Proposed Regulations Could Affect FTC and FDDEI Calculations for Multinational Taxpayers

Treasury and the IRS issued proposed regulations on September 10, 2026, under sections 904(b)(5) and 250(b)(3) of the Internal Revenue Code to implement significant international tax changes enacted as part of the One Big Beautiful Bill Act (OBBBA). The guidance addresses the allocation and apportionment of deductions to foreign-source section 951A category income for foreign tax credit (FTC) limitation purposes and the calculation of deduction eligible income (DEI) and foreign-derived deduction eligible income (FDDEI).

The proposed rules would generally prevent interest expense, research and experimental (R&E) expenditures, and certain indirect expenses from reducing section 951A category income, while providing detailed rules for determining which deductions remain directly allocable to that income. Multinational groups with controlled foreign corporations should evaluate the proposals carefully, particularly if they have significant interest expense, centralized corporate costs, section 986(c) gains or losses, domestic losses, or anticipated FTC limitation positions.

Section 951A FTC Limitation Rules

The OBBBA added section 904(b)(5), which provides special rules for allocating and apportioning deductions in determining foreign-source section 951A category income. The statute generally provides that interest expense and R&E expenditures may not reduce foreign-source section 951A category income and that other deductions may reduce that income only if they are directly allocable to it. Any amount that otherwise would have been allocated or apportioned to section 951A category income generally is instead allocated to U.S.-source income.

Directly Allocable Deductions

In practice, the rules would limit deductions that may reduce section 951A category income to expenses with a close and specific connection to that income. 

The proposed regulations interpret the term “directly allocable” as requiring a substantially closer relationship between a deduction and section 951A category income than the traditional allocation and apportionment standards under the section 861 regulations. A deduction generally is not directly allocable if it is a type of expense that may be apportioned using relative asset values or relative amounts of U.S. gross income, including modified gross income. The relevant inquiry is not how a particular deduction is apportioned in a specific year, but whether the category of deduction may be apportioned using those methods under the applicable expense allocation rules.

To provide certainty, the proposed regulations identify several categories of deductions that generally are not directly allocable to section 951A category income, including stewardship expenses, legal and accounting fees and expenses, damages awards, prejudgment interest, settlement payments, and supportive expenses such as overhead, general and administrative expenses, and supervisory expenses. The portion of these deductions that otherwise would have been allocated or apportioned to section 951A category income generally must be reallocated to U.S.-source income.

Interest Expense and R&E Expenditures

Consistent with the statute, the proposed regulations confirm that no amount of interest expense or R&E expenditures is allocated or apportioned to foreign-source section 951A category income. Interest expense includes amounts deductible under section 163, including original issue discount. R&E expenditures generally include amounts deducted, including amortization deductions, under sections 174, 174A, and 59(e)(2)(B).

The reallocation mechanics may differ for interest expense and R&E expenditures. The proposed regulations first apply the otherwise applicable allocation and apportionment rules without regard to section 904(b)(5) and then reallocate to U.S.-source income the amount that otherwise would have been assigned to section 951A category income. Because the existing section 861 rules generally do not allocate R&E expenditures to section 951A category income, there may be no R&E amount to reallocate under this preliminary calculation.

Section 986(c) Losses

The proposed regulations provide that a foreign-source section 986(c) loss associated with section 951A previously taxed earnings and profits (PTEP) is directly allocable to section 951A category income. Treasury concluded that these losses are determined separately by PTEP category and source and are not subject to asset-based or income-based apportionment methodologies. Accordingly, section 986(c) losses attributable to foreign-source section 951A PTEP generally continue to reduce section 951A category income.

Section 250 DEI and FDDEI Rules

The OBBBA amended section 250(b)(3) to exclude interest expense and R&E expenditures from the deductions that reduce DEI and FDDEI. The proposed regulations update the existing section 250 regulations to reflect this change and provide that taxpayers determine deductions properly allocable to gross DEI and gross FDDEI without regard to interest expense and R&E expenditures. As a result, these items generally should no longer decrease the amount of income eligible for the section 250 deduction.

The proposed regulations focus on the allocation of deductions in computing DEI and FDDEI. Treasury indicated that separate guidance is expected to address other OBBBA amendments to section 250, including the removal of the deemed tangible income return and deemed intangible income concepts from the section 250 calculation for taxable years beginning after December 31, 2025.

Net Operating Loss and Domestic Loss Considerations

The proposed regulations coordinate section 904(b)(5) with the separate limitation loss, net operating loss, and domestic loss rules. Section 904(b)(5) is taken into account in determining the separate limitation loss and U.S.-source loss components of an NOL arising in a taxable year beginning after December 31, 2025. Therefore, the portion of an NOL attributable to deductions reallocated away from section 951A category income generally is treated as a U.S.-source loss component rather than a section 951A separate limitation loss component.

The proposed regulations also provide that deductions reallocated to U.S.-source income are treated as U.S.-source deductions for all purposes of section 904. As a result, the reallocated deductions may create or increase a domestic loss and an overall domestic loss (ODL). Although moving deductions out of the section 951A category may increase current-year FTC capacity, taxpayers should evaluate whether the U.S.-source reallocation could reduce foreign-source income under the domestic loss rules or create future ODL recapture consequences.

Effective Dates

The proposed regulations generally would apply to taxable years beginning after December 31, 2025, consistent with the statutory effective dates of the underlying OBBBA amendments. Taxpayers may rely on the proposed regulations before finalization if the taxpayer and its related parties apply the proposed rules consistently and in their entirety. Comments and requests for a public hearing are due 60 days after publication in the Federal Register.