Navigating the foreign tax credit under the One Big Beautiful Bill Act

Executive summary: Key foreign tax credit changes under the OBBBA

The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, introduces the most significant overhaul to the U.S. foreign tax credit (FTC) regime since the 2017 Tax Cuts and Jobs Act (TCJA). This article outlines the key FTC-related provisions and their implications for U.S. multinational corporations. Major changes include:

• Expense allocation relief: Interest and research and development (R&D) expenses are no longer allocated to the section 951A basket, preserving more foreign-source income for FTC purposes.
• Increased FTC utilization: The deemed paid credit for net controlled foreign corporation tested income (NCTI)—formerly known as global intangible low-taxed income (GILTI)—rises from 80% to 90%, potentially eliminating residual U.S. tax on high-taxed foreign income.
• New sourcing rule: Up to 50% of income from U.S.-produced inventory sold abroad may be treated as foreign-source, offering partial FTC relief.
• Technical and structural updates: Adjustments to section 904 and 960 references, expanded CFC inclusions, and new section 951B may affect FTC calculations and compliance.
• Global tax coordination: The FTC changes intersect with international developments, including Pillar Two and G7 agreements, requiring careful modeling and planning.

Taxpayers should begin evaluating their structures and strategies now to optimize FTC outcomes under the new rules, which generally apply to tax years beginning after Dec. 31, 2025.

Direct changes to the FTC

The OBBBA makes direct modifications to the FTC rules.

Allocation of certain deductions to NCTI

The final bill adopts the Senate’s proposed changes to the allocation and apportionment of deductions to the section 951A category for purposes of calculating the FTC limitation. Under the OBBBA, only two types of deductions are allocated to this category:

1. The section 250 deduction related to NCTI under section 250(a)(1)(B) (and any deduction allowed under section 164(a)(3) for foreign income taxes imposed on amounts described in section 250 (a)(1)(B)); and
2. Deductions that are directly allocable to NCTI (i.e., expenses clearly and directly related to the section 951A category that are included in U.S. taxable income).

All other deductions that would have been allocated to GILTI under current law, are instead allocated to U.S.-source income.

Under current law, the FTC limitation is determined through a multistep process that begins with identifying a taxpayer’s gross income and determining whether each item is U.S.-source or foreign-source under the sourcing rules in sections 861 through 865.

Once sourced, the income is categorized into statutory income “baskets” defined under section 904(d), such as general, passive, foreign branch, and section 951A.

Deductions are then allocated to each class of gross income based on their factual relationship to the income. If required, these deductions are apportioned between U.S.-source and foreign-source income within each basket. Deductions that are not definitely related to a specific category are apportioned ratably using a reasonable method selected by the taxpayer.

After deductions are allocated and apportioned, the taxpayer calculates their foreign source taxable income (FSTI) for each basket by subtracting the relevant deductions from foreign-source gross income. This FSTI is then used to compute the FTC limitation for each category.

Importantly, a FTC can only be claimed against U.S. tax on foreign income within the same statutory basket—credits cannot be shifted across categories—highlighting the importance of accurately calculating FSTI by basket to determine the allowable credit.

Under current law, special apportionment rules are provided for stewardship expenses, legal and accounting fees, R&D, interest expense, and income taxes. U.S. taxpayers must generally allocate and apportion these expenses against their FSTI, as applicable, reducing the FTC limitation and ability to take a credit.

The OBBBA explicitly states that interest and R&D expenses should not be allocated against section 951A income. Notably, under Reg. section 1.861-17(d)(1)(iv), R&D expenditures are already excluded from apportionment to the section 951A category, since a U.S. person’s gross intangible income—linked to R&D—cannot include income assigned to that category. Therefore, the OBBBA does not change the allocation of R&D against section 951A category income, but this clarification is particularly favorable for taxpayers with significant interest expense.

The OBBBA does not explicitly address the treatment of other expenses—such as stewardship, legal and accounting fees, or state and local income taxes—which are generally not considered directly allocable. However, to the extent these expenses are not directly allocable to section 951A income, they would presumably be allocated to U.S. source income.

