United States

Proposed ordering rules for GILTI, FDII, NOL, 163(j) deductions

TAX ALERT  | 

Congress enacted special tax regimes for global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII), as part of 2017’s Tax Cuts and Jobs Act (TCJA). The section 250 deduction, also enacted in the TCJA, can reduce the effective tax rate for GILTI and FDII for certain taxpayers, generally corporations. The deduction, however, is subject to a taxable income limitation.

The Treasury Department and the IRS have released proposed regulations on the section 250 deduction. Our Alert discusses these proposed regulations generally. The proposed regulations provide ordering rules to apply when computing the taxable income limitation. This Alert addresses those ordering rules.

To the extent the sum of a corporation’s GILTI and FDII exceeds its taxable income, the section 250 deduction is reduced incrementally. The Tax Code, however, does not provide specific rules for the taxable income limitation computation, raising a number of questions: Does taxable income here include reductions to income due to utilization of net operating loss (NOL) carryforwards under section 172? Does taxable income include reductions due to utilization of interest expense deduction carryforwards under new section 163(j)? Inclusion of these deductions in the computation of taxable income could reduce the benefit of section 250 significantly. The proposed regulations address these questions, stating that taxable income for purposes of section 250 is determined after including all of the corporation’s other deductions, including the carryforward deductions of sections 163(j) and 172.

The alert reader may note, however, that section 163(j) likewise limits the interest expense deduction to a portion of taxable income, as does section 172 in regard to the NOL deduction. Moreover, under the section 163(j) proposed regulations published in December 2018, the section 250 deduction is accounted for in computing the section 163(j) taxable income limitation. This creates a conundrum – a potential circular calculation, or “chicken-and-egg” question.

To address this “chicken-and-egg” scenario, the proposed regulations set out ordering rules in their preamble and in an example. The proposal involves applying the following five steps sequentially:

  1. Compute the tentative amount of the FDII and section 250 deduction (Tentative Section 250 Deduction) taking into account all deductions except (i) section 163(j) interest deduction carryforwards or disallowances and (ii) section 172 NOL deductions.
  2. Compute the section 163(j) interest deduction, taking into account the amount of the Tentative Section 250 Deduction, but without regard to any section 172 NOL deductions.
  3. Compute the section 172 NOL deduction, taking into account the section 163(j) interest deduction, but without regard to the section 250 deduction (or the Tentative Section 250 Deduction).
  4. Compute the FDII, taking into account the section 163(j) deduction and the section 172 NOL deduction (determined in previous steps).
  5. Compute the section 250 deduction, taking into account the section 163(j) deduction and the section 172 NOL deduction (determined in previous steps).

These proposed regulations apply to taxable years ending on or after March 4, 2019. However, for taxable years beginning on or before March 4, 2019, taxpayers may use reasonable documentation maintained in the ordinary course of the taxpayer’s business to establish certain relevant facts. Due to the complexities involved in the computations of GILTI, FDII, the section 163(j) limitation and the section 250 deduction, taxpayers should consult with their tax advisors when performing or considering the necessary computations.

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