In 2017, the Tax Cuts and Jobs Act (TCJA) created IRS Code Section 250, allowing certain taxpayers a deduction for Global Intangible Low-Taxed Income (GILTI) and Foreign-Derived Intangible Income (FDII). FDII was created as an export incentive to encourage US businesses to locate intangible property in the US rather than foreign jurisdictions.

Instead of identifying specific intangible property that produces income that qualifies for FDII, the TCJA identified an amount deemed to be income from tangible property (like buildings and equipment) and excludes that amount. Because FDII defines intangible income so broadly, many companies operating in the US may already receive intangible income for FDII purposes. When these companies sell overseas, they neatly fit the activity the TCJA intended to promote with FDII.

In effect, FDII created a significant tax benefit for US companies selling goods and services overseas. As a result, US companies may get a corporate tax rate of 13.125% on sales to foreign people for foreign uses. FDII essentially created two income categories for US C Corporations, FDII income taxed at 13.125%, and non-FDII income taxed at 21%.

The FDII incentive is expansive and is available for most foreign sales, including property sales, services, royalties, and intercompany transactions. Nevertheless, here are some of the common limitations on which US taxpayers and transactions qualify for FDII:

• The taxpayer must be a US C Corporation
• Mechanically, the FDII calculation limits the benefit to taxpayers that have income and are not in an NOL position
• The lower tax rate only applies to sales to foreign people for foreign uses
• Subpart F and GILTI income are excluded from FDII
• Related party foreign branch transactions are excluded from FDII
• Financial services income is excluded from FDII

Common Considerations

• FDII may be used with other export incentives such as IC-DISCs, assuming all other qualifications of FDII and IC-Discs are met
• FDII sales have a documentation requirement, which may be less demanding for qualifying small business corporations
• Taxpayers may amend prior year returns, within certain limitations, to take advantage of the FDII benefit in those years
• The 13.125% tax rate on FDII income increases after tax year 2025 (along with an increased GILTI tax rate)
• FDII is intended to be the inverse tax incentive to GILTI and is integrated with GILTI to calculate the full Section 250 deduction
• Partnerships may calculate certain portions of FDII and disclose that information on Schedule K-3 to C Corporation partners
• C Corporation partners use their distributive share of the FDII attributes from the partnership to calculate their FDII

Note: These rules and attributes are not exhaustive, and the FDII deduction can be complex. Please consult your Aldrich tax advisor if you think the FDII deduction may apply to your company.

The FDII regime presents many opportunities for efficient tax planning while presenting certain intricate issues requiring astute counsel. Some of these issues include:

• FDII can be used with a transfer pricing policy to maximize the FDII benefit
• FDII and IC-DISC benefits can be modeled with both benefits and either/or scenarios
• Review of qualifying related-party foreign transactions

The calculation of FDII is usually broken into several steps:

Step 1: Determine DEI

Calculate Deduction Eligible Income (DEI) by reducing the corporation’s gross income by exclusions, including the Subpart F and GILTI income, foreign branch income, financial services income, domestic oil and gas income, etc. Then, allocate and apportion the appropriate deductions to the gross DEI.

Step 2: Determine DII

Calculate the corporation’s net fixed assets using the ADS depreciation method; 10% of the quarterly average of those net fixed assets (QBAI) is considered the “tangible return” and is subtracted from the DEI to get the Deemed Intangible Income (DII)

Step 3: Determine FDDEI

Calculate the gross Foreign-Derived Deduction Eligible Income (FDDEI), which is all income from sales to a foreign person for foreign use. Subtract the allocable COGS and allocable deductions from the gross FDDEI to arrive at the FDDEI.

Step 4: Determine FDII

Divide the FDDEI by the DEI to get the foreign sales ratio. Multiply the foreign sales ratio by the DII to arrive at the FDII amount.

Step 5: FDII Deduction

Multiply the FDII by 37.5% to arrive at the FDII deduction, which is deducted from taxable income. Note—this assumes no taxable income limitation.

Ultimately, C Corporation taxpayers in a taxable income position could have a significant tax benefit related to their foreign sales. If you’re interested in learning more about how these intangibles could affect your tax liability, let’s talk.