These changes could benefit many taxpayers by increasing the amount of FSTI in the section 951A basket. This, in turn, would raise the FTC limitation and potentially allow more foreign taxes to be credited. By reallocating expenses that are currently apportioned to section 951A category income—expressly interest and R&D—to U.S.-source income, the bill effectively preserves more FSTI in the section 951A category for FTC purposes.

However, the impact of this change will vary based on a taxpayer’s specific profile. Taxpayers with excess FTCs may see little to no benefit, while others could experience a meaningful reduction in residual U.S. tax on GILTI—now NCTI. The amendment applies to taxable years beginning after Dec. 31, 2025.

To prepare: Taxpayers should consider modeling the potential impact of these changes—alongside other provisions in the OBBBA—to assess the overall cash tax implications.

Other modifications to the FTC limitation

The OBBBA makes other modifications related to the FTC limitation:

These changes are primarily technical corrections to ensure the tax code references are accurate and consistent. However, they may also affect the characterization of certain types of income for FTC purposes.

For example, the reclassification of unsubstantiated dividend income from the section 951A basket to the passive category could impact how such income is treated for FTC limitation purposes. Additionally, the updated reference in section 904(d)(2)(H)(i) may influence the treatment of foreign taxes imposed on income that is not recognized as income for U.S. tax purposes—such as certain local income tax base differences—by characterizing them as general category rather than foreign branch category. While these adjustments may seem minor, they could have meaningful implications for taxpayers with complex international structures.

These amendments will apply to taxable years beginning after Dec. 31, 2025. This provides taxpayers with a clear timeline for when the changes will take effect, allowing them to plan and adjust their tax strategies accordingly.

Increase in deemed paid credit for NCTI taxes

The OBBBA increases the deemed paid FTC for NCTI from 80% to 90% of foreign income taxes attributable to tested income. Under the new provision, a controlled foreign corporation (CFC) would need to pay foreign income taxes at an effective rate of approximately 14% to potentially eliminate residual U.S. tax on NCTI. This threshold is calculated by applying the 21% U.S. corporate tax rate to the portion of NCTI income remaining after the proposed 40% deduction (i.e., 21% × (100% – 40%) = 12.6%, and 12.6% ÷ 90% ≈ 14%).

Currently, U.S. corporations may claim a deemed paid credit for 80% of foreign taxes attributable to GILTI income. In theory, this means that no residual U.S. tax would be due if the foreign ETR on GILTI earnings is at least 13.125%.

However, this assumes no expense allocations to the section 951A basket—an assumption that does not hold under current law, where such allocations often reduce FSTI, therefore reducing the FTC limitation (i.e., reducing FTCs allowed) and increasing residual U.S. tax liability.

When considered alongside the OBBBA’s changes to significantly reduce the amount of expenses allocated to the section 951A basket, the increase in the deemed paid credit makes it more likely that no residual U.S. tax would be due on NCTI when tested income is subject to at least a 14% foreign ETR. This combination of changes could provide meaningful relief for many taxpayers, depending on their specific fact patterns.

The proposed change would apply to taxable years beginning after Dec. 31, 2025.

Change in deemed paid credit for previously taxed NCTI

In addition to increasing the deemed paid credit, the OBBBA introduces a new limitation on FTCs for previously taxed NCTI income under section 960(d). Specifically, it disallows 10% of any foreign income taxes paid or accrued (or deemed paid) with respect to amounts excluded from gross income under section 959(a) due to a prior GILTI—now NCTI—inclusion under section 951A(a).

This means that when a U.S. shareholder receives a distribution of previously taxed GILTI—now NCTI—earnings from a CFC, only 90% of the associated foreign taxes may be creditable. This disallowance aligns with the increased 90% deemed paid credit and prevents taxpayers from receiving a full credit on income that has already been excluded from U.S. taxation.

Under current law, there is no limitation under section 960(d) on FTCs for previously taxed NCTI income.

Taxpayers must still look to section 960(c) for special rules regarding the FTC in year of receipt of previously taxed earnings and profits.

The disallowance would apply to distributions made after June 28, 2025.

