporation under the relevant relationship criteria at any point during the taxable year. If a person is treated as related to the corporation under the relevant relationship criteria for only a portion of the taxable year, the corporation includes in its AFSI for that taxable year the AFSI of the person for only the portion of the taxable year in which the relevant relationship criteria is satisfied. Similar to the rules in proposed § 1.56A-3 for CAMT entities with a financial accounting period that differs from the CAMT entity's taxable year, the related person determines AFSI for the portion of the corporation's taxable year by performing an interim closing of its books. For example, if a corporation has the calendar year as its taxable year and a person becomes related to the corporation on April 1 and unrelated on November 1 of the taxable year, the person would perform an interim closing of its books at the end of the day on March 31 and October 31, and the corporation would include the AFSI of that person on the person's books (after taking the interim closing of the books into account) from April 1 through October 31 for that year.

However, proposed § 1.59-2(f)(2) would provide additional rules if a corporation experiences a change in ownership during a taxable year. Proposed § 1.59-2(f)(2)(i) would provide that a corporation (that is not a test group parent) experiences a change in ownership during a taxable year if the corporation is no longer related under the relevant relationship criteria at the end of the taxable year to a test group parent it was related to as of the first day of the taxable year. If a corporation is treated as related to multiple test group parents under the relevant relationship criteria as of the first day of the taxable year, then the determination of whether the corporation experiences a change in ownership is made separately with respect to each test group parent. Therefore, such a corporation could experience a change in ownership during the taxable year with respect to one test group parent but not another. If a corporation experiences a change in ownership during a taxable year that results in the corporation and a person no longer being treated as related under the relevant relationship criteria, proposed § 1.59-2(f)(2)(i) would provide that the corporation does not include that person's AFSI in the corporation's AFSI for any period prior to the change in ownership to determine whether the corporation meets the average annual AFSI test described in proposed § 1.59-2(c) for the taxable year in which the change in ownership occurs or for any subsequent taxable year so long as the corporation and the person remain unrelated. In addition, if a corporation experiences a change in ownership during a taxable year that results in the corporation joining a tax consolidated group that is an applicable corporation for the taxable year that includes the corporation's first taxable year in which it is a member of the tax consolidated group, then the corporation is treated as an applicable corporation beginning with the first taxable year in which it is a member of the tax consolidated group. For the taxable years in which the corporation is a member of the tax consolidated group, the corporation's AFSI is included in the tax consolidated group's AFSI under § 1.1502-56A.

Stakeholders noted that the approach provided in section 3 of Notice 2023-7 would result in the AFSI of target and acquirer being double counted in determining the applicable corporation status of relevant corporations following the change in ownership. The Treasury Department and IRS are of the view that section 59(k)(1)(C)(i)(I) (providing that the term “applicable corporation” does not include any corporation if the corporation has a change in ownership) contemplates that a corporation that experiences a change in ownership should be afforded a “fresh start” following the change in ownership, including in determining the applicable corporation status of the corporation following the change in ownership (regardless of whether the corporation was an applicable corporation at the time of the change in ownership). Accordingly, a corporation that experiences a change in ownership sheds the AFSI history of any persons to which it is no longer related due to the change in ownership in determining its applicable corporation status following the change in ownership.

D. Simplified Method

Section 59(k)(3)(A) authorizes the Secretary to issue regulations or other guidance providing a simplified method for determining whether a corporation is an applicable corporation subject to the CAMT. Under that authority, proposed § 1.59-2(g) would provide a simplified safe harbor method for determining applicable corporation status. Except as discussed in this part XXVII.D of this Explanation of Provisions, the proposed regulations regarding the simplified method would be consistent with section 5 of Notice 2023-7.

Proposed § 1.59-2(g)(2) would provide that, under the simplified method, the average annual AFSI tests are applied with specified modifications. Under these modifications, the dollar thresholds in proposed § 1.59-2(c)(1)(i) and (c)(2)(i)(A) would be reduced from $1 billion to $500 million, and the dollar threshold in proposed § 1.59-2(c)(2)(i)(B) would be reduced from $100 million to $50 million.

Some stakeholders suggested that these reduced dollar thresholds, which would be consistent with the thresholds under the simplified method in section 5 of Notice 2023-7, should be raised. Other stakeholders suggested that these thresholds could be lowered further if necessary to extend the applicability of the safe harbor method. The thresholds used in Notice 2023-7 are based on an analysis prepared by the Treasury Department to reduce the risk that entities that meet the simplified method thresholds would have been applicable corporations subject to CAMT liability under the statutory tests. Accordingly, the thresholds used in Notice 2023-7 and that would be provided under proposed § 1.59-2(g)(2) are not intended to permit a corporation that would be an applicable corporation under the statutory tests to avoid that status by using the simplified method. The proposed regulations would retain these reduced thresholds but allow for further modifications in IRB guidance.

Proposed § 1.59-2(g)(2)(iii)(B) would further provide that, in determining AFSI under the simplified method, the only AFSI adjustments are those in proposed § 1.56A-8(b) (concerning taxes) and, solely for purposes of proposed § 1.59-2(c)(2)(i)(B) (the $100 million second prong of the FPMG test), in proposed § 1.56A-7 (concerning effectively connected income). In determining the AFSI of a person whose financial results are reflected on a consolidated AFS, those members of a test group whose financial results are reflected on the consolidated AFS would be treated as a single CAMT entity for purposes of § 1.56A-1(c)(3) and (4) (regarding FSI of a CAMT entity whose financial results are reflected on a consolidated AFS). Thus, consolidation entries would be taken into account and would not be disregarded, except for consolidation entries that eliminate transactions between persons whose AFSI is not aggregated for purposes of the average annual AFSI tests (that is, persons that are neither treated as a single employer under section 52(a) or (b) nor members of an FPMG). See proposed § 1.59-2(g)(2)(iii)(A). Section 5.03(2)(c)(ii) of Notice 2023-7 did not extend single CAMT entity treatment to members of an FPMG. The proposed simplified method also would permit a corporation that has a financial reporting year (AFS year) that differs from its taxable year to determine its AFSI by using its AFS year. See proposed § 1.59-2(g)(2)(iv).

Under section 5.03(1) of Notice 2023-7, the simplified method applies only for the first taxable year beginning after December 31, 2022. Stakeholders recommended that the simplified method be extended to subsequent taxable years. The simplified method should be extended to apply for any taxable year for which applicable corporation status is relevant. See proposed § 1.59-2(g)(1).

E. Termination of Applicable Corporation Status

Proposed § 1.59-2(h) would provide rules regarding the termination of applicable corporation status under section 59(k)(1)(C). Under proposed § 1.59-2(h)(1)(i), a corporation's status as an applicable corporation would terminate following certain ownership changes described in proposed § 1.59-2(f)(2)(i) (generally, an ownership change in which the corporation and its test group parent(s) no longer satisfy the relationship criteria under section 52(a) or (b) or section 59(k)(2)(A), as applicable). However, proposed § 1.59-2(h)(3)(ii) would provide that if a corporation whose status as an applicable corporation terminates for the taxable year due to a change in ownership that results in the corporation joining a tax consolidated group that is an applicable corporation for the tax consolidated group's taxable year that includes such taxable year, then the corporation is also treated as an applicable corporation for such taxable year and subsequent taxable years, as applicable.

Under proposed § 1.59-2(h)(1)(ii), a corporation's status as an applicable corporation also would terminate if the corporation did not meet the average annual AFSI test for five consecutive taxable years. As the determination of a corporation's status as an applicable corporation for a taxable year is based on average annual AFSI for a prior three-taxable-year period, a corporation with AFSI for a taxable year that is unusually high or inconsistent with historical levels or a corporation that is experiencing a consistent downward trend in AFSI for each taxable year would continue to remain an applicable corporation until such time that its average annual AFSI for the three taxable years either no longer includes an anomaly year or fully captures the downward trend AFSI. Accordingly, five taxable years is an appropriate period for determining whether the corporation's status should terminate under proposed § 1.59-2(h).

Finally, proposed § 1.59-2(h)(3)(i) would provide that, except for a corporation that joins a tax consolidated group that is already an applicable corporation, a corporation whose status as an applicable corporation is terminated under proposed § 1.59-2(h)(1) continues to apply the rules in proposed § 1.59-2 to determine whether it is an applicable corporation for the taxable year in which the status termination occurs (that is, the corporation may become an applicable corporation for the same taxable year in which its status terminates or for any taxable year thereafter).

F. Substantiation and Reporting Requirements

Proposed § 1.59-2(i) would require a corporation (other than an S corporation, a RIC, or a REIT) to maintain books and records sufficient to demonstrate whether the corporation is an applicable corporation for any taxable year, including the identification of all persons treated as a single employer with the corporation under section 52(a) or (b) and whether the corporation is a member of an FPMG under § 1.59-3. Proposed § 1.59-2(j) would require a corporation (other than an S corporation, a RIC, or a REIT) to provide information to demonstrate whether the corporation is an applicable corporation in the form and manner as Form 4626 and other applicable forms (or any successor forms) or instructions prescribe.

XXVIII. Proposed § 1.59-3: Rules for Foreign-Parented Multinational Groups

Pursuant to the authority granted by section 59(k)(2)(B), (k)(2)(D), and (k)(3), proposed § 1.59-3 would provide rules under section 59(k) for determining whether a corporation is a member of an FPMG. As discussed in part XXVII of this Explanation of Provisions, the average annual AFSI tests that apply in determining whether a corporation is an applicable corporation depend on whether the corporation is a member of an FPMG.

A. FPMG

Proposed § 1.59-3(c) would define an FPMG with respect to any taxable year of a corporation as two or more entities, one of which is the corporation, if: (1) at least one of the entities is a domestic corporation and at least one of the entities is a foreign corporation; (2) the entities are included in the same applicable financial statement for that taxable year; and (3) one of the entities is an FPMG common parent.

Under the proposed regulations, an FPMG common parent would be an ultimate parent that is a foreign corporation. See proposed § 1.59-3(b)(9). An ultimate parent is an entity that has a controlling interest in at least one other entity and in which no entity has a controlling interest. See proposed § 1.59-3(b)(12). A controlling interest is generally based on the entity's applicable financial accounting standard. Both terms are described subsequently.

In general, a foreign corporation includes, in addition to a foreign corporation for regular tax purposes, a deemed foreign corporation. See proposed § 1.59-3(b)(7). A deemed foreign corporation is an ultimate parent that is not a corporation and that directly or indirectly owns, other than through a domestic corporation (excluding a deemed domestic corporation), (1) a foreign trade or business as defined in § 1.989(a)-1(c), or (2) an equity interest in a foreign corporation in which the ultimate parent has a controlling interest (including through a domestic corporation). See proposed § 1.59-3(e). For example, if the ultimate parent is a partnership (PRS) that owns two assets, all the stock of a domestic corporation (DC) and 15 percent of the stock of a foreign corporation (FC), with the other 85 percent of the stock of FC owned by DC, and PRS has a controlling interest in FC, then PRS would be a deemed foreign corporation. However, if DC owned all the stock of FC, then PRS would not be a deemed foreign corporation. This rule reflects that, in some cases, the U.S. tax classification of the ultimate parent may have minimal or no U.S. tax relevance aside from CAMT and, without this rule, the FPMG rules could effectively be elective.

In general, a domestic corporation includes, in addition to a domestic corporation for regular tax purposes, a deemed domestic corporation. See proposed § 1.59-3(b)(5). For purposes of the FPMG determination under proposed § 1.59-3, a U.S. trade or business for purposes of section 882 of a foreign corporation (excluding a deemed foreign corporation) is treated as if it were a domestic corporation separate from, and wholly owned by, the foreign corporation. See proposed § 1.59-3(d). This allows the first prong of the FPMG definition (requiring at least one domestic corporation and at least one foreign corporation) to be met in the case of a single foreign corporation that is engaged in a U.S. trade or business. See proposed § 1.59-3(j)(1) ( Example 1). A U.S. trade or business is treated as a separate deemed domestic corporation only for purposes of the FPMG determination.

The foreign corporation may be engaged, or treated as engaged, in a U.S. trade or business as a result of activities of one or more disregarded entities or pass-through entities in which the foreign corporation has a direct or indirect interest. For example, if a foreign corporation owns a disregarded entity and that disregarded entity owns an interest in a partnership that is engaged in a U.S. trade or business, the foreign corporation's U.S. trade or business resulting from its indirect ownership of the partnership interest will be treated as a separate domestic corporation that is wholly owned by the foreign corporation.

For purposes of the FPMG determination under proposed § 1.59-3, an entity is any CAMT entity and any deemed domestic corporation. Any disregarded entity or branch that is owned by a CAMT entity, including through ownership of one or more disregarded entities or branches, is treated as part of that CAMT entity, except to the extent the disregarded entity or branch is a deemed domestic corporation. See proposed § 1.59-3(b)(6). For example, if a foreign corporation owns a disregarded entity that owns a second disregarded entity, both disregarded entities would be treated as part of the foreign corporation. If, instead, the foreign corporation owned a branch that was engaged in a U.S. trade or business for purposes of section 882, the U.S. trade or business would be treated as a separate domestic corporation that is wholly owned by the foreign corporation. As a result, even if there is only one legal entity, there may be two entities for purposes of proposed § 1.59-3, and that legal entity alone may qualify as an FPMG.

B. Controlling Interest

Whether an entity has a controlling interest is determined under proposed § 1.59-3(f). Under proposed § 1.59-3(f)(1) an entity (upper-tier entity) would have a controlling interest in another entity (lower-tier entity) if, under the applicable financial accounting standard (as described in part XXVIII.C of this Explanation of Provisions), the upper-tier entity's consolidated financial statement is required to reflect the assets, liabilities, equity, income, and expenses of the lower-tier entity. An upper-tier entity may have a controlling interest in a lower-tier entity without having a direct interest in that entity. Whether the upper-tier entity has a controlling interest under proposed § 1.59-3(f)(1) is based on the rules of the applicable financial accounting standard and therefore is not dependent on what is reflected in the entities' financial statements. For example, the analysis is not impacted by whether a consolidated financial statement is prepared and, if it is prepared, whether an entity's financial results are reflected in the consolidated financial statement. As a result, if a consolidated financial statement is not prepared, an upper-tier entity may nonetheless have a controlling interest in a lower-tier entity under the applicable financial accounting standard, or if a consolidated financial statement is prepared but erroneously excluded an entity, the upper-tier entity would still have a controlling interest in that erroneously excluded entity.

In addition, under proposed § 1.59-3(f)(2), there are three circumstances in which an upper-tier entity has a controlling interest in another entity even if there would not be a controlling interest under the applicable financial accounting standard. First, the upper-tier entity has a controlling interest in any deemed domestic corporation that the upper-tier entity, or any foreign corporation in which the upper-tier entity has a controlling interest, is treated as owning under proposed § 1.59-3(d). For example, if the upper-tier entity is engaged in a U.S. trade or business and therefore is deemed to own a deemed domestic corporation under proposed § 1.59-3(d), the upper-tier entity would be treated as having a controlling interest in that deemed domestic corporation even if for accounting purposes there would be only one entity and therefore no consolidated financial statement. Similarly, if the upper-tier entity has a controlling interest in a foreign corporation that is engaged in a U.S. trade or business and therefore is deemed to own a deemed domestic corporation under proposed § 1.59-3(d), then the upper-tier entity is treated as having a controlling interest in that deemed domestic corporation even if that deemed domestic corporation does not exist under the applicable financial accounting standards. See proposed § 1.59-3(f)(2)(i).

