Reversing a gap period transaction through late check-the-box election

By Allen Stenger, J.D., and Jane Vukmer, J.D., Washington, D.C.

Editor: Susan Minasian Grais, CPA, J.D.,LL.M.

In Letter Ruling 202135006, released Sept. 3, 2021, the IRS permitted a taxpayer effectively to undo planning undertaken during the so-called gap period (described later).

After many taxpayers implemented gap period strategies in 2018, Treasury and the IRS in 2019 issued regulations (the "extraordinary disposition regulations") under Secs. 245A and 954(c)(6) that retroactively neutralized, and in some cases penalized, gap period strategies. In the letter ruling, the IRS granted the taxpayer's request to make a late entity classification election (familiarly, a check-the-box election) that would cause the relevant transaction to become disregarded. This letter ruling is unique insofar as the taxpayer's stated motivation for requesting relief was to mitigate the "negative tax consequences" attributable to the extraordinary disposition regulations.


A gap period is relevant for a controlled foreign corporation (CFC) that has a fiscal (U.S.) tax year and a corporate U.S. shareholder (a Sec. 245A shareholder). The term refers to the period (1) beginning after Dec. 31, 2017 (the second E&P measurement date for purposes of the Sec. 965 transition tax); and (2) ending on the last day of the CFC's last tax year beginning before Jan. 1, 2018 (the last year to which the global intangible low-taxed income (GILTI) regime did not apply).

Before the extraordinary disposition and other regulations were issued, certain taxable transactions executed during a CFC's gap period were expected to have favorable tax consequences. Gain that the CFC recognized in its gap period (and the corresponding E&P) generally was not subject to U.S. federal income tax if the gain did not constitute Subpart F income or income effectively connected with a U.S. trade or business. (It would not be taken into account under Sec. 965 or the GILTI regime, and it could fund a dividend to the Sec. 245A shareholder for which the shareholder might be allowed an offsetting deduction under Sec. 245A.) Additionally, the increased basis attributable to the transaction might give rise to depreciation or amortization deductions or qualified business asset investment that would reduce the Sec. 245A shareholder's overall GILTI inclusion amount. Many Sec. 245A shareholders caused their fiscal-year CFCs to engage in gap period transactions, which necessarily occurred during 2018.

In October 2018, Treasury and the IRS proposed regulations under the GILTI regime with retroactive effect (REG-104390-18; the disqualified basis regulations, now found in final form at Regs. Secs. 1.951A-2(c)(5) and -3(h) (T.D. 9866)). Among other things, the regulations generally precluded taxpayers from taking into account basis increases resulting from gap period transactions (disqualified basis) when computing their GILTI inclusion amount. The disqualified basis regulations thus eliminated one of the primary benefits of gap period transactions. By that time, many taxpayers had executed gap period transactions. The regulations, however, did not trigger negative tax consequences for those taxpayers.

That changed when Treasury and the IRS issued the extraordinary disposition regulations — initially in temporary form (T.D. 9865; Temp. Regs. Sec. 1.245A-5T) in June 2019 and later as a final regulation (T.D. 9909; Regs. Sec. 1.245A-5) in August 2020. The extraordinary disposition regulations generally apply retroactively to certain transactions occurring during a CFC's gap period in 2018 (extraordinary dispositions). The extraordinary disposition regulations affect dividends distributed by a foreign corporation that has undertaken an extraordinary disposition. Depending on whether the distributee is a Sec. 245A shareholder or a CFC, the extraordinary disposition regulations render the dividend (in whole or in part) ineligible for a dividends-received deduction under Sec. 245A or for the exception to foreign personal holding company income in Sec. 954(c)(6). Accordingly, the extraordinary disposition regulations can cause a dividend to give rise to net taxable income (in the case of a CFC distributee, Subpart F income) when, absent the extraordinary disposition regulations, this result would not occur. Additionally, a 21% rate now applies to the gain from the extraordinary disposition, rather than the reduced effective rate for GILTI inclusions (currently, 10.5%) that might have applied if the gain had been recognized after the gap period.

