We have seen this deduction overlooked numerous times by taxpayers because they were not aware it existed. Any US corporate taxpayer with foreign revenue needs to run the numbers to see if this deduction can help their tax bill.
What is the deduction?
FDII stands for “Foreign-Derived Intangible Income” and is a corporate tax deduction on foreign intangible revenue earned through a domestic entity. The deduction was created by the 2017 Tax Cuts and Jobs Act (TCJA) under IRC §250. This deduction is intended to be a permanent part of the tax code, barring future legislation.
§250 takes a commonsense approach to a calculation that easily could have been a practitioner’s nightmare rivalling the QBI deduction. It is easy to spot who can take the deduction and the calculation is straightforward when compared to other new code sections. It is often overlooked as it is dismissed by taxpayers because they wrongly believe they must have intangible assets to qualify for the deduction, or they are unaware of it because they (or their advisor) do not do ‘international tax’.
How much is the deduction?
As of 2021, the deduction is 37.5% of foreign-derived intangible income leading to an effective tax rate of 13.125% on qualifying income.
For tax years beginning after December 31, 2025, the deduction is 21.875% of foreign-derived intangible income with an effective tax rate of 16.41% on qualifying income.
Who can take the deduction?
Any taxpayer operating a business through a US domestic corporate entity that has foreign revenues through that entity should perform the FDII calculation to determine if they can take the deduction. S Corporations and LLC’s cannot take the deduction nor can income earned through a foreign branch or controlled foreign corporation (CFC).
Since this provision applies regardless of revenues, even the smallest of taxpayer might benefit from the FDII deduction and owing intangibles are not necessary.
FDII was created to encourage the holding of intellectual property in the US by providing an advantageous tax rate on the income the intangible generates.
The Future of FDII
Left alone, the deduction will continue but in the real world, nothing really lasts forever. Under President Biden’s proposed tax plan, this tax break may be reduced but as of January 2021 there has been no movement on the topic.
In addition, the deduction is not viewed favorably in the European Union (EU) who complained to the World Trade Organization (WTO) that it violates international law and is an illegal government subsidy.
The only certainty is that it exists right now and should be considered.