The U.S. tax code includes numerous provisions that affect how foreign income is taxed, particularly when it comes to U.S. persons who own interests in foreign corporations.
This article focuses on the mechanics, benefits, and limitations of the Section 250 deduction, especially for those who are affected by Global Intangible Low-Taxed Income (GILTI) and Foreign Derived Intangible Income (FDII).
What Is the Section 250 Deduction?
The Section 250 deduction is a tax deduction available to a domestic corporation (and individuals making a Section 962 election) that earns foreign derived intangible income and/or global intangible low taxed income. The goal of this provision is to encourage U.S. businesses to retain and develop intangible income within the United States rather than shifting operations offshore. For eligible taxpayers, this deduction significantly reduces the taxable income arising from certain kinds of foreign and intangible income.
Specifically, the Section 250 deduction allows a taxpayer to deduct up to 50% of their GILTI and up to 37.5% of their FDII, subject to a taxable income limitation. Taxpayers can choose any reasonable method for determining taxable income for the FDII deduction, pending further guidance by the IRS. This limitation ensures that the deduction cannot exceed a certain percentage of overall taxable income in a taxable year, meaning excess foreign deductions may be lost if there is insufficient U.S. source income.
Who Can Claim the Section 250 Deduction?
The deduction is primarily available to domestic corporations, but individuals who make a Section 962 election may also access the deduction on their share of GILTI. For expats operating through a foreign business, particularly in a controlled foreign corporation, making the 962 election allows the taxpayer to be treated like a U.S. C corporation for purposes of calculating their liability on Subpart F income and GILTI. This enables the use of the Section 250 deduction, along with the foreign tax credit, which is essential for reducing double taxation. The final Sec. 250 regulations indicate that the FDII deduction is based on annual income and expenses.
Key Concepts: FDII and GILTI
To understand the Section 250 deduction, we need to first understand two key types of income: FDII and GILTI.
1. FDII – Foreign Derived Intangible Income
This refers to income a U.S. corporation earns from doing business with customers outside the U.S., especially when that income is related to intangible assets (like intellectual property or brand value).
FDII typically comes from:
Selling goods to foreign buyers for use outside the U.S.
Providing services to customers located outside the U.S.
Licensing intellectual property for use abroad
Example:
If a U.S. company sells software to customers in Europe or licenses technology to a Japanese company, the income may count as FDII.
2. GILTI – Global Intangible Low-Taxed Income
GILTI is a way for the U.S. tax system to capture income from foreign subsidiaries (CFCs) that is seen as excess or unusually high – typically tied to intangibles like patents, trademarks, or brand value.
Here’s how it works:
A foreign subsidiary is allowed a “routine” return on its tangible assets (like machinery or buildings), called QBAI (Qualified Business Asset Investment).
Any profit above that 10% return is considered GILTI and must be included in the U.S. parent company’s income and taxed.
Example:
If a U.S.-owned company in Ireland earns big profits but doesn’t have much physical equipment or property, most of its income would likely be considered GILTI.
Important Note for U.S. Expats:
While GILTI was originally aimed at capturing profits linked to intangibles, in practice it applies broadly to active income from foreign businesses. This means even ordinary business earnings—such as income from providing services, selling products, or running operations abroad—can be subject to U.S. tax under GILTI. For U.S. expats with foreign corporations, this inclusion of active income is one of the most significant and often misunderstood aspects of the GILTI regime.
How the Section 250 Deduction Works
Section 250 allows U.S. corporations to get a tax deduction for two types of income:
FDII (foreign income from sales/services/licenses)
GILTI (foreign subsidiary income above the normal asset-based return)
To determine the deduction:
First, calculate Deduction Eligible Income (DEI) – the portion of income that could potentially qualify for FDII.
Then identify how much of that DEI is foreign-derived (FDDEI).
Also, subtract the Deemed Tangible Income Return (10% of QBAI) to isolate what’s considered Deemed Intangible Income – the part that gets the favorable tax treatment.
How Is the Deduction Calculated?
