What Is Rev Code 250 and the FDII Deduction?
Explore Rev Code 250 and the FDII deduction, a U.S. tax provision incentivizing domestic corporations with foreign-derived income.
Internal Revenue Code (IRC) Section 250 offers a tax deduction for domestic corporations earning certain income from foreign sources. This provision encourages U.S. companies to retain and expand their operations, particularly those involving intellectual property and export activities, within the United States. The deduction aims to make the U.S. a more competitive location for generating income from global markets. It specifically targets income derived from selling goods or providing services to foreign customers, reducing the effective tax rate on that income.
Understanding Foreign-Derived Intangible Income (FDII)
Foreign-Derived Intangible Income (FDII) represents a portion of a U.S. corporation’s income generated from transactions with foreign customers. This income is generally considered to be derived from the use of intangible assets located in the U.S. The objective is to incentivize businesses to maintain their high-value, income-producing assets and operations within the U.S.
Qualifying income for FDII includes revenue from selling property to non-U.S. persons for foreign use, or providing services to non-U.S. persons or with respect to property not located in the U.S. For instance, if a U.S. company manufactures goods in the U.S. and exports them for use outside the U.S., the income from these sales can qualify for FDII. Similarly, income from licensing intellectual property to foreign entities for foreign use or performing services for foreign clients may also be eligible.
FDII is distinct from other international tax provisions like Global Intangible Low-Taxed Income (GILTI) or Subpart F income. While both FDII and GILTI address income related to intangible assets, GILTI generally applies to income earned by controlled foreign corporations (CFCs), whereas FDII applies to income generated by U.S. operations from foreign markets. The FDII deduction aims to create a more level playing field for U.S.-based intangible assets compared to those held abroad.
Calculating the Deduction
The Section 250 deduction involves a multi-step calculation to determine the qualifying FDII amount. The deduction is a percentage of the calculated FDII, which is currently 37.5%. This deduction results in a reduced effective tax rate on qualifying income.
The calculation begins with determining “Deduction Eligible Income” (DEI), which is the gross income of a domestic corporation minus certain excluded items and allocable deductions. From DEI, a “Deemed Tangible Income Return” (DTIR) is subtracted to arrive at “Deemed Intangible Income” (DII). DTIR is generally 10% of the corporation’s “Qualified Business Asset Investment” (QBAI), representing a normal return on tangible assets. QBAI refers to the average adjusted basis of specified tangible depreciable property used in the business to produce DEI.
The FDII is then determined by multiplying the DII by a “Foreign-Derived Ratio” (FDR), which compares foreign-derived deduction eligible income (FDDEI) to total DEI. FDDEI is the portion of DEI connected to sales of property to non-U.S. persons for foreign use or services provided to non-U.S. persons. Finally, the calculated FDII is multiplied by the applicable deduction percentage to arrive at the Section 250 deduction. The deduction is subject to a limitation based on the taxpayer’s overall taxable income, ensuring it does not exceed a certain percentage of that income.
Eligibility and Application
The Section 250 deduction is primarily available to domestic C corporations. Other entity types, such as S corporations, partnerships, and individuals, cannot directly claim this deduction. This eligibility limitation focuses the incentive on corporate structures that align with the policy goal of encouraging U.S.-based operations and investment in intangible assets.
Businesses that generate qualifying FDII are those engaged in exporting goods, providing services to foreign clients, or licensing intellectual property for foreign use. Examples include manufacturers selling products abroad, software companies providing services to international customers, or businesses licensing patents for use outside the U.S. The core requirement is that the income must be derived from transactions with foreign persons and for foreign use.