Understanding the Foreign-Derived Intangible Income Deduction (FDII)

By Howard Bakrins, Kutchins, Robbins & Diamond, Ltd. (KRD)

US corporations that generate income from export activities should consider if the foreign-derived intangible income (FDII) deduction applies. The Tax Cuts and Jobs Act (TCJA), passed in 2017, made significant changes to the taxation of foreign income of US businesses. One of these changes was the creation of the FDII deduction.

This deduction represents a valuable tax break for US corporations with foreign sales. This article includes an overview of the deduction and its benefits, and describes some new terminology related to the deduction. The FDII deduction creates a significant incentive to domestic C corporations by providing a tax deduction that effectively lowers the corporate tax rate on income derived from both tangible and intangible products and services in foreign markets. C corporations can claim a 37.5% tax deduction on FDII, which yields a 13.125% effective tax rate on FDII, as compared with a 21% rate on other income, for tax years beginning after 31 December 2017. Beginning in 2026, the FDII deduction is reduced to 21.875%, which yields an effective tax rate of 16.406%.

The FDII deduction is only available to domestic businesses that are taxed in the US as C corporations.

Computing the FDII deduction is a complex process that starts with computing the qualified business asset investment (QBAI), the deductioneligible income (DEI), and the foreignderived deduction-eligible income (FDDEI). These items are required to then calculate the deemed intangible income (DII) and the foreignderived intangible income (FDII).

The computation of deemed intangible income (DII) is made by taking the deduction-eligible income (DEI), minus 10% of the value of the depreciable tangible assets used in production of DEI of the US corporation. The foreign portion of this excess return is attributed to FDII and qualifies for the 37.5% deduction on the corporation’s US income tax return. It is important to note that the property does not need to be manufactured or produced by the corporation for the income to be qualified.

The FDII computation is complicated, but it is designed to approximate income from the sale of goods and services abroad attributable to USbased intangible assets such as patents, trademarks, and copyrights. It is computed by taking the income attributable to a US business’ intangible assets that exceeds a 10% deemed return on its depreciable tangible property. The portion of this excess income allocated to the sale of goods and services outside of the US is eligible for the deduction.

For example, assume a US corporation earned USD 100 million, and has tangible assets of USD 200 million (QBAI). The corporation would allocate the deemed intangible income (DII), USD 80 million (USD 100 million of earnings less the USD 20 million deemed return on its tangible assets), between foreign sales and domestic sales of goods and services. The FDII deduction would apply to the portion of the USD 80 million allocated to foreign sales, effectively reducing the US tax rate on this income from foreign sales to 13.125%, rather than the regular 21%.

In order to qualify for the deduction, the sales of products and services must be made to a person or business that is not a US person and be for a foreign use. Included are sales, leases, licensing, exchanges, and other dispositions. Property includes both tangible and intangible property. The term “foreign use” means any use, consumption, or disposition that is not within the United States.

Some of the issues that require careful attention are selling to related parties, allocating expenses to various classes of income, the calculation of QBAI, and the corporation’s existing accounting methods.

If your business may be eligible for the FDII deduction or any other provisions of the TCJA, you should consult with your tax advisor in order to maximize the benefits and minimize the risks of these new provisions.

Howard Bakrins

Howard Bakrins

GGI member firm
Kutchins, Robbins & Diamond, Ltd. (KRD)
Auditing & Accounting Tax, Advisory, Corporate Finance, Fiduciary & Estate Planning
Chicago (IL), USA
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KRD Ltd. is CPA firm that offers a full range of client services: accounting and software consulting, audit and assurance, tax strategy and preparation, business valuations and financial planning advisory services. Their team of 80 members has been serving clients in Chicago and the surrounding areas for 30 years.

Howard Bakrins has over 18 years of accounting experience as a CPA. His expertise lies in middlemarket corporations and high-net-worth individuals, dealing with a large range of clients. Corporate executives and wealthy family groups value his experience with income tax planning, establishing charitable foundations, estate and gift tax planning, family limited partnerships, and transactional planning and analysis. Howard is also knowledgeable in the tax laws pertaining to hedge fund transactions. Howard earned his BS from University of Illinois and is a member of the AICPA and the Illinois CPA Society.

Published: International Taxation Newsletter, No. 11, Autumn 2019 l Photo: rudi1976 - stock.adobe.com

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