Second, if an entity is owned, directly or indirectly, by a member of an FPMG without regard to this controlling interest rule and both entities are in the same section 52 group, then the member of the FPMG (and therefore the FPMG common parent) would have a controlling interest in the entity. A section 52 group, with respect to a person, means that person and the persons whose AFSI is required to be aggregated with the AFSI of that person under proposed § 1.59-2(c)(1)(ii)(A). See proposed § 1.59-3(b)(11). If a member of the FPMG has a controlling interest in an entity under this rule, any other member of the FPMG that has a controlling interest in that member (whether pursuant to this rule or another one) would also have a controlling interest in the entity that the member has a controlling interest in under this rule. The rule applies iteratively up the chain of entities with controlling interests, ending with the FPMG common parent. See proposed § 1.59-3(f)(3). This rule applies only to controlling interests under proposed § 1.59-3(f)(2)(ii) because the other controlling interest rules in proposed § 1.59-3(f)(2) apply accounting principles to determine controlling interests, which include direct and indirect controlling interests. For example, if a foreign corporation has a controlling interest in only one entity, which is a domestic subsidiary, under its applicable financial accounting standard and no entity has a controlling interest in the foreign corporation, so the foreign corporation would be the FPMG common parent, then if either the foreign corporation or domestic subsidiary also owns an interest in another entity and that entity is part of either the foreign corporation's or domestic subsidiary's section 52 group, the foreign corporation or domestic subsidiary has a controlling interest in such other entity under this rule (and therefore, either way, the foreign corporation has a controlling interest in such entity). See proposed § 1.59-3(f)(2)(ii) and (f)(3).

Third, the upper-tier entity has a controlling interest in any entity in which it would have a controlling interest but for the fact that the entity is (or would be) excluded from the upper-tier entity's consolidated financial statement: (1) based on size or materiality; (2) because the entity is held for sale; (3) because the entity or business is being wound down, liquidating, or otherwise ceasing operations or being terminated or disposed of; or (4) because the entity is permitted but not required to be excluded under the applicable financial accounting standard from a consolidated financial statement of the upper-tier entity. For example, if a foreign corporation wholly owned a domestic corporation that was held for sale, even if the foreign corporation is not treated as having a controlling interest in the domestic corporation under the applicable financial accounting standard because the stock of the domestic corporation is held for sale, the foreign corporation would be treated as having a controlling interest in the domestic corporation.

The Treasury Department and the IRS are considering structures that may result in divergence between the financial accounting rules and economics (for example, where taxpayers own a significant economic interest in an entity but are not treated as having a controlling interest), as well as how to address structures that are linked, including multi-parented groups, companies with stapled stock, and dual listed companies, as those structures may present additional questions regarding which entity is the ultimate parent for purposes of determining whether there is an FPMG and who are the members of the FPMG under proposed § 1.59-3. Future guidance may include these structures for determining the FPMG and its members, including by treating more than one entity as an FPMG common parent of the FPMG.

C. Applicable Financial Accounting Standard

Under the general rule in proposed § 1.59-3(f)(1), the determination of whether an upper-tier entity has a controlling interest in a lower-tier entity would depend on the applicable financial accounting standard. The applicable financial accounting standard for this purpose would be GAAP unless an exception applies. See proposed § 1.59-3(g)(1). Proposed § 1.59-3(g)(2) would identify the exceptions, which can only apply in cases in which there is not a GAAP consolidated financial statement prepared that includes the ultimate parent (determined by treating GAAP as the applicable financial accounting standard). See the last sentence of proposed § 1.59-3(g)(2)(i).

The goal of these exceptions is, for cases in which a group prepares a consolidated financial statement that is of the ultimate parent and that is filed with the SEC or a foreign equivalent, to apply the controlling interest test based on the financial accounting standard used in preparing that consolidated financial statement. The Treasury Department and the IRS are of the view that this would appropriately reduce compliance burden because the controlling interest determination required under proposed § 1.59-3(f) would generally already have been made for purposes of preparing the consolidated financial statement and would increase reliability due to review by an external auditor and regulator.

For special cases, such as consolidated financial statements of the ultimate parent that are prepared under multiple financial accounting standards, there would be a prioritization of GAAP over IFRS and IFRS over other financial accounting standards. This order of priority is set forth in proposed § 1.59-3(g)(2)(i) through (iii). If there are no consolidated financial statements of the ultimate parent, if consolidated financial statements are prepared for only a sub-group that does not include the ultimate parent, or if there are multiple consolidated financial statements at the same priority but for different ultimate parents, GAAP would be the default financial accounting standard for purposes of applying the controlling interest test for FPMG determination purposes. See proposed § 1.59-3(g)(1).

Under the first exception, IFRS is the applicable financial accounting standard if the assets, liabilities, equity, income, and expenses of the corporation being tested for applicable corporation status (tested corporation) are reflected in the consolidated financial statement described in § 1.56A-2(c)(2)(i) of its ultimate parent (determined by treating IFRS as the applicable financial accounting standard). See proposed § 1.59-3(g)(2)(ii). A consolidated financial statement is described in proposed § 1.56A-2(c)(2)(i) if it is prepared in accordance with IFRS and filed with the SEC or with an agency of a foreign government that is equivalent to the SEC. For example, if the assets, liabilities, equity, income, and expenses of the tested corporation are reflected only in consolidated financial statements described in proposed § 1.56A-2(c)(1) (GAAP) and (c)(2)(i) (IFRS) but the GAAP consolidated financial statement is not that of its ultimate parent, whereas the IFRS consolidated financial statement is that of its ultimate parent, then IFRS would be the applicable financial accounting standard. If, instead, the IFRS consolidated financial statement is not that of its ultimate parent, then the first exception would not apply and, because the second exception is not relevant under these facts, GAAP would be the applicable financial accounting standard.

Under the second exception, a financial accounting standard other than GAAP or IFRS would be the applicable financial accounting standard if the assets, liabilities, equity, income, and expenses of the tested corporation are reflected in a consolidated financial statement described in § 1.56A-2(c)(3)(i) prepared using the financial accounting standard and the consolidated financial statement is that of the ultimate parent (as determined under that financial accounting standard). See proposed § 1.59-3(g)(2)(iii)(A). A consolidated financial statement is described in § 1.56A-2(c)(3)(i) if it is prepared in accordance with another generally accepted accounting standard and filed with the SEC or with an agency of a foreign government that is equivalent to the SEC. If these conditions are met for more than one consolidated financial statement prepared under different financial accounting standards (other than GAAP or IFRS), then the exception applies only if the ultimate parent is the same under each financial accounting standard (otherwise, GAAP would be the applicable financial accounting standard). See proposed § 1.59-3(g)(2)(iii)(B).

In such cases, if the accounting standard used to prepare one of those consolidated financial statements was the applicable financial accounting standard in the prior taxable year, that accounting standard would be the applicable financial accounting standard. See proposed § 1.59-3(g)(2)(iii)(B)( 1). If none of the consolidated financial statements were prepared using the applicable financial accounting standard from the prior taxable year, the tested corporation would choose one of the accounting standards used to prepare those consolidated financial statements to be the applicable financial accounting standard, provided that the tested corporation specifies that choice on a statement attached to the Form 4626, Alternative Minimum Tax-Corporations (or any successor form), of the tested corporation or as otherwise directed in the instructions to the form for the first applicable tax year. If the tested corporation does not choose an accounting standard, chooses one that is not permitted, or fails to specify its choice as required, the Commissioner would have discretion to either treat GAAP as the applicable financial accounting standard (consistent with the default rule) or to treat the accounting standard used to prepare one of those consolidated financial statements as the applicable financial accounting standard. See proposed § 1.59-3(g)(2)(iii)(B)( 2).

The exceptions apply in descending order and only if there is not a GAAP consolidated financial statement prepared that is that of the ultimate parent, as determined by treating GAAP as the applicable financial accounting standard. Therefore, if an exception under an earlier paragraph of proposed § 1.59-3(g)(2) applies, the later exceptions do not. See proposed § 1.59-3(g)(2)(i). For example, if proposed § 1.59-3(g)(2)(ii) applies (regarding IFRS), then proposed § 1.59-3(g)(2)(iii) (regarding financial accounting standards other than GAAP or IFRS) does not apply.

For purposes of the applicable financial accounting standard determination, the assets, liabilities, equity, income, and expenses of the tested corporation are treated as reflected in a consolidated financial statement if either they are reflected in the consolidated financial statement, or they would have been but for the tested corporation being excluded for a reason mentioned in the controlling interest test in proposed § 1.59-3(f)(2)(iii)(A) through (D). For example, if the assets, liabilities, equity, income, and expenses of the tested corporation would have been reflected in the consolidated financial statement but for the fact the stock of the tested corporation is held for sale, the assets, liabilities, equity, income, and expenses of the tested corporation would be treated as reflected in the consolidated financial statement. See proposed § 1.59-3(g)(3).

The tested corporation is required to specify the financial accounting standard that is its applicable financial accounting standard on a statement attached to the Form 4626 (or any successor form) of the tested corporation or as otherwise directed in the instructions to the form each taxable year the applicable financial accounting standard is relevant in determining whether the tested corporation is a member of an FPMG. See proposed § 1.59-3(g)(4).

D. Included in the Same Applicable Financial Statement for That Taxable Year and FPMG Members

Under proposed § 1.59-3(h), the FPMG common parent and all entities in which the FPMG common parent has a controlling interest at any time during the taxable year would be included in the same applicable financial statement for that taxable year for purposes of proposed § 1.59-3. The relevant taxable year is dependent on who is applying the provision and would generally be the taxable year of the corporation determining if it is an applicable corporation. For purposes of determining which entities are included in the same applicable financial statement for that taxable year, it is not relevant whether a consolidated financial statement of the FPMG common parent is prepared or whether an entity is included in a consolidated financial statement of the FPMG common parent or would be if one was prepared. For example, if the FPMG common parent is treated as having a controlling interest in an entity under proposed § 1.59-3(f)(2) during the taxable year, that entity will be treated as included in the same applicable financial statement for that taxable year. The entities treated as included in the same applicable financial statement for that taxable year may differ from the entities included in the applicable financial statement(s) determined under proposed § 1.56A-2.

Each entity included in the same applicable financial statement for that taxable year under proposed § 1.59-3(h) as the FPMG common parent is a member of that FPMG (including the FPMG common parent). See proposed § 1.59-3(i). As with the determination of who is included in the same applicable financial statement for that taxable year, the members of the FPMG are not dependent on whether there is a consolidated financial statement or whether the entity is included on one. For example, if CP is the FPMG common parent and CP has a controlling interest in A, B, and C during the taxable year and no consolidated financial statement is prepared, then all those entities (A, B, C, and CP) would be included in the same applicable financial statement for that taxable year for purposes of this test and would be members of the FPMG that has CP as its FPMG common parent.

XXIX. Proposed § 1.59-4: Rules for Determining the CAMT FTC

A. Overview

Under section 59(l), if an applicable corporation chooses to claim a foreign tax credit for any taxable year, the applicable corporation is allowed a CAMT foreign tax credit (CAMT FTC) for the taxable year. Section 59(l)(1) provides that the amount of the CAMT FTC for the applicable corporation for the taxable year equals the sum of:

(i) The lesser of (A) the aggregate of the applicable corporation's pro rata share (as determined under section 56A(c)(3)) of the amount of income, war profits, and excess profits taxes (within the meaning of section 901) imposed by any foreign country or possession of the United States that are taken into account in the AFS of each CFC with respect to which the applicable corporation is a U.S. shareholder, and paid or accrued (for Federal income tax purposes) by each such CFC, or (B) the product of the amount of the adjustment under section 56A(c)(3) and the percentage specified in section 55(b)(2)(A)(i) (currently, 15 percent); and

(ii) In the case of an applicable corporation that is a domestic corporation, the amount of foreign income taxes imposed by any foreign country or possession of the United States to the extent such taxes are taken into account in the applicable corporation's AFS and paid or accrued (for Federal income tax purposes) by the applicable corporation.

Section 59(l)(2) further provides that, if an applicable corporation's pro rata shares of foreign income taxes of the CFCs in which it is a U.S. shareholder exceeds 15 percent of the adjustment under section 56A(c)(3) (such excess, unused CFC taxes), then the unused CFC taxes are carried forward to any of the first five succeeding taxable years to the extent not absorbed in a prior taxable year. Finally, section 59(l)(3) authorizes the Secretary to issue regulations or other guidance as is necessary to carry out the purposes of section 59(l).

Pursuant to the authority granted by section 59(l)(3), proposed § 1.59-4 would provide rules under section 59(l) for determining the amount of the CAMT FTC that may be claimed in a taxable year.

B. Eligible Taxes

Generally, under proposed § 1.59-4, a CAMT FTC would be available only with respect to an “eligible tax.” Under proposed § 1.59-4(b)(1), an “eligible tax” would include a foreign income tax other than a foreign income tax for which a credit is disallowed or suspended for regular tax purposes under sections 245A(d) and (e)(3), 901(e) and (f), 901(i) through (m), 907, 908, 909, 965(g), 999, and 6038(c) of the Code.

The Treasury Department and the IRS are of the view that the policies underlying these disallowances and suspensions for regular tax purposes apply equally in the context of the CAMT FTC. For instance, the Treasury Department and the IRS are of the view that CAMT FTCs should not be available with respect to taxes paid or accrued to specified foreign countries under section 901(j) based on the same foreign policy grounds that justify the disallowance for regular tax purposes. Accordingly, the Treasury Department and the IRS are exercising the authority under section 59(l)(3) to incorporate the specified disallowances and suspensions into CAMT to carry out the purposes of section 59(l). Incorporating the same amount of disallowances or suspensions for regular tax purposes, instead of creating a separate, parallel set of CAMT FTC rules, is intended to reduce taxpayers' compliance burden and the IRS's administrative burden.

C. Amount of CAMT FTC

Proposed § 1.59-4(c) would provide rules for determining the amount of the CAMT FTC an applicable corporation can claim if it chooses to claim the foreign tax credit under section 901. Generally, for an applicable corporation that is a domestic corporation, the amount of the CAMT FTC for the taxable year would equal the sum of: (i) the lesser of (A) the aggregate of the applicable corporation's pro rata share of taxes of CFCs, as determined under proposed § 1.59-4(d), or (B) the product of the amount of the adjustment under proposed § 1.56-6(b)(1) and the percentage specified in section 55(b)(2)(A)(i) (currently, 15 percent), and (ii) the amount of eligible taxes paid by the applicable corporation during the taxable year, to the extent the taxes have been taken into account, within the meaning of proposed § 1.56A-8(d), on the applicable corporation's AFS.

