From GILTI to NCTI: The 2026 Tax Changes Every U.S. Owner of a Foreign Business Should Know

U.S. Taxation of Foreign Business Income

For purposes of this discussion, a “U.S. person” generally includes a U.S. citizen, lawful permanent resident (green card holder), an individual who satisfies the substantial presence test, and a domestic corporation, partnership, trust, or estate.

When a U.S. person owns an interest in a foreign operating company, several layers of taxation and reporting may apply. These can include the corporate income tax imposed by the foreign country, foreign withholding taxes on distributions, U.S. federal income tax, state income tax in certain jurisdictions, and extensive international information-reporting requirements.

One of the most important—and frequently misunderstood—features of the U.S. international tax system is that the United States does not necessarily wait until foreign earnings are distributed to the U.S. owner.

Under the anti-deferral provisions of the Internal Revenue Code, principally Subpart F and Section 951A, profits earned inside certain foreign corporations can be taxable to a U.S. shareholder in the year the income is earned, even if the foreign corporation makes no distribution to the shareholder.

Beginning with taxable years of foreign corporations beginning after December 31, 2025, the Section 951A regime changed significantly. The legislation enacted on July 4, 2025, commonly referred to as the One Big Beautiful Bill Act (“OBBBA”), replaced the familiar concept of Global Intangible Low-Taxed Income (“GILTI”) with Net CFC Tested Income (“NCTI”).

Although NCTI retains much of the framework of GILTI, several important changes can materially affect U.S. owners of foreign businesses.

Controlled Foreign Corporations

Both GILTI and NCTI operate through the Controlled Foreign Corporation (“CFC”) rules.

Generally, a foreign corporation is a CFC when more than 50 percent of the corporation’s total combined voting power or total value is owned by “United States shareholders.”

For this purpose, a United States shareholder generally is a U.S. person that owns at least 10 percent of the foreign corporation’s voting power or value.

Determining ownership can be more complicated than simply examining the shareholder register. U.S. tax law applies direct, indirect, and constructive ownership rules, including attribution among certain family members and related entities. As a result, CFC status can exist even when a taxpayer does not believe that he or she directly controls the foreign company.

Entity classification is also determined under U.S. federal tax principles rather than solely by the entity’s classification under foreign law. Depending on the circumstances and available elections, a foreign entity may be treated for U.S. tax purposes as a corporation, partnership, or disregarded entity.

GILTI 

GILTI was introduced by the Tax Cuts and Jobs Act of 2017.

Under the former regime, U.S. shareholders of CFCs generally were required to include their share of the CFCs’ “tested income,” subject to statutory exclusions and adjustments.

One particularly important feature was the Qualified Business Asset Investment (“QBAI”) exclusion. GILTI generally permitted a deemed 10 percent return on certain depreciable tangible property used in the foreign business, subject to adjustments including certain interest expense.

The practical result was that businesses with substantial investments in factories, machinery, hotels, agricultural equipment, and other tangible assets could potentially reduce their GILTI exposure through the QBAI calculation.

For an eligible domestic corporation, Section 250 generally provided a 50 percent deduction for GILTI, resulting in an effective federal corporate tax rate of approximately 10.5 percent before foreign tax credits.

In addition, a domestic corporate shareholder generally could claim a deemed-paid foreign tax credit for 80 percent of qualifying foreign income taxes attributable to the GILTI inclusion.

Now Beginning in 2026 NCTI Changes

NCTI retains the basic Section 951A anti-deferral structure but significantly changes the calculation.

The QBAI Exclusion Is Gone

Perhaps the most significant conceptual change is the elimination of the deemed tangible-asset return.

Under NCTI, the former QBAI-based reduction no longer applies. This means tested income is no longer reduced by a deemed 10 percent return on qualified tangible business assets.

The change can be particularly significant for capital-intensive foreign businesses, including manufacturers, hotels, agricultural operations, transportation companies, and businesses with substantial machinery or equipment.

