FDII Transformed: How the OBBBA Reshapes the Deduction for Foreign-Derived Income

The One Big Beautiful Bill Act (OBBBA) enhances and expands an important deduction for selling goods and services abroad, making it more valuable and accessible to a range of businesses and industries.

The deduction for foreign-derived intangible income (FDII) has been modified under the OBBBA, receiving a new name: foreign-derived deduction eligible income (FDDEI). Among the changes are a reduced deduction percentage as well as several significant revisions to the calculation. Most of the changes are effective for tax years beginning after December 31, 2025.

The updates affect taxpayers who export products to foreign persons for foreign use or provide services to persons or with respect to property outside the U.S.

In addition to changing the name, the OBBBA modifies the deduction as follows:

• The deduction rate is reduced from 37.5% to 33.34%, thereby increasing the effective U.S. tax rate on FDDEI from 13.125% to 14%.
• The qualified business asset investment (QBAI) component of the FDDEI calculation is eliminated.
• Income or gain from a disposition of intangible property (IP) as defined under Section 367(d) or property subject to depreciation, amortization, or depletion no longer qualifies as FDDEI.
• Interest expense and research and experimentation (R&E) expenses are excluded from the FDDEI calculation.

The changes could enhance the value of the deduction for many taxpayers despite the decrease to the deduction rate, particularly for industries with significant fixed assets, R&E costs, or interest expense. Taxpayers should begin assessing potential planning and arbitrage opportunities given the change in the rate and rules and the interplay between FDDEI and other tax code provisions. There may be accounting method opportunities that could increase the benefit in current and future years.

The following sections provide further insight into the changes as well as discuss potential planning opportunities for FDDEI.

Goodbye, QBAI 

Enacted as part of the Tax Cuts and Jobs Act of 2017, the FDII rules were largely intended to encourage taxpayers to keep intangible assets in the U.S. by granting a deduction for a percentage of eligible foreign income. The deduction targeted intangible income by requiring taxpayers to reduce their eligible FDII by a deemed 10% return on tangible property (QBAI). The OBBBA eliminates the QBAI return from the calculation of FDDEI, potentially resulting in larger deductions for many types of taxpayers across several industries. 

Taxpayers with significant depreciable property may not be able to benefit under the current FDII regime due to the requirement to reduce their eligible income by the QBAI return. The OBBBA’s elimination of the QBAI return from the calculation means that capital-intensive taxpayers may now be able to claim the FDDEI deduction under the new regime. This change is effective for tax years beginning after December 31, 2025.

Intangibles, It's Over

Consistent with the original intent of the provision, the OBBBA excludes income or gain derived from transfers of IP to a foreign corporation in a Section 367(d) transaction or otherwise through a sale or exchange of such property from FDDEI. The change is effective for transfers occurring after June 16, 2025. Consequently, the exportation of patents, copyrights, or other proprietary know-how will no longer receive the same preferential treatment as exports of other property or eligible services.

No Allocation/Apportionment of Interest or R&E

Effective for tax years beginning after December 31, 2025, taxpayers are no longer required to allocate interest or R&E expenses against eligible income. Under the current FDII regime, taxpayers with substantial interest expense or R&E expenditures frequently experience a significant reduction—or even elimination—of their FDII deduction as a result of the allocation and apportionment of these costs.

This change may benefit many taxpayers, especially in the private equity space, who have been limited by Section 163(j) and unable to claim a FDII deduction under the current rules. The change also may benefit taxpayers who resume immediately expensing R&E costs under new Section 174A (see below). 

Now is the Time to Plan

Although many taxpayers still have returns for their 2024 and 2025 tax years to file before the changes to FDII take effect (generally for tax years beginning after December 31, 2025), now is the time for taxpayers to begin preparing and evaluating strategies for FDII/FDDEI benefits across the two regimes. Planning opportunities may involve accounting methods as well as planning for the implications of newly enacted R&E expensing and bonus depreciation rules.

It is important for taxpayers to model the impact of planning opportunities so that strategies are considered from a holistic perspective. Scenario modeling also helps tax leaders make the most beneficial decisions for their companies. 

Accounting Method Planning 

Taxpayers may be able to use accounting method planning opportunities to adjust the timing of deductions and income across the FDII/FDDEI effective dates. Taxpayers may consider accelerating income or deferring deductions if the current FDII regime is more advantageous to them as compared to the new FDDEI rules. The reverse may be true for taxpayers expecting future benefits from the positive FDDEI changes.  

In some cases, accounting method planning may require a taxpayer to obtain IRS approval to change an accounting method, which can be done under either the automatic or the non-automatic approval procedures.

R&E Expenses 

The OBBBA creates Section 174A, which permanently restores expensing of domestic research costs for tax years beginning after December 31, 2024. Section 174 is retained and amended to provide for the continued 15-year amortization of foreign research costs. Software development is statutorily included in the definition of research for purposes of Section 174A. Taxpayers retain the option of electing to capitalize domestic research costs and amortize such amounts over either 10 years or the useful life of the research (with a 60-month minimum). 

The legislation generally requires taxpayers to implement the new treatment with an automatic accounting method change on a cut-off basis. Alternatively, taxpayers can elect to claim any unamortized R&E amounts incurred in calendar years 2022, 2023, and 2024:

• In the first tax year beginning after 2024; or 
• Ratably over the first two tax years beginning after 2024. 

Separate transition rules are available for eligible small business taxpayers meeting the gross receipts test under Section 448 ($31 million in 2025) for the first tax year beginning after 2024, allowing those taxpayers to file amended returns to expense R&E for tax years before 2025.

FDDEI Considerations 

The FDDEI deduction, like the FDII deduction, is limited based on taxable income. Therefore, taxpayers should consider how immediate R&E expensing, as well as electing to deduct prior year unamortized R&E costs, will impact their FDII/FDEI deductions. For example, electing to deduct prior capitalized Section 174 costs in 2025/2026 (a temporary / timing deduction) could reduce or even eliminate the taxpayer’s ability to claim a Section 250 deduction (a permanent benefit) for those years. Further consideration should be given to electing to capitalize R&E expenditures to help taxpayers leverage their deductions holistically.

Bonus Depreciation

The OBBBA permanently restores 100% bonus depreciation for property acquired and placed in service after January 19, 2025. 

The legislation also creates a new elective 100% depreciation allowance under Section 168(n) for any portion of nonresidential real property that is considered “qualified production property.” The election is available if construction on the property begins after January 19, 2025, and before January 1, 2029, and the property is placed in service in the U.S. (or a possession of the U.S.) by the end of 2030.

FDDEI Considerations 

Allowing producers, refiners, and manufacturers to fully expense buildings rather than depreciate them over 39 or 15 years offers a significant benefit in terms of the reduction to current-year taxable income. However, the increased deduction most likely also reduces FDDEI. The benefits of electing bonus depreciation, therefore, should be weighed against any associated costs, such as a reduced FDDEI benefit. 

Transfer Pricing and IP Considerations

Given the OBBBA changes to the FDII/FDDEI regime, now is an opportune time for taxpayers to reevaluate their value chains. Taxpayers should strategically consider the location of manufacturing, research and development, and IP in light of the positive changes to FDDEI. In doing so, however, valuation issues, non-U.S. exit tax considerations, and other transfer pricing and tax effects must be assessed.