Overview
- For taxable years beginning after December 31, 2025, the proposed regulations would affect the Section 250 deduction for deduction eligible income (DEI), foreign-derived deduction eligible income (FDDEI), and the foreign tax credit (FTC) limitation rules for foreign source §951A category income.
- Interest expense deductible under §163, including original issue discount (OID), and research or experimental (R&E) expenditures generally would be excluded from the DEI and FDDEI calculations and disallowed from allocation or apportionment to foreign source §951A category income.
- For §904(b)(5), deductions allocable to foreign source §951A category income would be limited to specified statutory deductions and other deductions that are directly allocable under the proposed regulations.
- Deductions that are disallowed or not directly allocable and that otherwise would reduce foreign source §951A category income would be reallocated to U.S. source income, potentially affecting overall domestic loss (ODL), separate limitation loss (SLL), overall foreign loss (OFL), and net operating loss (NOL) calculations.
Proposed regulations (REG-117273-25) would apply to two related areas: the §250 deduction and the §904(b)(5) foreign tax credit limitation rules. The §250 changes address the calculation of DEI and FDDEI, while the FTC limitation rules under §904(b)(5) determine which deductions may reduce foreign source §951A category income. Taxpayers may rely on the proposed regulations before final regulations are published if they apply the proposed regulations in their entirety.
Section 250 DEI and FDDEI Calculations
For §250 purposes, the proposed regulations would amend §1.250(b)-1 so that allocable deductions reducing gross DEI and gross FDDEI are computed without regard to interest expense deductible under §163, including OID and R&E expenditures deducted or amortized in the taxable year under §§174, 174A, or 59(e)(2)(B). The proposed rules also retain the exclusions for deductions under §§170(b)(2), 172, 246(b), and 250. Deductions would continue to be allocated and apportioned under the §861 regulations, with §250(b) treated as an operative section and gross FDDEI, gross residual deduction eligible income (gross RDEI), and excluded gross income treated as separate groupings.
Section 904(b)(5) Deduction Framework for Section 951A Income
For §904(b)(5), the proposed regulations establish a framework for determining which deductions may be allocated or apportioned to foreign source §951A category income.
- Permitted statutory deductions:
- Deductions under §250(a)(1)(B), apportioned under §1.861-8(e)(14)
- State and local income taxes deductible under §164(a)(3) that are imposed on net controlled foreign corporation (CFC) tested income or the §78 gross-up, apportioned under §1.861-8(e)(6)
- Directly allocable deductions
- Directly allocable deductions:§986(c) foreign currency gains or losses on distributions of §951A previously taxed earnings (PTEP) and NOL deductions under §172 are treated as directly allocable.
- The proposed regulations generally exclude from directly allocable deduction those that are of a type apportioned by relative asset value or gross income, including stewardship expenses, legal and accounting fees, damages awards, prejudgment interest, settlement payments, and supportive, general and administrative, or overhead expenses.
- Disallowed deductions: Interest expense deductible under §163, (including OID, and R&E expenditures deducted or amortized under §§174, 174A, or 59(e)(2)(B),) may not be allocated to foreign source §951A category income.
Reallocation Mechanics and Loss Account Effects
The reallocation rules apply in two steps. First, deductions are tentatively allocated and apportioned under the standard §861 rules without regard to §904(b)(5). Second, any deduction that is disallowed or not directly allocable and that tentatively falls into foreign source §951A category income is reallocated to U.S. source income for all §904 purposes.
Because §1.861-17 allocates R&E expenditures exclusively to gross intangible income, which excludes §951A inclusions, no R&E expense is tentatively allocated to §951A income in the first step. As a result, §904(b)(5) generally should not produce a reallocation of R&E deductions to U.S. source income.
The reallocation mechanics can affect loss accounts. Reallocated deductions reduce net U.S. source income and may create or increase an ODL if the domestic loss offsets foreign source income, potentially requiring future recapture as foreign source income. At the same time, this prevents disallowed deductions from reducing §951A income, which may avoid creating §951A SLL or OFLs. The proposed regulations also coordinate these rules with NOL components by taking §904(b)(5) into account when determining SLL and U.S. source loss components, and when applying an NOL carryover.
How We Can Help
Given the potential impact on §250 benefits, FTC limitation modeling, domestic loss planning, and NOL attributes, taxpayers should evaluate how the proposed regulations may affect quarterly estimates, forecasts, and worldwide effective tax rate modeling. Forvis Mazars can help analyze these implications based on your company’s facts and incorporate the rules into tax models to provide a clearer picture of expected outcomes. Reach out to a professional today.