The Section 250 Deduction Is Reduced

For eligible domestic corporations, the Section 250 deduction applicable to NCTI is 40 percent, rather than the former 50 percent GILTI deduction.

At the current 21 percent corporate income tax rate, this produces an effective federal rate of approximately 12.6 percent on NCTI before taking foreign tax credits into account.

Foreign Tax Credit Relief Improves

At the same time, the deemed-paid foreign tax credit percentage increases.

Under the former GILTI regime, only 80 percent of qualifying foreign taxes were generally creditable. Under the new NCTI rules, that percentage increases to 90 percent.

As a simplified mathematical matter, a 12.6 percent U.S. effective rate divided by a 90 percent credit percentage produces a break-even foreign tax rate of approximately 14 percent, although the actual result depends on the taxpayer’s facts, foreign tax credit limitation, expense allocation, and other applicable rules.

The new law also modifies the allocation of expenses for purposes of the Section 951A foreign tax credit limitation. In particular, interest expense and research and experimental expenditures generally are not allocated to the NCTI category in the same manner as under prior law. For some multinational groups, this can significantly increase the amount of usable foreign tax credits and reduce or eliminate residual U.S. tax.

There is an important counterpoint. The new rules generally disallow a foreign tax credit for 10 percent of certain foreign taxes imposed on distributions of previously taxed Section 951A earnings, including qualifying previously taxed earnings and profits (“PTEP”). Thus, foreign withholding taxes imposed when previously taxed NCTI or GILTI earnings are later distributed require careful analysis.

The Timing Rules Are Broader

OBBBA also significantly changed who bears a CFC inclusion when ownership changes during the year.

Under the former rules, a U.S. shareholder generally needed to own CFC stock on the last relevant day of the foreign corporation’s taxable year to have the corresponding Subpart F or GILTI inclusion.

Beginning under the new rules, a U.S. shareholder can have an inclusion based on the portion of the CFC year during which the shareholder owned the stock while the foreign corporation was a CFC.

This change is particularly important in mergers, acquisitions, and sales of foreign businesses.

A seller generally can no longer assume that selling the CFC stock before year-end eliminates the current-year inclusion. Purchase agreements involving CFC stock should therefore address the allocation of Subpart F and NCTI exposure between buyers and sellers.

The Treasury Department and IRS have already issued proposed guidance addressing these revised pro rata share rules.

The One-Month CFC Deferral Election Was Repealed

OBBBA also repealed the one-month deferral election previously available under Section 898(c)(2).

Foreign corporations that previously used the election—often resulting in a November 30 year-end where the majority U.S. shareholder used a calendar year—may have a short taxable year as they transition to the required year.

IRS Notice 2025-72 provided interim guidance addressing the allocation of foreign income taxes affected by this transition, and the Treasury Department and IRS subsequently issued proposed regulations addressing the allocation rules.

The transition should be reviewed carefully because the Section 898 amendments and the new Section 951A rules have different effective-date provisions.

Other Important International Tax Changes

OBBBA made several related changes that should be considered together with NCTI.

The Section 954(c)(6) CFC look-through rule, which generally permits qualifying dividends, interest, rents, and royalties received from related CFCs to avoid treatment as foreign personal holding company income, was made permanent.

The former Foreign-Derived Intangible Income (“FDII”) terminology was also replaced with Foreign-Derived Deduction Eligible Income (“FDDEI”). For taxable years beginning after December 31, 2025, the Section 250 deduction for qualifying FDDEI is 33.34 percent, producing an effective federal corporate tax rate of approximately 14 percent at the current 21 percent corporate rate.

Individual Shareholders and the Section 962 Election

The 12.6 percent NCTI rate described above applies to eligible domestic corporate shareholders. The treatment of an individual shareholder can be dramatically different.

An individual who owns CFC shares directly generally does not automatically receive the Section 250 deduction or the indirect foreign tax credit available to a domestic corporation. Without additional planning, a Section 951A inclusion can therefore be taxed at ordinary individual income tax rates.

