IRS Issues Guidance on Deduction for FDII, GILTI

AAFCPAs would like to make clients aware that the IRS and Treasury issued final regulations recently covering the Section 250 deduction for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI). FDII and GILTI were introduced to US tax law as part of the 2017 Tax Cuts and Jobs Act and apply to domestic corporations with foreign operations.  The FDII deduction was also extended to U.S. corporate partners as part of the final regulations. The final regulations provide clarification on documentation requirements, the determination of FDII, and computation of the corresponding deduction.

Section 250 deductions can be vital from a tax minimization standpoint to help offset, by as much as 50%, any required inclusions under the anti-deferral rules of GILTI and/or provide an additional reward for business operational activity which satisfies the criteria for FDII. The Section 250 deduction is available to domestic corporations for a portion of profits attributable to U.S. activities that serve foreign markets (FDII) and a portion of profits with respect to foreign corporations which are controlled by a U.S. corporation (GILTI). This could be in the form of an “excess return” derived from directly serving foreign markets from the U.S. under FDII, or an excess return which is derived through foreign affiliates under GILTI. To the extent there is an “excess return,” which is generally defined as a return in excess of fixed returns on tangible assets, under either scenario, a potential deduction could be afforded to the domestic corporate taxpayer. Such deduction results in an overall lower effective U.S. tax rate and lower overall tax liability.

Documentation Requirements

The final regulations relax the Specific Substantiation Standards, including an exemption from compliance entirely for taxpayers and all related parties of the taxpayer with less than $25 million in gross receipts worldwide during the prior taxable year (subject to further definitive guidance from the Treasury). This makes the administrative burden much less for many taxpayers who can instead follow the general documentation standards in place. So long as it is deemed sufficient, general documentation can include the use of readily available business records. The final regulations also eliminate the use of market research to establish foreign usage of the goods or services as an available substantiation measure.

More stringent requirements remain in effect for sales of general property to resellers and manufacturers, sales of general services to recipients, and sales of intangible property, which relate to deductions under FDII. If these specific transactions are relevant to your business, we recommend you consult with your AAFCPAs Partner to ensure compliance with the more detailed documentation requirements for your operational activity eligible for the Section 250 deduction.

How to Compute FDII, GILTI

A domestic corporation’s FDII is defined as its deemed intangible income (DII) multiplied by the foreign derived ratio—which is the ratio of its foreign-derived deduction eligible income (FDDEI) to its deduction eligible income (DEI). The final regulations retain the rule that the domestic corporation must allocate expenses to its gross FDDEI in order to properly determine the numerator in the foreign derived ratio.

From a GILTI standpoint, final regulations extend the Section 250 deduction to individuals, which includes both individual partners and S corporation shareholders provided a Section 962 election is made. This essentially treats individuals as a domestic corporation. This may prove to be a valuable tax planning strategy for passthrough or individual shareholders, who otherwise would not be afforded the benefits of the Section 250 deduction available to corporations.  However, as with all tax strategies, we encourage you to contact your AAFCPAs Tax Partner to evaluate your unique facts and circumstances.

AAFCPAs continues to monitor ever-changing developments in international tax, including their impact on US tax code. If you have questions, please contact: Tony Dello Stritto, CPA, MST at adellostritto@nullaafcpa.com, 774.512.9020; Bella Amigud, CPA, MST, at bamigud@nullaafcpa.com, 774.512.4060; or your AAFCPAs Partner.