The deduction for FDII involves determining deemed intangible income, which is the excess of deduction eligible income over a routine return on the corporation’s tangible assets. The routine return, or deemed tangible income return, is 10% of the corporation’s qualified business asset investment. This excess is considered intangible income, which is then multiplied by the ratio of foreign derived deduction eligible income to total deduction eligible income to determine the FDII.
For GILTI, the calculation begins with identifying tested income from CFCs, subtracting related foreign tax and routine returns, and applying the inclusion to the U.S. shareholder. Section 250 deduction then allows the domestic corporation (or taxpayer with a Section 962 election) to deduct 50% of the GILTI inclusion.
These calculations are subject to a taxable income limitation, which means if the overall taxable income is too low, some of the Section 250 deduction may be disallowed for that taxable year.
When and Why Would an Expat Use It?
For U.S. expats who operate through a foreign company and are subject to GILTI, electing Section 962 allows them to benefit from corporate-level tax treatment, including the Section 250 deduction. This is particularly useful if their foreign income would otherwise be taxed at the full U.S. individual rate.
For example, a U.S. expat owning a UK limited company that earns significant profits abroad might face U.S. tax on those earnings under GILTI rules. With a Section 962 election, the taxpayer can use the Section 250 deduction to reduce their effective U.S. tax on that intangible income, along with claiming a foreign tax credit for taxes paid to the UK.
Interaction With Other Rules and Limitations
The Section 250 deduction allows a domestic corporation to deduct a portion of its foreign derived intangible income (FDII) and global intangible low taxed income (GILTI). However, the total deduction is limited if the corporation’s FDII plus GILTI exceeds its taxable income. In such cases, the deduction is proportionally reduced under the taxable income limitation rule.
Example:
Under IRC §250(a)(2), the total deduction for FDII and GILTI cannot exceed the corporation’s taxable income.
So if:
FDII = $100
GILTI = $100
Combined deduction = $50 (GILTI) + $37.50 (FDII) = $87.50
But the corporation’s total taxable income = $80, then…
You can’t deduct $87.50 — you’re limited to $80 total, and the deduction gets scaled down proportionally.
Section 250 also interacts with other provisions, including the interest expense limitation under Section 163(j) and rules for allocating expenses to foreign income, including transactions with related parties or unrelated parties. The final and proposed regulations clarify that expenses properly allocable to FDII (such as R&D, advertising, and interest) reduce the amount of deduction-eligible income, which in turn lowers the Section 250 deduction.
Originally, for tax years beginning after 2025, the FDII deduction was set to drop from 37.5% to 21.875%, and the GILTI deduction from 50% to 37.5%. However, these reductions were eliminated by 2025 legislation signed under the Jobs Act and Economic Security Act, which made the Tax Cuts and Jobs Act (TCJA) provisions permanent. As of the 2025 taxable year, the deduction percentages remain at 37.5% for FDII and 50% for GILTI.
Taxpayers must carefully apply these rules when determining their Section 250 deduction, including how to allocate costs among tested income, such services, and such property, especially when dealing with foreign income from activities within or outside the United States. Accurate reporting depends on applying the IRS final regulations and ensuring all allocations are properly documented for such taxpayer and such corporation.
IRS Guidance and Reporting Requirements
Taxpayers must follow final regulations, proposed regulations, and other such regulations issued under IRC 250. Compliance includes filing Form 8993 to calculate and report the Section 250 deduction, and possibly Form 5471 or Form 8858, depending on whether the foreign entity is a CFC or disregarded entity.
It is important for such domestic corporations or expats making a Section 962 election to maintain documentation related to the gross income, property, services, and any other persons involved in the qualifying transactions. Special attention should also be paid to rules relating to foreign branch income, financial services income, and gas extraction income, as these may affect eligibility or calculation.
Need Help With the Section 250 Deduction?
The Section 250 deduction can significantly reduce U.S. tax on foreign derived intangible income and global intangible low taxed income, but it’s complex—especially with rules around tested income, related party transactions, and expenses allocable to foreign income.
We offer free tax advice to U.S. expats. If you have questions or need help applying the rules to your situation, reach out anytime.
For more complex cases, including business structuring and optimizing the Section 962 election, we also offer one-hour tax consultations.
Contact us to get started.