Section 962 can change that result. An individual who holds shares directly or through a partnership or S corporation receives no Section 250 deduction and no credit for the corporate-level foreign taxes. The inclusion is taxed as ordinary income at graduated rates reaching thirty-seven percent. 

An election under Section 962 allows an individual to be taxed as though a domestic corporation stood in the chain, capturing the forty percent deduction and the ninety percent credit, at the cost of additional tax when the earnings are ultimately distributed; that later distribution can qualify for the 20 percent dividend rate if the CFC is resident in a treaty country. 

Whether that election helps depends on the foreign rate, the distribution policy, treaty status, and the owner’s other income.Where the CFC’s foreign effective rate exceeds 18.9 percent, the high-tax exclusion may remove the income from NCTI altogether.

Have IRS Tax Problems?

     Contact the Tax Lawyers at

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This post is for general information only and is not legal or tax advice. The application of these rules depends on the specific facts. Please contact us to discuss your situation.

Sources:

• Public Law 119-21 (July 4, 2025), One Big Beautiful Bill Act (OBBBA) — particularly §§ 70321–70323 and related international tax provisions. The statute changes the §250 deduction to 40% for NCTI, replaces GILTI terminology with NCTI, and eliminates the former QBAI/deemed tangible-income return. Congress.gov
  Public Law 119-21 — Full Text

• Internal Revenue Code §951A — Net CFC Tested Income — principal statutory provision governing current inclusions of NCTI by U.S. shareholders of CFCs, as amended by OBBBA. Congress.gov

• Internal Revenue Code §250 — FDDEI and NCTI Deduction — provides the 40% deduction for qualifying NCTI and 33.34% deduction for FDDEI for applicable post-2025 taxable years. Congress.gov

• Internal Revenue Code §§951, 957, 958 and 960 — governing Subpart F inclusions, CFC status, stock ownership and attribution, pro rata shares, and deemed-paid foreign tax credits.

• IRS Notice 2025-72, 2025-51 I.R.B. — guidance concerning repeal of the §898(c)(2) one-month deferral election and allocation of foreign income taxes during the transition. IRS
  IRS Notice 2025-72

• 2026 Proposed Regulations under §§951, 951A and 6038 — Treasury and IRS guidance addressing the new pro rata share rules and NCTI provisions for post-2025 taxable years. IRS
  IRS Internal Revenue Bulletin 2026-39

• IRS Form 5471 and Instructions — reporting requirements for certain U.S. persons with interests in foreign corporations, including CFC reporting and the post-2025 §898 year-end rules. IRS
  IRS Instructions for Form 5471

• IRS Form 8992 — Calculation of Net Controlled Foreign Corporation Tested Income (NCTI) and Form 8993 — Section 250 Deduction for FDDEI and NCTI. The IRS's 2026 draft forms expressly incorporate the new NCTI terminology and calculations. IRS
  IRS 2026 Draft Tax Forms

• IRS FATCA Guidance / Form 8938 — reporting requirements and penalties concerning specified foreign financial assets; Form 8938 reporting is separate from FBAR reporting. IRS
  IRS FATCA Information for Individuals

Innocent Spouse Relief Does Not Erase a Federal Tax Lien on an Ex-Spouse’s Property Interest

A recent U.S. Tax Court decision provides an important warning for divorcing spouses, family-law attorneys, and tax practitioners: obtaining innocent spouse relief does not necessarily protect property from a federal tax lien attributable to an ex-spouse.

In Hasznos v. Commissioner, T.C. Memo. 2026-100, the Tax Court addressed whether a taxpayer who had obtained innocent spouse relief was entitled to recover the full amount paid to the IRS from the proceeds of real property that had been addressed in her divorce proceedings.

The answer depended not simply on the divorce judgment, but on who actually owned the property when the federal tax lien attached.

The Dispute

Emese Hasznos and her former husband had outstanding federal income tax liabilities for tax years 2012 through 2016. The IRS ultimately received $623,701 from the sale of real property and applied those funds toward the couple's outstanding liabilities.

Hasznos sought innocent spouse relief and requested a refund of the amount collected from the sale proceeds.

