# Prop. Treas. Reg. § 1.904(b)-4: Deductions treated as allocable to foreign source section 951A category income. Proposed regulation, not in force. REG-117273-25, 91 FR 57832, published 2026-09-11 . Interprets 26 U.S.C. § 904. Par. 6. Add § 1.904(b)-4 to read as follows: (a) In general. Section 904(b)(5) provides special rules for purposes of section 904 for allocating and apportioning deductions to foreign source income described in section 904(d)(1)(A) ( foreign source section 951A category income ) and for reallocating certain deductions to U.S. source income. Paragraph (b) of this section provides rules for determining deductions allocated and apportioned to foreign source section 951A category income, including deductions that are directly allocable to such income. Paragraph (c) of this section provides rules for reallocating to U.S. source income deductions that would have been allocated and apportioned to foreign source section 951A category income but for section 904(b)(5). Paragraph (d) of this section contains examples illustrating the rules set forth in this section. Paragraph (e) of this section provides the applicability date of this section. (b) Deductions allocated and apportioned to foreign source section 951A category income —(1) In general. For purposes of section 904, foreign source section 951A category income is determined by allocating and apportioning to such income only those deductions that are— (i) Allowed under section 250(a)(1)(B) to the extent allocated and apportioned to foreign source section 951A category income in accordance with § 1.861-8(e)(14); (ii) Allowed under section 164(a)(3) for State and local income taxes to the extent allocated and apportioned to foreign source section 951A category income in accordance with § 1.861-8(e)(6); or (iii) Directly allocable to foreign source section 951A category income under paragraph (b)(2) of this section. (2) Directly allocable —(i) In general. A deduction (other than a deduction described in paragraph (b)(1)(i), (ii), or (b)(3) of this section) that, under the applicable rules for allocating and apportioning deductions (without regard to section 904(b)(5)), is allocated and apportioned to foreign source section 951A category income is directly allocable to foreign source section 951A category income only if the deduction is of a type that is not subject to apportionment based on the relative value of assets or amounts of U.S. gross income (including modified gross income). It is not relevant how a particular item of deduction is in fact apportioned, but instead whether the item of deduction is of a type that could be apportioned based on the relative value of assets or amounts of U.S. gross income. (ii) Application —(A) Non-directly allocable deductions. For purposes of this paragraph (b)(2), deductions that are not directly allocable to foreign source section 951A category income include deductions for stewardship expenses; legal and accounting fees and expenses; damages awards, prejudgment interest, and settlement payments; and supportive expenses (such as overhead, general and administrative, and supervisory expenses). (B) Directly allocable deductions. For purposes of this paragraph (b)(2), deductions that are directly allocable to foreign source section 951A category income, if allocated and apportioned to foreign source section 951A category income under the applicable rules for allocating and apportioning deductions (without regard to section 904(b)(5)), include foreign currency loss recognized under section 986(c) with respect to a distribution of previously taxed earnings and profits (as described in section 959 or 1293(c)) (see § 1.904-4(p)) and net operating loss deductions (see § 1.861-8(e)(8)). (3) Non-allocable deductions. No amount of interest expense or research and experimental expenditures is allocated or apportioned to foreign source section 951A category income for purposes of section 904. For purposes of this paragraph (b)(3), interest expense means any expense that is deductible under section 163 (including original issue discount) and research and experimental expenditures means any expenditure that a taxpayer deducts (including as an amortization deduction) in a taxable year under section 174, 174A, or 59(e)(2)(B). (c) Reallocation to U.S. source income. Any deduction that, but for paragraph (b) of this section, would have been allocated or apportioned to foreign source section 951A category income for purposes of section 904 is instead allocated to U.S. source income for all purposes of section 904 ( reallocated deduction ). Thus, for example, a reallocated deduction is allocated to U.S. source income for purposes of determining a loss from sources within the United States under section 904(f)(5)(D) and a domestic loss under section 904(g)(2)(B). Similarly, a reallocated deduction is treated as allocated or apportioned to U.S. source income for purposes of applying other rules where section 904 is the operative section, for example, in assigning interest income from a downstream partnership loan under § 1.861-9(e)(8) or upstream partnership loan under § 1.861-9(e)(9). (d) Examples. The following examples illustrate the application of this section. (1) Example 1: Section 986(c) loss—(i) Facts. USP is a domestic corporation that uses the U.S. dollar as its functional currency. USP owns all the shares of the only class of stock of CFC, a controlled foreign corporation that uses the British pound (£) as its functional currency. CFC makes a £300x distribution of money with respect to its stock. The distribution is a dividend (as defined in section 316), determined without regard to section 959(d). All of CFC's previously taxed earnings and profits ( PTEP ) result from USP's income inclusions under sections 951(a)(1)(A) and 951A in the taxable year of the distribution. The income inclusion under section 951(a)(1)(A) is general category income. The table below shows CFC's PTEP immediately before the distribution (which reflects adjustments for income inclusions under sections 951(a)(1)(A) and 951A in the taxable year of the distribution). The spot rate on the date of the distribution is $1 = £0.8. The average exchange rate in the year of the inclusion is $1 = £0.75. **Table 1 to Paragraph ( d )( 1 )( i ) of This Section** | PTEP from section 