Department of the Treasury, Internal Revenue Service, Allocation and Apportionment of Deductions to Foreign Source Section 951A Category Income and Deduction Eligible Income, Notice of Proposed Rulemaking, REG-117273-25, RIN 1545-BR90, 26 C.F.R. Part 1, 91 Fed. Reg. (scheduled for publication Sept. 11, 2026).

The Department of the Treasury and the Internal Revenue Service (IRS) have issued a Notice of Proposed Rulemaking (REG-117273-25, RIN 1545-BR90) providing long-awaited regulatory guidance regarding 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”. These proposed regulations primarily implement the statutory mandates enacted under Public Law 119-21, 139 Stat. 72 (July 4, 2025), commonly known as the One, Big, Beautiful Bill Act (OBBBA).

Specifically, the rulemaking updates existing regulations under Treasury Regulation § 1.250(b)-1, amends Treasury Regulation § 1.861-8 and § 1.904(b)-3, and introduces new Proposed Treasury Regulation § 1.904(b)-4. The provisions significantly alter how domestic corporations determine foreign-derived deduction eligible income (FDDEI) and calculate foreign tax credit (FTC) limitations under Internal Revenue Code (I.R.C.) § 904(a) for foreign source global intangible low-taxed income (GILTI) category income (section 951A category income).

This article provides tax practitioners, CPAs, and Enrolled Agents (EAs) with a rigorous technical examination of the background, statutory revisions, administrative rationale, effective dates, and taxpayer reliance rules established by Treasury in these proposed regulations.

Legislative Context and Reasons for Release

The issuance of these proposed regulations was directly prompted by statutory modifications made by the OBBBA to I.R.C. § 250(b)(3)(A) and I.R.C. § 904(b). For taxable years beginning after December 31, 2025, I.R.C. § 250(a)(1)(A) provides domestic corporations with a deduction equal to a prescribed percentage of foreign-derived deduction eligible income (FDDEI). Prior to the OBBBA, deduction eligible income (DEI) was defined under I.R.C. § 250(b)(3)(A) as gross income (excluding certain statutory categories) over the deductions (including taxes) properly allocable to such gross income. Section 70322(b) of the OBBBA amended I.R.C. § 250(b)(3)(A)(ii) to specify that gross income is reduced by “expenses and deductions (including taxes), other than interest expense and research or experimental expenditures, properly allocable to such gross income”.

Simultaneously, Section 70311(c) of the OBBBA enacted I.R.C. § 904(b)(5), creating special statutory rules for allocating and apportioning deductions to foreign source section 951A category income for foreign tax credit limitation purposes under I.R.C. § 904(a). Under I.R.C. § 904(b)(5)(A), deductions allowed under I.R.C. § 250(a)(1)(B) and I.R.C. § 164(a)(3) for taxes on amounts described in § 250(a)(1)(B) are allocated and apportioned to foreign source section 951A category income. Under I.R.C. § 904(b)(5)(B), “no amount of interest expense or research and experimental (R&E) expenditures is allocated or apportioned to foreign source section 951A category income”. Under I.R.C. § 904(b)(5)(C), any other deduction is allocated and apportioned to foreign source section 951A category income “only if the deduction is directly allocable to such income”. Furthermore, the second sentence of I.R.C. § 904(b)(5) mandates that any deduction that would have been allocated or apportioned to foreign source section 951A category income but for I.R.C. § 904(b)(5)(B) and (C) must be reallocated exclusively to United States source income.

Because these statutory changes take effect for taxable years beginning after December 31, 2025, Treasury and the IRS released these proposed regulations to align existing regulatory frameworks with the OBBBA and to establish clear rules for distinguishing directly allocable expenses from non-allocable expenses.

Regulatory Revisions, Additions, and Deletions

The proposed regulations modify existing regulatory text across Title 26 of the Code of Federal Regulations in several critical areas:

Revisions and Deletions in Section 250 Regulations

The proposed regulations update Proposed Treasury Regulation § 1.250(b)-1 to reflect the revised statutory definition of DEI. Under Proposed Treasury Regulation § 1.250(b)-1(a), gross DEI and gross FDDEI are reduced by properly allocable expenses and deductions deducted during the taxable year. The explicit term “expenses” is added to align regulatory language with amended I.R.C. § 250(b)(3)(A)(ii).

Crucially, Proposed Treasury Regulation § 1.250(b)-1(d)(2)(ii) establishes that deductions properly allocable to gross DEI and gross FDDEI must be determined “without regard to interest expense, research or experimental expenditures, and sections 170(b)(2), 172, 246(b), and 250”. For this purpose, interest expense is defined as “any expense that is deductible under section 163 (including original issue discount)” and R&E expenditures are defined as “any expenditure that a taxpayer deducts (including as an amortization deduction) in a taxable year under section 174, 174A, or 59(e)(2)(B)”.

