Article

Revamp and rebrand of the FDII regime

Aug. 12, 2025 · Authored by James C. Lawson, Nikki Grams

On July 4, 2025, President Trump signed into law the One Big Beautiful Bill Act (the Act) (P.L. 119-21). The Act made some key changes to the existing foreign-derived intangible income (FDII) deduction regime as tax practitioners have come to know it.

Background

For reference, the FDII deduction, as initially established under the Tax Cuts and Jobs Act of 2017 (TCJA), was intended to encourage export activities by C corporations that are attributable to U.S. intangible assets. FDII is equal to deemed intangible income (DII) multiplied by its foreign-derived ratio, which is foreign-derived deduction eligible income (FDDEI) divided by deduction eligible income (DEI). DEI is generally all gross income of the taxpayer, less certain prescribed exclusions (e.g., global intangible low-taxed income (GILTI), subpart F income and foreign branch income, less deductions properly allocable to such income (including interest and research and development (R&D) expenses). DII is the excess of DEI over the deemed tangible income return (DTIR) or 10% of the taxpayer’s qualified business asset investment (QBAI). DTIR is effectively a substance-based hurdle that was designed to promote an FDII benefit that is attributable to the residual income being generated from a company's intangible assets used in serving foreign markets through U.S. operations as derived through the proxy of a deemed intangible income return (that being eligible income in excess of this hurdle amount). This in turn provides a similar tax incentive to U.S. corporate exporters as provided to U.S. corporations earning income via controlled foreign corporations (CFCs) at a reduced GILTI tax rate, while encouraging investment, creation of jobs and development/retention of IP within the U.S. from an overall domestic tax policy perspective. FDDEI generally includes the gross income of a taxpayer that is from qualified foreign-derived sales and services less allocated and apportioned deductions which, again, inclusive of U.S. interest and R&D expenses. The resulting FDII amount is then multiplied by the FDII deduction percentage, which under TCJA is 37.5% resulting in an effective tax rate of 13.125% on qualifying foreign-derived income.

The Act

Applicable taxpayers should be made aware of the following key changes brought about by the Act that impact upon the application of the FDII regime: (1) the removal of the substance-based hurdle, (2) the exclusion from DEI of any income and gain from the sale or other disposition of intangible property or any other property of a type that is depreciable, amortizable or depletable, (3) a decreased available deduction percentage and (4) a simplification for expense allocation and apportionment. Changes to the regime will mostly apply to taxable years beginning after Dec. 31, 2025, unless otherwise noted.

A note on accounting for income taxes: FDII is generally accounted for as a period benefit so any change due to the Act will be reflected for the financial year in which such a deduction is utilized.

1. Removal of the substance-based hurdle for taxable years beginning in 2026 and beyond

For taxable years beginning after Dec. 31, 2025, the substance-based hurdle, or DTIR, is removed from the FDII calculation and FDII effectively becomes FDDEI in providing taxpayers with a benefit for all qualifying export income regardless of whether such income is derived from intangible or tangible assets.

Planning consideration: Taxpayers with substantial domestic qualified business assets may have been unable to benefit from a FDII deduction historically but may have the ability to now benefit on a FDDEI basis and it is anticipated that a greater number of C corporations will be positioned to take advantage of this benefit. Taxpayers should consider modelling out the implications of this change (and others herein) to determine any additional tax benefits that may be provided by the FDDEI deduction. Applicable taxpayers will need to incorporate this change into their estimated tax and extension payments, as applicable, for taxable years beginning after Dec. 31, 2025.

2. The exclusion from DEI of any income and gain from sales or other dispositions of intangible property or any other property of a type that is depreciable, amortizable or depletable occurring after June 16, 2025

Any income and gain from the sale or other disposition of intangible property or any other property of a type subject to depreciation, amortization or depletion by the seller is now excluded income for purposes of the FDDEI deduction consistent with the treatment of GILTI, subpart F income and foreign branch income as prescribed exclusions from DEI (and FDDEI). This change will apply to applicable sales or dispositions occurring after June 16, 2025.

Planning consideration: Taxpayers undertaking sales or dispositions of tangible property subject to depreciation, amortization or depletion or of intangible property occurring after June 16, 2025, will need to ensure they exclude any income and gain from their DEI and FDDEI for purposes of their remaining 2025 estimated tax payments, extension payments and tax returns.

Planning consideration: Special care should be given to taxpayers that complete any outbound transfers of intangible property after June 16, 2025, which are covered under section 367(d) whereby any associated deemed royalty income arising from the transfer, each in the year of transfer and any applicable succeeding taxable years, is treated as excludable income for purposes of the FDDEI deduction. Associated deemed royalty income arising from outbound transfers completed on or before that date remains includable income for DEI purposes, as does income from the actual licensing of intangible property not the subject of a sale or other disposition (note: the definition of “sale” otherwise used for purposes of the FDDEI rules (e.g., in including licensing income as qualifying sales income) does not apply for purposes of this new rule).

3. Decreased deduction percentage to 33.34% for taxable years beginning in 2026 and beyond

For taxable years beginning after Dec. 31, 2025, the FDDEI deduction (formerly FDII deduction) will decrease from 37.5% to 33.34%.

Planning consideration: With this change, the effective tax rate on qualifying export income transitions from 13.125% to 14%. Taxpayers should consider the impact of this change under their given facts and circumstances in conjunction with other changes to the former FDII regime for their 2026 estimated tax and extension payments, tax provisions and tax returns.

4. Simplified expense allocation and apportionment for taxable years beginning in 2026 and beyond

Taxpayers only need to allocate and apportion expenses that are properly allocable to DEI (and FDDEI), which specifically excludes U.S. interest and R&D expenses for taxable years beginning after Dec. 31, 2025.

Planning consideration: Taxpayers may see an increased FDDEI benefit due to the removal of the requirement to allocate and apportion US interest and R&D expenses to DEI and FDDEI. Taxpayers will need to consider the impact of the simplified apportionment with respect to any FDDEI deduction in conjunction with other changes discussed herein for their 2026 estimated tax and extension payments, tax provisions and tax returns.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.