951(a)(1)(A) inclusion (section 951(a)(1)(A) PTEP) | Foreign source | U.S. source | PTEP from section 951A inclusion (section 951A PTEP) | Foreign source | U.S. source | | --- | --- | --- | --- | --- | --- | | £0 | £100x | £200x | £200x | | | (ii) Analysis. The distribution is made pro rata from section 951(a)(1)(A) PTEP and section 951A PTEP. Therefore, £240x (£300x × £400x/£500x) is assigned to section 951A PTEP of which £120x is foreign source (£240x × £200x/£400x). Under section 986(c), USP is required to recognize foreign currency gain or loss on the distribution of PTEP. Foreign currency gain or loss recognized under section 986(c) is assigned to the separate category or categories of the PTEP from which the distribution is made. § 1.904-4(p). The section 986(c) gain or loss is from the same source as the associated income inclusion. Section 986(c)(1). USP's section 986(c) loss with respect to the distribution of foreign source section 951A PTEP is determined by translating the PTEP into U.S. dollars using the spot rate on the date of the distribution (£120x × $1/£0.8 = $150x) and then subtracting from that U.S. dollar amount the dollar basis of the PTEP (£120x × $1/£0.75 = $160x). Thus, USP's section 986(c) loss with respect to the distribution of foreign source section 951A PTEP is $10x ($150x−$160x). The section 986(c) loss of $10x is directly allocable to foreign source section 951A category income. (2) Example 2: Reallocation of Deductions —(i) Facts. USP is a domestic corporation that owns all the stock of a controlled foreign corporation. USP chooses to claim foreign tax credits for the taxable year and all prior taxable years. USP has no loss carried back to the taxable year from a subsequent taxable year. USP's deductions that would have been allocated and apportioned to foreign source section 951A category income but for section 904(b)(5) consist of interest expense and supportive deductions. After allocation and apportionment of all deductions except interest expense and supportive deductions, USP has $100x of U.S. source income, $60x of foreign source section 951A category income, and $50x of foreign source general category income (within the meaning of section 904(d)(1)(D)). USP has $100x of interest expense, $10x of which is allocated and apportioned to foreign source general category income and, before taking into account section 904(b)(5), $50x of which would be allocated and apportioned to U.S. source income and $40x of which would be allocated and apportioned to foreign source section 951A category income. USP also has $50x of supportive deductions, $20x of which is allocated and apportioned to foreign source general category income and, before taking into account section 904(b)(5), $20x of which would be allocated and apportioned to U.S. source income and $10x of which would be allocated and apportioned to foreign source section 951A category income. (ii) Analysis. But for section 904(b)(5), USP would have U.S. source income of $30x ($100x−$50x−$20x), foreign source section 951A category income of $10x ($60x−$40x−$10x), and foreign source general category income of $20x ($50x−$10x−$20x). The $40x of interest expense and $10x of supportive deductions which, but for section 904(b)(5), would have been allocated and apportioned to foreign source section 951A category income are reallocated deductions. Under paragraph (c) of this section, the reallocated deductions are allocated to U.S. source income. After the allocation of reallocated deductions, USP has a $20x loss from sources within the United States within the meaning of section 904(f)(5)(D) ($30x−$50x), foreign source section 951A category income of $60x, and foreign source general category income of $20x. The $20x loss is a domestic loss within the meaning of section 904(g)(2)(B). Under section 904(f)(5)(D), the $20x loss reduces USP's foreign source section 951A category income and foreign source general category income on a pro rata basis. As a result, USP's foreign source section 951A category income is $45x ($60x−$20x × $60x/$80x) and USP's foreign source general category income is $15x ($20x−$20x × $20x/$80x). The $20x domestic loss also results in an overall domestic loss within the meaning of section 904(g)(2)(A) (ODL) of $20x. In later years, the ODL causes USP's U.S. source income to be treated as foreign source income in accordance with section 904(g) and the regulations thereunder. (3) Example 3: Reallocation of Deductions —(i) Facts. USP is a domestic corporation that owns all the stock of a controlled foreign corporation. USP chooses to claim foreign tax credits for the taxable year. After allocation and apportionment of all deductions except reallocated deductions, USP has $500x of U.S. source income and $100x of foreign source section 951A category income. USP has a reallocated deduction of $400x that would have been allocated to foreign source section 951A category income but for section 904(b)(5). (ii) Analysis. But for section 904(b)(5)(B) and (C), the reallocated deduction of $400x would have created a separate limitation loss of $300x with respect to the income category described in section 904(d)(1)(A) (section 951A category). Under the rules in paragraph (c) of this section, all $400x is allocated to U.S. source income, reducing U.S. source income to $100x. USP has no separate limitation loss with respect to the section 951A category. (4) Example 4: Research and Experimental Expenditures —(i) Facts. USP is a domestic corporation that owns all the stock of a controlled foreign corporation. USP deducted research and experimental expenditures under section 174A for the taxable year. Before taking into account section 904(b)(5), all of the research and experimental expenditures would be allocated to foreign source income. (ii) Analysis. No amount of the research and experimental expenditures is a reallocated deduction because, before taking into account section 904(b)(5), none of the research and experimental expenditures would have been allocated or apportioned to foreign source section 951A category income. See § 1.861-17(b)(2). Therefore, none of the research and experimental expenditures is allocated to U.S. source income under section 904(b)(5). (e) Applicability date. This section applies to taxable years beginning after December 31, 2025.