Foreign Tax Credit Basketing: A Primer on Reg. §1.861-20

The Tax Cuts and Jobs Act (“TCJA”)’s addition of categories (“baskets”) under Code Sec. 904(d) has increased the likelihood that foreign tax credits (“FTCs”) will be unable to be utilized due to a Code Sec. 904 limitation. Likewise, Code Sec. 960(a) and Code Sec. 960(d)’s deemed-paid foreign tax credit mechanism operates on the basis of current-year taxes and current income only. This creates the definite possibility that foreign taxes will become trapped at the controlled foreign corporation (“CFC”) level, such that the FTCs will disappear forever. Finally, the proliferation of the groupings of previously taxed earnings and profits (“PTEP”) under IRS Notice 2019-1 makes tracking and utilizing FTCs with respect to PTEP under Code Sec. 960(b) more challenging. 

In the context of all of these rules, taxpayers claiming foreign tax credits must match foreign income with the related foreign taxes. As the basic scaffolding behind these rules sits Reg. §1.861-20, an important regulation in determining the allocation of foreign income taxes among groupings of U.S. taxable income. These detailed rules supersede the more principles-based approach of former Reg. §1.904-6, as it existed prior to TCJA. Depending on how it is applied to a particular set of facts, Reg. §1.861-20 can result in loss of foreign tax credits. 

The following discussion provides a primer on these important rules that determine the basketing of FTCs under Code Sec. 904(d), as well as other key areas.

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