The innocent spouse issue itself was not the central problem. Instead, the dispute turned on the ownership of the real estate and the effect of the federal tax lien against her former husband's interest.

Under federal tax lien principles, when a taxpayer neglects or refuses to pay a federal tax liability after demand, the resulting lien generally attaches to all property and rights to property belonging to that taxpayer. Whether the taxpayer possesses a property interest is generally determined under applicable state law, while federal law determines the consequences of that interest for purposes of the federal tax lien.

The Divorce Judgment Did Not Transfer Title

The case illustrates an important distinction between being entitled to the proceeds from property and actually owning the entire property.

The divorce judgment contemplated the disposition of the real estate and gave Hasznos rights to the net proceeds. But the Tax Court examined Florida property law and concluded that the divorce proceedings did not eliminate her former husband's ownership interest in the property.

Following the divorce, sufficient incidents of ownership remained with the former husband for him to possess a 50% tenancy-in-common interest.

That distinction proved decisive.

Because the former husband continued to own an interest in the property, the federal tax lien against him could attach to that interest. The divorce judgment's allocation of the sale proceeds to Hasznos did not retroactively eliminate the property interest to which the federal tax lien had attached.

Innocent Spouse Relief Has Limits

Section 6015 of the Internal Revenue Code can provide significant protection to a spouse who otherwise would be jointly liable for taxes attributable to a joint return.

But Hasznos demonstrates that innocent spouse relief and federal tax lien law address different questions.

Innocent spouse relief can eliminate or reduce a taxpayer's personal liability for a joint tax debt. It does not necessarily eliminate a federal tax lien that validly attached to property owned by the other spouse.

Thus, although Hasznos was entitled to innocent spouse relief, she could not recover the portion of the proceeds attributable to her former husband's ownership interest.

The Tax Court effectively limited her recovery to 50% of the net sale proceeds, leaving approximately $311,851 attributable to the former husband's interest available to satisfy the federal tax lien.

The Indemnification Provision Was Not Enough

The divorce arrangement also provided Hasznos with rights against her former husband. But contractual rights between former spouses do not necessarily defeat the government's federal tax lien.

The practical problem was particularly significant because the former husband had reportedly left the United States and could not be located.

The Tax Court recognized the difficulty this created for Hasznos, but the Court could not simply shift the economic loss to the government on equitable grounds. Her remedy for the amount attributable to her former husband's interest was essentially against the former husband under the parties' indemnification arrangements.

That remedy may have had little practical value if he could not be found or collection against him was impossible.

A Critical Lesson for Divorce and Tax Planning

Hasznos is a reminder that a divorce decree stating that one spouse is entitled to property—or to all of the proceeds from its eventual sale—should not automatically be treated as equivalent to a completed transfer of legal title.

When real estate is involved, practitioners should determine:

• Who holds legal title after the divorce?

• Did the divorce judgment itself transfer ownership under applicable state law?

• Was a deed or other appropriate transfer instrument executed and recorded?

• Are there existing federal tax liens against either spouse?

• Could a lien attach between the divorce and a later sale or transfer?

• Does the settlement merely allocate future sale proceeds rather than actually transferring the underlying property?

These questions can have dramatically different federal tax consequences.

Practical Takeaway

The result in Hasznos might have been very different if the former husband's ownership interest had been properly transferred before the federal tax lien attached.

For taxpayers and advisers, the lesson is straightforward: do not assume that a marital settlement agreement or divorce judgment allocating property economically also accomplishes the necessary legal transfer of title.

When one spouse is intended to become the sole owner of real estate following a divorce, practitioners should confirm that the transfer has actually occurred under state law and that the public records accurately reflect the intended ownership.

Tax liens follow property rights—not merely the parties' economic intentions.

Hasznos v. Commissioner therefore sits at an important intersection of divorce law, state property law, innocent spouse relief, and federal tax collection. A failure to coordinate those rules can turn what appears to be a favorable divorce settlement into a substantial and unexpected federal tax collection problem.