Proposed § 1.59-4(d) would provide rules for determining an applicable corporation's pro rata share of the taxes of a CFC in which the applicable corporation is a U.S. shareholder for a taxable year. Generally, under proposed § 1.59-4(d), an applicable corporation's pro rata share of the taxes of a CFC in which the applicable corporation is a U.S. shareholder for the taxable year is the sum of two amounts: (i) the applicable corporation's pro rata share of taxes under section 960(b) of the Code, and (ii) the applicable corporation's pro rata share of eligible current year taxes, as defined in § 1.960-1(b)(5), of the CFC, in each case reduced to reflect the suspensions and disallowances described in the definition of “eligible tax” that apply at the level of the U.S. shareholder.

Specifically, under proposed § 1.59-4(d)(2), an applicable corporation may claim a CAMT FTC for the amount of foreign income taxes deemed paid by the applicable corporation under § 1.960-3(b) for its taxable year, to the extent the taxes have been taken into account, within the meaning of § 1.56A-8(d), on the AFS of the applicable corporation or any CFC with respect to which the applicable corporation is a U.S. shareholder. Under proposed § 1.59-4(d)(3), an applicable corporation may claim a CAMT FTC for its pro rata share of eligible current year taxes, as defined in § 1.960-1(b)(5), for a taxable year. The applicable corporation's pro rata share of eligible current year taxes comprises: (i) the amount of eligible current year taxes that are deemed paid by the applicable corporation under § 1.960-2(b) for regular tax purposes (relating to foreign income taxes properly attributable to subpart F income) for the taxable year; (ii) the aggregate of the applicable corporation's proportionate share of eligible current year taxes of the CFC for each tested income group within each section 904 category of the CFC, as determined under § 1.960-2(c)(5) for regular tax purposes for the taxable year; (iii) in the case of a subpart F income group or tested income group within a section 904 category of the CFC for which the denominator of the applicable corporation's proportionate share fraction (as described in § 1.960-2(b)(3)(i) and (c)(5), respectively) is zero or less than zero (which may occur because the CFC has a loss in such income group or, in the case of a subpart F income group, because the denominator of the fraction is reduced under § 1.960-2(b) in respect of the current year E&P limitation or a chain deficit under section 952(c)(1)(A) or (C), respectively), the aggregate amount of eligible current year taxes of the CFC for each such subpart F income group and tested income group within a section 904 category of the CFC multiplied by the pro rata share percentage, as defined in proposed § 1.59-4(b)(3), for the taxable year of the CFC that ends with or within the taxable year of the applicable corporation; and (iv) the aggregate amount of eligible current year taxes of the CFC for each residual income group of the CFC multiplied by the pro rata share percentage, as defined in proposed § 1.59-4(b)(3), for the taxable year of the CFC that ends with or within the taxable year of the applicable corporation. Finally, the applicable corporation can claim a CAMT FTC for its pro rata share of taxes of its CFC only to the extent the taxes have been taken into account, within the meaning of proposed § 1.56A-8(d), on the AFS of the CFC or the applicable corporation. As reflected in proposed § 1.59-4(d)(2), the Treasury Department and the IRS are of the view that providing a CAMT FTC for PTEP taxes deemed paid by the applicable corporation would be consistent with the purposes of section 59(l). Furthermore, as reflected in proposed § 1.59-4(d)(3), the Treasury Department and the IRS are of the view that a CAMT FTC generally should be provided with respect to taxes imposed on the earnings of a CFC regardless of the character of those earnings for regular tax purposes, because all the earnings of the CFC are taken into account for CAMT purposes under section 56A(c)(3). For instance, the proposed regulations would allow a CAMT FTC with respect to taxes imposed on the residual earnings of a CFC because such earnings of the CFC are included in AFSI of the U.S. shareholder of the CFC through the application of section 56A(c)(3). But see proposed § 1.59-4(b)(1) (incorporating certain FTC disallowances that apply for regular tax purposes, such as section 245A(d)). The Treasury Department and the IRS request comments on additional rules that may be appropriate in determining an applicable corporation's pro rata share of eligible current year taxes where the applicable corporation takes into account a qualified deficit of a CFC under section 951(c)(1)(B) impacting the determination of eligible current year taxes that are deemed paid by the applicable corporation under § 1.960-2(b) for regular tax purposes.

Additionally, incorporating certain regular tax rules for determining an applicable corporation's pro rata share of PTEP taxes and eligible current year taxes of CFCs, instead of creating a separate set of CAMT FTC rules, is intended to reduce taxpayers' compliance burden and the administrative burden on the IRS. Notably, the proposed regulations do not apply the limitations under section 960(d) with respect to taxes imposed on tested income of the CFC because the underlying character of the CFC earnings generally are not relevant for CAMT purposes. Additionally, proposed § 1.59-4(d)(3)(iii) provides rules for determining the applicable corporation's pro rata share of taxes in the case of a subpart F income group or tested income group with a loss, and in certain cases where the current year E&P limitation or the chain deficit rule applies, as in these cases taxes of a CFC may not be credited under the regular tax rules. Similarly, proposed § 1.59-4(d)(3)(iv) provides rules for determining the applicable corporation's pro rata share of taxes imposed on the residual income of the CFC because the regular tax rules do not provide mechanics for doing so. See also proposed § 1.59-4(b)(3) (defining pro rata share percentage for such purpose). Finally, as reflected in proposed § 1.59-4, the CAMT FTC is not subject to the section 904 limitation.

D. Carryover of Unused CFC Taxes

Proposed § 1.59-4(b)(3) would define “unused CFC taxes” as the excess (if any) of (i) the aggregate of the applicable corporation's pro rata shares of taxes of CFCs, as determined under proposed § 1.59-4(d), over (ii) the product of the amount of the adjustment under proposed § 1.56A-6(b)(1) and the percentage specified in section 55(b)(2)(A)(i) (currently, 15 percent). If an applicable corporation chooses to claim the foreign tax credit under section 901 for regular tax purposes for a taxable year, any unused CFC taxes for the taxable year are carried to each of the five succeeding taxable years, in chronological order, to the extent not absorbed as taxes deemed paid in a prior taxable year. See proposed § 1.59-4(e)(1). Under proposed § 1.59-4(e)(1), the amount of taxes deemed paid under proposed § 1.59-4(e)(2) in a carryover taxable year is absorbed regardless of whether the taxpayer chooses to claim a foreign tax credit under section 904 of the Code for regular tax purposes for the carryover taxable year. Proposed § 1.59-4(e)(2) would provide rules determining the amount of the unused CFC taxes that are deemed paid in the carryover taxable year, and proposed § 1.59-4(e)(3) would provide an ordering rule requiring the unused CFC taxes from the fifth preceding taxable year to be absorbed first, followed sequentially by the unused CFC taxes from the fourth, third, second, and first preceding taxable year.

E. Timing of the CAMT FTC

As reflected in proposed § 1.59-4, a foreign income tax may be claimed as a CAMT FTC in the taxable year in which the tax is paid, within the meaning of § 1.901-2(g)(5), to the extent the taxes have been taken into account, within the meaning of § 1.56A-8(d), in the AFS of the CFC or the applicable corporation, as applicable. In many instances, the timing of the CAMT FTC will align with the timing of the foreign tax credit for regular tax purposes. However, under proposed § 1.59-4(f), foreign income taxes paid or accrued as a result of a foreign tax redetermination, as defined in § 1.905-3(a), would be eligible to be claimed as a CAMT FTC only if the domestic corporation is an applicable corporation in the taxable year to which the foreign tax redetermination relates (relation-back year). A CAMT FTC with respect to such foreign income taxes may be claimed only in the relation-back year, even if the taxes are reflected in a journal entry of an AFS within a taxable year that is later than the relation-back year. See proposed § 1.59-4(f).

F. Treatment of Partnership Taxes

Under proposed § 1.59-4(g), for purposes of proposed § 1.59-4(c)(2), the amount of eligible taxes paid or accrued for the taxable year by an applicable corporation that is a direct or indirect partner in a partnership includes the amount of creditable foreign tax expenditures, within the meaning of § 1.704-1(b)(4)(viii), allocated to the applicable corporation for regular tax purposes, reduced by the suspensions and disallowances described in the definition of “eligible tax” that apply at the level of the partner. See proposed § 1.59-4(g). See also proposed § 1.59-4(d), which would address fact patterns where a CFC is a direct or indirect partner in a partnership.

G. Tax Consolidated Groups

Proposed § 1.59-4(h) would provide that members of a tax consolidated group are treated as a single U.S. shareholder for purposes of applying the CAMT FTC provisions in proposed § 1.59-4. For rules regarding the use of consolidated unused CFC taxes, see proposed § 1.1502-56A(i).

XXX. Proposed §§ 1.1502-2, 1.1502-3, 1.1502-53, and 1.1502-55: Computation of Tax Liability of a Tax Consolidated Group and Computation of Alternative Minimum Tax of Consolidated Groups

Proposed § 1.1502-2(a)(10) would add the alternative minimum tax imposed by section 55(a) to the list of taxes that are added together to determine the tax liability of a tax consolidated group for a consolidated return year.

Section 1.1502-3(d)(4) is proposed to be removed and reserved because it relates to the former corporate alternative minimum tax.

Pursuant to the authority granted by sections 53, 56A(e), and 1502, proposed § 1.1502-53 would provide rules under section 53 regarding the determination of a tax consolidated group's consolidated minimum tax credit. Proposed § 1.1502-53(b) would define the consolidated minimum credit and set out the application of the limitation in section 53(c) to consolidated groups, based on consolidated regular tax liability and consolidated tentative minimum tax.

Under proposed § 1.1502-53(c), a tax consolidated group's use of a member's minimum tax credits arising in separate return years (as defined in § 1.1502-1(e)) is limited to the member's contribution to the consolidated section 53(c) limitation. Proposed § 1.1502-53(c)(2) would specify how to calculate each member's contribution to the consolidated section 53(c) limitation. In general, a member's contribution to the consolidated section 53(c) limitation is determined by subtracting the member's share of consolidated tentative minimum tax from the member's share of consolidated net regular tax liability. A member's share of the consolidated tentative minimum tax would be determined by multiplying the consolidated tentative minimum tax by a fraction, the numerator of which is the member's positive separate AFSI, and the denominator of which is the tax consolidated group's AFSI. For years in which the group has CAMT liability, the member's contribution to the section 53(c) limitation would be reduced by the member's share of the group's CAMT liability under proposed § 1.1502-56A(j). See part XXXI.K of this Explanation of Provisions. The rule would also specify which years are included in the computation and how to coordinate these calculations with SRLY subgroup principles and section 383.

Proposed § 1.1502-53(d) would provide that, if any consolidated MTC that is attributable to a member may be carried to a separate return year of the member, the amount attributable to the member is apportioned to the member and carried to the separate return year, and the apportioned MTC may not be carried over to an equivalent, or later, consolidated return year of the tax consolidated group. The amount attributable to the member would be determined in the same manner as under proposed § 1.1502-56A(j) (concerning consolidated CAMT liability). See part XXXI.K of this Explanation of Provisions.

The proposed method for allocating the consolidated MTC would be consistent with the approach suggested by certain stakeholders, who recommended allocating the consolidated MTC under the mechanisms of § 1.1502-21(b)(2) (with certain modifications, such as substituting “AFSI” for “taxable income”) in the interest of administrability. The proposed method would differ from, and would be simpler than, the allocation method in proposed regulations under section 55 that were published on December 30, 1992 ( see57 FR 62251-01) and that were never finalized due in part to concerns about their complexity and administrability.

Section 1.1502-55 is proposed to be removed and reserved because it relates to the former corporate alternative minimum tax.

XXXI. Proposed § 1.1502-56A: Application of CAMT to Consolidated Groups

Pursuant to the authority granted by section 56A(c)(2)(B), (c)(15), and (e), and section 1502, proposed § 1.1502-56A would provide rules under section 56A regarding the application of the CAMT to tax consolidated groups.

A. Overview

Section 56A(c)(2)(B) provides a general rule that, if the taxpayer is part of a tax consolidated group for any taxable year, AFSI for that group for that taxable year must take into account items on the group's AFS that are properly allocable to members of that group. However, section 56A(c)(2)(B) authorizes the Secretary to prescribe by regulation exceptions to that general rule.

Proposed § 1.1502-56A would provide rules regarding the computation of the AFSI and CAMT liability of a tax consolidated group. The proposed rules would implement the single-entity computations inherent in section 56A(c)(2)(B) and would provide guidance for applying the AFSI computational rules in proposed § 1.56A-1(c) and (d) to tax consolidated groups.

Additionally, proposed § 1.1502-56A would provide rules regarding (i) the use of FSNOL, CFC adjustment, and unused CFC tax carryovers (including the limitations that apply for purposes of computing the AFSI of a tax consolidated group after a corporation joins the group), (ii) the computation of CAMT basis in member stock, (iii) tax items relating to intercompany transactions (as defined in § 1.1502-13(b)(1)(i)), and (iv) the allocation of CAMT liability, the consolidated minimum tax credit (consolidated MTC), and AFSI among members of a tax consolidated group.

B. Single-entity Treatment

Consistent with section 3.05 of Notice 2023-7, proposed § 1.1502-56A(a)(2) would provide that members of a tax consolidated group are treated as a single CAMT entity during their period of consolidation for purposes of determining AFSI and CAMT liability, except as otherwise provided in proposed § 1.1502-56A (for example, see the discussion in part XXXI.E of this Explanation of Provisions).

C. Calculation of FSI of a Tax Consolidated Group

Consistent with section 6.03(1) of Notice 2023-64, proposed § 1.1502-56A(c)(1) would provide that, if the consolidated AFS for a taxable year includes the income, expense, gain, and loss solely of members of a tax consolidated group, the group's FSI for the year equals the FSI on the group's consolidated AFS for the year, as determined under proposed §§ 1.56A-1(c) and 1.56A-2(g)(2). Consistent with section 6.03(2) of Notice 2023-64, proposed § 1.1502-56A(c)(2) would provide that, if a tax consolidated group's consolidated AFS includes the income, expense, gain, or loss of one or more CAMT entities that are not members of the group, the group's FSI for the taxable year is determined from the consolidated AFS by treating all members of the group as a single CAMT entity.

Thus, for example, a tax consolidated group's FSI would be determined by taking into account each AFS consolidation entry regarding (i) a transaction between members and (ii) one member's investment in another member. However, these consolidating entries would be taken into account only as long as the relevant members continue to be members of the same tax consolidated group at the end of the taxable year and if any relevant property continues to be held by the tax consolidated group at the end of the taxable year. The group's FSI also would be determined by disregarding each AFS consolidation entry regarding (i) a transaction between a member and a non-member, (ii) a member's investment in a non-member, and (iii) a non-member's investment in a member. See proposed § 1.1502-56A(c)(2) and (3).

