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

• Author: Stenger, Allen

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.

Background

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 lowtaxed 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...