Have IRS Tax Problems?

     Contact the Tax Lawyers at

Marini & Associates, P.A. 

for a FREE Tax HELP Contact us at:
www.TaxAid.com or www.OVDPLaw.com
or Toll Free at 888 8TAXAID (888-882-9243)

This post is for general information only and is not legal or tax advice. The application of these rules depends on the specific facts. Please contact us to discuss your situation.

Mistake or Fraud? What the GAO's New $304 Billion Estimate Means for Taxpayers

On September 25, 2026, the U.S. Government Accountability Office released a report titled "Tax Fraud: The Federal Government Loses an Estimated $116 Billion to $304 Billion Annually." It is the first comprehensive federal estimate of how much revenue is lost to tax fraud each year, as opposed to honest mistakes or ordinary noncompliance.

The headline number will get attention in Washington. For taxpayers and their advisors, the more useful question is what the report says about where IRS enforcement is likely headed.

The Numbers

GAO estimates annual federal tax fraud losses at $116 billion to $304 billion, based on data from 2018 through 2024. Applied to tax year 2022, that is roughly 2% to 6% of all federal tax owed.

Put another way, against a 2022 total tax liability of about $4.6 trillion and a gross tax gap of about $696 billion, fraud may account for 17% to 43% of the tax gap.

GAO built the estimate from three sources of data:

• IRS cases of actual and potential fraud;

• The portion of the tax gap attributable to potential fraud; and

• Tax evasion from the "shadow economy," meaning economic activity deliberately hidden from the government.

GAO ran these inputs through a Monte Carlo simulation. The low end of the range comes from IRS case data and tax-gap fraud; the high end comes from a separate estimate of shadow-economy evasion. GAO acknowledges that the figures are "inherently uncertain" but says they reflect the best available evidence and methods.

Fraud Is Not the Same as a Mistake

GAO defines fraud as a "willful misrepresentation to obtain something of value". That distinction matters, and it is where the IRS pushed back.

In the IRS's formal response, IRS CEO Frank Bisignano wrote that the report "does not sufficiently distinguish fraud with broader taxpayer noncompliance," noting that underreported income or inaccurate reporting "do not necessarily meet the legal threshold for fraud." GAO disagreed. It said its estimate excludes non-fraud noncompliance and uses a definition consistent with the IRS's own.

This is more than a technical argument. Under the tax law, the line between negligence and fraud has major consequences:

• Penalties. An accuracy-related penalty for negligence or substantial understatement is generally 20% of the underpayment (IRC § 6662). The civil fraud penalty is 75% (IRC § 6663).

• Statute of limitations. The IRS normally has three years to assess additional tax. When a return is fraudulent, there is no limitations period at all (IRC § 6501(c)(1)).

• Criminal exposure. Willful evasion can be prosecuted under IRC § 7201, and willfully filing a false return under § 7206(1).

• Burden of proof. The IRS must prove civil fraud by clear and convincing evidence (IRC § 7454(a)). That is a higher bar than it faces for ordinary deficiencies.

A report that puts a large dollar figure on "fraud" adds to the political pressure to treat questionable positions as more than honest error. Taxpayers with a legitimate explanation for a reporting problem should make sure that explanation is documented early.

What the IRS Does Today

The report credits the IRS with real results. Its Return Review Program, an automated system that screens individual returns for identity theft and refund fraud, stopped about $88 billion in invalid and potentially fraudulent refunds from 2018 through 2024. Over the same period, the IRS closed more than 4.8 million audits recommending an average of $24.9 billion a year in additional tax. That figure covers all types of noncompliance, not just fraud.

GAO also found that IRS auditors are trained to spot fraud indicators during routine exams. When they do, the case can lead to civil penalties, a criminal investigation, or referral for prosecution.

The report gives one example: a Georgia man who filed two 2021 returns under different Social Security numbers, claimed losses from a supposed gold-mining business in Ghana, and received a refund of more than $3.3 million. He was sentenced in January 2026 to 14 years and seven months in prison.