D. Treatment of Captive Partnerships

Consistent with section 6.03(2) of Notice 2023-64, proposed § 1.1502-56A(c)(4) would clarify that treating a tax consolidated group as a taxpayer for purposes of proposed § 1.1502-56A does not change the Federal tax classification of an entity classified as a partnership that is owned only by members of the group.

E. Gain or Loss on Dispositions of Member Stock

Although proposed § 1.1502-56A generally would treat members of a tax consolidated group as a single CAMT entity for purposes of determining AFSI and CAMT liability, proposed § 1.1502-56A(d)(1) would provide that the group's AFSI includes gain or loss from one member's sale or exchange of stock of another member. For this purpose, gain or loss would be computed relative to the CAMT basis of the stock (as determined under proposed § 1.1502-56A(d)(3)). See proposed § 1.1502-56A(d)(2).

F. Basis of Member Stock

As discussed in part XVIII.C.4 of this Explanation of Provisions, the CAMT basis of stock generally equals the regular tax basis as of the beginning of the first taxable year beginning after December 31, 2019, adjusted as required by proposed §§ 1.56A-18 and/or 1.56A-19. Any stock of members of a tax consolidated group held as of the beginning of the first taxable year beginning after December 31, 2019, would be subject to this rule.

However, the group's initial CAMT basis in any member stock acquired after that date would equal the CAMT basis of the stock in the hands of a shareholder member immediately after the acquisition (again adjusted as required by proposed §§ 1.56A-18 and/or 1.56A-19). See proposed § 1.1502-56A(d)(3)(i).

Adjustments would be made to the AFS basis of member stock on the consolidated AFS for the period during which the member is a member of the group, including adjustments to reflect all other adjustments to FSI under section 56A(c) and the section 56A regulations. See proposed § 1.1502-56A(d)(3)(ii). These adjustments are necessary because section 56A(c)(2)(B) and proposed § 1.1502-56A(a)(2) effectively impose a single level of CAMT on the earnings and operations of a tax consolidated group. To ensure that the same economic income or loss is not duplicated in computing the AFSI of a tax consolidated group, the CAMT basis of subsidiary member stock would be adjusted to reflect the member's income or loss items for purposes of the CAMT.

Therefore, consistent with proposed § 1.1502-56A(c), financial accounting adjustments to the AFS basis of subsidiary member stock (as modified under section 56A and the section 56A regulations) would be respected for purposes of determining inclusions for CAMT purposes with regard to that stock. For example, the CAMT operating income or loss of a member of a tax consolidated group would be reflected for purposes of the CAMT in the CAMT basis of the member stock in the hands of its shareholder member. However, the AFS basis of the stock would include negative adjustments for deductions or losses of a subsidiary member only to the extent those items are absorbed by a member of the group under section 56A and the section 56A regulations. These proposed rules are in general conformity with the stock basis adjustment rules applicable for regular tax purposes. See § 1.1502-32.

G. Tax Items Relating to Intercompany Transactions

For purposes of computing AFSI, several provisions in section 56A(c) and the section 56A regulations disregard items that appear on a CAMT entity's AFS and replace them with regular tax items. See section 56A(c)(13) and proposed § 1.56A-15 (concerning certain depreciation deductions) and section 56A(c)(14) and proposed § 1.56A-16 (concerning certain amortization deductions).

Proposed § 1.1502-56A(e) would address the application of the foregoing provisions to tax items relating to intercompany transactions. These proposed rules are intended to clarify that intercompany transactions do not affect the tax items taken into account in determining a tax consolidated group's AFSI. Cf. § 1.1502-13(a)(1) (providing that the purpose of § 1.1502-13 is to provide rules to clearly reflect the taxable income (and tax liability) of a tax consolidated group as a whole by preventing intercompany transactions from creating, accelerating, avoiding, or deferring consolidated taxable income (or consolidated tax liability)).

The regular tax items substituted into AFSI under section 56A(c)(13) and (14) and proposed §§ 1.56A-15 and 1.56A-16 could be construed to include a member's increased depreciation or amortization deductions as a result of an intercompany transaction. For example, if one member of a tax consolidated group sells section 168 property to another member at a gain, the asset may give rise to higher depreciation deductions in the hands of the buying member (which has a higher basis in the asset) than in the hands of the selling member. Cf. § 1.1502-13(c)(7)(ii)(D) ( Example 4).

This outcome is inappropriate because it is inconsistent with the general treatment of a tax consolidated group as a single entity for purposes of computing AFSI. See proposed § 1.1502-56A(a)(2). Instead, section 56A(c)(13) and proposed § 1.56A-15, and section 56A(c)(14) and proposed § 1.56A-16, would substitute only the single-entity amount of tax depreciation or tax amortization, respectively. Accordingly, proposed § 1.1502-56A(e)(2) would clarify that, with regard to any regular tax item that is substituted into AFSI, increases or decreases in the amount of the regular tax items resulting from an intercompany transaction are disregarded. Proposed § 1.1502-56A(e)(3) would restore these increases or decreases when consolidating entries related to the transaction cease to be taken into account (for example, if one of the parties to the intercompany transaction leaves the tax consolidated group; see part XXXI.C of this Explanation of Provisions). While this proposal is intended to serve purposes similar to those of § 1.1502-13, the Treasury Department and the IRS did not believe it necessary to incorporate all of the complexities of § 1.1502-13, and so proposed § 1.1502-56A(e) reflects a simplified approach.

H. Use of FSNOL Carryovers

Stakeholders recommended that the proposed regulations allocate FSNOLs to members of a tax consolidated group under the mechanisms of § 1.1502-21(b)(2) (concerning the carryover and carryback of consolidated net operating losses (CNOLs), including rules regarding the allocation of CNOLs to corporations that cease to be members of a tax consolidated group), with certain modifications (such as substituting “AFSI” for “taxable income”).

The Treasury Department and the IRS tentatively have determined that consolidated FSNOLs (that is, the portion of an FSNOL that is attributable to a tax consolidated group) should be treated in a manner similar to CNOLs. Accordingly, under proposed § 1.1502-56A(f), the use of consolidated FSNOL carryovers to offset the AFSI of a tax consolidated group would be determined under rules that are based upon, and that are intended to operate in a manner consistent with, the rules in § 1.1502-21(b).

Proposed § 1.1502-56A(f)(1) generally would provide that the amount of consolidated FSNOL carryovers of a tax consolidated group that can be used to offset the AFSI of the group for any consolidated return year is the aggregate of the group's consolidated FSNOL carryovers to that year. Proposed § 1.1502-56A(f)(2) would provide that consolidated FSNOL carryovers include both (i) any consolidated FSNOL of the consolidated group, and (ii) any FSNOLs of the members of the group arising in the respective separate return years of those members (to the extent available for use under proposed §§ 1.56A-23 and 1.1502-56A). Proposed § 1.1502-56A(f)(3) would provide rules regarding the application of the 80-percent limitation in section 56A(d)(1). Proposed § 1.1502-56A(f)(4) and (5) would provide detailed rules regarding the carryover of consolidated FSNOLs, including rules regarding situations in which one or more tax consolidated group members deconsolidate from the group.

Stakeholders also recommended that a tax consolidated group's absorption of the FSNOLs of a new member should be subject to the limitations under § 1.1502-21(c) (which provides rules limiting the use of NOLs arising in a separate return limitation year (SRLY)) and section 382 of the Code and the regulations under section 382, with modifications to align with the provisions of the CAMT.

The Treasury Department and the IRS are of the view that a limitation akin to the SRLY limitations in §§ 1.1502-21(c) and 1.1502-15(c) (which imposes a SRLY limitation on built-in losses) should apply to a tax consolidated group's absorption of FSNOLs. Accordingly, proposed § 1.56A-23(e), as described in part XXII of this Explanation of Provisions, would limit the use of FSNOLs acquired from outside the tax consolidated group.

However, as noted previously, the Treasury Department and the IRS do not propose to apply section 382 and the regulations under section 382 to limit the use of FSNOL carryovers. Although the Treasury Department and the IRS are concerned that taxpayers might have incentive to acquire a business that has generated FSNOLs even if there is no business reason for the acquisition, applying section 382 and the regulations under section 382 to the use of FSNOL carryovers is not necessary to carry out the purposes of section 56A for two reasons: (i) the SRLY-like limitation in proposed § 1.56A-23(e) would operate to deter such transactions in many situations, and (ii) the administrative burdens of applying section 382 and the section 382 regulations to FSNOLs would outweigh the benefits of applying this limitation to FSNOLs.

I. Use of CFC Adjustment Carryovers

Consolidated CFC adjustment carryovers (that is, the portion of a CFC adjustment carryover that is attributable to a tax consolidated group) should generally be treated in a manner similar to FSNOL carryovers. Accordingly, under proposed § 1.1502-56A(h), the use of consolidated CFC adjustment carryovers to reduce the tax consolidated group's adjustment to AFSI under § 1.56A-6(b)(1) would be determined under rules that are based upon the rules in proposed § 1.1502-56A(f), with certain differences to reflect the differences in the rules for CFC adjustment carryovers as compared with the rules for FSNOL carryovers. For example, the 80-percent limitation in section 56A(d)(1) does not apply to CFC adjustment carryovers and is therefore not included in § 1.1502-56A(h).

Proposed § 1.1502-56A(h)(1) generally would provide that the amount of consolidated CFC adjustment carryovers of a tax consolidated group that can be used to reduce the group's adjustment to AFSI under proposed § 1.56A-6(b)(1) is the aggregate of the group's consolidated CFC adjustment carryovers to that year. Proposed § 1.1502-56A(h)(2) generally would provide that consolidated CFC adjustment carryovers include both (i) any consolidated CFC adjustment carryovers of the tax consolidated group, and (ii) any CFC adjustment carryovers of the members of the group arising in the respective separate return years of those members (to the extent available for use under proposed §§ 1.56A-6 and 1.1502-56A).

The Treasury Department and the IRS are of the view that a limitation akin to the SRLY limitations in § 1.1502-21(c) should also apply to a tax consolidated group's absorption of CFC adjustment carryovers. Because CFC adjustment carryovers can only be used to reduce a group's adjustment to AFSI under proposed § 1.56A-6(b)(1), SRLY limitations akin to § 1.1502-21(c) may be sufficient and the more expansive limitations in proposed § 1.56A-23(e), applicable to FSNOLs, may not be required. Accordingly, proposed § 1.1502-56A(h)(3) would generally provide that, in any consolidated return year, the aggregate amount of CFC adjustment carryovers from all separate return years of a member of a tax consolidated group that can be used to reduce the group's adjustment to AFSI under proposed § 1.56A-6(b)(1) cannot exceed the adjustment to AFSI under proposed § 1.56A-6(b)(1) generated by the member. However, the Treasury Department and the IRS are considering whether CFC adjustment carryovers generated in a separate return year should be subject to more expansive limitations similar to the limitations in proposed § 1.56A-23(e), which currently are proposed to apply to FSNOLs and certain built-in items. The Treasury Department and the IRS welcome comments on this matter.

Proposed § 1.1502-56A(h)(4) would provide ordering rules for the use of CFC adjustment carryovers, generally following the rules that apply to FSNOL carryovers under proposed § 1.1502-56A(f)(4). Proposed § 1.1502-56A(h)(5) would provide rules regarding the carryover of CFC adjustment carryovers to separate return years, which apply when a member deconsolidates from a tax consolidated group. Consistent with the general approach of incorporating rules that apply to FSNOL carryovers, proposed § 1.1502-56A(h)(5) directs taxpayers to apply the principles of proposed § 1.1502-56A(f)(5).

J. Use of Consolidated Unused CFC Taxes

Proposed § 1.1502-56A(i)(1) generally would provide that the amount of consolidated unused CFC taxes of a tax consolidated group that can be used to determine the consolidated tentative minimum tax of the group for any consolidated return year is the aggregate of the group's unused CFC taxes in that year. Proposed § 1.1502-56A(i)(2) would provide that consolidated unused CFC taxes include both (i) any unused CFC taxes of the consolidated group to the extent available for use under the carryover rules in proposed § 1.59-4(e), and (ii) any unused CFC taxes of the members of the group arising in the respective separate return years of those members to the extent available for use under the carryover rules in proposed § 1.59-4(e). Proposed § 1.1502-56A(i)(3) would provide rules limiting the use of unused CFC taxes from separate return years of a member. Proposed § 1.1502-56A(i)(4) would provide rules regarding the amount of unused CFC taxes that can be used in a consolidated return year. Proposed § 1.1502-56A(i)(5) would provide rules regarding situations in which one or more members deconsolidate from the group.

The Treasury Department and the IRS are of the view that a limitation akin to the SRLY limitations in § 1.1502-21(c) should apply to a tax consolidated group's absorption of unused CFC taxes. Accordingly, proposed § 1.1502-56A(i)(3) would limit, in any consolidated return year, the use of unused CFC taxes from all separate return years of a member of a tax consolidated group to an amount equal to (1) the product of (a) the AFSI adjustment with respect to CFCs described in proposed § 1.56A-6(b)(1) generated by the member and (b) 15 percent (the percentage specified in section 55(b)(2)(A)(i) for the consolidated year); less (2) the amount of the member's share of taxes of CFCs for which it is a U.S. shareholder, as determined under proposed § 1.59-4(d) for the consolidated return year.

K. CAMT Liability

Proposed § 1.1502-56A(j) would provide rules for allocating CAMT liability among members of a tax consolidated group. Proposed § 1.1502-56A(j)(1) would provide that liability for the tax imposed on a tax consolidated group under section 55(b)(2) for a consolidated return year is apportioned among members based on the percentage of AFSI attributable to each member for the year. Under proposed § 1.1502-56A(j)(2), the percentage of AFSI for the consolidated return year attributable to a member equals the separate positive AFSI of the member (determined by computing the AFSI by reference to only the member's items of income, gain, expense, and loss) for the consolidated return year, divided by the sum of the AFSI for that year of all members having positive AFSI for that year. This allocation rule is based upon, and is intended to operate in a manner consistent with, the allocation rules in § 1.1502-21(b)(2). See part XXX of this Explanation of Provisions for a similar allocation rule for the consolidated minimum tax credit.

L. Allocation of AFSI on Deconsolidation

The allocation of AFSI that would occur under proposed § 1.59-2 if a corporation's test group changes is intended to ensure that any future group of which the CAMT entity is a member accurately reflects the income-generating history of the members of the group following the acquisition. The accurate reflection of this history is no less important in cases in which the CAMT entity departing the test group is a member of a tax consolidated group.

Proposed § 1.1502-56A(k)(1) would provide that, on leaving a tax consolidated group, a member is allocated its AFSI for purposes of applying the average annual AFSI test under proposed § 1.59-2(c) as if the member had been a separate taxpayer during the relevant years. The AFSI allocated to the departing member would not be subtracted from the AFSI of the tax consolidated group of which the corporation ceased to be a member. See proposed §§ 1.1502-56A(k)(2) and 1.59-2.

