IRS guidance clarifies new haircut of foreign taxes attributable to certain distributions of GILTI (or NCTI) PTEP

The IRS and Treasury have released Notice 2025-77 which clarifies the new rules surrounding the haircut of foreign taxes paid (or deemed paid) on distributions of global intangible low-taxed income (GILTI) or net CFC tested income (NCTI) previously taxed earnings and profits (PTEP), specifically addressing timing and tracking of annual GILTI (or NCTI) PTEP accounts as well as taxes properly allocable and apportionable to such PTEP.

Overview

The Tax Cuts and Jobs Act (TCJA) in 2017 introduced the GILTI regime that imposed a quasi-minimum tax on a U.S. shareholder’s pro rata share of the aggregate derived intangible income of its foreign subsidiaries, specifically, controlled foreign corporations (CFCs). Along with a related deduction to reduce this inclusion of income, U.S. corporations are also eligible for an 80% foreign tax credit on foreign taxes deemed paid with respect to GILTI earned by CFCs included in such shareholder’s taxable income. CFC income, to the extent it is previously taxed under the GILTI regime (or, separately, the subpart F regime) is generally not subject to tax again upon distribution to its U.S. shareholder (special rules apply with respect to individual U.S. shareholders that make a section 962 election with respect to the earlier deemed inclusion of income). Under TCJA, any foreign income tax paid or accrued (or deemed paid) properly allocable to a distribution of GILTI PTEP may be creditable (by means of an increased foreign tax credit limitation) and not subject to a haircut. This exercise generally requires tracking annual PTEP accounts and foreign income taxes attributable to each PTEP category (e.g., GILTI, passive, etc.).

OBBBA and Notice 2025-77

The One Big Beautiful Bill Act (OBBBA) reduces the existing 20% foreign tax haircut to 10% in allowing for a 90% foreign tax credit on foreign taxes deemed paid with respect to GILTI (or NCTI post-2025). OBBBA further introduces symmetry on distributions of GILTI (or NCTI) PTEP by imposing a corresponding 10% haircut on taxes paid (or deemed paid) on such distributions.

The IRS and Treasury have released Notice 2025-77, which is the third of four notices on the various OBBBA international tax provisions. The Notice announces forthcoming proposed regulations on this change, as well as promised amendments to the already proposed PTEP regulations. The Notice clarifies that this rule will apply to taxes paid or accrued (or deemed paid) with respect to distributions that are attributable to a GILTI or NCTI inclusion of a U.S. shareholder which was included in a taxable year of the U.S. shareholder ending after June 28, 2025. For example, a U.S. shareholder that receives a distribution of GILTI PTEP which relates to the U.S. shareholder’s GILTI inclusion incurred for its Dec. 31, 2025, year-end, would be subject to this rule. This is true even if that GILTI inclusion relates to one or more CFCs with taxable years ending prior to the June 28, 2025, date.

This results in the need to maintain two separate groups of GILTI (or NCTI) PTEP (or rather section 951A PTEP) for proper application of the new haircut, the first for PTEP related to section 951A inclusions arising in a U.S. shareholder’s taxable year ending on or before June 28, 2025, and the second for section 951A inclusions arising in a U.S. shareholder’s taxable year ending after June 28, 2025. The 10% foreign tax credit haircut will be applied to those foreign income taxes properly allocated and apportioned to the post-June 28, 2025, section 951A PTEP group only. These same rules will apply to section 951A PTEP that has been reclassified due to the investment in U.S. property rules.

Applicability dates and reliance

The Notice can generally be relied upon for foreign income taxes paid or accrued (or deemed paid) that relate to distributions of section 951A PTEP attributable to U.S. shareholder taxable years ending after June 28, 2025. Note: the haircut reduction from 20% to 10% on foreign taxes deemed paid with respect to an original deemed inclusion of income under the NCTI regime (not upon later distribution of that PTEP) will be effective for U.S. shareholder taxable years beginning after Dec. 31, 2025.

Other resources

For more on OBBBA changes related to GILTI please see:

• 2025 Year-end tax considerations for international tax planning
• Revamp and rebrand of the GILTI regime in the One Big Beautiful Bill Act
• IRS provides guidance on new pro rata share transition rule under OBBBA
• IRS releases guidance on new foreign income tax allocation under OBBBA

If you have questions on how the above information may impact your tax situation, please reach out to your Baker Tilly tax advisor.