What GAO Recommends

GAO's main criticism is organizational. The IRS assesses fraud risk routinely but has no antifraud strategy and no designated antifraud entity to manage fraud risk "in a strategic and coordinated manner". GAO made two recommendations to the Commissioner:

1. Develop and document an antifraud strategy, either agency-wide or within operating divisions.

2. Designate an entity to coordinate and oversee fraud risk management.

The IRS partially agreed with both. It said it would "consider developing an agency wide antifraud strategy" and that its Chief Tax Compliance Officer already serves as the coordinating entity. GAO called that designation "a positive step" but said the IRS still needs to document that office's full responsibilities.

The report has also entered the IRS funding debate. Rep. Richard Neal, the ranking Democrat on the House Ways and Means Committee, cited it as evidence that the IRS needs staffing and enforcement funding.

Practical Takeaways

• Expect more fraud-focused screening, not less. GAO designed the estimate to help Congress and the IRS weigh the cost of new controls against the losses they would prevent. More automated filters usually mean more legitimate returns get flagged along with fraudulent ones.

• Refund claims deserve extra care. Large refunds, amended returns, and claims driven by business losses or credits draw the most scrutiny. Keep documentation ready before you file.

• Protect your identity. An IRS Identity Protection PIN blocks anyone else from filing a return under your Social Security number. You can request one through the IRS website.

• Correct problems before the IRS finds them. If a past return has an error, fixing it voluntarily is almost always better than waiting for an exam. That applies with extra force to unreported foreign accounts, offshore income, and cash-business receipts, which sit close to the "shadow economy" GAO is measuring.

• If an examiner raises fraud, get counsel right away. Fraud referrals change the stakes: higher penalties, no statute of limitations, and possible criminal exposure. How you answer the first questions can shape the rest of the case.

Bottom Line

GAO's estimate is a range built on imperfect data, and the IRS disputes parts of it. Still, it gives Congress a concrete number to point to at a time when IRS funding and enforcement priorities are being debated. Taxpayers should read it as a sign that fraud detection will stay a priority. The best protection remains accurate reporting, good records, and prompt correction of past errors.

Have IRS Tax Problems?

     Contact the Tax Lawyers at

Marini & Associates, P.A. 

for a FREE Tax HELP Contact us at:
www.TaxAid.com or www.OVDPLaw.com
or Toll Free at 888 8TAXAID (888-882-9243)

This post is for general information only and is not legal or tax advice. The application of these rules depends on the specific facts. Please contact us to discuss your situation.

Marini & Associates, PA Recognized in Chambers Florida Spotlight Guide 2027 for Tax Law

Marini & Associates, PA is proud to announce that the firm has been ranked in the Chambers Florida Spotlight Guide 2027 for Tax Law, an honor that distinguishes the firm as one of Florida’s leading tax law practices and a credible alternative to Big Law.

Chambers, the world’s leading legal ranking and insights intelligence company, has spent over 30 years identifying and ranking exceptional legal talent through an unparalleled research methodology. Its rankings are based on independent and impartial market analysis, assessing law firms and lawyers across more than 200 jurisdictions worldwide. 

“This recognition reflects our unwavering commitment to delivering sophisticated tax law solutions and exceptional client service,” said Ronal A. Marini, Managing Partner of Marini & Associates, PA.

 “We take pride in offering clients the expertise and strategic capabilities that rival the largest firms, while providing the personalized attention that sets us apart.”

The Chambers Florida Spotlight Guide highlights law firms that embody excellence, leadership, and innovation within their fields. Being selected in this prestigious guide underscores Marini & Associates, PA’s reputation for results-driven legal counsel in complex tax matters, including IRS disputes, international tax compliance, estate planning, and corporate tax strategies.

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IRS Targets "Tax-Aware" ETF and Fund Strategies in Notice 2026-62

On September 28, 2026, Treasury and the IRS released Notice 2026-62, which identifies a group of investment fund strategies they believe produce tax results "inconsistent with the purpose and proper application" of the Internal Revenue Code . At the same time, the IRS issued Revenue Ruling 2026-20. That ruling treats one of the most heavily marketed strategies, the so-called "Section 351 ETF conversion," as a taxable exchange.