XXXII. CAMT Entities Subject to Tonnage Tax

The Treasury Department and the IRS are considering rules that would provide AFSI adjustments for a corporation that elects under section 1354(a) of the Code (electing corporation), or an electing group as defined in section 1355(a)(2) of the Code that includes an electing corporation, to be subject to the provisions of sections 1352 through 1359 of the Code (tonnage tax regime). The tonnage tax is imposed in lieu of the Federal corporate income tax that would otherwise be imposed under section 11 of the Code on the income of an electing corporation (or electing group) from qualifying shipping activities. See H.R. No. 108-548 Part 1 (2004) at 177.

Under section 1352, an electing corporation's qualifying shipping activities are subject to tax on a notional amount of shipping income, which is determined under section 1353(b) based on the net tonnage of qualifying vessels that the electing corporation operates in foreign trade during the taxable year. Section 1357(a) provides that the gross income of an electing corporation does not include its income from qualifying shipping activities. Section 1357(b) provides that gross income of a corporation (other than an electing corporation) that is a member of an electing group also does not include its income from qualifying shipping activities conducted by such member. Section 1355(a)(2) defines the term “electing group” to mean a controlled group that would be treated as a single employer under section 52(a) or (b) of the Code (without regard to section 52(a)(1) or (2)) and one or more members of which is an electing corporation. Under section 1357(c), items of loss, deduction, or credit of any taxpayer from activities giving rise to income excluded under section 1357 are disallowed, subject to limited exceptions for certain depreciation and interest.

The tonnage tax regime was enacted to bolster the U.S. shipping industry by eliminating a competitive disadvantage faced by operators of United States-flag vessels that otherwise would be subject to higher taxes than their foreign-based competition. H.R. No. 108-548 Part 1 (2004) at 177. By incentivizing United States-flag shipping, the tonnage tax regime also supports the national security goals of the Maritime Security Program (MSP), which maintains a fleet of active, militarily-useful, privately-owned vessels to meet national defense and other security requirements and maintains a United States presence in international commercial shipping. See section 651 of the Merchant Marine Act, 1936, as modified by section 2 of Public Law 104-239, 110 Stat. 3118, 3118-3119 (October 8, 1996), commonly known as the Maritime Security Act of 1996.

The Treasury Department and the IRS received feedback from stakeholders noting that, unlike former section 56(g) of the Code, section 56A does not provide an AFSI adjustment for an electing corporation and requesting that an AFSI adjustment be provided, in part, to exclude income subject to the tonnage tax regime from AFSI (and therefore from the CAMT). Stakeholders noted that there is tension with applying the CAMT to income subject to the tonnage tax regime given that the regime's purpose is to encourage the use of United States-flag vessels in international shipping. These stakeholders also noted that maintaining United States-flag and United States-crewed merchant vessels for the MSP is important to United States national security, both in peacetime and during times of war. The stakeholders therefore suggested that subjecting such income to the CAMT could undermine the United States national security purpose of the tonnage tax regime.

The Treasury Department and the IRS are considering rules that would provide AFSI adjustments with respect to electing corporations and electing groups within the scope of the tonnage tax regime, including adjustments relating to income from qualifying shipping activities and other adjustments that may be necessary to prevent the imposition of duplicative alternative tax regimes that limit the benefit of certain deductions, NOLs, and credits. The Treasury Department and the IRS request comments on whether to provide such rules addressing the interaction of the CAMT and the tonnage tax, including comments on how best to provide AFSI adjustments to meet the United States national security policy goals of the tonnage tax regime and the MSP while appropriately imposing the CAMT with respect to other AFSI of such entities.

XXXIII. Transition Rules and AFSI-Only Change Procedures

A. Transition Rules To Implement Final Regulations

Pursuant to the authority granted by section 56A(c)(15), the Treasury Department and the IRS are considering transition rules to address AFSI and CAMT attribute adjustments necessary to implement the rules in final regulations if a CAMT entity accounted for and reported the AFSI adjustment or CAMT attribute in a manner inconsistent with the final regulations in prior taxable years. The Treasury Department and the IRS are considering three different transition approaches that may apply under the final regulations. The transition approach applied may vary based on the particular AFSI adjustment or CAMT attribute; thus, different transition approaches may be applied in specified circumstances under the transition rules in the final regulations. The transition rules would apply to the CAMT entity's first taxable year for which a particular final rule is applicable (transition year).

1. Transition Year Adjustment Approach

Under one potential transition approach, a CAMT entity would be required to redetermine as of the beginning of the transition year the cumulative amount of AFSI, and redetermine any relevant CAMT attribute, as if the entity had first applied the rules in the final regulations in its first taxable year beginning after December 31, 2019. The difference between the redetermined cumulative AFSI amount and the aggregate AFSI amounts reported in years prior to the transition year would result in an adjustment to AFSI (transition year adjustment). In conjunction with the transition year adjustment, any CAMT attribute previously determined using the prior treatment would be adjusted to equal the redetermined CAMT attribute as of the beginning of the transition year.

The transition year adjustment would be an adjustment to the CAMT entity's AFSI for the transition year. However, the Treasury Department and the IRS are also considering whether to allow CAMT entities to spread the transition year adjustment across multiple taxable years for AFSI purposes in specified circumstances. The Treasury Department and IRS are considering a rule that would allow a transition year adjustment that involves a change in the timing of when an AFSI adjustment amount is included in AFSI to be spread over periods similar to those for section 481(a) adjustments, while transition year adjustments that do not involve timing differences would be spread ratably over four taxable years, beginning with the transition year. The Treasury Department and the IRS request comments as to whether the transition year rules should address which AFSI adjustments represent an AFSI timing difference and how such determination should be made. The Treasury Department and the IRS also request comments as to whether there are circumstances where a transition year adjustment should be entirely taken into account, with no spread period, in the transition year.

The Treasury Department and the IRS are considering the scope of the final rules that should be subject to a transition year adjustment. For example, such rules may include, but would not be limited to, items similar to those included within the scope of AFSI-only changes ( see discussion in part XXXIII.C of this Explanation of Provisions; for example, AFSI adjustments and determination of CAMT basis of section 168 property under proposed § 1.56A-15)), the determination of CAMT retained earnings, and the computation and carryforward of a FSNOL under proposed § 1.56A-23. The Treasury Department and the IRS request comments on the scope of AFSI adjustments, and related CAMT attributes, that should be subject to the transition year adjustment to prevent the duplication or omission of the CAMT entity's AFSI. In addition, to the extent transition rules are provided allowing transition year adjustments to be spread, the Treasury Department and IRS request comments as to whether the applicable spread period should be determined separately for each AFSI adjustment or if certain AFSI adjustments (for example, all adjustments to AFSI for section 168 property under proposed § 1.56A-15) should be combined into a net transition year adjustment for purposes of determining the applicable spread period.

As noted previously, while the transition year adjustment would be determined by recomputing prior year AFSI and CAMT attributes to reflect the final rules, the transition year adjustment is an adjustment to the CAMT entity's AFSI for the transition year (subject to proposed spread periods). Accordingly, with respect to a CAMT entity with a partnership investment, the partnership would not need to file an amended partnership return or file a request for an administrative adjustment under section 6227, as applicable, to revise the amount of any partnership-related item relevant in determining the application of section 56A that was reported to the CAMT entity partner in prior taxable years. Instead, the transition rules would provide that the partnership should report additional information to the CAMT entity partner for the first taxable year in which a final rule is appliable to the extent necessary for the CAMT entity partner to determine its transition year adjustment for such partnership-related item. The Treasury Department and the IRS request comments on the application of this transition approach to a CAMT entity that is a partner in a partnership to which this approach would apply.

2. Cut-off Basis Transition Approach

Under a second potential transition approach, the transition to the final regulations for certain AFSI adjustments and CAMT attributes would be implemented on a cut-off basis similar to the approach provided in section 2.07 of Rev. Proc. 2015-13, 2015-5 I.R.B. 419. Accordingly, under a cut-off basis transition approach, there would be no transition year adjustment to AFSI for the transition year. In addition, under a cut-off basis transition approach, CAMT attributes (such as the CAMT basis of an asset) would not be redetermined as of the beginning of the transition year as if the CAMT entity had first applied the rules in the final regulations in its first taxable year beginning after December 31, 2019. The Treasury Department and the IRS are considering applying the cut-off basis transition approach to AFSI adjustments and CAMT attributes where the CAMT entity no longer holds the property and has already accounted for the disposition of such property in AFSI in a taxable year not subject to the final regulations (even if accounted for in a manner not consistent with the final regulations), for example, certain transactions subject to proposed § 1.56A-18, 1.56A-19, or 1.56A-20. In such situations, the Treasury Department and the IRS request comments as to whether special rules are needed for the transferor or transferee to prevent the duplication or omission of the transferor's or transferee's AFSI related to the transaction. The Treasury Department and the IRS also request comments on the scope of AFSI adjustments and CAMT attributes that should be subject to a cut-off basis transition approach and the application of such transition approach to a CAMT entity that is a partner in a partnership to which this transition approach would apply.

3. Fresh Start Transition Approach

Finally, under a third potential transition approach, the transition to the final regulations for certain rules would be implemented using a “fresh start” transition approach with the relevant CAMT attribute redetermined as of the beginning of the transition year as if the entity had first applied the rules in the final regulations in its first taxable year beginning after December 31, 2019. Accordingly, under a “fresh start” transition approach, there would be no transition year adjustment to AFSI as of the beginning of the transition year. For instances where the CAMT basis of an asset may be subject to a “fresh start” transition approach, the Treasury Department and the IRS request comments as to whether the CAMT basis should be based on amounts other than the amounts that should have been reflected in AFSI in prior years under the final rules, such as the actual amounts reflected in AFSI in prior years. For example, if AFSI in prior years reflected excess amortization because the CAMT basis of an amortizable asset exceeded what the CAMT basis would have been had the final regulations applied (for example, due to push down accounting which is disregarded under proposed §§ 1.56A-4(c)(4) and 1.56A-18(c)(3)), comments are requested as to whether the redetermined CAMT basis should reflect a reduction for the actual amortization reflected in AFSI in prior years or if the redetermined CAMT basis should instead reflect a reduction for the amortization that would have been reflected in AFSI under the final rules.

The Treasury Department and the IRS are considering the scope of the final rules that should be subject to a “fresh start” transition approach. For example, such items may include, but are not limited to, determination of CAMT basis of assets of a foreign corporation under proposed § 1.56A-4, CFC adjustment carryovers with respect to controlled foreign corporations under proposed § 1.56A-6, determination of CAMT basis of assets of a domestic corporation under proposed §§ 1.56A-18 and 1.56A-19, and any unused CFC taxes under proposed § 1.59-4. The Treasury Department and the IRS request comments on the scope of CAMT attributes that should be subject to a “fresh start” transition approach as well as the application of such an approach to a CAMT entity that is a partner in a partnership to which this transition approach would apply.

The Treasury Department and the IRS welcome comments on these three transition approaches, as well as other approaches for handling changes in the treatment of an item to comply with the final regulations.

B. Transition Rules for Taxable Years Prior to the Final Regulations

The Treasury Department and the IRS are aware that a CAMT entity may have a duplication or omission of AFSI or a CAMT attribute if the CAMT entity accounted for and reported the AFSI adjustment or CAMT attribute in a taxable year in a manner inconsistent with the manner used to determine such item in a prior taxable year. To avoid creating undue administrative burden for CAMT entities, and to facilitate a less burdensome interim period before the final regulations are applicable, the Treasury Department and the IRS are of the view that transition rules, including transition adjustments to AFSI, are not appropriate to account for any potential duplication or omission of AFSI or a CAMT attribute for taxable years prior to the transition year. Accordingly, CAMT entities may not make any AFSI adjustments as a result of a redetermination of the cumulative amount of AFSI or redetermine any CAMT attribute as of the beginning of, or during, any taxable year prior to the first taxable year in which a final rule is applicable. See proposed § 1.56A-1(d)(2) (except as otherwise provided in the section 56A regulations, a CAMT entity may not make any adjustments to its FSI in determining its AFSI). Any difference between a redetermined AFSI amount and the AFSI amount previously determined using the CAMT entity's prior treatment does not result in an adjustment to AFSI for any taxable year prior to the transition year. Similarly, any difference between a redetermined CAMT attribute and the CAMT attribute previously determined using the prior treatment does not result in an adjustment to the CAMT attribute for any taxable year prior to the transition year.

C. Consent Procedures for Making AFSI-Only Changes

For taxable years beginning after the transition year ( see discussion in part XXXIII.A of this Explanation of Provisions), the Treasury Department and the IRS are aware that a CAMT entity may need to make corrections to the treatment of an AFSI adjustment due to incorrect application of the final rules. Accordingly, the Treasury Department and the IRS are also considering rules and procedures to address a change in the treatment of an item for AFSI purposes under the final regulations that involves either determining the proper time for taking the item into account or determining the proper amount of the item to prevent duplications or omissions of amounts in AFSI (AFSI-only change). For this purpose, an AFSI-only change would include a change to begin making an AFSI adjustment, a change to properly determine the amount of an AFSI adjustment, or a change to take the AFSI adjustment into account in the appropriate taxable year (AFSI-only items). For this purpose, AFSI adjustments that may be subject to the AFSI-only change procedures may include, but are not limited to, AFSI adjustments to a partner's distributive share of partnership AFSI under proposed § 1.56A-5, AFSI adjustments with respect to section 168 property under proposed 1.56A-15, and AFSI adjustments with respect to qualified wireless spectrum under proposed § 1.56A-16. An AFSI-only change would not include a change in method of accounting being made for regular tax purposes or an accounting principle change for an item in FSI subject to proposed § 1.56A-17(c). Similarly, an AFSI-only change would generally not include items for which an AFSI adjustment is already provided in the final regulations (for example, AFSI adjustments associated with tax capitalization method changes described in proposed § 1.56A-15(b)(10) or 1.56A-16(b)(7), as well as AFSI restatement adjustments and other AFSI adjustments to prevent duplications or omissions of income described in proposed § 1.56A-17(d) and (e)).

In order for a CAMT entity to make an AFSI-only change, the Treasury Department and the IRS are considering rules that would require a CAMT entity to follow consent procedures similar to those that apply for changes in method of accounting for regular tax purposes under sections 446 and 481. Similar to a change in method of accounting for regular tax purposes, a CAMT entity would not be permitted to make an AFSI-only change on an amended return or by filing an administrative adjustment request under section 6227. The AFSI-only change procedures would instead require that a CAMT entity request advance consent from the IRS before changing the item under consent procedures similar to those required under section 446(e) and Rev. Proc. 2015-13 (or successor) on a form similar to Form 3115. However, similar to Rev. Proc. 2015-13, automatic consent may be provided for certain changes. If automatic consent is provided for an AFSI-only change, the manner of obtaining automatic consent may involve reduced filing requirements or certain streamlined procedures. In addition, the consent procedures for AFSI-only changes may also include the computation of a cumulative adjustment to AFSI resulting from the AFSI-only change, which the CAMT entity would include in AFSI over a prescribed number of taxable years beginning with the year of change. Finally, such consent procedures would provide audit protection to taxpayers that voluntarily request to make an AFSI-only change in certain circumstances. Applying procedures to AFSI-only changes that are similar to the change in method of accounting principles under section 446(e) may encourage voluntary compliance when a CAMT entity is inadvertently accounting for an AFSI-only item in an impermissible manner because the CAMT entity would be afforded audit protection and favorable spread periods.