To effectuate these statutory exclusions, Treasury deleted the prior cross-reference to I.R.C. § 163(j) in existing Treasury Regulation § 1.250(b)-1(d)(2)(ii) because interest expense is completely excluded from allocation to gross DEI and gross FDDEI.

Additions and Framework of Proposed Treasury Regulation Section 1.904(b)-4

Treasury added Proposed Treasury Regulation § 1.904(b)-4 to govern deduction allocation and apportionment to foreign source section 951A category income for foreign tax credit limitation calculations. Under Proposed Treasury Regulation § 1.904(b)-4(b)(1), only three specific classes of deductions are permitted to reduce foreign source section 951A category income:

Deductions allowed under I.R.C. § 250(a)(1)(B), allocated and apportioned in accordance with Treasury Regulation § 1.861-8(e)(14);
Deductions allowed under I.R.C. § 164(a)(3) for State and local income taxes, allocated and apportioned in accordance with Treasury Regulation § 1.861-8(e)(6) to the extent imposed on net CFC tested income or section 78 gross-up; and
Deductions that are “directly allocable” to foreign source section 951A category income under Proposed Treasury Regulation § 1.904(b)-4(b)(2).

All other deductions, including interest expense under I.R.C. § 163 and R&E expenditures under I.R.C. § 174, 174A, or 59(e)(2)(B), are prohibited from being allocated or apportioned to foreign source section 951A category income.

Amendments to Net Operating Loss Rules Under Section 861

Treasury amended Treasury Regulation § 1.861-8(e)(8)(i) and Treasury Regulation § 1.904(b)-3(d)(2) to adjust Net Operating Loss (NOL) component characterization. Under Proposed Treasury Regulation § 1.861-8(e)(8)(i), when determining the source and separate category components of an NOL, the adjustments required under I.R.C. § 904(b)(5) are taken into account. This represents a explicit exception to the general rule under Treasury Regulation § 1.861-8(e)(8)(i), which continues to disregard adjustments under I.R.C. § 904(b)(2) and (4) when determining NOL components.

Administrative and Legal Analysis Justifying the Regulations

Treasury and the IRS set forth detailed statutory analysis and legal rationales to justify the regulatory structure in the preamble to the proposed regulations.

Legal Construction of “Directly Allocable”

Because I.R.C. § 904(b)(5)(C) does not define “directly allocable,” Treasury analyzed the statutory context to establish a operative definition. Treasury noted that while “properly allocable” is used broadly throughout I.R.C. §§ 861, 862, 863, and 904, the statutory insertion of the modifier “directly” in § 904(b)(5)(C) requires “a closer, more direct relationship between the deduction and income than the term ‘properly allocable’ as construed under the section 861 regulations”.

Treasury reasoned that “directly allocable” deductions represent “a subset of the ‘properly allocable’ deductions that, before the enactment of section 904(b)(5), would have reduced foreign source section 951A category income”. Under general Treasury Regulation § 1.861-8 principles, deductions subject to apportionment based on broad proxies—such as asset valuation or gross income ratios—do not exhibit the requisite direct connection. Consequently, Proposed Treasury Regulation § 1.904(b)-4(b)(2)(i) establishes that a deduction is not directly allocable if it is “of a type that, under the applicable rules for allocating and apportioning deductions (without regard to section 904(b)(5)), is subject to apportionment based on the relative value of assets or amounts of U.S. gross income (including modified gross income)”.

Applying this standard, Proposed Treasury Regulation § 1.904(b)-4(b)(2)(ii)(A) explicitly classifies the following expenses as non-directly allocable:

Stewardship expenses under Treasury Regulation § 1.861-8(e)(4)(ii)(C);
Legal and accounting fees and expenses under Treasury Regulation § 1.861-8(e)(5);
Damage awards, prejudgment interest, and settlement payments; and
Supportive expenses (such as overhead, general and administrative, and supervisory expenses) under Treasury Regulation § 1.861-8(b)(3).

Conversely, Proposed Treasury Regulation § 1.904(b)-4(b)(2)(ii)(B) identifies deductions that are directly allocable:

Foreign currency losses recognized under I.R.C. § 986(c) with respect to distributions of previously taxed earnings and profits (PTEP) assigned to the section 951A category under Treasury Regulation § 1.904-4(p); and
Net operating loss deductions under I.R.C. § 172 allocated under Treasury Regulation § 1.861-8(e)(8).

Treasury justified treating I.R.C. § 986(c) foreign currency losses as directly allocable because section 986(c) losses are determined separately for specific PTEP distributions and are not apportioned using asset values or gross income proxies.

