Reg. § 1.965-2 — Adjustments to earnings and profits and basis.

(a) Scope This section provides rules relating to adjustments to earnings and profits and basis to determine and account for the application of section and (b) and and a rule that limits the amount of gain recognized under section by reason of distributions attributable to section previously taxed earnings and profits (as defined in of this section) in the inclusion year. of this section provides rules relating to adjustments to earnings and profits of a specified foreign corporation for purposes of applying sections , , , and . of this section provides rules regarding adjustments to earnings and profits by reason of section . of this section provides rules regarding adjustments to earnings and profits by reason of section . Paragraph (e) provides rules regarding adjustments to basis by reason of section . of this section provides an election to make certain adjustments to basis corresponding to adjustments to earnings and profits by reason of section . of this section provides rules that limit the amount of gain recognized in connection with the application of section and that require related reductions in basis. of this section provides rules regarding basis adjustments. of this section provides definitions that apply for purposes of this section. of this section provides examples illustrating the application of this section.

(b) Determination of and adjustments to earnings and profits of a specified foreign corporation for purposes of applying sections 902, 959, 960, and 965 For the taxable year of a specified foreign corporation in which an E&P measurement date occurs, and the last taxable year of a specified foreign corporation that begins before January 1, 2018, and the taxable year of a section U.S. shareholder in which or with which any such year ends, the adjustments to earnings and profits described in through of this section apply in sequence. For purposes of determining the consequences under sections and of a distribution or an inclusion under section , after the application of those paragraphs, the ordering rule in applies except that section is applied with respect to any distributions from the specified foreign corporation described in of this section that are not disregarded under before section is applied with respect to an inclusion or distribution described in , , or of this section.

(1) Each of the subpart F income of the specified foreign corporation and the amount required to be included in income under section , if any, are determined without regard to section , but taking into account any relevant distributions, and earnings and profits of the specified foreign corporation that are described in section with respect to the section U.S. shareholder are increased to the extent of the section U.S. shareholder's inclusion under section without regard to section (including to the extent provided in section ).

(2) The treatment of a distribution by the specified foreign corporation to another specified foreign corporation that is made before January 1, 2018, and, in the case of a taxable year of a specified foreign corporation before its last taxable year that begins before January 1, 2018, any other distribution from the specified foreign corporation made before the relevant E&P measurement date, is determined under section .

(3) Each of the post-1986 earnings and profits (including a deficit) of the specified foreign corporation, the accumulated post-1986 deferred foreign income of the specified foreign corporation, the section earnings amount of the specified foreign corporation, and the section inclusion amount with respect to the specified foreign corporation, if any, is determined, taking into account the rules of , and the earnings and profits (including a deficit) of the specified foreign corporation are adjusted as provided in and of this section. For a rule disregarding subpart F income earned after an E&P measurement date for purposes of calculating accumulated post-1986 deferred foreign income as of the E&P measurement date, see .

(4) The treatment of distributions described in of this section that are disregarded under is redetermined (if necessary) and the treatment of all distributions from the specified foreign corporation other than those described in of this section is determined under section .

(5) An amount is determined under section with respect to the specified foreign corporation and the section U.S. shareholder; earnings and profits of the specified foreign corporation described in section with respect to the section U.S. shareholder are reclassified as earnings and profits described in section with respect to the section U.S. shareholder to the extent the amount determined under section would, but for section , be included by the section U.S. shareholder under section ; and earnings and profits described in section with respect to the section U.S. shareholder are further increased to the extent of the section U.S. shareholder's inclusion under section .

(c) Adjustments to earnings and profits by reason of section 965(a) The earnings and profits of a deferred foreign income corporation described in section with respect to a section U.S. shareholder are increased by an amount equal to the section inclusion amount of the section U.S. shareholder with respect to the deferred foreign income corporation, if any, translated (if necessary) into the functional currency of the deferred foreign income corporation using the spot rate on December 31, 2017, provided the section inclusion amount is included in income by the section U.S. shareholder. For purposes of the section regulations, the earnings and profits described in section by reason of this and the earnings and profits initially described in section by reason of this but subsequently reclassified as earnings and profits described in section , if any, are referred to as section previously taxed earnings and profits. Furthermore, the earnings and profits (including a deficit) of the deferred foreign income corporation that are described in section (or that would be described in section but for the application of section and the section regulations) are reduced (or, in the case of a deficit, increased) by an amount equal to the section previously taxed earnings and profits.

(d) Adjustments to earnings and profits by reason of section 965(b)

(1) Adjustments to earnings and profits described in section 959(c)(2) and (c)(3) of deferred foreign income corporations The earnings and profits of a deferred foreign income corporation described in section with respect to a section U.S. shareholder are increased by an amount equal to the reduction to the section U.S. shareholder's pro rata share of the section earnings amount of the deferred foreign income corporation under section , , and , as applicable, translated (if necessary) into the functional currency of the deferred foreign income corporation using the spot rate on December 31, 2017, provided the section U.S. shareholder includes the section inclusion amount (if any) with respect to the deferred foreign income corporation in income. For purposes of the section regulations, the earnings and profits described in section by reason of this and the earnings and profits initially described in section by reason of this but subsequently reclassified as earnings and profits described in section are referred to as section previously taxed earnings and profits, and are treated as having been previously included in the gross income of the section U.S. shareholder under section for purposes of section . Furthermore, the earnings and profits (including a deficit) described in section 959(c)(3) of the deferred foreign income corporation (or that would be described in section but for the application of section and the section regulations) are reduced (or, in the case of a deficit, increased) by an amount equal to the section previously taxed earnings and profits.

(2) Adjustments to earnings and profits described in section 959(c)(3) of E&P deficit foreign corporations

(i) Increase in earnings and profits by an amount equal to the portion of the section 958(a) U.S. shareholder's pro rata share of the specified E&P deficit taken into account

(A) In general For an E&P deficit foreign corporation's last taxable year that begins before January 1, 2018, the earnings and profits of the E&P deficit foreign corporation described in section are increased by an amount equal to the portion of a section U.S. shareholder's pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under section , , and , as determined under of this section, translated (if necessary) into the functional currency of the E&P deficit foreign corporation using the spot rate on December 31, 2017. For purposes of section , the earnings and profits of the E&P deficit foreign corporation attributable to the increase described in the preceding sentence are not treated as earnings and profits of the taxable year described in section . See also for the timing of this adjustment for purposes of determining foreign taxes deemed paid under sections and .

