The Tax Times: From GILTI to NCTI: New International Tax Rules Fuel State Apportionment Battles

· The One Big Beautiful Bill Act (H.R. 1) replaces GILTI with net CFC tested income (NCTI) for tax years beginning after 2025, eliminating the QBAI/NDTIR exclusion and effectively taxing the first dollar of net CFC income.

· The Section 250 deduction is reduced (generally 40% instead of 50%), moving the corporate effective federal rate on NCTI to about 12.6% starting in 2026.

· The foreign tax credit haircut is eased from 20% to 10%, so up to 90% of foreign taxes on NCTI may be creditable federally, making it easier to shelter NCTI at the federal level when foreign effective tax rates are at or above roughly 14%.

These changes mean more foreign income is fully in the federal base, but less residual U.S. tax may be due; states conforming to the federal base can end up taxing that same income without any offsetting state-level foreign tax credit.

Where state conformity creates distortion

· Many states piggyback on federal taxable income but do not adopt the federal foreign tax credit mechanics or baskets, and they often do not grant credits for foreign income taxes paid on NCTI.

· Some states already treat GILTI/NCTI as dividend or subpart F–like income and include a portion (for example, 50%) in the state base without providing any factor representation for the underlying CFC property, payroll, or sales.

· As NCTI replaces GILTI and captures broader CFC income, including income with little nexus to any given state, conforming states are pulling more foreign earnings into the base while continuing to use a purely domestic property/payroll/sales denominator, inflating the effective state tax rate on those earnings.

For multistate corporate groups with material foreign operations, this combination sets up a classic “tax base in, factors out” distortion that invites requests for alternative apportionment.

Illustration of the mechanics

Assume a U.S. corporate group with large non‑U.S. CFC operations generating significant NCTI. Federally, the group may pay little incremental tax on that NCTI after the enlarged foreign tax credit, but a conforming state that (1) includes 50–100% of the NCTI amount in the state tax base, (2) offers no foreign tax credit, and (3) refuses to include foreign property/payroll/sales in the denominator, effectively overstates the portion of global income reasonably attributable to that state.

Constitutional backbone: Kraft and foreign Commerce Clause

· In Kraft General Foods v. Iowa, the U.S. Supreme Court struck down Iowa’s regime that allowed a dividends-received deduction for domestic, but not foreign, subsidiaries, holding that differential treatment of foreign commerce violated the Foreign Commerce Clause.

· The Court emphasized that states may not structure their tax rules to favor domestic over foreign operations when reasonable, nondiscriminatory alternatives exist.

Applied to NCTI:

· When a state includes NCTI (reflecting foreign subsidiary earnings) in the base but refuses to accord the same apportionment treatment (or equivalent relief) that would apply to comparable domestic subsidiary income, the regime begins to resemble the discrimination problem condemned in Kraft.

· The discrimination can arise either from (1) including foreign income without factor representation, or (2) denying a practical equivalent to a dividends‑received deduction/credit structure that relieves double taxation for domestic but not foreign earnings.

NCTI has made the foreign‑versus‑domestic disparity more visible and more material.

Alternative apportionment and practical planning

Taxpayers may respond by:

· Statutory and equitable relief: Most states allow petitions for alternative apportionment where the standard formula does not fairly represent the extent of a taxpayer’s business activity in the state (e.g., UDITPA‑style provisions).

· Core argument: Including significant NCTI in the tax base without a corresponding inclusion of CFC factors produces a constitutionally suspect distortion, especially when the state also denies any credit for foreign taxes paid.

· Litigation posture: Kraft and post‑Kraft commentary on Foreign Commerce Clause discrimination provide a roadmap for arguing that a state’s chosen method discriminates against foreign commerce and must yield to a method that affords factor representation or a comparable adjustment.

· State conformity watching brief: States are still amending their conformity statutes in response to the One Big Beautiful Bill; some have clarified their treatment of GILTI/NCTI, others have not, and a few treat GILTI and NCTI identically for inclusion percentage purposes.

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