The Creation and Treatment of Section 951A PTEP

The Global Intangible Low-Taxed Income (GILTI) regime is a U.S. tax provision that functions as an anti-deferral measure for income from American-owned foreign companies. It subjects U.S. shareholders to current taxation on their share of certain foreign income, preventing indefinite tax deferral. To prevent this income from being taxed a second time when distributed, it is reclassified as Previously Taxed Earnings and Profits (PTEP). When a U.S. shareholder pays tax on a GILTI inclusion, that income becomes PTEP, an accounting mechanism allowing for the tax-free repatriation of those earnings.

The GILTI Inclusion Under Section 951A

The GILTI regime requires a “U.S. shareholder” to include a specific amount of foreign income in their annual U.S. taxable income. A U.S. shareholder is a U.S. person who owns 10% or more of a foreign corporation’s stock. The foreign corporation must be a “Controlled Foreign Corporation” (CFC), where U.S. shareholders own more than 50% of its stock.

The calculation of the GILTI inclusion begins with the CFC’s “tested income,” which is its gross income less certain deductions, like foreign taxes paid. Certain types of income are excluded from this calculation, including income effectively connected with a U.S. trade or business and subpart F income. The objective is to isolate mobile income often subject to low foreign tax rates.

From the aggregate tested income, a deduction is allowed for the “net deemed tangible income return” (NDTIR). NDTIR is 10% of the shareholder’s share of the “qualified business asset investment” (QBAI) of each CFC. QBAI represents the average adjusted basis of tangible property used in the business, such as machinery.

The final GILTI inclusion amount under Internal Revenue Code Section 951A is the excess of the net tested income over the NDTIR. For instance, if a shareholder’s CFC has $1,000 of tested income and $2,000 of QBAI, the NDTIR is $200. The shareholder’s GILTI inclusion would be $800, which must be reported as gross income.

Creation and Categorization of PTEP

Following the determination of the GILTI inclusion, the corresponding earnings and profits (E&P) of the CFC are recharacterized as PTEP. This recharacterization under Internal Revenue Code Section 959 ensures that income taxed once is not subject to a second layer of tax when distributed. The amount of the GILTI inclusion directly creates an equal amount of PTEP.

These previously taxed amounts are not tracked in a single account. Tax regulations require that PTEP be maintained in distinct categories or “baskets” based on the U.S. tax provision that caused the income inclusion. This detailed tracking is necessary because different types of PTEP can have different foreign tax credit implications and are subject to specific ordering rules upon distribution.

The regulations establish several annual PTEP groups. For income included under the GILTI regime, a specific category is created, often referred to as “Section 951A PTEP.” This category is maintained separately from other PTEP categories, such as PTEP arising from traditional subpart F inclusions. The Section 951A PTEP account represents the accumulated amount of a shareholder’s prior GILTI inclusions from that CFC that have not yet been distributed.

Tax Treatment of PTEP Distributions

The primary benefit of classifying earnings as PTEP is that distributions of PTEP are excluded from the gross income of the U.S. shareholder. This exclusion prevents double taxation, as the shareholder has already paid U.S. tax on these earnings. The distribution is treated as a tax-free return of previously taxed capital up to the amount of the shareholder’s PTEP account balance.

When a CFC makes a distribution, the tax code imposes strict ordering rules that dictate the source of the funds. Distributions are deemed to come first from the various categories of PTEP. Only after all PTEP in all categories has been fully distributed will any further distribution be treated as a taxable dividend to the extent of the CFC’s remaining, non-taxed E&P.

The regulations further specify the ordering among the different PTEP categories. Distributions are sourced first from PTEP related to investments in U.S. property, and then from PTEP related to subpart F and GILTI inclusions. Within these groups, distributions follow a last-in, first-out (LIFO) ordering rule, meaning earnings from the most recent year are distributed first.

For example, if a U.S. shareholder has a Section 951A PTEP account of $800 with a CFC, and the CFC distributes $500, that distribution is sourced from the PTEP account. The shareholder receives the $500 free of U.S. income tax. The shareholder’s Section 951A PTEP account balance for that CFC is then reduced to $300.

Basis Adjustments and Reporting Requirements

The GILTI and PTEP regimes are accompanied by specific rules under Internal Revenue Code Section 961 for adjusting a U.S. shareholder’s basis in CFC stock. When a shareholder has a GILTI inclusion, their basis in the stock is increased by the amount of the inclusion. This upward adjustment reflects that the shareholder has paid tax on earnings retained by the corporation, preventing a capital gain on the value attributable to the already-taxed amount.

Conversely, when the CFC makes a distribution of that Section 951A PTEP, the shareholder’s basis in the CFC stock is decreased by the amount of the tax-free distribution. This downward adjustment is necessary to prevent an inappropriate tax benefit. Without this reduction, the shareholder could receive the PTEP tax-free and then sell the stock at a loss.

Compliance requires detailed reporting on several IRS forms. The primary form is Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.” Schedule J of Form 5471 is used to report the CFC’s E&P, while Schedule P tracks the shareholder’s PTEP accounts by category. U.S. shareholders must also file Form 8992, “U.S. Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI),” to compute their annual inclusion amount.