The One, Big, Beautiful Bill Act (OBBBA) significantly revises the mechanics of the deduction available to U.S. businesses that earn income from foreign customers or related parties through the sale of goods, services, or licensed property. Under the OBBBA, the deduction previously known as foreign-derived intangible income (FDII) has been renamed foreign-derived deduction eligible income (FDDEI). OBBBA introduces a lower deduction rate and several major changes to how the deduction is calculated. Most of these updates will apply to tax years starting after Dec. 31, 2025. The changes could bring additional opportunities to taxpayers — particularly those with significant fixed assets, research and developmental (R&E) expenditures, and interest expense.
What’s the history and background of the FDII deduction?
Originally enacted under the Tax Cuts and Jobs Act (TCJA), Section 250 was designed to encourage U.S. corporations to retain income-generating assets domestically. The FDII deduction was 37.5% of a corporate taxpayer’s intangible income attributable to foreign sales through 2025. The deduction percentage was scheduled to decrease to 21.875% under the original TCJA provisions. Intangible income for FDII purposes is typically taxable income from qualifying transactions (after certain exclusions) less a deemed return of 10% of the tax basis in production assets computed under the Alternate Depreciation System (ADS), referred to as qualified business asset investment (QBAI). Under OBBBA, the deduction has been restructured and renamed to FDDEI, with a revised deduction rate of 33.34% for qualifying foreign income. The updated rules eliminate the previous requirement to calculate a deemed return on tangible assets, simplifying the deduction formula and broadening eligibility.
FDDEI may arise from transactions with both foreign unrelated parties and foreign related parties, provided the applicable qualification requirements are satisfied. In general, qualifying FDDEI includes taxable income attributable to the following categories of transactions:
- Sales of inventory and other property to foreign persons for foreign use.
- Services provided to foreign persons or with respect to property located outside the United States.
- Licenses of eligible property for use and exploitation outside the United States.
These categories are subject to important exclusions, most notably income from the disposition of certain intangible property and depreciable property, as clarified under the OBBBA amendments. As a result, while FDDEI retains broad applicability across foreign business activities, it no longer extends to gains from outbound transfers under Section 367(d), sales of qualifying intangibles, or depreciable assets.
Third-party foreign transactions and FDDEI
For transactions with unrelated foreign customers, qualification generally hinges on satisfaction of two core requirements:
- The transaction must be sold to a foreign person.
- The income must be derived from foreign use, meaning the property, services, or licensed rights are used, consumed, or exploited outside the United States.
In practice, foreign use for property sales typically requires that the property is ultimately delivered, consumed, or resold outside the United States. For services, the determination focuses on where the benefit of the service is received, and for licenses, on where the licensed rights are used. The requirements emphasize the actual economic location of use and benefit rather than solely focusing on billing mechanics.
Foreign related-party transactions and FDDEI
Importantly, foreign related-party transactions aren’t excluded from FDDEI, provided additional look through conditions are satisfied. In particular:
- Intercompany sales of property may qualify where the foreign related party ultimately resells the property, or incorporates it into a finished product, that’s sold to an unrelated foreign customer.
- Services and licenses provided to foreign related parties may qualify when they’re directly connected to the foreign affiliate’s third-party sales or services, including activities that support foreign manufacturing, distribution, R&D, or use of property in foreign markets.
Specific categories of expenses — in particular, interest and R&E expenses — are no longer allocable to FDDEI, which should typically increase the base amount that the deduction percentage is applied to. The FDDEI deduction remains available only to C corporations with qualifying foreign transactions, even if they don’t hold significant intangible property.
What follows is a list of key changes and a refresher on the documentation requirements previously issued in the FDII final regulations in 2020.
Key changes to the FDII (now FDDEI) deduction
Reduction of QBAI
Effective for tax years beginning after Dec. 31, 2025, under the OBBBA, the QBAI reduction is eliminated from the FDDEI calculation. Removing this adjustment means taxpayers will no longer have to offset their FDII benefit by the deemed 10% return on tangible property. As a result, many businesses, particularly those with significant tangible asset bases, could see a substantial increase in their FDII deduction. This change is expected to provide opportunities for corporate taxpayers operating in a wide range of industries, including manufacturing and fixed asset-intensive businesses, where QBAI previously eroded the potential FDII benefit.
Expense allocation
Effective for tax years beginning after Dec. 31, 2025, taxpayers are no longer required to allocate interest or R&E expenses against eligible income. Specifically, these expenditures are statutorily removed from the definition of deduction-eligible income and thus taxpayers don’t have to allocate and apportion them against their FDDEI. Under the current FDII regime, taxpayers with substantial interest expense or R&E expenditures frequently experienced a significant reduction or even elimination of their FDII deduction because of the allocation and apportionment of these costs.
Indirect impacts
When modeling and evaluating other opportunities and provisions introduced by the OBBBA, taxpayers should carefully consider how claiming additional temporary deductions — which may need to be allocated and could reduce FDDEI in 2025 — compares to the value of the permanent FDDEI benefit. In other words, it’s important to weigh the short-term advantages of temporary deductions against the permanent benefit that the FDDEI deduction provides under the new rules.
IRS Notice 2025-78
This notice outlines forthcoming proposed regulations that clarify how the new exclusion from deduction-eligible income (DEI) applies to certain transactions. The notice clarifies how the exclusion applies to sales, licenses, and other dispositions, including deemed dispositions and transactions subject to Section 367(d), that occur after June 16, 2025. The notice also defines “other excludable property” as any property subject to amortization or depreciation, which may prevent the related income from qualifying for the FDDEI deduction. Taxpayers may rely on this guidance before regulations are finalized, provided they follow the rules consistently across applicable years.
Will the prior FDII documentation requirements be the same as FDDEI documentation requirements?
As of now, it’s unknown whether Treasury will issue further clarifications in this area around documentation and other requirements after changes in the OBBBA beyond the guidance contained in Notice 2025-78. The 2020 final regulations provided criteria that allow taxpayers to presume that transactions meet the “foreign person” or “foreign use” qualification in some circumstances.
To claim the FDDEI deduction, taxpayers must maintain documentation proving that the buyer is a foreign person and that the sale or service qualifies for foreign use. The 2020 FDII final regulations allow taxpayers to presume foreign person and foreign use in certain cases, such as when goods are shipped to addresses outside the United States, unless the taxpayer knows or has reason to know otherwise. Careful consideration should be paid to the specific transactions to fully understand the required documentation for each transaction structure.
For component sales that may ultimately be used in the United States, taxpayers must document that the component undergoes substantial manufacturing abroad. The final regulations prohibited taxpayers from claiming the deduction for property ultimately used in the United States but allowed an exemption for sales of components that were subject to further manufacture outside of the United States. To qualify for the exemption under the 2019 proposed rules, the taxpayer would’ve had to show that the component’s fair market value was less than 20% of the fair market value of the end product into which it is integrated. The final regulations acknowledge that this information may not be available to taxpayers and adopt a facts and circumstances rule that requires components to enter a manufacturing process that is “substantial in nature.” The final regulations do retain 20% as a safe harbor provision to meet the substantive rule, but the substantial manufacturing process provides an additional path to qualification.
Key takeaways
- Changes to the FDII rules may provide additional planning opportunities for taxpayers that previously couldn’t take advantage of FDII.
- Along with other changes in the OBBBA, taxpayers should ensure they’re optimizing both cash tax dollars weighing the interaction of FDII with other deductions that may be temporary.