The notice is not a final rule. It is a warning. It describes the transactions, asks for comments by October 28, 2026, and says that future guidance could include regulations, revenue rulings, or designating the transactions as listed transactions or transactions of interest. Any such guidance could apply retroactively . The IRS also says it may challenge these strategies on examination under existing law, including judicial doctrines .

If you have invested in, sponsor, or advise on any of the funds described below, now is the time to review your position.

Why ETFs Are at the Center

Most of the strategies rely on Section 852(b)(6). Under that rule, a regulated investment company (RIC) does not recognize gain when it distributes appreciated property to redeem shares at a shareholder's demand . ETFs use this rule every day. When an "authorized participant" redeems a creation unit, the ETF can hand over low-basis securities without triggering gain. This is a big reason ETFs are more tax-efficient than traditional mutual funds .

The IRS is not challenging ordinary ETF creation and redemption activity. The notice expressly says it does not address those routine distributions . The concern is that the redemption mechanism is being used "not simply to operate an ETF in the normal course," but to eliminate income or gain that Subchapter M and other Code provisions expect to be taxed .

The Strategies Under Scrutiny:

1. Section 351 ETF Conversions (See Rev. Rul. 2026-20)

In this strategy, investors transfer diversified portfolios of appreciated stock to a newly formed ETF and claim tax-free treatment under Section 351. Soon after, as part of the plan, the ETF issues creation units to an authorized participant for cash or "on-thesis" securities. It then redeems those units with the investor's original securities. The result is that the investor ends up owning a fund with a materially different portfolio, without recognizing any built-in gain .

Rev. Rul. 2026-20 applies substance-over-form and step-transaction principles and treats the ETF as a mere conduit. The investor is treated as making a taxable exchange under Section 1001 with the authorized participant, so Section 351 does not apply to the securities used to redeem the authorized participant assets.law360news+1. The ruling does not state an effective date or offer transition relief. 

The notice does carve out ordinary ETF "seeding." A Section 351 transfer of assets that fit the ETF's investment thesis, and that the fund expects to keep, is not covered .

2. Partnership "Exchange Fund" Variations

Investors whose holdings are too concentrated to qualify as a diversified portfolio under Section 351(e) have been offered a different path. They first contribute appreciated stock to a partnership that holds at least 20% non-securities assets, which is meant to avoid "investment company" status under Section 721(b). The partnership then carries out a Section 351 conversion . Treasury and the IRS are considering guidance that would deny nonrecognition to these contributions or recharacterize them .

3. Box Spread Funds

Some ETFs build returns similar to Treasury bills using "box spreads," which combine four options that together produce a short-term interest rate return. Before the gain options expire, the fund distributes them to redeem creation units. Shareholders receive no current dividends and instead recognize capital gain only when they sell . A related version pairs the box spread with a straddle, distributes only the gain leg, and deducts the loss leg .

4. Record Date Strategies

A "parent" ETF that holds other index ETFs can redeem out the acquired ETF shares just before a dividend record date and replace them with a different ETF tracking the same index. The parent ETF takes the position that it never recognizes the dividend income, even though its economic exposure stays essentially the same .

5. RIC Income Test Avoidance

To qualify as a RIC, a fund must get at least 90% of its gross income from qualifying sources under Section 851(b)(2). Some ETFs that hold commodities or digital assets, directly or through grantor trusts, distribute appreciated non-qualifying assets through redemptions. They then take the position that the unrecognized gain does not count against the income test . Commentators note that this piece could affect certain commodity and crypto fund structures.