(B) Reduction of a qualified deficit For purposes of section , a section U.S. shareholder's pro rata share of the earnings and profits of an E&P deficit foreign corporation is increased by an amount equal to the portion of the section U.S. shareholder's pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under section , , or , as applicable, as determined under of this section, translated (if necessary) into the functional currency of the E&P deficit foreign corporation using the spot rate on December 31, 2017, and such increase is attributable to the same activity to which the deficit so taken into account was attributable.

(ii) Determination of portion of a section 958(a) U.S. shareholder's pro rata share of a specified E&P deficit taken into account

(A) In general The portion of a section U.S. shareholder's pro rata share of a specified E&P deficit of an E&P deficit foreign corporation taken into account under section , , or , as applicable, is 100 percent of the section U.S. shareholder's pro rata share of the specified E&P deficit if either of the following conditions is satisfied:

(1) The section U.S. shareholder (including a consolidated group of which the section U.S. shareholder is a member) does not have an excess aggregate foreign E&P deficit (as defined in ), or

(2) If the section U.S. shareholder is a member of an affiliated group in which not all members are members of the same consolidated group, the amount described in with respect to the affiliated group is equal to or greater than the amount described .

(B) Designation of portion of a section 958(a) U.S. shareholder's pro rata share of a specified E&P deficit taken into account If neither the condition in paragraph (d)(2)(ii)(A)(1) nor the condition in paragraph (d)(2)(ii)(A)(2) is satisfied with respect to a section U.S. shareholder, then the section U.S. shareholder must designate the portion taken into account by reporting to each E&P deficit foreign corporation of the section U.S. shareholder, and maintaining, in its books and records, a statement setting forth the following information—

(1) The portion of the section U.S. shareholder's pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under section , , or , as designated under , as applicable, and

(2) In the case of an E&P deficit foreign corporation that has a qualified deficit (as determined under section and ), the portion (if any) of the section shareholder's pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under of this section that is attributable to a qualified deficit, including the qualified activities to which such portion is attributable.

(e) Adjustments to basis by reason of section 965(a)

(1) General rule Except as provided in of this section, a section U.S. shareholder's basis in section stock of a deferred foreign income corporation, or a section U.S. shareholder's basis in applicable property with respect to a deferred foreign income corporation, is increased by the section U.S. shareholder's section inclusion amount with respect to the deferred foreign income corporation included in income by the section U.S. shareholder. See section .

(2) Section 962 election In the case of a section U.S. shareholder who has made an election under section for a section U.S. shareholder's inclusion year, the increase in basis in the section U.S. shareholder's section stock of, or applicable property with respect to, a deferred foreign income corporation cannot exceed an amount equal to the amount of tax paid under chapter 1 of the Code with respect to the section U.S. shareholder's section inclusion amount with respect to the deferred foreign income corporation, taking into account any section election made by the section U.S. shareholder.

(f) Adjustments to basis by reason of section 965(b)

(1) In general Except as provided in of this section, no adjustments to basis of stock or property are made under section (or any other provision of the Code) to take into account the reduction to a section U.S. shareholder's pro rata share of the section earnings amount of a deferred foreign income corporation under section , , or , as applicable.

(2) Election to make adjustments to basis to account for the application of section 965(b)

(i) In general If a section U.S. shareholder makes the election as provided in this , the adjustments to basis described in of this section are made with respect to each deferred foreign income corporation and each E&P deficit foreign corporation in which the section U.S. shareholder owns section stock.

(ii) Basis adjustments

(A) Increase in basis with respect to a deferred foreign income corporation

(1) In general Except as provided in and of this section, a section U.S. shareholder's basis in section stock of a deferred foreign income corporation, or a section U.S. shareholder's basis in applicable property with respect to a deferred foreign income corporation, is increased by an amount equal to the section previously taxed earnings and profits of the deferred foreign income corporation with respect to the section U.S. shareholder, translated (if necessary) into U.S. dollars using the spot rate on December 31, 2017.

(2) Limited basis adjustment A section U.S. shareholder may, in lieu of applying of this section, designate the amount by which it increases its basis in section stock of, or applicable property with respect to, a deferred foreign income corporation, provided that—

(i) The increase does not exceed the section previously taxed earnings and profits of the deferred foreign income corporation with respect to the section U.S. shareholder, translated (if necessary) into U.S. dollars using the spot rate on December 31, 2017; and

(ii) The aggregate amount of a section U.S. shareholder's increases in basis with respect to stock or applicable property pursuant to of this section does not exceed the aggregate amount of the section U.S. shareholder's reductions in basis pursuant to of this section subject to the limitation under of this section.

(B) Reduction in basis with respect to an E&P deficit foreign corporation

(1) In general Except as provided in and of this section, a section U.S. shareholder's basis in section stock of an E&P deficit foreign corporation, or a section U.S. shareholder's basis in applicable property with respect to an E&P deficit foreign corporation, is reduced by an amount equal to the portion of the section U.S. shareholder's pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under section , , and , as applicable, as determined under of this section, translated (if necessary) into U.S. dollars using the spot rate on December 31, 2017. For rules requiring gain recognition, see of this section.

(2) Limited basis adjustment If a section U.S. shareholder adjusts its basis in section stock of, or applicable property with respect to, one or more deferred foreign income corporations under of this section, the section U.S. shareholder's aggregate reductions in basis in section stock of, or applicable property with respect to, an E&P deficit foreign corporation pursuant to of this section on a day may not exceed the amount of the section U.S. shareholder's basis in the section stock of, or applicable property with respect to, such E&P deficit foreign corporation, determined without taking into account specified basis adjustments to the section stock of, or applicable property with respect to, such E&P deficit foreign corporation.

(C) Section 962 election In the case of a section U.S. shareholder who has made an election under section for a section U.S. shareholder's inclusion year, the adjustments provided in and of this section do not apply.