Responding to complaints from taxpayers and tax practitioners that the simultaneous application of the disqualified basis regulations and extraordinary disposition regulations resulted in double taxation, Treasury and the IRS subsequently issued new regulations (the "coordination regulations," at Regs. Secs. 1.245A-6 et seq.). The coordination regulations effectively subjected gain to one of the two sets of regulations but not both. The coordination regulations are extremely complex, however, and complying with them requires significant time and expense.


In Letter Ruling 202135006, U.S. Parent, a publicly traded corporation, owned the stock of non-U.S. subsidiaries. Parent's CFC, FSub, owned all the outstanding equity interests of a foreign corporation (Taxpayer).

On an unspecified date (presumably during FSub's gap period), FSub contributed assets to Taxpayer in exchange for Taxpayer's stock (the contribution). Taxpayer represented that the contribution did not qualify as a tax-free transaction under Sec. 351(a). Accordingly, FSub recognized gain in the contributed assets, and Taxpayer's aggregate basis in the assets increased by the amount of gain that FSub recognized.

After FSub executed the contribution, Treasury and the IRS issued the extraordinary disposition regulations, which (retroactively) encompassed the contribution. Because the contribution constituted an extraordinary disposition, the regulations could cause future dividends from FSub to be wholly or partially taxable.

If Taxpayer had been classified as a disregarded entity for U.S. federal tax purposes at the time of the contribution (rather than as a corporation), the contribution would have been disregarded. FSub would have recognized no gain, the basis of the contributed assets would not have increased, and the extraordinary disposition regulations would not apply.

Having missed the deadline for making a check-the-box election to be classified as a disregarded entity as of the contribution, Taxpayer requested a ruling from the IRS allowing it to make the election and "unwind" the contribution.


To obtain the requested relief, Regs. Sec. 301.9100-3 required Taxpayer to demonstrate (among other things) that it "acted reasonably and in good faith" and that granting the relief would not "prejudice the interests of the government."

Although the relief requested (a late check-the-box election) was fairly routine, the context arguably was not. The late election would cause a transaction (one Taxpayer presumably had fully intended to undertake as of the original election deadline) to become disregarded. Taxpayer sought to satisfy the conditions of Regs. Sec. 301.9100-3 based on the adverse effect that the extraordinary disposition regulations — which had not existed at the time of the deadline, probably could not then have been foreseen, and which had retroactive effect — would have if the transaction remained regarded.

Based on Taxpayer's representations, the IRS ruled that these conditions had been satisfied. Taxpayer had failed to make the check-the-box election because, "after exercising reasonable diligence," Taxpayer was unaware of the "negative tax consequences" that could result "if an election was not made." Taxpayer was not informed in all material respects of the election and its consequences because "its tax advisors did not advise [Taxpayer] of the negative tax consequences that could result if an election was not made."

Though the extraordinary disposition regulations had been issued after the election deadline, Taxpayer had not used hindsight in requesting relief. The issuance of the regulations was not a relevant event, at least where the regulations were (retroactively) effective continuously since prior to the election deadline. The interests of the government would not be prejudiced by granting relief because the relief would produce the same result as if the election had been timely. The letter ruling did not mention the disqualified basis regulations (or the coordination regulations).


Before Letter Ruling 202135006 was issued, it was not clear whether the IRS would permit taxpayers to "unwind" gap period transactions. In this letter ruling, the IRS allowed a taxpayer to achieve that result, albeit by granting Taxpayer relief to make a late check-the-box election that would cause the transaction to be disregarded.

Many taxpayers undertook gap period transactions in 2018. Many of those transactions (like the one in this letter ruling) would become disregarded if a late check-the-box election could be made. Taxpayers that undertook such a transaction may want to evaluate whether they, too, might be eligible for relief, enabling them to cause their transaction to be disregarded. Disregarding the transaction, at a minimum, would relieve taxpayers from the burden of complying with the complex coordination regulations. It remains to be seen whether this letter ruling reflects a broader willingness on the part of the IRS to allow other types of relief in response to retroactive regulations.


Susan Minasian Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C. For additional information about these items, contact Ms. Grais at 202-327-8788 or

Contributors are members of or associated with Ernst & Young LLP.

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