Demystifying the new international E&P rules

By Jim Alajbegu, CPA, and Christopher Brown, CPA, J.D., LL.M., New York City

Editor: Mark Heroux, J.D.

With the deluge of international tax regulations issued since the enactment of the law known as the Tax Cuts and Jobs Act, P.L. 115-97, one could certainly be forgiven for procrastinating on reading the many documents that merely describe guidance Treasury and the IRS intend to issue. However, Notice 2019-1 is a must-read for anyone considering repatriating offshore cash.

This discussion provides a summary of some of the basic previously taxed earnings and profits (PTEP) ordering rules likely to apply to distributions made by controlled foreign corporations (CFCs).

To understand the ordering rules, start with the simple graph "PTEP Ordering Rules" (below).

PTEP ordering rules

Putting aside the column headings for a moment, two things about this graph should jump out: the years along the left side and the arrows. The years are included because Treasury and the IRS intend to issue regulations that will move from a "pooling" approach to an annual calculation of PTEP.

The arrows represent the general last-in, first-out (LIFO) ordering rule for distributions of PTEP (the different PTEP accounts in each Sec. 959(c) category have been combined — this discussion does not illustrate the pro rata distribution requirements of Notice 2019-1). A simplistic description of this rule can be summarized as follows: source, exhaust, move down one box, repeat. After reaching the lowest box in the column, move one column to the right and reapply the LIFO rule. Any distributions that are in excess of the amount this method allows would not be distributions of PTEP or earnings and profits (E&P). A major exception to the LIFO rule is described below, after a discussion of the column labels.

The left-hand column (labeled "Sec. 959(c)(1)") generally consists of Sec. 959(c)(2) PTEP "reclassed" from the middle column, PTEP from investments in U.S. property, and the PTEP from the now-repealed Sec. 956A. The middle column (labeled "Sec. 959(c)(2)"), for purposes of this discussion, includes PTEP from Subpart F income, Sec. 951A global intangible low-taxed income (GILTI), and Sec. 965 transition tax inclusions. Finally, the right-hand column (labeled "Sec. 959(c)(3)") consists of E&P that has not been subject to tax. If that sounds confusing, it is, and it is certainly worth several reads.

Now that the columns have been described, it is time to return to the exception to the LIFO rule. Section 3.02 of Notice 2019-1 indicates that the IRS and Treasury intend to write regulations providing that PTEP from Sec. 965(a) inclusions will receive priority in sourcing distributions.

The LIFO rule and the Sec. 965(a) inclusion priority are applied on a column-by-column basis. Again, this is confusing and is not a true application of LIFO sourcing of a CFC's PTEP. For example, a distribution may first be sourced under the Sec. 965(a) inclusion rule applied to PTEP in the "Sec. 959(c)(1)" column, then sourced under the LIFO rule in the "Sec. 959(c)(1)" column, then sourced under the Sec. 965(a) inclusion rule applied to PTEP in the "Sec. 959(c)(2)" column, and then sourced under the LIFO rule to PTEP in the "Sec. 959(c)(2)" column.

With this background, it is time to take a quick look at how these basic rules are applied in a simplified version of Example 1 of Notice 2019-1.

Example: Domestic corporation (DC) owns all of the shares of a foreign corporation that is a CFC (FC), and both corporations are calendar-year taxpayers that use the dollar as their functional currency. FC makes a $210 distribution in 2018. The amounts in the accounts prior to the distribution are shown in the table "FC's PTEP and E&P Prior to Distribution" (below). Of the $125 amount in 2017 in column "Sec. 959(c)(1)," assume $100 of the amount is Sec. 965 PTEP, and the entire $25 in 2017 in column "Sec. 959(c)(2)" is Sec. 965 PTEP. Finally, assume that the PTEP of FC in each PTEP group and that all of the Sec. 959(c)(3) E&P of FC are in a single Sec. 904 category.

FC’s PTEP and E&P prior to distribution

To determine the sourcing of the distribution, think back to the arrows in the "PTEP Ordering Rules" graph. They start in the box in the "Sec. 959(c)(1)" column and on the "2018" line. This may lead one to believe that the $210 distribution should first be sourced from the $30 on the 2018 line in the "Sec. 959(c)(1)" column under the LIFO rule; however, this is not the case. The $100 Sec. 965 PTEP earned in 2017 and contained in the "Sec. 959(c)(1)" column takes priority. Only after the 2017 Sec. 965 PTEP is exhausted does the LIFO rule kick in to source $80 of the distribution from the rest of the PTEP in the "Sec. 959(c)(1)" column (first the $30 in 2018, next the remaining $25 in 2017, and then finally the $25 in 2016).

Now move to the "Sec. 959(c)(2)" column to source the remaining $30 of the distribution. As one might have guessed by now, Notice 2019-1 requires going back and using the Sec. 965(a) inclusion priority rule to the extent of Sec. 965 PTEP in this column (which is assumed to be the full $25 in 2017). Now refer back to the LIFO rule to source the remaining $5 from the Sec. 959(c)(2) PTEP earned in 2018. When the dust settles, FC's graph appears as shown in the table "FC's PTEP After Distribution" (below).

FC’s PTEP after distribution

Few things in the international tax space are more prosaic than E&P. Although the changes that are underway are complex, if practitioners learn a few basic ordering rules, sourcing offshore cash repatriated from CFCs can be a manageable exercise.


Mark Heroux, J.D., is a principal with the Specialty Tax Services Group at Baker Tilly Virchow Krause LLP.

For additional information about these items, contact Mr. Heroux at 312-729-8005 or

Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.

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