(iii) Rules regarding the election

(A) Consistency requirement In order for the election described in this to be effective, a section U.S. shareholder and each section U.S. shareholder of an E&P deficit foreign corporation or of a deferred foreign income corporation with respect to which the second section U.S. shareholder's pro rata share of the section earnings amount is reduced under section , , or that is related to the first section U.S. shareholder must make the election described in this . For purposes of this , a person is treated as related to a section U.S. shareholder if the person bears a relationship to the section U.S. shareholder described in section or .

(B) Manner of making election

(1) Timing

(i) In general Except as provided in of this section, the election provided in this must be made no later than the due date (taking into account extensions, if any) for the section U.S. shareholder's return for the first taxable year that includes the last day of the last taxable year of a deferred foreign income corporation or E&P deficit foreign corporation of the shareholder that begins before January 1, 2018. Relief is not available under or to file a late election. Except as provided in of this section, the election provided in this is irrevocable.

(ii) Transition rule If the due date referred to in of this section occurs before May 6, 2019, the election must be made by May 6, 2019. In the case of an election made before February 5, 2019, the election may be revoked by attaching a statement, signed under penalties of perjury, to an amended return filed by May 6, 2019. The statement must contain the section U.S. shareholder's name and taxpayer identification number and a statement that the section U.S. shareholder and all related persons, as defined in of this section, that are section U.S. shareholders of E&P deficit foreign corporations or of deferred foreign income corporations with respect to which the section U.S. shareholder's pro rata share of the section earnings amount is reduced under section , , or revoke the election provided in this .

(2) Election statement Except as otherwise provided in publications, forms, instructions, or other guidance, to make the election provided in this , a section U.S. shareholder must attach a statement, signed under penalties of perjury consistent with the rules for signatures applicable to the section U.S. shareholders return, to its return for the first taxable year that includes the last day of the last taxable year of a deferred foreign income corporation or E&P deficit foreign corporation of the shareholder that begins before January 1, 2018. The statement must include the section U.S. shareholder's name, taxpayer identification number, and a statement that the section U.S. shareholder and all related persons, as defined in of this section, that are section U.S. shareholders of E&P deficit foreign corporations or of deferred foreign income corporations with respect to which the section U.S. shareholder's pro rata share of the section earnings amount is reduced under section , , or make the election provided in this . If the section U.S. shareholder increases its basis in stock or applicable property under of this section and decreases its basis in stock or applicable property pursuant to of this section subject to the limitation under of this section, the election statement must so indicate. The attachment of an unsigned copy of the election statement to the timely-filed return for the relevant taxable year satisfies the signature requirement of this if the section U.S. shareholder retains the original signed election statement in the manner specified by .

(g) Gain reduction rule

(1) Reduction in gain recognized under section 961(b)(2) by reason of distributions attributable to section 965 previously taxed earnings and profits in the inclusion year

(i) In general If a section U.S. shareholder receives a distribution from a deferred foreign income corporation (including through a chain of ownership described under section ) during the inclusion year of the deferred foreign income corporation that is attributable to section previously taxed earnings and profits of the deferred foreign income corporation, then the amount of gain that otherwise would be recognized under section by the section U.S. shareholder with respect to the section U.S. shareholder's section stock of the deferred foreign income corporation or interest in applicable property with respect to the deferred foreign income corporation is reduced (but not below zero) by an amount equal to the section previously taxed earnings and profits of the deferred foreign income corporation with respect to the section U.S. shareholder, translated (if necessary) into U.S. dollars at the spot rate on December 31, 2017.

(ii) Definition of section 965 previously taxed earnings and profits For purposes of of this section, the term section previously taxed earnings and profits means, with respect to a deferred foreign income corporation and a section U.S. shareholder, the sum of the section previously taxed earnings and profits of the deferred foreign income corporation with respect to the section U.S. shareholder, and, if the section U.S. shareholder has made the election described in of this section, the section previously taxed earnings and profits of the deferred foreign income corporation with respect to the section U.S. shareholder.

(2) Reduction in basis by an amount equal to the gain reduction amount If a section U.S. shareholder does not recognize gain under section by reason of of this section with respect to a distribution from a deferred foreign income corporation (including through a chain of ownership described under section ), the section U.S. shareholder's basis in the section stock of the deferred foreign income corporation, or the section U.S. shareholder's basis in the applicable property with respect to the deferred foreign income corporation, is reduced by the amount of gain that would otherwise be recognized by the section U.S. shareholder without regard to of this section.

(h) Rules of application for specified basis adjustments This applies for purposes of making any adjustment to the basis of section stock or applicable property with respect to a specified foreign corporation described in , , or of this section (collectively, specified basis adjustments, and each a specified basis adjustment).

(1) Timing of basis adjustments Except as provided in of this section, a specified basis adjustment to section stock or applicable property with respect to a specified foreign corporation is made as of the last day of the last taxable year of the specified foreign corporation that begins before January 1, 2018, on which it is a specified foreign corporation.

(2) Netting of basis adjustments If one or more specified basis adjustments occur on the same day with respect to the same section stock or applicable property, a single basis adjustment is made as of the close of such day with respect to such stock or applicable property in an amount equal to the net amount, if any, of the increase or reduction, as applicable.

(3) Gain recognition for reduction in excess of basis The excess (if any) of a net reduction in basis with respect to section stock or applicable property of a section U.S. shareholder by reason of one or more specified basis adjustments over the section U.S. shareholder's basis in such stock or applicable property without regard to the specified basis adjustments is treated as gain from the sale or exchange of property.

(4) Adjustments with respect to each share

(i) Section 958(a) stock If a specified basis adjustment is made with respect to section stock, the specified basis adjustment is made with respect to each share of the section stock in a manner consistent with the section U.S. shareholder's pro rata share of the section earnings amount or specified E&P deficit, as applicable, by reason of such share.

(ii) Applicable property If a specified basis adjustment is made with respect to applicable property, the adjustment is made with respect to the applicable property in a manner consistent with the application of of this section.

(5) Stock or property for which adjustments are made

(i) In general Except as provided in of this section, a specified basis adjustment is made solely with respect to section stock owned by the section U.S. shareholder within the meaning of section or applicable property owned directly by the section U.S. shareholder.