"Tax-Aware" Funds: Manufacturing Capital Gain and Ordinary Loss

Section 3 of the notice moves beyond ETFs. It addresses "tax-aware" partnerships and separately managed accounts that use technical rules to pair capital gains (taxed at lower rates or deferred) with ordinary losses that offset wages or other ordinary income . The IRS says labeling a strategy "tax-aware" is not a problem in itself, and it recognizes traditional tax-loss harvesting as legitimate . The strategies it flags are:

• Mixed-character identified straddles. These pair a Section 988 foreign currency forward (ordinary) with an offsetting Section 1256 futures contract (60/40 capital), or an equity index swap with an index future. The futures leg is always terminated first, so gains come out capital and losses come out ordinary .

• Hindsight Section 988(a)(1)(B) elections. The fund enters into same-day currency forwards and elects capital treatment only for the winners after the trading day ends, leaving the losers ordinary .

• Selective NPC terminations. The fund terminates appreciated short-term swaps just before a scheduled payment to claim capital treatment under Section 1234A, but holds losing swaps to maturity to claim ordinary expense .

What Taxpayers and Advisors Should Do Now

• Inventory exposure. Find clients who took part in a Section 351 ETF conversion or an exchange fund feeding one, or who hold interests in box spread, fund-of-ETF, commodity/digital asset, or "tax-aware" long-short vehicles.

• Revisit the reporting positions. Rev. Rul. 2026-20 sets out the IRS's view of current law. Clients who treated a conversion as tax-free should evaluate whether they need to amend, disclose, or take other protective steps, especially for years that are still open.

• Watch for listed transaction status. If any of these strategies becomes a listed transaction or transaction of interest, participants and material advisors could face Form 8886 and Form 8918 disclosure duties and significant penalties for failing to comply.

• Get the documentation from sponsors. Ask fund sponsors for their tax opinions, their descriptions of how redemptions are handled, and whether the fund plans to change its structure.

• Consider commenting. Sponsors and industry groups that believe their products are legitimately different from the transactions described have until October 28, 2026 to say so .

The Bottom Line

Notice 2026-62 shows that Treasury and the IRS are paying close attention to fund structures that turn Section 852(b)(6) and similar technical rules into tools for eliminating or recharacterizing income. The Section 351 ETF conversion has already been ruled a taxable exchange. The other strategies are clearly on the path to further guidance, possible listed transaction designation, and examination. Taxpayers who used these products should talk with their tax advisor before the next filing season.

Have IRS Tax Problems?

     Contact the Tax Lawyers at

Marini & Associates, P.A. 

for a FREE Tax HELP Contact us at:
www.TaxAid.com or www.OVDPLaw.com
or Toll Free at 888 8TAXAID (888-882-9243)

This post is for general information only and is not legal or tax advice. The application of these rules depends on the specific facts. Please contact us to discuss your situation.

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References

1. Internal Revenue Service, Notice 2026-62, Guidance and Other Actions Being Considered Regarding Certain Potentially Abusive Investment Fund Strategies Involving Financial Products (Sept. 28, 2026). https://www.irs.gov/pub/irs-drop/n-26-62.pdf (also available at https://assets.law360news.com/2530000/2530914/n-26-62.pdf)

2. Internal Revenue Service, Rev. Rul. 2026-20, Determination of Amount of and Recognition of Gain or Loss (Sept. 28, 2026). https://www.irs.gov/pub/irs-drop/rr-26-20.pdf

3. KPMG TaxNewsFlash, "Rev. Rul. 2026-20 and Notice 2026-62: Potentially abusive transactions involving investment funds" (Sept. 28, 2026). https://kpmg.com/us/en/taxnewsflash/news/2026/09/tnf-rev-rul-2026-20-and-notice-2026-62-potentially-abusive-transactions-involving-investment-funds.html

4. Mitrade, "The IRS May Be Coming for Crypto ETFs Next: Which Funds Are at Risk?" (Sept. 28, 2026). https://www.mitrade.com/ae-en/insights/news/live-news/article-3-2122030-20260929

5. Internal Revenue Code §§ 311(b), 351(e), 721(b), 851(b)(2), 852(b)(6), 988(a)(1), 1092(a)(2), 1234A, 1256; Treas. Reg. §§ 1.351-1(c), 1.446-3.