On July 15, the U.S. Department of the Treasury and the IRS published final regulations addressing the computation of the deduction for foreign-derived intangible income (FDII) under IRC Section 250. Enacted as part of the Tax Cuts and Jobs Act of 2017 (TCJA) and effective for taxable years beginning on or after Jan. 1, 2018, Section 250 allows corporate taxpayers a deduction equal to 37.5% of their FDII and 50% of their global intangible low-taxed income inclusion under Section 951A. Although the final regulations largely adopted the calculus guidance in the proposed regulations issued in March 2019, they provide additional guidance and clarification. Following are highlights of the calculation mechanics of the deduction under the final regulations. A previous article focused on the documentation requirements under the final regulations.
Net operating losses (NOLs)
Section 250(a)(2) limits the benefit of the FDII deduction based on a taxpayer’s taxable income. The proposed regulations did not explicitly address whether pre-TCJA NOLs must be considered for this limitation. The final regulations expressly provide that all NOLs, including those arising in pre-TCJA years, are taken into account when determining a taxpayer’s taxable income.
IRC Sections 163(j), 172, and 250 all are used in determining taxable income and are based, in part, on taxable income, resulting in a circular calculation. The proposed regulations contained a five-step ordering rule that directed taxpayers on how to resolve the circularity. Taxpayers submitted numerous comments noting problems and weaknesses with the ordering rule application. In response to these comments, the preamble to the final regulations explains that the final regulations do not include an ordering rule so Treasury and the IRS can study the issue. In the interim, taxpayers are permitted to use any reasonable method to address the circular calculation as long as the method is applied consistently for all tax years beginning on or after Jan. 1, 2021. Both the ordering rule contained in the proposed regulations and a simultaneous computation method are considered reasonable methods.