Alternatively, the Treasury Department and the IRS are considering providing taxpayers with automatic consent for all AFSI-only changes, along with reduced filing requirements, that may only require that a statement or abbreviated form be attached to the CAMT entity's tax return for the year in which the AFSI-only change is made. While this alternative may streamline the process for a CAMT entity to correct its AFSI if it is accounting for an AFSI-only item in an impermissible manner, the Treasury Department and IRS are considering whether to provide the CAMT entity with audit protection under this type of procedure and whether more restrictive spread periods should apply.

The Treasury Department and the IRS are evaluating whether consent procedures similar to those required for changes in method of accounting under section 446(e) and Rev. Proc. 2015-13 should apply to an AFSI-only change and request comments on this issue, as well as other approaches for implementing AFSI-only changes. The Treasury Department and the IRS request comments on the scope of AFSI-only items that should be subject to the consent procedures. The Treasury Department and the IRS also request comments on the criteria to be applied by a CAMT entity to determine whether it has established a consistent treatment for an AFSI-only item and, thus, is eligible for an AFSI-only change (for example, whether a CAMT entity needs to treat an AFSI-only item in an impermissible manner for a single taxable year, or multiple taxable years, before it may apply the procedures for making an AFSI-only change). The Treasury Department and the IRS also request comments on the consent procedure terms and conditions that should apply for making an AFSI-only change, including audit protection and the spread period of the corresponding adjustments to AFSI to implement the AFSI-only change.

Proposed Applicability Dates and Reliance on the Proposed Regulations

The provisions of the following sections are proposed to apply to taxable years ending after September 13, 2024: proposed §§ 1.56A-1 through 1.56A-4, 1.56A-6 through 1.56A-11, 1.56A-13, 1.56A-14, 1.56A-17, 1.56A-26, 1.56A-27, and 1.59-2 through 1.59-4 (together, with proposed § 1.56A-5(l)(2)(ii) and (iii), the specified regulations). The provisions of the following sections are proposed to apply to taxable years ending after [date of publication of final regulations in the Federal Register ]: proposed §§ 1.56A-5 (other than 1.56A-5(l)(2)(ii) and (iii)), 1.56A-12, 1.56A-15, 1.56A-16, and 1.56A-18 through 1.56A-25. The provisions of proposed § 1.56A-5(l)(2)(ii) and (iii) are proposed to apply to taxable years ending after September 13, 2024 and on or before [date of publication of final regulations in the Federal Register ] in order to coordinate with certain provisions of the specified regulations. In accordance with section 1503 of the Code, the provisions of the following sections are proposed to apply to consolidated return years for which the date of the income tax return (without extensions) is after [date of publication of final regulations in the Federal Register ]: proposed §§ 1.1502-2, 1.1502-53, and 1.1502-56A.

The Treasury Department and the IRS request comments regarding whether a different applicability date should apply for purposes of applying any specific provision of the proposed regulations and will consider such comments along with all other comments received in response to this notice of proposed rulemaking.

Taxpayers may rely on the specified regulations for any taxable year ending on or before September 13, 2024, provided the taxpayer, and each member of its test group determined under proposed § 1.59-2 for that taxable year, consistently follow all of the specified regulations in their entirety in that taxable year and each subsequent taxable year (taking into account any changes to its test group determined under proposed § 1.59-2 for each subsequent taxable year) until the first taxable year in which the final regulations are applicable. In the case of rules described in proposed §§ 1.56A-4 and 1.56A-6 that apply to transfers (as defined in proposed § 1.56A-4(b)(3)), taxpayers may rely on such rules for a transfer occurring on or before September 13, 2024, provided the taxpayer, and each member of its test group determined under proposed § 1.59-2 for the taxable year of the taxpayer that includes the date of the transfer, consistently follow all of the rules in proposed §§ 1.56A-4 and 1.56A-6 for all such transfers occurring on or before September 13, 2024, and if any such transfers occur in taxable years ending on or before September 13, 2024, must rely on the specified regulations for such taxable years.

Taxpayers may rely on one or more other sections of the proposed regulations for any taxable year ending on or before [date of publication of final regulations in the Federal Register ], provided that, for each section on which the taxpayer relies, the taxpayer, and each member of its test group determined under proposed § 1.59-2 for that taxable year, consistently follow that section in its entirety and also follow all of the specified regulations in their entirety in that taxable year and each subsequent taxable year (taking into account any changes to its test group determined under proposed § 1.59-2) until the first taxable year in which the final regulations are applicable. Notwithstanding the prior sentence, a taxpayer may not rely on proposed §§ 1.56A-18, 1.56A-19, and 1.56A-21 in any taxable year unless the taxpayer and each member of its test group determined under proposed § 1.59-2 for that taxable year relies on each such section in its entirety. In addition, a taxpayer may not rely on proposed §§ 1.56A-5 (excluding 1.56A-5(l)(2)(ii) and (iii)) and 1.56A-20 in any taxable year unless the taxpayer and each member of its test group determined under proposed § 1.59-2 for that taxable year relies on each such section in its entirety.

Special Analyses

I. Regulatory Planning and Review

Pursuant to the Memorandum of Agreement, Review of Treasury Regulations under Executive Order 12866 (June 9, 2023), tax regulatory actions issued by the IRS are not subject to the requirements of section 6 of Executive Order 12866, as amended. Therefore, a regulatory impact assessment is not required.

II. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) generally requires that a Federal agency obtain the approval of the Office of Management and Budget (OMB) before collecting information from the public, whether such collection of information is mandatory, voluntary, or required to obtain or retain a benefit. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number.

This proposed regulation contains reporting, third-party disclosure, and recordkeeping requirements that are required to identify applicable corporations and determine their liability for the CAMT. These collections of information would generally be used by the IRS for tax compliance purposes and by taxpayers to facilitate proper reporting and recordkeeping. The likely respondents to these collections are businesses.

This proposed regulation requires corporations to report their determinations regarding whether they are applicable corporations and, if so, report their CAMT liability by using Form 4626 and the applicable form in the Form 1120 series. These requirements and associated forms are already approved by OMB under 1545-0123. To the extent there is a change in burden as a result of this proposed regulation, the change in burden will be reflected in updated burden estimates for the referenced forms.

This proposed regulation requires partnerships that receive a request for information to provide the information to partners that are subject to the CAMT (or partners directly or indirectly owned by an applicable corporation) and to report the information to the IRS on Schedules K and K-1 of Form 1065. For taxable year 2023, a partnership that receives a request for information after the preparation of its Schedules K and K-1 may provide the information to the partner on a separate statement. This proposed regulation contains recordkeeping requirements associated with the foregoing reporting obligations. These requirements and associated forms are already approved by OMB under 1545-0123. To the extent there is a change in burden as a result of this proposed regulation, the change in burden will be reflected in updated burden estimates for the referenced forms.

This proposed regulation requires a corporation to maintain records sufficient to substantiate its determination regarding whether it is an applicable corporation, including the identification of all persons treated as a single employer with the corporation under section 52(a) or (b) and whether the corporation is a member of an FPMG under proposed § 1.59-3. This proposed regulation requires a corporation that is an applicable corporation to maintain records sufficient to substantiate its determination of liability for the CAMT. This proposed regulation also requires a corporation or other entity whose financial results are reflected in a consolidated financial statement to maintain books and records sufficient to demonstrate how the entity's financial statement income reconciles to the income reported on the consolidated financial statement. The recordkeeping requirements within this proposed regulation are considered general tax records under § 1.6001-1(e). For PRA purposes, general tax records are already approved by OMB under 1545-0123 for business filers. To the extent there is a change in burden as a result of this proposed regulation, the change in burden will be reflected in updated burden estimates for Form 4626 and the applicable form in the Form 1120 series.

III. Regulatory Flexibility Act

The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA) imposes certain requirements with respect to Federal rules that are subject to the notice and comment requirements of section 553(b) of the Administrative Procedure Act (5 U.S.C. 551 et seq.) and that are likely to have a significant economic impact on a substantial number of small entities. Unless an agency determines that a proposal is not likely to have a significant economic impact on a substantial number of small entities, section 603 of the RFA requires the agency to present an initial regulatory flexibility analysis (IRFA) of the proposed rule. The Treasury Department and the IRS have not determined whether the proposed rule, when finalized, would likely have a significant economic impact on a substantial number of small entities. This determination requires further study. However, because there is a possibility of economic impact on a substantial number of small entities, an IFRA is provided in these proposed regulations. The Treasury Department and the IRS invite comments on both the number of entities affected and the economic impact on small entities.

Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking has been submitted to the Chief Counsel of the Office of Advocacy of the Small Business Administration for comment on its impact on small business.

A. Need For and Objectives of the Rule

The proposed regulations would provide guidance for the application of the CAMT, which is based on the AFSI of certain corporations for taxable years beginning after December 31, 2022. The proposed regulations would provide necessary definitions and rules that relate to the determination of AFSI, whether a corporation is an applicable corporation subject to the tax, and various statutory adjustments to AFSI, including rules regarding the application of the CAMT in the tax consolidated group, partnership, and international contexts. The Treasury Department and the IRS intend and expect that this guidance will allow corporations to determine whether they are subject to the tax and their total liability under the tax.

B. Affected Small Entities

The RFA directs agencies to provide a description of, and if feasible, an estimate of, the number of small entities that may be affected by the proposed rules, if adopted. The Small Business Administration's Office of Advocacy estimates in its 2023 Frequently Asked Questions that 99.9 percent of American businesses meet its definition of a small business. While the CAMT applies only to certain corporations averaging over $1 billion of annual AFSI, referred to as applicable corporations, certain provisions in these proposed regulations apply irrespective of the size of the business, as defined by the Small Business Administration. As is described more fully in the preamble to this proposed regulation and in this IRFA, these proposed regulations may affect a variety of different businesses across several different industries.

These proposed regulations contain reporting, third-party disclosure, and recordkeeping requirements that are required to identify applicable corporations and to determine their liability for the CAMT. In determining whether a corporation is an applicable corporation, it may be necessary to aggregate its AFSI with the AFSI of other entities. Further, in determining the CAMT liability of an applicable corporation, it may be necessary to include in AFSI the applicable corporation's income from its investments in partnerships. In most cases, the AFSI of entities whose AFSI is aggregated with that of a corporation will be based on consolidated financial statements prepared by very large corporations that will bear this burden so that it should not be considered a burden imposed on small entities. However, under the proposed regulations, in order to determine the CAMT liability of an applicable corporation, partnerships would be compelled to provide information to their applicable corporation partners (and, in the case of structures with tiers of partnerships, to partners that are directly or indirectly owned by the applicable corporation) regarding the partner's distributive share of the partnership's AFSI, and to keep associated records. We estimate that approximately 25,000 of the partnerships that would be affected by this burden are small entities.

The Treasury Department and the IRS expect to receive more information on the impact on small businesses through comments on these proposed regulations.

C. Impact of the Rules

The proposed regulations will impose recordkeeping and reporting requirements for partnerships directly or indirectly owned by applicable corporations. These proposed regulations require partnerships that receive a request for information to provide the information to partners that are subject to the CAMT (or to partners that are directly or indirectly owned by an applicable corporation) and to report the information to the IRS on Schedules K and K-1 of Form 1065. For taxable year 2023, a partnership that receives a request for information after the preparation of its Schedules K and K-1 may provide the information to the partner on a separate statement. The proposed regulations impose recordkeeping requirements associated with the foregoing reporting obligations.

D. Alternatives Considered

The Treasury Department and the IRS considered alternatives to the proposed regulations. As described in the Explanation of Provisions of this preamble, the Treasury Department and the IRS considered alternative approaches for computing an applicable corporation's distributive share of a partnership's AFSI. Under these approaches, an applicable corporation would generally have required a more limited amount of information from a partnership for the purpose of computing its distributive share of a partnership's AFSI.

One alternative approach considered was a “top-down” approach in which an applicable corporation would use the FSI reported on its AFS with respect to a partnership and adjust that amount by taking into account adjustments required under section 56A. The information necessary for an applicable corporation to compute these adjustments would need to be provided by the partnership. As this approach would still require the partnership to provide information to the partner, it did not substantially lessen the impact of the rules adopted in the proposed regulations.

Another set of approaches considered was to use tax information otherwise required to be maintained for tax purposes. That is, a partner's distributive share of a partnership's AFSI would be an applicable corporation's distributive share of a partnership's book income computed in accordance with the section 704(b) rules, or an applicable corporation's distributive share of partnership taxable income as reported on Schedule K-1.

Yet another alternative considered was the addition of a safe harbor to the proposed approach that would allow applicable corporations to use their financial statement income without making adjustments for partnership investments under section 56A(c)(2)(D)(i). This safe harbor would be in lieu of having the partnership report the partner's distributive share of AFSI to the partners.

These alternative approaches were not adopted in the proposed regulations because the Treasury Department and the IRS are of the view that they are not consistent with the statutory language or its purpose of taxing an applicable corporation's book income, as adjusted under section 56A. In many cases, an applicable corporation would not be able to reasonably take into account the adjustments required under section 56A to compute AFSI, or the applicable corporation would have to rely heavily or exclusively on regular tax amounts, or both.

E. Duplicative, Overlapping, or Conflicting Federal Rules

The proposed rule would not duplicate, overlap, or conflict with any relevant Federal rules. As discussed previously, the proposed regulations would provide rules for the application of the CAMT. The Treasury Department and the IRS invite input from interested members of the public about identifying and avoided overlapping, duplicative, or conflicting requirements.

IV. Unfunded Mandates Reform Act

Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) requires that agencies assess anticipated costs and benefits and take certain other actions before issuing a final rule that includes any Federal mandate that may result in expenditures in any one year by a State, local, or Tribal government, in the aggregate, or by the private sector, of $100 million (updated annually for inflation). This proposed rule does not include any Federal mandate that may result in expenditures by State, local, or Tribal governments, or by the private sector in excess of that threshold.

V. Executive Order 13132: Federalism

Executive Order 13132 (Federalism) prohibits an agency from publishing any rule that has Federalism implications if the rule either imposes substantial, direct compliance costs on State and local governments, and is not required by statute, or preempts State law, unless the agency meets the consultation and funding requirements of section 6 of the Executive order. This proposed rule does not have Federalism implications and does not impose substantial direct compliance costs on State and local governments or preempt State law within the meaning of the Executive order.