Reallocation Mechanics to United States Source Income

Under the second sentence of I.R.C. § 904(b)(5), deductions that are excluded from foreign source section 951A category income under § 904(b)(5)(B) and (C) are reallocated to U.S. source income. Proposed Treasury Regulation § 1.904(b)-4(c) adopts a two-step method to compute reallocated deductions:

Preliminary Step: Allocating and apportioning deductions to foreign source section 951A category income under existing Treasury Regulation § 1.861-8 rules without regard to I.R.C. § 904(b)(5).
Reallocation Step: Taking the deductions apportioned to section 951A category income under Step 1 and reallocating them directly to U.S. source income.

Proposed Treasury Regulation § 1.904(b)-4(c) confirms that reallocated deductions are allocated to U.S. source income “for all purposes of section 904 including when applying rules, such as the section 861 regulations, when section 904 is the operative section”.

Treasury highlighted critical foreign tax credit interaction effects resulting from this reallocation:

Domestic Loss and ODL Mechanics: By shifting deductions to U.S. source income, reallocated deductions may create or increase a domestic loss under I.R.C. § 904(g)(2)(B). This domestic loss offsets foreign source taxable income under I.R.C. § 904(f)(5)(D) and creates an Overall Domestic Loss (ODL) under I.R.C. § 904(g)(2)(A), enabling taxpayers to recapture U.S. source income as foreign source income in subsequent years.
Overall Foreign Loss (OFL) Protection: Because reallocated deductions reduce U.S. source income rather than foreign source income, they are not treated as properly apportioned to foreign source income for determining an OFL under I.R.C. § 904(f)(2).

Statutory Analysis Regarding Research and Experimental Expenditures

Treasury provided a detailed analysis explaining why R&E expenditures are not reallocated to U.S. source income under the second sentence of I.R.C. § 904(b)(5). Under Treasury Regulation § 1.861-17, R&E expenditures are allocated exclusively to gross intangible income and cannot be allocated to section 951A category income. As Treasury observed from the preamble to the 2020 final § 1.861-17 regulations (85 Fed. Reg. 71,998), “R&E expenditures cannot be allocated to section 951A category income because R&E expenditures, whether or not ultimately successful, are incurred to produce intangible property and a taxpayer’s section 951A inclusions do not result from R&E expenditures incurred by the taxpayer”.

Because R&E expenditures are not allocated to section 951A category income under Step 1 of the allocation process, there is no amount of R&E expenditure that “would have been allocated or apportioned” to GILTI in the first instance. Consequently, zero R&E expense is reallocated to U.S. source income under I.R.C. § 904(b)(5).

Justification for Net Operating Loss Treatment

Treasury justified taking I.R.C. § 904(b)(5) into account when determining NOL components under Proposed Treasury Regulation § 1.861-8(e)(8)(i) to preserve statutory intent. Treasury noted that if § 904(b)(5) were ignored during NOL creation, “the portion of an NOL that is attributable to a deduction that would be allocated or apportioned to foreign source section 951A category income but for section 904(b)(5) could create an SLL with respect to the section 951A category that is carried over to reduce foreign source section 951A category income in a different taxable year”. Treasury concluded that allowing an NOL carryover to reduce future section 951A category income would directly contravene Congress’s instruction in § 904(b)(5).

Proposed Applicability Dates and Taxpayer Reliance

Pursuant to I.R.C. § 7805(b)(2), the proposed regulations are structured to apply to taxable years beginning after December 31, 2025:

Proposed Treasury Regulation § 1.250(b)-1(a) and (d)(2) apply to taxable years beginning after December 31, 2025.
Proposed Treasury Regulation § 1.904(b)-4 and the amendments to Treasury Regulation § 1.861-8(e)(8) apply to taxable years beginning after December 31, 2025.

Taxpayer Reliance Pending Final Regulations

Treasury explicitly grants taxpayers the right to rely on these proposed regulations prior to the publication of final regulations in the Federal Register. Specifically:

Taxpayers may rely on the proposed regulations regarding I.R.C. § 250(b)(3) for taxable years beginning after December 31, 2025, and before the publication of final regulations, “provided the taxpayer follows the proposed regulations regarding section 250(b)(3) in their entirety”.
Taxpayers may rely on Proposed Treasury Regulation § 1.904(b)-4 and Proposed Treasury Regulation § 1.861-8(e)(8) for taxable years beginning after December 31, 2025, and before final regulations are published, “provided the taxpayer follows them in their entirety”.

Practitioners must advise corporate clients that partial or selective reliance on individual provisions is impermissible; compliance with the proposed regulations must be complete across all integrated sections.

Prepared with assistance from Gemini Notebook.