(ii) Special rule for an interest in a foreign pass-through entity If the applicable property of the section U.S. shareholder described in of this section is an interest in a foreign pass-through entity, then, for purposes of determining the foreign pass-through entity's basis in section stock or applicable property, as applicable, with respect to the section U.S. shareholder, a specified basis adjustment is made with respect to section stock or applicable property of the section U.S. shareholder owned through the foreign pass-through entity in the same manner as if the section stock or applicable property were owned directly by the section U.S. shareholder. In the case of tiered foreign pass-through entities, this applies with respect to each foreign pass-through entity.

(i) Definitions This provides definitions that apply for purposes of this section.

(1) Applicable property The term applicable property means, with respect to a section U.S. shareholder and a specified foreign corporation, property owned by the section U.S. shareholder (including through one or more foreign pass-through entities) by reason of which the section U.S. shareholder is considered under section as owning section stock of the specified foreign corporation.

(2) Foreign pass-through entity The term foreign pass-through entity means a foreign partnership or a foreign estate or trust (as defined in section ) (including a controlled domestic partnership treated as a foreign partnership pursuant to ).

(3) Property The term property has the meaning provided in .

(j) Examples The following examples illustrate the application of this section.

(1) Example 1. Determination of accumulated post-1986 deferred foreign income with subpart F income earned before E&P measurement date on November 2, 2017

(i) Facts USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation, which owns all of the stock of CFC2, also a foreign corporation. USP, CFC1, and CFC2 all have taxable years ending December 31, 2017. As of January 1, 2017, CFC1 has no earnings and profits, and CFC2 has 100u of earnings and profits described in section that were accumulated in taxable years beginning after December 31, 1986, while CFC2 was a specified foreign corporation, and $21x of post-1986 foreign income taxes. None of CFC2's earnings and profits are attributable to income treated as effectively connected with the conduct of a trade or business within the United States. On March 1, 2017, CFC1 earns 30u of subpart F income (as defined in section ), and CFC2 earns 20u of subpart F income. No foreign income tax is imposed on CFC1's or CFC2's subpart F income. For purposes of section , the post-1986 undistributed earnings, subpart F income, and post-1986 foreign income taxes are in the general category. On July 1, 2017, CFC2 distributes 40u to CFC1. On November 1, 2017, CFC1 distributes 60u to USP. USP does not have an aggregate foreign E&P deficit. USP includes in gross income all amounts that it is required to include under section . No foreign income tax is imposed or withheld on the distribution by CFC2 to CFC1 or the distribution by CFC1 to USP.

(ii) Analysis

(A) Adjustments to section 959(c) classification of earnings and profits for inclusion under section 951(a)(1)(A) without regard to section 965 The distribution from CFC2 to CFC1 does not give rise to subpart F income to CFC1 due to the application of section . Accordingly, USP's inclusion under section without regard to section is 30u with respect to CFC1 and 20u with respect to CFC2 for their taxable years ending December 31, 2017. As a result of the inclusions under section , CFC1 and CFC2 increase their earnings and profits described in section by 30u and 20u, respectively.

(B) Distributions between specified foreign corporations before January 1, 2018 The distribution of 40u from CFC2 to CFC1 is treated as a distribution of 20u out of earnings and profits described in section (attributable to inclusions under section without regard to section ) and 20u out of earnings and profits described in section .

(C) Section 965(a) inclusion amount USP determines whether CFC1 and CFC2 are deferred foreign income corporations and, if so, determines its section inclusion amounts with respect to CFC1 and CFC2. CFC1 and CFC2 are specified foreign corporations, and CFC1 and CFC2 each have accumulated post-1986 deferred foreign income greater than zero as of an E&P measurement date. Accordingly, CFC1 and CFC2 are deferred foreign income corporations. USP's section inclusion amount with respect to each of CFC1 and CFC2, respectively, equals the section earnings amount of CFC1 and CFC2, respectively.

(1) CFC1 section 965(a) earnings amount The section earnings amount with respect to CFC1 is 20u, the amount of its accumulated post-1986 deferred foreign income as of both November 2, 2017, and December 31, 2017, which is equal to 70u of post-1986 earnings and profits (30u earned and 40u attributable to the CFC2 distribution) reduced by 50u of such post-1986 earnings and profits described in section (30u earned and 20u attributable to the CFC2 distribution) under section and . Under section and , the post-1986 earnings and profits of CFC1 are not reduced by the 60u distribution to USP.

(2) CFC2 section 965(a) earnings amount The section earnings amount with respect to CFC2 is 80u, the amount of its accumulated post-1986 deferred foreign income as of both November 2, 2017, and December 31, 2017, which is equal to the amount of CFC2's post-1986 earnings and profits of 80u. CFC2's accumulated post-1986 deferred foreign income is equal to its post-1986 earnings and profits because CFC2 does not have earnings and profits that are attributable to income of the specified foreign corporation that is effectively connected with the conduct of a trade or business within the United States and subject to tax under chapter 1, or that, if distributed, would be excluded from the gross income of a United States shareholder under section or from the gross income of another shareholder if such shareholder were a United States shareholder, and, therefore, no adjustment is made under section or . CFC2's 80u of post-1986 earnings and profits consists of 120u of earnings and profits that it earned, reduced by the 40u distribution to CFC1 under section and . The amount of the reduction to the post-1986 earnings and profits of CFC2 for the 40u distribution is not limited by because CFC1's post-1986 earnings and profits are increased by 40u as a result of the distribution. Furthermore, because the 40u distribution was made on July 1, 2017, which is before the E&P measurement date on November 2, 2017, is not relevant.

(3) Effect on earnings and profits described in section 959(c)(2) and (3) CFC1 and CFC2 increase their earnings and profits described in section by USP's section inclusion amounts with respect to CFC1 and CFC2, 20u and 80u, respectively, and reduce their earnings and profits described in section by an equivalent amount.

(D) Distribution to United States shareholder The distribution from CFC1 to USP is treated as a distribution of 60u out of the earnings and profits of CFC1 described in section , which include earnings and profits attributable to the section inclusion amount taken into account by USP.