VI. Executive Order 13175: Consultation and Coordination With Indian Tribal Governments

Executive Order 13175 (Consultation and Coordination With Indian Tribal Governments) prohibits an agency from publishing any rule that has Tribal implications if the rule either imposes substantial, direct compliance costs on Indian Tribal governments and is not required by statute, or preempts Tribal law, unless the agency meets the consultation and funding requirements of section 5 of the Executive order. These proposed regulations do not have a substantial direct effect on one or more Federally recognized Indian Tribes and do not impose substantial direct compliance costs on Indian Tribal governments within the meaning of the Executive order.

However, the Treasury Department and the IRS held consultation with Alaska Native Corporations on December 2, 2022, to address questions under the IRA, including the application of the CAMT to Alaska Native Corporations, which informed the development of these proposed regulations. The Treasury Department and the IRS also intend to conduct consultation with Alaska Native Corporations on these proposed regulations.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments regarding the notice of proposed rulemaking that are submitted timely to the IRS, as prescribed in this preamble under the ADDRESSES section. The Treasury Department and the IRS request comments on all aspects of the proposed regulations. All comments will be made available at https://www.regulations.gov . Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn.

A public hearing has been scheduled for January 16, 2025 beginning at 10 a.m. EST, in the Auditorium at the Internal Revenue Building, 1111 Constitution Avenue NW, Washington DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. Participants may alternatively attend the public hearing by telephone.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit an outline of the topics to be discussed and the time to be devoted to each topic by December 12, 2024. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing. If no outline of the topics to be discussed at the hearing is received by December 12, 2024, the public hearing will be cancelled. If the public hearing is cancelled, a notice of cancellation of the public hearing will be published in the Federal Register .

Individuals who want to testify in person at the public hearing must send an email to publichearings@irs.gov to have your name added to the building access list. The subject line of the email must contain the regulation number REG-112129-23 and the language TESTIFY in Person. For example, the subject line may say: Request to TESTIFY in Person at Hearing for REG-112129-23.

Individuals who want to testify by telephone at the public hearing must send an email to publichearings@irs.gov to receive the telephone number and access code for the hearing. The subject line of the email must contain the regulation number REG-112129-23 and the language TESTIFY Telephonically. For example, the subject line may say: Request to TESTIFY Telephonically at Hearing for REG-112129-23.

Individuals who want to attend the public hearing in person without testifying must also send an email to publichearings@irs.gov to have your name added to the building access list. The subject line of the email must contain the regulation number REG- 112129-23 and the language ATTEND In Person. For example, the subject line may say: Request to ATTEND Hearing in Person for REG-112129-23. Requests to attend the public hearing must be received by 5 p.m. EST on January 14, 2025.

Individuals who want to attend the public hearing by telephone without testifying must also send an email to publichearings@irs.gov to receive the telephone number and access code for the hearing. The subject line of the email must contain the regulation number REG-112129-23 and the language ATTEND Hearing Telephonically. For example, the subject line may say: Request to ATTEND Hearing Telephonically for REG-112129-23. Requests to attend the public hearing must be received by 5 p.m. EST on January 14, 2025.

Hearings will be made accessible to people with disabilities. To request special assistance during a hearing please contact the Publications and Regulations Branch of the Office of Associate Chief Counsel (Procedure and Administration) by sending an email to publichearings@irs.gov (preferred) or by telephone at (202) 317-6901 (not a toll-free number) by at least January 13, 2025.

Drafting Information

The principal authors of these regulations are Madeline Padner, Frank Dunham III, John Aramburu, James Yu, and C. Dylan Durham of the Office of Associate Chief Counsel (Income Tax and Accounting); Jeremy Aron-Dine, William W. Burhop, and John Lovelace of the Office of Associate Chief Counsel (Corporate); Diane Bloom, Seth Groman, and Chris Dellana of the Office of Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes); Yosef Koppel, Elizabeth Zanet, and Brian Barrett of the Office of Associate Chief Counsel (Passthroughs and Special Industries); Daren J. Gottlieb, Dylan J. Steiner, Ryan Connery, John J. Lee, Michelle L. Ng, Joel Deuth, and Karen Walny of the Office of Associate Chief Counsel (International); Ian Follansbee and Vanessa Mekpong of the Office of Associate Chief Counsel (Financial Institutions and Products). However, other personnel from the Treasury Department and the IRS participated in their development.

Proposed Amendments to the Regulations

Accordingly, the Treasury Department and the IRS propose to amend 26 CFR part 1 as follows:

Paragraph 1. The authority citation for part 1 is amended by adding entries in numerical order for §§ 1.56A-1 through 1.56A-27, 1.59-2 through 1.59-4, 1.1502-53, and 1.1502-56A to read, in part, as follows:

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

Section 1.56A-1 also issued under 26 U.S.C. 56A(c)(2)(B), 56A(c)(15), and 56A(e).

Section 1.56A-2 also issued under 26 U.S.C. 56A(b), 56A(c)(15), and 56A(e).

Section 1.56A-3 also issued under 26 U.S.C. 56A(c)(1), 56A(c)(15), and 56A(e).

Section 1.56A-4 also issued under 26 U.S.C. 56A(c)(2)(C), 56A(c)(15), and 56A(e).

Section 1.56A-5 also issued under 26 U.S.C. 56A(c)(2)(D)(i), 56A(c)(15), and 56A(e).

Section 1.56A-6 also issued under 26 U.S.C. 56A(c)(5), 56A(c)(15), and 56A(e).

Section 1.56A-7 also issued under 26 U.S.C. 56A(c)(15) and 56A(e).

Section 1.56A-8 also issued under 26 U.S.C. 56A(c)(5), 56A(c)(15), and 56A(e).

Sections 1.56A-9 through 1.56A-12 also issued under 26 U.S.C. 56A(c)(15) and 56A(e).

Section 1.56A-13 also issued under 26 U.S.C. 56A(c)(11)(A), 56A(c)(15), and 56A(e).

Section 1.56A-14 also issued under 26 U.S.C. 56A(c)(15) and 56A(e).

Section 1.56A-15 also issued under 26 U.S.C. 56A(c)(13)(B)(ii), 56A(c)(15), and 56A(e).

Section 1.56A-16 also issued under 26 U.S.C. 56A(c)(14)(A)(ii)(II), 56A(c)(15), and 56A(e).

Section 1.56A-17 also issued under 26 U.S.C. 56A(c)(15), and 56A(e).

Sections 1.56A-18 and 1.56A-19 also issued under 26 U.S.C. 56A(c)(2)(C), 56A(c)(15), and 56A(e).

Section 1.56A-20 also issued under 26 U.S.C. 56A(c)(2)(D)(i), 56A(c)(15), and 56A(e).

Sections 1.56A-21 through 1.56A-24 also issued under 26 U.S.C. 56A(c)(15) and 56A(e).

Section 1.56A-25 also issued under 26 U.S.C. 56A(e).

Sections 1.56A-26 and 1.56A-27 also issued under 26 U.S.C. 56A(c)(15) and 56A(e).

Section 1.59-2 also issued under 26 U.S.C. 59(k)(1)(C) and (k)(3).

Section 1.59-3 also issued under 26 U.S.C. 59(k)(2)(B) and (D) and 59(k)(3).

Section 1.59-4 also issued under 26 U.S.C. 59(l)(3).

Sections 1.1502-53 and 1.1502-56A also issued under 26 U.S.C. 53, 56A(C)(2)(B), 56A(c)(15), 56A(e), and 1502.

Par. 2. Remove the undesignated center heading “Tax Surcharge” immediately following § 1.51-1.

Par. 3. Remove and reserve § 1.53-1.

Par. 4. Add an undesignated center heading to read “Alternative Minimum Tax” above reserved § 1.53-1.

Par. 5. Remove §§ 1.53-2 and 1.53-3.

Par. 6. Remove § 1.56-0.

Par. 7. Remove the undesignated center heading “Regulations Applicable to Taxable Years Beginning in 1969 and Ending in 1970” immediately before § 1.56(g)-0.

Par. 8. Remove the undesignated center heading “Tax Preference Regulations” immediately following § 1.56(g)-1.

Par. 9. Sections 1.56A-0 through 1.56A-27 are added to read as follows:

(a) Overview —(1) In general. This section provides general definitions that apply for purposes of the regulations provided in this section and §§ 1.56A-2 through 1.56A-27, 1.59-2 through 1.59-4, 1.1502-53, and 1.1502-56A and provides general rules under section 56A of the Code for determining financial statement income (FSI) and adjusted financial statement income (AFSI), which are relevant for determining whether, and to what extent, a corporation is subject to the corporate alternative minimum tax (CAMT) under section 55(a) of the Code. Paragraph (b) of this section provides general definitions that apply for purposes of this section and §§ 1.56A-2 through 1.56A-27 and 1.1502-56A (collectively, the section 56A regulations), as well as §§ 1.59-2 through 1.59-4 and 1.1502-53. Paragraph (c) of this section provides general rules for determining an entity's FSI, including for situations in which the financial results of an entity are consolidated with the financial results of one or more other entities in a consolidated financial statement. Paragraph (d) of this section provides general rules for determining an entity's AFSI. Paragraph (e) of this section provides rules for translating AFSI that is denominated in a currency other than the U.S. dollar. Paragraph (f) of this section provides rules for determining the classification of an entity for purposes of the section 56A regulations. Paragraph (g) of this section provides general substantiation requirements. Paragraph (h) of this section provides general reporting requirements. Paragraph (i) of this section provides the applicability date of this section.

(2) Scope of the section 56A regulations. The section 56A regulations apply to determine a CAMT entity's AFSI, modified FSI, or adjusted net income or loss, as applicable, for purposes of sections 55 through 59 of the Code. The section 56A regulations apply to any CAMT entity whose AFSI, modified FSI, or adjusted net income or loss, as applicable, is relevant for determining—

(i) Whether the CAMT entity or any other CAMT entity is an applicable corporation under section 59(k); or

(ii) The tentative minimum tax under section 55(b)(2)(A) of the CAMT entity or any other CAMT entity.

(b) Definitions. For purposes of the section 56A regulations:

(1) Adjusted financial statement income. The term adjusted financial statement income (AFSI) means:

(i) With respect to a corporate alternative minimum tax (CAMT) entity whose applicable financial statement (AFS) for the taxable year is not described in § 1.56A-2(c)(6), the CAMT entity's FSI for the taxable year, adjusted as provided in the section 56A regulations. The IRS may publish IRB guidance that permits CAMT entities to make other AFSI adjustments.

(ii) With respect to a CAMT entity whose AFS for the taxable year is described in § 1.56A-2(c)(6)—

(A) For a CAMT entity that is a controlled foreign corporation, the amount described in paragraph (b)(20)(ii) of this section for the taxable year, adjusted as provided in the section 56A regulations;

(B) For a CAMT entity that is a partnership, the partnership's items of income, gain, loss, and deduction that are reflected on the partnership's return of partnership income for the taxable year and taken into account in determining the taxable income of each partner (without adjustment); and

(C) For a CAMT entity other than a controlled foreign corporation or a partnership, the CAMT entity's taxable income for the taxable year (without adjustment).

(2) Adjusted net income or loss. The term adjusted net income or loss means, with respect to a controlled foreign corporation for a taxable year, the amount provided in § 1.56A-6(c).

(3) AFS basis. The term AFS basis means the carrying value of an item for AFS purposes. See paragraph (c)(4) of this section for rules that apply to determine a CAMT entity's AFS basis in an item if the CAMT entity's AFS is a consolidated financial statement.

(4) AFS consolidation entries. The term AFS consolidation entries means the financial accounting journal entries that are made in preparing a consolidated financial statement for a financial statement group in order to present the financial results of that financial statement group as though all members of the financial statement group were a single economic entity, including journal entries—

(i) To eliminate the effect of transactions and investments between members of the financial statement group;

(ii) To report amounts that are not recorded in the separate books and records of one or more members of the financial statement group; and

(iii) To correct or otherwise adjust amounts that are reported in the separate books and records of one or more members of the financial statement group.

(5) Applicable corporation. The term applicable corporation has the meaning provided in § 1.59-2(b)(1).

(6) Applicable financial statement. The term applicable financial statement (AFS) has the meaning provided in § 1.56A-2(b).

(7) CAMT basis. The term CAMT basis means the basis of an item for purposes of determining AFSI. Except as otherwise provided in the section 56A regulations (for example, §§ 1.56A-4(d)(5), 1.56A-15(e) and 1.56A-16(e)), the CAMT basis of an item is the AFS basis of the item, adjusted as provided in the section 56A regulations. See paragraph (d)(3) of this section for rules for determining the AFS basis of an item that arose in a taxable year beginning before January 1, 2023.

(8) CAMT entity. The term CAMT entity means any entity identified in section 7701 of the Code and the regulations under section 7701 other than a disregarded entity.

(9) CAMT foreign tax credit. The term CAMT foreign tax credit means the credit allowed to an applicable corporation under section 59(l), as computed under § 1.59-4(c).

(10) CFC adjustment carryover. The term CFC adjustment carryover has the meaning provided in § 1.56A-6(b)(6).

(11) Change in accounting principle. The term change in accounting principle means a change from using one accepted accounting principle or practice to another accepted accounting principle or practice for AFS purposes if there are two or more accepted accounting principles or practices that apply or if the original accepted accounting principle or practice is no longer accepted. A change in the method of applying an accepted accounting principle or practice for AFS purposes also is considered a change in accounting principle. See, for example, FASB Accounting Standards Codification (ASC) 250-10-20.

(12) Consolidated financial statement. The term consolidated financial statement means a financial statement that presents the assets, liabilities, equity, income, and expenses of more than one CAMT entity as those of a single economic entity.

(13) Controlled foreign corporation. The term controlled foreign corporation has the meaning provided under section 957 of the Code or, if applicable, section 953(c)(1)(B) of the Code.

(14) Disregarded entity. The term disregarded entity means an entity that is disregarded as separate from its owner under § 301.7701-3 of this chapter, a qualified subchapter S subsidiary within the meaning of section 1361(b)(3)(B) of the Code, and a qualified real estate investment trust subsidiary within the meaning of section 856(i)(2) of the Code.

(15) Equity method. The term equity method means the practice, under financial accounting principles, of a CAMT entity (investor) initially recording its investment in the equity of another CAMT entity (investee) as an asset in the investor's AFS, generally, at cost and then adjusting the AFS basis of such asset by the investor's share of the earnings or losses of the investee for periods following the date of investment. See, for example, ASC 323. The equity method includes the hypothetical liquidation at book value (HLBV) method under which the investor uses a balance sheet approach to calculate the investor's share of investee earnings or losses based on the change in the investor's claim on the net assets of the investee.

(16) Equity method basis adjustment. The term equity method basis adjustment means the practice, under financial accounting principles, of a CAMT entity (investor) adjusting its AFS basis in an investment in the equity of another CAMT entity (investee) accounted for under the equity method to reflect amortization of the difference (or a portion of the difference) between the investor's proportionate share of the fair value of the investee's net assets and the investor's proportionate share of the carrying value of the investees net assets as of the date investor acquired the investment. See, for example, ASC 323-10-35-13.