Sourcing income from U.S. produced inventory

The OBBBA provides that, for the purposes of the FTC limitation, if a U.S. taxpayer has a fixed place of business in a foreign country, a portion of the income from selling U.S.-produced inventory outside the U.S. may be treated as foreign-source income. However, this foreign-source portion is capped at 50% of the total income from the sale.

Under existing regulations, income from the sale of inventory produced in the U.S. is treated entirely as U.S.-source income, regardless of where the sale occurs. This treatment is crucial when calculating the FTC limitation, which restricts the amount of foreign taxes a U.S. taxpayer can credit against their U.S. tax liability.

The new rule offers meaningful, though limited, relief for U.S. multinational corporations facing double taxation. By allowing up to 50% of the income from the foreign sale of U.S.-produced inventory to be treated as foreign-source—provided the taxpayer maintains a fixed place of business abroad and the income is attributable to that location—companies may be able to claim a larger FTC and reduce their overall U.S. tax liability.

Potential benefits may include:

• Increased FTC utilization: This partial reclassification of income could be particularly beneficial for businesses operating in higher-tax foreign jurisdictions, where FTC limitations often result in unused credits. By treating up to 50% of the income as foreign-source, companies can potentially utilize more of their FTCs, reducing their overall U.S. tax burden.
• Reduction in double taxation: The ability to treat a portion of the income as foreign-source can help mitigate the impact of double taxation, which is a significant concern for multinational corporations.

Potential limitations and considerations may include:

• Capped benefit: The benefit is capped at 50% of the income from the sale, meaning that only a portion of the income qualifies for the foreign-source treatment. This cap may not fully offset the foreign taxes paid, especially for companies with substantial foreign operations.
• Attribution requirement: Only income attributable to the foreign office or fixed place of business qualifies. This introduces a new layer of analysis in determining eligibility.
• Operational impact: The provision could incentivize companies to establish or maintain foreign offices to qualify for the treatment. This may influence operational and structural decisions, potentially leading to increased costs and complexity.
• Compliance requirements: Taxpayers will need to carefully document the attribution of income to foreign business locations. This adds complexity to tax reporting and planning, requiring meticulous record-keeping and potentially more robust internal controls.
• Permanent establishment (PE) risk: Establishing a fixed place of business abroad to qualify for the sourcing benefit may trigger a PE under foreign tax law. This could subject the U.S. taxpayer to additional foreign tax obligations, compliance burdens, and potential controversy with foreign tax authorities. Careful planning and jurisdiction-specific analysis are strongly recommended.

This amendment applies to taxable years beginning after Dec. 31, 2025.

Sourcing income from U.S. produced inventory: Comparison to pre-TCJA section 863(b)

This provision is conceptually related to the pre-TCJA, or former, section 863(b) of the Internal Revenue Code, but with a narrower and more targeted application to the FTC limitation. Here is how they compare:

While both provisions deal with sourcing income from inventory sales, the OBBBA is a targeted FTC relief mechanism that builds on the logic of the pre-TCJA section 863(b) but applies it in a more limited and strategic way. This new provision is designed to give partial FTC relief to U.S. companies with foreign operations, without reopening the broader sourcing framework.

The OBBBA’s indirect impact to the FTC

In addition to the OBBBA’s direct changes to the FTC regime, several other provisions in the tax package could indirectly affect FTC outcomes.

Key structural and computational changes

The table below summarizes the potential indirect impacts to the FTC, particularly in relation to section 163(j), section 174, NCTI, foreign-derived deduction eligible income (FDDEI) (formerly foreign-derived intangible income (FDII)), and base erosion and anti-abuse tax (BEAT):

Every taxpayer’s facts and circumstances are unique, and a detailed analysis is essential to fully understand the potential impact of these proposed changes on their foreign tax credit position.