(E) Section 902 and section 960 consequences

(1) Distribution by and inclusions with respect to CFC2 Under section , USP is deemed to pay $3.50x ($21x × (20u/120u)) of CFC2's post-1986 foreign income taxes as a result of its inclusion under section without regard to section with respect to CFC2. As a result of the distribution from CFC2 to CFC1, CFC2's post-1986 foreign income taxes are reduced, and CFC1's post-1986 foreign income taxes are increased, by the foreign income taxes deemed paid by CFC1 under section of $3.50x (($21x−$3.50x) × (20u/120u−20u)). Under section , USP is deemed to pay $14x (($21x−$3.50x−$3.50x) × 80u/(120u−40u)) of CFC2's post-1986 foreign income taxes as a result of its section inclusion with respect to CFC2. The taxes deemed paid by USP as a result of its section inclusion with respect to CFC2 are subject to the applicable percentage disallowance under section .

(2) Inclusions with respect to CFC1 As determined in paragraph (j)(1)(ii)(E)(1) of this section (paragraph (E)(1) in the analysis in this Example 1), as a result of the distribution from CFC2 to CFC1, CFC1 is deemed under section to pay $3.50x of CFC2's post-1986 foreign income taxes. Under section , USP is deemed to pay $2.10x ($3.50x × (30u/(30u + 20u))) of CFC1's post-1986 foreign income taxes as a result of its inclusion under section without regard to section with respect to CFC1. Under section , USP is deemed to pay $1.40x (($3.50x−$2.10x) × 20u/(30u + 20u−30u)) of CFC1's post-1986 foreign income taxes as a result of its section inclusion with respect to CFC1. The taxes deemed paid by USP as a result of its section inclusion with respect to CFC1 are subject to the applicable percentage disallowance under section .

(2) Example 2. Determination of accumulated post-1986 deferred foreign income with subpart F income earned after E&P measurement date on November 2, 2017

(i) Facts The facts are the same as in of this section (the facts in Example 1), except that on December 1, 2017, CFC1 earns an additional 50u of subpart F income (as defined in section ), and neither CFC1 nor CFC2 has any post-1986 foreign income taxes.

(ii) Analysis

(A) Adjustments to section 959(c) classification of earnings and profits for inclusion under section 951(a)(1)(A) without regard to section 965 USP determines its inclusion under section without regard to section , which is 80u with respect to CFC1 and 20u with respect to CFC2 for their taxable years ending December 31, 2017. As a result of the inclusions under section , CFC1 and CFC2 increase their earnings and profits described in section by 80u and 20u, respectively.

(B) Distributions between specified foreign corporations before January 1, 2018 The analysis is the same as in of this section (paragraph (B) in the analysis in Example 1).

(C) Section 965(a) inclusion amount USP determines whether CFC1 and CFC2 are deferred foreign income corporations and, if so, determines its section inclusion amounts with respect to CFC1 and CFC2. CFC1 and CFC2 are specified foreign corporations, and CFC1 and CFC2 each have accumulated post-1986 deferred foreign income greater than zero as of an E&P measurement date. Accordingly, CFC1 and CFC2 are deferred foreign income corporations. USP's section inclusion amount with respect to each of CFC1 and CFC2, respectively, equals the section earnings amount of CFC1 and CFC2, respectively.

(1) CFC1 section 965(a) earnings amount The section earnings amount with respect to CFC1 is 20u, the greater of—

(i) The amount of its accumulated post-1986 deferred foreign income as of November 2, 2017, 20u, which is equal to 70u of post-1986 earnings and profits (30u earned and 40u attributable to the CFC2 distribution) reduced by 50u of such post-1986 earnings and profits described in section without regard to the subpart F income earned after November 2, 2017 (30u earned and 20u attributable to the CFC2 distribution) under section and and , and

(ii) The amount of its accumulated post-1986 deferred foreign income as of December 31, 2017, 20u, which is equal to 120u of post-1986 earnings and profits (80u earned and 40u attributable to the CFC2 distribution) reduced by 100u of such post-1986 earnings and profits described in section with regard to the subpart F income earned on or before December 31, 2017 (80u earned and 20u attributable to the CFC2 distribution) under section and and .

(2) CFC2 section 965(a) earnings amount The analysis is the same as in of this section (paragraph (C)(2) in the analysis in Example 1)).

(3) Effect on earnings and profits described in section 959(c)(2) and (3) The analysis is the same as in of this section (paragraph (C)(3) in the analysis in Example 1).

(D) Distribution to United States shareholder The analysis is the same as in of this section (paragraph (D) in the analysis in Example 1).

(3) Example 3. Determination of accumulated post-1986 deferred foreign income with subpart F income earned after E&P measurement date on November 2, 2017, but previously taxed earnings and profits attributable to the subpart F income distributed before E&P measurement date on November 2, 2017

(i) Facts The facts are the same as in of this section (the facts in Example 1), except that on December 1, 2017, CFC2 earns an additional 50u of subpart F income (as defined in section ), and neither CFC1 nor CFC2 has any post-1986 foreign income taxes.

(ii) Analysis

(A) Adjustments to section 959(c) classification of earnings and profits for inclusion under section 951(a)(1)(A) without regard to section 965 USP determines its inclusion under section without regard to section , which is 30u with respect to CFC1 and 70u with respect to CFC2 for their taxable years ending December 31, 2017. As a result of the inclusions under section , CFC1 and CFC2 increase their earnings and profits described in section by 30u and 70u, respectively.

(B) Distributions between specified foreign corporations before January 1, 2018 The distribution of 40u from CFC2 to CFC1 is treated as a distribution of 40u out of earnings and profits described in section (attributable to inclusions under section without regard to section ).

(C) Section 965(a) inclusion amount USP determines whether CFC1 and CFC2 are deferred foreign income corporations, and, if so, determines its section inclusion amounts with respect to CFC1 and CFC2. Because USP wholly owns CFC1 and CFC2 under section and USP does not have an aggregate foreign E&P deficit, USP's section inclusion amount with respect to each of CFC1 and CFC2, respectively, equals the section earnings amount, if any, of CFC1 and CFC2, respectively.