(17) Fair value method. The term fair value method means the practice, under financial accounting principles, of a CAMT entity (investor) recording its investment in the equity of another CAMT entity (investee) as an asset in the investor's AFS and adjusting the AFS basis of such asset as of each reporting date by reference to the investment's fair value (or by reference to the original cost of the investment, reduced for any impairment, if the fair value is not readily determinable). See, for example, ASC 321-10.

(18) Federal income taxes. The term Federal income taxes means taxes imposed by subtitle A of the Code (subtitle A). Federal income taxes include amounts allowed as credits against taxes imposed by subtitle A, including credit amounts that are generated by a partnership and passed through to a partner.

(19) Financial statement group. The term financial statement group means a group of CAMT entities whose financial results are consolidated and reported on the same consolidated financial statement.

(20) Financial statement income. The term financial statement income (FSI) means:

(i) With respect to a CAMT entity other than a CAMT entity described in paragraph (b)(20)(ii) of this section for a taxable year, the net income or loss of the CAMT entity set forth on the income statement (sometimes referred to as the statement of earnings, the statement of operations, or the statement of profit and loss) included in the CAMT entity's AFS for the taxable year. FSI includes all the CAMT entity's items of income, expense, gain, and loss reflected in the net income or loss set forth on the income statement for the taxable year, including nonrecurring items and net income or loss from discontinued operations. FSI does not include amounts reflected elsewhere in the CAMT entity's AFS, including in equity accounts such as retained earnings and other comprehensive income (OCI). See paragraph (c) of this section for rules that apply to determine FSI of a CAMT entity.

(ii) With respect to a CAMT entity that is a controlled foreign corporation and whose AFS is the tax return under § 1.56A-2(c)(6), the amount determined under § 1.964-1(a)(1) for a taxable year without adjustment for § 1.964-1(a)(1)(iii).

(21) Financial statement net operating loss. The term financial statement net operating loss (FSNOL) has the meaning provided in § 1.56A-23(b).

(22) For regular tax purposes. The term for regular tax purposes means for purposes of computing a CAMT entity's regular tax liability, as defined under section 26(b) of the Code, or, if the CAMT entity is a pass-through entity or a controlled foreign corporation, the regular tax liability of a direct or indirect owner of the CAMT entity, as applicable.

(23) Foreign income tax. The term foreign income tax has the meaning provided in § 1.901-2.

(24) FPMG. The term FPMG (foreign-parented multinational group) has the meaning provided in § 1.59-3(c).

(25) FPMG common parent. The term FPMG common parent has the meaning provided in § 1.59-3(b)(9).

(26) FSNOL carryover. The term FSNOL carryover has the meaning provided in § 1.56A-23(d).

(27) GAAP. The term GAAP means United States Generally Accepted Accounting Principles, which are a common set of accounting rules, standards, and procedures that are generally issued by the Financial Accounting Standards Board (FASB) and, where applicable, the United States Securities and Exchange Commission (SEC).

(28) IFRS. The term IFRS means International Financial Reporting Standards, which are a common set of accounting rules, standards, and procedures that are generally issued by the International Accounting Standards Board.

(29) Impairment loss. The term impairment loss means a loss reflected in a CAMT entity's FSI from the impairment write-down of the AFS basis of an asset (or a group of assets) to fair value while the asset (or group of assets) is still held by the CAMT entity. An impairment write-down occurs if an asset (or a group of assets) is tested for impairment and the asset (or group of assets) has an AFS basis that exceeds the fair value of the asset (or group of assets). The frequency with which an asset (or a group of assets) is tested for impairment is not relevant in determining whether an impairment loss has occurred.

(30) Impairment loss reversal. The term impairment loss reversal means the reversal of a prior-year impairment loss that is reflected in the current-year computation of FSI.

(31) IRB guidance. The term IRB guidance means guidance published in the Internal Revenue Bulletin ( see § 601.601(d) of this chapter) after [DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER ].

(32) Modified FSI. The term modified FSI means, with respect to a partnership for a taxable year, the amount provided in § 1.56A-5(e)(3).

(33) Partnership and tiered partnership. The term partnership has the meaning provided under sections 761(a) and 7701(a)(2) of the Code and the regulations under sections 761 and 7701. The term tiered partnership means a structure in which a partnership (upper-tier partnership) owns an interest in another partnership (lower-tier partnership).

(34) Pass-through entity. The term pass-through entity means a partnership, an S corporation as defined in section 1361(a)(1) of the Code, or any other CAMT entity other than a C corporation, as defined in section 1361(a)(2) of the Code, to the extent that the income or deductions of the entity are included in the income of one or more direct or indirect owners or beneficiaries of the entity for regular tax purposes.

(35) Purchase accounting. The term purchase accounting means the practice, under financial accounting principles, of a CAMT entity recording acquisitions of other CAMT entities or lines of business on its AFS at fair value, with the acquiring CAMT entity valuing the assets and liabilities of the acquired CAMT entity or line of business at their fair value as of the acquisition date. See, for example, ASC 805-20-25-1.

(36) Push down accounting. The term push down accounting means the practice, under financial accounting principles, of an acquired CAMT entity adjusting the AFS basis of its assets and liabilities and the assets and liabilities of any lower-tier entities to fair value as of the date the CAMT entity is acquired. See, for example, ASC 805-50-25-4.

(37) Qualified wireless spectrum. The term qualified wireless spectrum has the meaning provided in § 1.56A-16(b)(4).

(38) Restated AFS. The term restated AFS means an AFS for a specific accounting period that is revised and reissued to correct the original AFS issued for that accounting period. Adjustments to the financial results of a prior accounting period that are disclosed in an original AFS for comparison purposes (for example, in the case of a change in accounting principle) do not constitute a restated AFS for that prior accounting period.

(39) Section 56A regulations. The term section 56A regulations means the regulations provided in this section and §§ 1.56A-2 through 1.56A-27 and 1.1502-56A.

(40) Section 168 property. The term section 168 property has the meaning provided in § 1.56A-15(b)(6).

(41) Separate financial statement. The term separate financial statement means a financial statement that is not a consolidated financial statement and that presents the assets, liabilities, equity, income, and expenses of a single CAMT entity (including the assets, liabilities, equity, income, and expenses of that single CAMT entity with respect to its investment in other CAMT entities).

(42) Statutory references —(i) Chapter 1. The term chapter 1 means chapter 1 of subtitle A.

(ii) Code. The term Code means the Internal Revenue Code.

(iii) Subchapter K. The term subchapter K means subchapter K of chapter 1.

(iv) Subtitle A. The term subtitle A means subtitle A of the Code.

(43) Tax consolidated group. The term tax consolidated group has the meaning given the term consolidated group in § 1.1502-1(h).

(44) United States shareholder. The term United States shareholder has the meaning provided under section 951(b) of the Code or, if applicable, section 953(c)(1)(A) of the Code.

(c) General rules for determining FSI —(1) Federal income tax treatment not relevant for FSI. FSI includes all items of income, expense, gain, and loss reflected in the net income or loss of a CAMT entity set forth in the income statement included in the CAMT entity's AFS, regardless of whether the amounts are realized, recognized, or otherwise taken into account for regular tax purposes. For example, FSI includes income reported on the income statement included in a CAMT entity's AFS for a taxable year even if the income is not treated as AFS revenue for that taxable year for purposes of the AFS income inclusion rule under § 1.451-3(b). Similarly, FSI includes gain or loss reported on the income statement included in a CAMT entity's AFS for a taxable year even if the gain or loss is deferred or not recognized for regular tax purposes (for example, gain on a like-kind exchange that qualifies for nonrecognition treatment under section 1031 of the Code).

(2) Tax consolidated groups; CAMT entities that own disregarded entities —(i) Tax consolidated groups. For purposes of the section 56A regulations, if the AFS of each member of a tax consolidated group is not the same consolidated financial statement after the application of § 1.56A-2(g), then the tax consolidated group combines the financial results of all CAMT entities reflected in the different AFSs of its members to form one consolidated financial statement that is treated as the AFS of the tax consolidated group (tax consolidated group AFS). For purposes of the preceding sentence, the financial results of each CAMT entity may not be included in the tax consolidated group AFS more than once, and the tax consolidated group makes any AFS consolidation entries not otherwise reflected in the AFS of any member that would have been made if the tax consolidated group AFS actually had been prepared. For additional rules for determining the FSI of a tax consolidated group, see § 1.1502-56A.

(ii) CAMT entities that own a disregarded entity or branch. For rules for determining the FSI of a CAMT entity that owns a disregarded entity or branch, see § 1.56A-9.

(3) Determining FSI from a consolidated AFS. If a CAMT entity's AFS is a consolidated financial statement under paragraph (c)(2)(i) of this section or § 1.56A-2(g) (consolidated AFS), the CAMT entity applies this paragraph (c)(3) to determine the amount of the net income or loss of the financial statement group set forth on the income statement included in the consolidated AFS (consolidated FSI) that is the CAMT entity's FSI. Except as provided in § 1.1502-56A(c), the CAMT entity's FSI is determined in accordance with this paragraph (c)(3).

(i) In general. The amount of consolidated FSI that is the CAMT entity's FSI must be supported by the CAMT entity's separate books and records (including trial balances) used to create the consolidated AFS.

(ii) No netting losses against income within the consolidated AFS. Except as provided in paragraphs (c)(3)(iii)(B) and (C) of this section, the amount of consolidated FSI that is the CAMT entity's FSI is determined without regard to the financial results of other CAMT entities that are members of the financial statement group for which the consolidated AFS is prepared. Accordingly, if two or more CAMT entities are members of that financial statement group, the loss of one CAMT entity may not offset the income of another CAMT entity for purposes of determining the FSI of either CAMT entity, notwithstanding that the amounts are reflected in the consolidated FSI on a net basis.

(iii) Elimination journal entries. In determining the amount of consolidated FSI that is the CAMT entity's FSI:

(A) AFS consolidation entries that eliminate the effect of transactions between the CAMT entity and another CAMT entity that is a member of the financial statement group for which the consolidated AFS is prepared are disregarded.

(B) AFS consolidation entries that eliminate any income, loss, expense, asset, liability, or other item of the CAMT entity with respect to its investment in another CAMT entity (for example, an interest in a partnership or stock in a corporation) that is a member of the financial statement group for which the consolidated AFS is prepared are disregarded.

(C) If a CAMT entity has an investment in a partnership or a domestic corporation that is a member of the CAMT entity's financial statement group for which the consolidated AFS is prepared, the income or loss reflected in the FSI of the CAMT entity with respect to the investment (after the application of paragraph (c)(3)(iii)(B) of this section) and any balance sheet accounts reflected in the CAMT entity's separate books and records with respect to the investment are determined as though the CAMT entity prepared a separate financial statement in which the investment was properly accounted for under the relevant accounting standards for investments in other entities (for example, the Parent-Entity Financial Statement accounting standards described in ASC 810-10-45-11), if the CAMT entity does not so account for the investment in the CAMT entity's separate books and records used to prepare the consolidated AFS.

(iv) Consolidation entries other than elimination entries. AFS consolidation entries, other than elimination entries described in paragraphs (c)(3)(iii)(A) and (B) of this section, that relate to one or more CAMT entities that are members of the financial statement group for which the consolidated AFS is prepared and that are not reflected in the separate books and records of one or more of the CAMT entities are appropriately allocated or pushed down (or both), as applicable, to each CAMT entity to which the AFS consolidation entries relate and taken into account in each CAMT entity's FSI.

(v) Reconciliation requirement. The CAMT entity must maintain books and records sufficient to demonstrate how its FSI (as determined under this paragraph (c)(3)) reconciles to consolidated FSI.

(4) Determining AFS basis and balance sheet account amounts if the CAMT entity's AFS is a consolidated financial statement —(i) In general. If, under § 1.56A-2(g), a CAMT entity's AFS is a consolidated financial statement, and if the CAMT entity's balance sheet accounts or AFS basis in any item is relevant for determining the CAMT entity's AFSI, then the CAMT entity uses the balance sheet accounts or AFS basis reflected in the CAMT entity's separate books and records (including the CAMT entity's trial balance) used to create the consolidated financial statement. The balance sheet accounts or AFS basis are determined without regard to any AFS consolidation entries described in paragraphs (c)(3)(iii)(A) and (B) of this section, but with regard to paragraphs (c)(3)(iii)(C) and (c)(3)(iv) of this section.

(ii) Purchase accounting and push down accounting. In the case of a CAMT entity subject to the accounting standards for business combinations, the application of paragraphs (c)(3) and (c)(4)(i) of this section will result in any purchase accounting and push down accounting adjustments, as applicable, being reflected in the CAMT entity's AFS basis, balance sheet accounts, and FSI. However, the purchase accounting and push down accounting adjustments, as applicable, may be disregarded under other sections of the section 56A regulations for purposes of determining the CAMT entity's CAMT basis and AFSI ( see, for example, §§ 1.56A-18(c)(3) and 1.56A-4(c)(4) and (d)(4)).

(5) Coordination rule. This paragraph (c) applies before paragraphs (d) and (e) of this section and before all other sections of the section 56A regulations other than § 1.56A-2. Accordingly, references to AFS basis and FSI in paragraphs (d) and (e) of this section and in §§ 1.56A-3 through 1.56A-27 mean AFS basis and FSI as determined under this paragraph (c).

(6) Examples. The following examples illustrate the application of paragraph (c)(3) of this section.

(i) Example 1: FSI of component members of a financial statement group— (A) General Facts. X is a domestic corporation and Y is a domestic partnership. X is a general partner in Y with a 40% interest in Y. The financial results of X are consolidated with the financial results of Y on a consolidated AFS (XY Consolidated AFS) for the financial reporting period beginning January 1, 2024, and ending December 31, 2024. X and Y are the only CAMT entities whose financial results are reflected in the XY Consolidated AFS. Under § 1.56A-2(g), X's AFS and Y's AFS is the XY Consolidated AFS.

(B) Facts: Consolidation entries. The XY Consolidated AFS, which is prepared under GAAP, reflects consolidated FSI of $1,650x. X's and Y's separate books and records used to prepare the XY Consolidated AFS disclose that X had net income of $2,000x and that Y had a net loss of $500x. Further, the $2,000x net income of X includes $1x of income for services rendered to Y and a loss of $200x reflecting X's share of Y's net loss, which is consistent with the loss that X would have reported with respect to X's investment in Y had it prepared a nonconsolidated AFS in which X's investment in Y was accounted for under the Parent-Entity Statement accounting standards described in ASC 810-10-45-11. These amounts are eliminated from consolidated FSI through AFS consolidation entries made in preparing the XY Consolidated AFS. Y's loss of $500x includes $1x of expense that Y incurred for services provided by X. The $1x expense is also eliminated from consolidated FSI through AFS consolidation entries made in preparing the XY Consolidated AFS. An AFS consolidation entry is also made to take into account in consolidated FSI $50x of expenses incurred by X to a third party and not reflected in X's separate books and records. Accordingly, the information from X's and Y's source documents, the AFS consolidation entries, and consolidated FSI for the XY Consolidated AFS are summarized as follows (all amounts are stated in U.S. dollars):