Foreign-Derived Intangible Income

Enacted as part of the 2017 Tax Cuts and Jobs Act (the “Act”), new Internal Revenue Code Section 250 creates a new tax deduction for income derived by domestic corporations from serving foreign markets. This new deduction, effective for tax years beginning January 1, 2018, is for foreign-derived intangible income, also known as FDII. The FDII deduction results in a lower effective rate on the foreign income but is only available to domestic corporations that are taxed as C Corporations. Individuals, trusts, S Corporations, and partnerships are not eligible for this deduction.

Income considered to be foreign-derived is income earned from providing goods and services outside of the United States. The property must be leased, licensed, or sold to a foreign person or persons not located within the United States for use outside of the U.S.

Domestic corporations are currently allowed a deduction equal to 37.5% of their foreign-derived intangible income (this rate will be lowered to 21.875% starting in 2026). This deduction is allowed in addition to the 50% deduction allowed as an offset to the Global Intangible Low-Taxed Income (“GILTI”), which is included in the gross income of the domestic corporation. The FDII deduction yields a 13.125% effective tax rate, but if the intangible income is zero or less, no benefit is available.

There are two alternative ways to calculate FDII:

1. FDII = Foreign-Derived Deduction Eligible Income – (10% x Tangible Depreciable Property)
2. FDII = Deemed Intangible Income x Foreign-Derived Deduction Eligible Income / Deduction Eligible Income

“Foreign-derived deduction eligible income” is the corporation’s gross income, less exceptions, minus the deductions (including taxes).

The exceptions to eligible income are:

• Subpart F Income.
• Global Intangible Low-Taxed Income (GILTI).
• Dividends received from CFCs.
• Financial Services Income.
• Domestic Oil and Gas Extraction Income.
• Foreign Branch Income.

“Deemed intangible income” is equal to the corporation’s deduction eligible income, less the total of 10% multiplied by the Qualified Business Asset Investment.

In summary, the Foreign-Derived Intangible Income deduction provides a great benefit for owning intangible property and conducting business operations within the United States. GILTI and FDII work together to provide an overall deductible amount to United States taxpayers who are selling goods or services outside the United States. The deduction can be considered an incentive to keep intangible assets in the United States and also encourage export activity by C Corporations in order to effectively reduce the tax on their foreign-derived sales and service income.