(1) CFC1 section 965(a) earnings amount CFC1 is not a deferred foreign income corporation and does not have a section earnings amount because the amount of its accumulated post-1986 deferred foreign income as of both November 2, 2017, and December 31, 2017, is 0u, which is equal to 70u of post-1986 earnings and profits (30u earned and 40u attributable to the CFC2 distribution) reduced by 70u of such post-1986 earnings and profits described in section (30u earned and 40u attributable to the CFC2 distribution) under section and .

(2) CFC2 section 965(a) earnings amount The section earnings amount with respect to CFC2 is 100u, the greater of the amounts in and of this section (paragraph (C)(2)(i) and (ii) in the analysis in this Example 3)—

(i) The amount of its accumulated post-1986 deferred foreign income as of November 2, 2017, 80u. CFC2's 80u of accumulated post-1986 deferred foreign income as of November 2, 2017, is equal to its 80u of post-1986 earnings and profits because no adjustment is made under section or , as CFC2 does not have earnings and profits that are attributable to income of the specified foreign corporation that is effectively connected with the conduct of a trade or business within the United States and subject to tax under chapter 1, or that, if distributed, would be excluded from the gross income of a United States shareholder under section or from the gross income of another shareholder if such shareholder were a United States shareholder, without regard to the subpart F income earned after November 2, 2017. CFC2's 80u of post-1986 earnings and profits consists of 120u of earnings and profits that it earned, reduced by the 40u distribution to CFC1 under section and . The amount of the reduction to the post-1986 earnings and profits of CFC2 for the 40u distribution is not limited by because CFC1's post-1986 earnings and profits are increased by 40u as a result of the distribution. Furthermore, because the 40u distribution was made on July 1, 2017, which is before any E&P measurement date, is not relevant.

(ii) The amount of its accumulated post-1986 deferred foreign income as of December 31, 2017, 100u, which is equal to 130u of post-1986 earnings and profits reduced by 30u of such post-1986 earnings and profits described in section with regard to the subpart F income earned before December 31, 2017, under section and and . CFC2's 130u of post-1986 earnings and profits consists of 170u of earnings and profits that it earned, reduced by the 40u distribution to CFC1 under section and .

(3) Effect on earnings and profits described in section 959(c)(2) and (3) CFC2 increases its earnings and profits described in section by USP's section inclusion amount with respect to CFC2, 100u, and reduces its earnings and profits described in section by an equivalent amount.

(D) Distribution to United States shareholder The analysis is the same as in of this section (paragraph (D) in the analysis in Example 1).

(4) Example 4. Determination of accumulated post-1986 deferred foreign income with distribution made after E&P measurement date on November 2, 2017

(i) Facts USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation, which owns all of the stock of CFC2, also a foreign corporation. USP, CFC1, and CFC2 all have taxable years ending December 31, 2017. As of January 1, 2017, CFC1 has 10u of earnings and profits described in section that were accumulated in taxable years beginning after December 31, 1986, while CFC1 was a specified foreign corporation, and $2x of post-1986 foreign income taxes; and CFC2 has 100u of earnings and profits described in section that were accumulated in taxable years beginning after December 31, 1986, while CFC2 was a specified foreign corporation and $10x of post-1986 foreign income taxes. For purposes of section , the post-1986 undistributed earnings and post-1986 foreign income taxes are in the general category. None of CFC1's or CFC2's earnings and profits are attributable to income treated as effectively connected with the conduct of a trade or business within the United States. On December 1, 2017, CFC2 distributes 100u to CFC1, and CFC1 distributes 10u to USP. USP does not have an aggregate foreign E&P deficit. USP includes in gross income all amounts that it is required to include under section . No foreign income tax is imposed or withheld on the distribution by CFC2 to CFC1 or the distribution by CFC1 to USP. USP does not apply to determine the post-1986 earnings and profits of CFC1 and CFC2.

(ii) Analysis

(A) Adjustments to section 959(c) classification of earnings and profits for inclusion under section 951(a)(1)(A) without regard to section 965 The distribution from CFC2 to CFC1 does not give rise to subpart F income to CFC1 due to the application of section . Accordingly, USP does not have an inclusion under section without regard to section with respect to CFC1 or CFC2 for their taxable years ending December 31, 2017. As a result, neither CFC1 nor CFC2 has earnings and profits described in section .

(B) Distributions between specified foreign corporations before January 1, 2018 The distribution of 100u from CFC2 to CFC1 is initially treated as a distribution out of earnings and profits described in section .

(C) Section 965(a) inclusion amount USP determines whether CFC1 and CFC2 are deferred foreign income corporations, and, if so, determines its section inclusion amounts with respect to CFC1 and CFC2. CFC1 and CFC2 are specified foreign corporations, and CFC1 and CFC2 each have accumulated post-1986 deferred foreign income greater than zero as of an E&P measurement date. Accordingly, CFC1 and CFC2 are deferred foreign income corporations. USP's section inclusion amount with respect to each of CFC1 and CFC2, respectively, equals the section earnings amount of CFC1 and CFC2, respectively.

(1) CFC1 section 965(a) earnings amount The section earnings amount with respect to CFC1 is 10u, the amount of its accumulated post-1986 deferred foreign income as of both November 2, 2017, and December 31, 2017, which is equal to the amount of CFC1's post-1986 earnings and profits of 10u. CFC1's accumulated post-1986 deferred foreign income is equal to its post-1986 earnings and profits because CFC1 does not have earnings and profits that are attributable to income of the specified foreign corporation that is effectively connected with the conduct of a trade or business within the United States and subject to tax under chapter 1, or that, if distributed, would be excluded from the gross income of a United States shareholder under section or from the gross income of another shareholder if such shareholder were a United States shareholder, and therefore no adjustment is made under section or . But for , CFC1's post-1986 earnings and profits as of December 31, 2017, would be 110u, but because the distribution from CFC2 is a specified payment, it is disregarded in determining CFC1's post-1986 earnings and profits as of December 31, 2017, under . Under section and , the post-1986 earnings and profits of CFC1 are not reduced by the 10u distribution to USP.

