IRS Notice 2025-72 Explained: Allocating Foreign Taxes Correctly
You know how sometimes a simple rule change creates a domino effect of problems that nobody saw coming? Well, that is exactly what happened recently with US multinational tax laws. A seemingly small tweak to the calendar caused a massive headache for companies with foreign operations. 🤯
If you’re dealing with Specified Foreign Corporations (CFCs), you might be looking at your books and wondering why the numbers for 2025 look completely out of whack. Don’t panic! The IRS has stepped in with a fix, and to be honest, it’s actually quite logical. Let’s break down exactly what happened and how to solve it without getting a migraine. 😊
The “One-Month Deferral” Headache 🗓️
First, let’s set the stage. For decades, US companies with foreign subsidiaries (CFCs) had a handy little option called the “one-month deferral.” Basically, if the US parent’s tax year ended on December 31st, the foreign subsidiary could end theirs on November 30th. It gave accountants a nice 30-day buffer to get the books in order.
But a new law passed on July 4, 2025, scrapped this practice. The goal was to align everyone’s calendars. The result? Foreign subsidiaries suddenly had to close a “short tax year” running just one month—from December 1 to December 31, 2025—to get in sync with the US parent.
This “short year” is just a one-time transition period. Starting January 1, 2026, both the US parent and the foreign subsidiary will be perfectly aligned on a standard calendar year.
Why the Math Didn’t Add Up 📉
Here is where things got messy. In many foreign countries, tax bills for the entire year are officially booked on the very last day of the year.
So, imagine this scenario: Your foreign subsidiary earned income for just that one month (December). But, because the foreign tax year ended on December 31st, the local government sent a tax bill for the full 12 months.
Suddenly, your US tax return shows:
- Income: Tiny (1 month worth)
- Tax Expense: Massive (12 months worth)
It’s like getting your electricity bill for the entire year on your January statement. It destroys your profit margins on paper and messes up your foreign tax credits. It looked like companies were taking a huge loss when they weren’t.
Without a fix, companies risked losing valuable foreign tax credits because the expense was disproportionately high compared to the income for that short period.
The IRS Fix: The Allocation Percentage 🛠️
Thankfully, the IRS released Notice 2025-72. They realized that jamming a year’s worth of taxes into one month was unfair. Their solution is a logical 4-step process to allocate the taxes correctly.
- Determine Total Tax: Figure out the foreign tax bill for the entire foreign tax year.
- Break it Down: Separate that tax by income groups (different types of income).
- Calculate Allocation %: This is the key. You calculate what percentage of the year’s income was earned during that short month.
- Assign the Tax: Multiply the total tax by that percentage. That’s the tax you assign to the short year. The rest rolls over to the next year.
Let’s look at a quick comparison of the “Old Way” (Chaos) vs. the “New Way” (IRS Fix):
| Category | Without the Fix ❌ | With IRS Notice 2025-72 ✅ |
|---|---|---|
| Income Recognized | 1 Month | 1 Month |
| Tax Expense Recognized | 12 Months (Full Year) | Proportional (Allocation %) |
| Financial Outcome | Huge Loss / Mismatch | Accurate Matching |
🔢 Short-Year Tax Calculator
Use the logic from the IRS example to see how much tax applies to the short year.
The “120-Month” Currency Wrinkle 💱
There was one other hidden trap. Foreign currency gains and losses are usually calculated over a period of “10 taxable years.”
The problem? The law treated that tiny one-month short year as a full taxable year. This meant you would burn through one of your 10 allowable years in just 30 days, completely throwing off the timeline for currency calculations.
The IRS fixed this with a simple wording change. Instead of “10 taxable years,” the new rule uses 120 months. It’s the same amount of time, but by using months, that short December period counts exactly as what it is—one month—rather than a whole year. Elegant, right?
Key Takeaways: IRS Fix
Frequently Asked Questions ❓
It’s a relief to see the IRS proactively fixing these “hidden complexities” before they become disasters. This guidance gives companies the certainty they need to close their books confidently. If you have any more questions about how this impacts your specific tax situation, feel free to ask in the comments! 😊