Expanded CFC inclusions and attribution of foreign taxes

The OBBBA includes changes that may indirectly affect FTC outcomes through expanded CFC inclusions and the mechanics of foreign tax attribution. Specifically, the bill modifies the pro rata share rules under section 951 to require U.S. shareholders to include their pro rata share of CFC income based on if they owned the CFC at any time during the taxable year, rather than only include their pro rata share of CFC income if they owned stock in the CFC on the last day of the CFC’s taxable year. This change may increase the amount of subpart F income and NCTI included in a U.S. shareholder’s return, and consequently, the amount of foreign taxes deemed paid.

Separately, the bill retains the existing requirement under section 960(d) that foreign taxes must be “properly attributable” to tested income to qualify for the NCTI deemed paid credit. While this language is not new, it remains a critical standard for determining creditability. The interaction between expanded CFC inclusions and the attribution of foreign taxes may increase the complexity of FTC calculations, particularly for taxpayers with mid-year ownership changes or tiered CFC structures.

Interaction with Pillar Two

The FTC changes under the OBBBA come at a pivotal moment in the global tax landscape. At the G7 Summit in June 2025, the seven member countries—Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States—reached a mutual understanding to collaborate on a side-by-side solution that would exclude U.S.-parented groups from the Organisation for Economic Co-operation and Development’s (OECD’s) Pillar Two rules, including the income inclusion rule (IIR) and undertaxed profits rule (UTPR), in respect of both foreign and domestic profits. The proposed solution would also include efforts to simplify Pillar Two administration and compliance. In exchange, the U.S. agreed to remove proposed section 899 from the final legislation.

However, it is important to note that the G7 understanding does not constitute enacted legislation. Until legislative changes are formally adopted, financial reporting under U.S. GAAP must continue to account for the potential impacts of the IIR and UTPR on U.S.-parented multinational enterprises.

Furthermore, the G7 understanding does not automatically extend to other jurisdictions that have enacted Pillar Two legislation, nor does it alter the obligations of EU member states under the EU Directive mandating implementation of Pillar Two rules.

The OBBBA does not directly address Pillar Two or the OECD’s global minimum tax framework, but its changes to the FTC regime—particularly the treatment of NCTI and the increase in the deemed paid credit—may have indirect implications for U.S. multinationals navigating both U.S. and foreign minimum tax regimes.

IRS Notice 2023-80 provides guidance on the FTC treatment of taxes imposed under Pillar Two. The notice outlines specific criteria for determining whether such taxes qualify as creditable under sections 901 or 903. Taxpayers should carefully evaluate the nature of any foreign top-up taxes and consider how they interact with U.S. FTC rules, particularly in light of the OBBBA’s modifications to the NCTI regime.

As jurisdictions continue to implement Pillar Two, taxpayers should assess the potential for non-creditable foreign taxes to affect their global effective tax rate. Modeling the interaction between U.S. and foreign minimum tax regimes will be critical to understanding the full impact of the OBBBA and related international developments.

Introduction of section 951B

The OBBBA restores section 958(b)(4), which generally prevents downward attribution of stock owned by foreign persons to U.S. persons for purposes of determining whether a foreign corporation is a CFC. However, to address potential avoidance concerns, the legislation also introduces new section 951B, which selectively re-enables downward attribution in certain cases and expands the scope of subpart F and NCTI inclusions.

Under section 951B, certain foreign-controlled U.S. shareholders may be required to include income from foreign corporations that are treated as CFCs solely due to downward attribution from a common foreign parent. Importantly, section 951B modifies the constructive ownership rules—affecting who qualifies as a U.S. shareholder—but taxpayers must still look to section 951(a) to determine the amount of any subpart F or NCTI inclusion.

While section 951B is not a FTC provision directly, it may have indirect implications for the FTC regime. U.S. taxpayers subject to inclusions under this rule may be eligible to claim FTCs for foreign taxes paid by the underlying CFCs, subject to the rules under section 960.

However, the availability and timing of those credits will depend on the ownership structure, the character of the income, and whether the foreign taxes meet U.S. creditability requirements. These inclusions may also affect the allocation of deductions and the FTC limitation across income baskets, particularly where NCTI is involved.

Taxpayers with foreign-parented structures should carefully evaluate whether section 951B applies to their U.S. entities and assess the potential impact on their U.S. tax liability and FTC position.