(2) CFC2 section 965(a) earnings amount The section earnings amount with respect to CFC2 is 100u, the amount of its accumulated post-1986 deferred foreign income as of both November 2, 2017, and December 31, 2017, which is equal to the amount of CFC2's post-1986 earnings and profits of 100u. CFC2's accumulated post-1986 deferred foreign income is equal to its post-1986 earnings and profits because CFC2 does not have earnings and profits that are attributable to income of the specified foreign corporation that is effectively connected with the conduct of a trade or business within the United States and subject to tax under chapter 1, or that, if distributed, would be excluded from the gross income of a United States shareholder under section or from the gross income of another shareholder if such shareholder were a United States shareholder, and therefore no adjustment is made under section or . But for , CFC2's post-1986 earnings and profits as of December 31, 2017, would be 0u, but because the distribution to CFC1 is a specified payment, it is disregarded in determining CFC2's post-1986 earnings and profits as of December 31, 2017, under .

(3) Effect on earnings and profits described in section 959(c)(2) and (3) CFC1 and CFC2 increase their earnings and profits described in section by USP's section inclusion amounts with respect to CFC1 and CFC2, 10u and 100u, respectively, and reduce their earnings and profits described in section by an equivalent amount.

(D) Distributions

(1) Distribution that is a specified payment The distribution from CFC2 to CFC1 is recharacterized as a distribution of 100u out of the earnings and profits of CFC2 described in section , which include earnings and profits attributable to the section inclusion amount taken into account by USP.

(2) Distribution to United States shareholder The distribution from CFC1 to USP is treated as a distribution of 10u out of the earnings and profits of CFC1 described in section , which include earnings and profits attributable to the section inclusion amount taken into account by USP.

(E) Section 902 and section 960 consequences Under section , USP is deemed to pay $10x ($10x × (100u/100u)) of CFC2's post-1986 foreign income taxes as a result of its section inclusion with respect to CFC2 and $2x ($2x × (10u/10u) of CFC1's post-1986 foreign income taxes as a result of its section inclusion with respect to CFC1. Such taxes are subject to the applicable percentage disallowance under section .

(5) Example 5. Determination of accumulated post-1986 deferred foreign income with section 951(a)(1)(B) inclusion after E&P measurement date on November 2, 2017

(i) Facts USP, a domestic corporation, owns all of the stock of CFC, a foreign corporation. USP has a taxable year ending December 31, 2017, and CFC has a taxable year ending November 30, 2017. As of December 1, 2016, CFC has 110u of earnings and profits described in section that were accumulated in taxable years beginning after December 31, 1986, while CFC was a specified foreign corporation. CFC holds 150u of United States property throughout its taxable year ending November 30, 2017, but disposes of it on December 1, 2017, recognizing no gain or loss on the property. Between December 1, 2017, and December 31, 2017, CFC earns an additional 10u of income that does not constitute subpart F income or income treated as effectively connected with the conduct of a trade or business within the United States that gives rise to 10u of earnings and profits. USP includes in income all amounts that it is required to include under section .

(ii) Analysis

(A) Section 965(a) inclusion amount USP determines whether CFC is a deferred foreign income corporation, and, if so, determines its section inclusion amount with respect to CFC. CFC is a specified foreign corporation, and CFC has accumulated post-1986 deferred foreign income greater than zero as of an E&P measurement date. Accordingly, CFC is a deferred foreign income corporation. USP's section inclusion amount with respect to CFC equals the section earnings amount of CFC.

(1) CFC section 965(a) earnings amount The section earnings amount with respect to CFC is 110u, the greater of the amount of its accumulated post-1986 deferred foreign income as of November 2, 2017, which is 110u, and the amount of its accumulated post-1986 deferred foreign income as of December 31, 2017, which is 10u. CFC's accumulated post-1986 deferred foreign income as of November 2, 2017, is equal to its 110u of post-1986 earnings and profits, which are not reduced by the 110u of earnings and profits described in section as a result of USP's section inclusion with respect to CFC as of December 31, 2017, because such amounts would not be excluded from the gross income of a United States shareholder under section under section or if distributed on November 2, 2017. CFC's accumulated post-1986 deferred foreign income as of December 31, 2017, is equal to its 120u of post-1986 earnings and profits reduced by the 110u of earnings and profits described in section as a result of USP's section inclusion with respect to CFC as of December 31, 2017, which would be excluded from the gross income of a United States shareholder under section under section or if distributed on December 31, 2017.

(2) Effect on earnings and profits described in section 959(c)(2) and (3) In USP's taxable year ending December 31, 2018, CFC increases its earnings and profits described in section by USP's section inclusion amount with respect to CFC, 110u, and reduces its earnings and profits described in section by an equivalent amount.

(B) Section 956 inclusion In USP's taxable year ending December 31, 2017, USP increases its earnings and profits described in section by USP's amount included under sections and with respect to CFC, 110u, and reduces its earnings and profits described in section by an equivalent amount.

(6) Example 6. Section 1248 inclusion

(i) Facts USP1, a domestic corporation, owns all of the stock of CFC, a foreign corporation, until it sells all of such stock to USP2, a domestic corporation, on December 1, 2017, in a sale on which USP1 recognizes $100x of gain. Throughout 2017, 1u=$1x. USP1, USP2, and CFC all have taxable years ending December 31, 2017. As of January 1, 2017, CFC has 100u of earnings and profits described in section that were accumulated in taxable years beginning after December 31, 1986, while CFC was wholly owned by USP1. On March 1, 2017, CFC distributes 20u to USP1. None of CFC's earnings and profits are attributable to income treated as effectively connected with the conduct of a trade or business within the United States. USP2 does not have an aggregate foreign E&P deficit. USP1 and USP2 include in income all amounts that they are required to include under sections and .

(ii) Analysis

(A) Adjustments to section 959(c) classification of earnings and profits for section 1248 inclusion USP1's inclusion under section with respect to CFC is $80x ($100x−$20x). As a result of the inclusion under section , under section , CFC increases its earnings and profits described in section by 80u.

