On January 15, 2025, the Department of the Treasury (Treasury) and the  Internal Revenue Service (IRS) issued final regulations (Final Regulations) that largely adopt the provisions of the August 2024 proposed regulations regarding disregarded payment losses (DPLs), albeit with a delayed applicability date beginning in 2026. Treasury and IRS stated that they intend to finalize the remaining provisions of the proposed regulations (regarding dual consolidated losses (DCLs)) in future guidance. In addition, the preamble to the Final Regulations announced additional transitional relief with respect to DCLs and Pillar 2 (global anti-base erosion (GloBE)) taxes. 

Final DPL Rules

As discussed in previous coverage, DPL rules generally require an income inclusion for a domestic owner of a specified eligibility entity that has net loss from certain disregarded payments if there is a foreign use of the DPL or if the domestic owner fails to comply with DPL certification requirements. Commenters to the proposed regulations took issue with Treasury's statutory authority to issue the DPL rules in light of the language of section 1503(d) and the limited adoption of the Organisation for Economic Cooperation and Development (OECD) recommendations on hybrid mismatches in section 267A and section 245A. In the preamble to the Final Regulations, Treasury defended its rulemaking authority as "a reasonable response to significant policy concerns resulting from the check-the-box regulations." Treasury also backed away from statements in the preamble of the proposed regulations that justified the regulations on the basis of the OECD recommendations rather than U.S. tax policy concerns. 

The Final Regulations dispense with the "deemed consent" concept of the proposed regulations whereby the owner of a disregarded entity is deemed to consent to the DPL rules. Instead, Treas. Reg. § 301.7701-2(c)(2)(vii)(A) now includes "special rules" that provide that transactions described in the DPL regulations "are in effect taken into account as if the entity were regarded and the deduction was denied, and therefore give rise to an income inclusion, and corresponding suspended deduction, to the entity's owner." 

Although the Final Regulations generally adopt the operative provisions of the proposed regulations, they do make some technical modifications to the concept of the "DPL cumulative register." Under the proposed regulations, the DPL cumulative register was equal to the net amount of disregarded payment income and disregarded payment loss for the disregarded entity not including the triggered DPL. The Final Regulations modify these operative rules to prevent a double inclusion of the same DPL or a permanent increase to their U.S. taxable income. First, if the domestic owner derives disregarded payment income in a year following a DPL inclusion, the owner is permitted a "suspended" deduction with the same character and source to the extent of the disregarded payment income. Second, the "DPL cumulative register" now only includes disregarded payment income and is decreased to the extent a cumulative register balance is used to reduce the DPL inclusion amount or allow a suspended deduction. 

In addition, the Final Regulations expand the definition of a disregarded payment entity to include foreign branches that are owned through one or more domestic partnerships. Taxpayers are advised to review tiered partnership structures because the amendment applies broadly to foreign resident entities that are treated as partnerships for U.S. federal income tax purposes. 

The Final Regulations also provide for a de minimis exception for disregarded payment entities that are engaged in an active trade or business and incur a loss that is the lesser of $3 million or 10 percent of aggregate deductible items under foreign law. Further, the definition of disregarded payment entity is revised under the Final Regulations to exclude entities that are foreign tax residents and unrelated to a disregarded payment entity owner, i.e., less than 50 percent owned within the meaning of section 954(d)(3). In addition, the definition of "foreign use" was narrowed to exclude a deemed foreign use of a DPL that would otherwise occur under the mirror legislation rules in Treas. Reg. § 1.1503(d)-3(e)(1). 

Final DCL Rules 

The Final Regulations generally did not finalize the provisions of the proposed regulations related to DCLs, in particular proposed rules excluding items arising from stock ownership and rules addressing the application of the DCL rules to the Pillar 2 rules. They did, however, finalize the deemed ordering rules for DCL and DPL calculations and anti-avoidance rules, which apply "if a transaction, series of transactions, plan, or arrangement is engaged in with a view to avoid the purposes" the DCL and DPL rules. 

Transitional Relief With Respect to GloBE Rules 

Citing the need for further consideration of OECD guidance, the preamble to the Final Regulations provides transitional relief to taxpayers concerning the interaction of the DCL rules and GloBE regime. Taxpayers may exclude any top-up taxes derived from the income inclusion rule (IIR) and undertaxed profits rule (UTPR), or qualified domestic minimum top-up taxes (QDMTTs) from their application of the DCL rules for taxable years beginning before August 31, 2025. 

Applicability Date

The Final Regulations regarding DPLs apply to taxable years beginning on or after January 1, 2026. The anti-avoidance rule applies to DCLs incurred in taxable years ending on or after August 6, 2024 and to DPLs in taxable years beginning on or after January 1, 2026. 

For more information, please contact:

Layla J. Asali, lasali@milchev.com, 202-626-5866

Caroline R. Reaves, creaves@milchev.com, 202-626-5939

Candice C. James, cjames@milchev.com, 202-626-5810

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