How Does the Section 250 Deduction Work for FDII and GILTI?

The Section 250 deduction is a key element of the U.S. tax code, offering significant benefits for businesses engaged in international operations. It provides deductions related to Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI), components introduced by the Tax Cuts and Jobs Act of 2017. Understanding these deductions can greatly affect a company’s effective tax rate.

These provisions encourage domestic corporations to retain intangible assets in the United States while enhancing global competitiveness. Companies must understand the calculations for FDII and GILTI deductions to take full advantage of these benefits.

Qualifying Entities

To claim the Section 250 deduction, a company must qualify as a domestic C corporation subject to U.S. taxation. This includes both publicly traded and privately held corporations, while S corporations and partnerships are generally excluded. Additionally, the entity must generate income from foreign sources, such as the sale of goods, services, or licensing of intangible property to foreign entities. The focus on foreign-derived income underscores the deduction’s goal of improving U.S. competitiveness.

Eligibility also requires that the income qualifies as either FDII or GILTI, which involves specific definitions and calculations. Corporations must maintain detailed records to substantiate their claims, as the IRS closely examines compliance with these provisions.

FDII Calculation

Calculating Foreign-Derived Intangible Income (FDII) involves several steps to determine the deduction amount, which directly impacts a corporation’s tax liability.

Identifying Relevant Income

The first step is identifying income derived from foreign sources. FDII is based on revenue from sales of goods, services, or licensing of intangible property to foreign entities. Corporations must accurately separate domestic and foreign-derived income. For instance, a U.S. company exporting products to Europe must categorize this revenue as foreign-derived. Clear identification is essential for accurate deductions.

Determining Deduction-Eligible Expenses

Next, determine expenses directly attributable to foreign-derived income. These include production, marketing, and distribution costs for goods or services sold internationally. The IRS provides guidelines for allocating expenses under IRC Section 861. For example, if a company spends $1 million on marketing and 40% of sales are to foreign customers, $400,000 of marketing expenses may be allocated to foreign-derived income. Proper documentation is critical for compliance.

Computing the Final Deduction

The final step is applying the statutory rate to net foreign-derived income, which is income after subtracting eligible expenses. The FDII deduction rate is currently 37.5%. For example, if a company has $2 million in net foreign-derived income, the deduction would be $750,000 ($2 million x 37.5%). This reduces taxable income and lowers overall tax liability. Precise calculations and adherence to the tax code are essential to maximize this benefit.

GILTI Calculation

Calculating Global Intangible Low-Taxed Income (GILTI) involves determining the income U.S. shareholders of controlled foreign corporations (CFCs) must include in their taxable income.

Determining GILTI Inclusion

The GILTI inclusion amount is calculated by aggregating the tested income of all CFCs owned by a U.S. shareholder. GILTI equals net CFC tested income minus a deemed tangible income return, which is 10% of the qualified business asset investment (QBAI). For example, if a shareholder’s net tested income is $1 million and their QBAI is $5 million, the deemed tangible income return is $500,000. The GILTI inclusion would be $500,000 ($1 million – $500,000). This ensures income exceeding a reasonable return on tangible assets is subject to U.S. taxation.

Determining Tested Income

Tested income is the net income of a CFC after excluding certain items, such as effectively connected income, subpart F income, and high-taxed income. For instance, if a CFC has gross income of $2 million, with $200,000 in subpart F income and $300,000 in high-taxed income, the tested income would be $1.5 million ($2 million – $200,000 – $300,000). Proper identification of these exclusions is critical for compliance.

Calculating the Deduction

The Section 250 deduction reduces the effective tax rate on GILTI. The current deduction rate for GILTI is 50%, effectively halving the taxable amount. For example, if a corporation’s GILTI inclusion is $500,000, the deduction would be $250,000, resulting in a taxable GILTI of $250,000. This aligns the U.S. tax rate on GILTI with global minimum tax rates. Accurate calculations and documentation are essential to avoid errors and potential liabilities.

Applying the Deduction for Both FDII and GILTI

Incorporating FDII and GILTI deductions into a company’s tax strategy is vital for optimizing tax efficiency. Leveraging these deductions requires a thorough understanding of international tax regulations and careful planning. By doing so, corporations can significantly reduce their effective tax rate while remaining compliant with U.S. tax laws.

To maximize benefits, companies should carefully allocate expenses and income between domestic and foreign operations. This may involve analyzing the distribution of intangible assets and adjusting international licensing agreements or transfer pricing policies to optimize income allocation between FDII and GILTI.

Corporations should also account for the influence of foreign tax credits and the GILTI high-tax exclusion, which can further reduce net tax liability. Scenario analyses can help companies anticipate tax implications and align strategies with financial goals and shareholder interests.