(B) Section 965(a) inclusion amount USP2 determines whether CFC is a deferred foreign income corporation and, if so, determines its section inclusion amount with respect to CFC. CFC is a specified foreign corporation, and CFC has accumulated post-1986 deferred foreign income greater than zero as of an E&P measurement date. Accordingly, CFC is a deferred foreign income corporation. USP2's section inclusion amount with respect to CFC equals the section earnings amount of CFC. The section earnings amount with respect to CFC is 20u, the amount of its accumulated post-1986 deferred foreign income as of both November 2, 2017, and December 31, 2017, which is equal to 100u of post-1986 earnings and profits reduced by 80u of such post-1986 earnings and profits described in section under section and . CFC increases its earnings and profits described in section by USP2's section inclusion amount with respect to CFC, 20u, and reduces its earnings and profits that would be described in section but for the application of section by an equivalent amount.

(C) Distributions to United States shareholders The distributions from CFC to USP1 (including the deemed dividend under section ) are treated as distributions out of the earnings and profits of CFC described in section .

(7) Example 7. Distribution attributable to section 965(a) previously taxed earnings and profits

(i) Facts USP, a domestic corporation, owns all of the stock of CFC1, a specified foreign corporation that has no post-1986 earnings and profits (or deficit in post-1986 earnings and profits), and CFC1 owns all the stock of CFC2, a deferred foreign income corporation. USP is a calendar year taxpayer. CFC1's last taxable year beginning before January 1, 2018, ends on November 30, 2018; CFC2 has an inclusion year that ends on November 30, 2018. The functional currency of CFC1 and CFC2 is the U.S. dollar. USP's adjusted basis in the stock of CFC1 is zero. On January 1, 2018, CFC2 distributes $100x to CFC1, and CFC1 distributes $100x to USP. USP has a section inclusion amount of $100x with respect to CFC2 that is taken into account for USP's taxable year ending December 31, 2018. CFC2 has no earnings and profits described in section or (2) other than section previously taxed earnings and profits.

(ii) Analysis Under of this section, CFC2 has $100x of section previously taxed earnings and profits with respect to USP. USP receives a distribution from CFC2 through a chain of ownership described in section during the inclusion year of CFC2 that is attributable to the $100x of section previously taxed earnings and profits of CFC2. Under of this section, the amount of gain that USP otherwise would recognize with respect to the stock of CFC1 under section is reduced (but not below zero) by $100x, the amount of CFC2's section previously taxed earnings and profits with respect to USP. As of the close of November 30, 2018, USP's basis in CFC1 is increased under of this section by USP's section inclusion amount with respect to CFC2 ($100x), and is reduced under of this section by the amount of gain that would have been recognized by USP under section but for the application of of this section ($100x).

(8) Example 8. Distribution attributable to section 965(b) previously taxed earnings and profits; parent-subsidiary

(i) Facts The facts are the same as in of this section (the facts in Example 7), except that CFC1 has a specified E&P deficit of $100x. Because of the specified E&P deficit of CFC1, USP's section inclusion amount with respect to CFC2 is reduced to zero pursuant to section and . USP makes the election described in of this section.

(ii) Analysis

(A) Application of the gain reduction rule Under of this section, CFC2 has $100x of section previously taxed earnings and profits with respect to USP, and, under of this section, CFC1's earnings and profits described in section are increased by $100x to $0. USP receives a distribution from CFC2 through a chain of ownership described in section during the inclusion year of CFC2 that is attributable to the $100x of section previously taxed earnings and profits of CFC2. Under of this section, the amount of gain that USP otherwise would recognize with respect to the stock of CFC1 under section is reduced (but not below zero) by $100x, the amount of CFC2's section previously taxed earnings and profits with respect to USP under of this section.

(B) Adjustments to the basis of CFC1 Because USP makes the election described in of this section, as of the close of November 30, 2018, USP's basis in CFC1 is increased under of this section by an amount equal to CFC2's section previously taxed earnings and profits with respect to USP under of this section ($100x), reduced under of this section by an amount equal to the portion of the specified E&P deficit of CFC1 taken into account in determining USP's section inclusion amount with respect to CFC2 ($100x), and reduced under of this section by the amount of gain that would have been recognized by USP with respect to the stock of CFC1 under section but for the application of of this section ($100x). Under and of this section, the excess of the net reduction from the adjustments under and of this section over USP's basis in the stock of CFC1 (in this case, $100x) is treated as gain recognized by USP from the sale or exchange of property.

(9) Example 9. Distribution attributable to section 965(b) previously taxed earnings and profits; brother-sister

(i) Facts The facts are the same as in of this section (the facts in Example 8), except that USP owns all the stock of CFC2, USP's adjusted basis in the stock of CFC2 is zero, CFC1 made no distributions, and on January 1, 2018, CFC2 distributes $100x to USP.

(ii) Analysis

(A) Application of the gain reduction rule Under of this section, CFC2 has $100x of section previously taxed earnings and profits with respect to USP, and, under of this section, CFC1's earnings and profits described in section (deficit of $100x) are increased by $100x to $0. USP receives a distribution from CFC2 during the inclusion year of CFC2 that is attributable to the $100x of section previously taxed earnings and profits of CFC2. Under of this section, the amount of gain that USP otherwise would recognize with respect to the stock of CFC2 under section is reduced (but not below zero) by $100x, the amount of CFC2's section previously taxed earnings and profits with respect to USP under of this section.

(B) Adjustments to the basis of CFC1 and CFC2 Because USP makes the election described in of this section, as of the close of November 30, 2018, USP's basis in the stock of CFC2 is increased under of this section by the amount of CFC2's section previously taxed earnings and profits with respect to USP under of this section ($100x) and reduced under of this section by the amount of gain that would have been recognized by USP with respect to the stock of CFC2 under section but for the application of of this section ($100x). As of the close of November 30, 2018, USP's basis in CFC1 is reduced under of this section by an amount equal to the portion of USP's pro rata share of the specified E&P deficit of CFC1 taken into account in determining USP's section inclusion amount with respect to CFC2 ($100x). Under of this section, the excess of the reduction under of this section over USP's basis in the stock of CFC1 (in this case, $100x) is treated as gain recognized by USP from the sale or exchange of property.

Reg. § 1.965-2 Adjustments to earnings and profits and basis.