The proposed regulations set new rules for allocating deductions to foreign source Section 951A income and calculating deduction eligible income, with changes affecting interest, R&E expenses, foreign tax credits, and overall domestic losses.
The US Internal Revenue Service (IRS) and Treasury Department have issued a notice of proposed rulemaking titled Allocation and Apportionment of Deductions to Foreign Source Section 951A Category Income and Deduction Eligible Income, published in the Federal Register on 11 September 2026.
This document contains proposed regulations related to the allocation and apportionment of deductions to foreign source section 951A category income for foreign tax credit limitation purposes and for purposes of calculating deduction eligible income. The proposed regulations would affect taxpayers that operate in foreign countries through foreign corporations and domestic corporations that claim the deduction for foreign-derived deduction eligible income.
These tax rules, influenced by the One, Big, Beautiful Bill Act, detail how expenses like research expenditures and interest are handled for tax credit purposes. Finally, the Forest Service provides a brief notice extending the public comment period for a proposed rule regarding roadless area conservation.
Affected taxpayers and scope
The proposed regulations apply to domestic corporations claiming Foreign Derived Deduction Eligible Income deductions under Section 250 and taxpayers with Controlled Foreign Corporations that earn Section 951A category income. They provide rules for allocating expenses and deductions when taxpayers calculate taxable income and Foreign Tax Credit limitations.
Updates to Section 250 (DEI and FDDEI calculations)
The OBBBA changed how taxpayers calculate Deduction Eligible Income and Foreign Derived Deduction Eligible Income. Taxpayers must exclude interest expenses and Research and Experimental expenditures when allocating deductions to gross DEI and FDDEI. They must reduce these amounts only by other properly allocable deductions. The IRS said it will issue separate guidance on other Section 250 changes, including the removal of the deemed tangible income return.
FTC limitations for Section 951A income (Section 904(b)(5))
The OBBBA added Section 904(b)(5), which sets special rules for allocating deductions to foreign source Section 951A category income.
- Permissible allocable deductions: Only three types of deductions can reduce Section 951A category income. These include Section 250 deductions, certain state and local income taxes directly linked to Section 951A income, and deductions with a direct factual connection to that income.
- Directly allocable vs. excluded expenses: The proposed rules narrowly define directly allocable deductions. Expenses allocated using general measures, such as assets or gross income, cannot reduce Section 951A income. These excluded expenses include stewardship costs, legal and accounting fees, damages, settlements, and general administrative expenses. Some expenses can qualify when they directly relate to Section 951A income. Examples include certain foreign currency losses and NOL deductions. Interest expenses and R&E expenditures cannot reduce Section 951A category income.
Reallocation mechanism and impact on domestic loss (ODL)
The proposed rules require taxpayers to reallocate certain excluded deductions to US source income. This can reduce US source income and create or increase an Overall Domestic Loss. An ODL may allow taxpayers to treat some future US source income as foreign source income, which can increase their Foreign Tax Credit capacity. The rules also address NOLs. They prevent excluded deductions from creating separate limitation losses that could improperly reduce Section 951A income in later years.
Applicability, reliance, and comments timeline
The proposed regulations apply to taxable years beginning after 31 December 2025. Taxpayers may rely on the proposed rules before finalisation for these taxable years, provided they follow the regulations in their entirety. The IRS will accept electronic or written comments and requests for a public hearing through 10 November 2026.
