The Tax Times: Treasury and IRS Propose New Rules for Allocating Deductions to GILTI/NCTI Income Under the OBBBA

On September 10, 2026, the Treasury Department and the IRS released proposed regulations under REG-117273-25, scheduled for publication in the Federal Register on September 11, 2026. The guidance addresses how domestic corporations allocate and apportion deductions to foreign source section 951A category income — the income category that includes GILTI, now often called "net CFC tested income" or NCTI — for purposes of the foreign tax credit limitation, and how those same corporations calculate deduction eligible income (DEI) for the section 250 foreign-derived deduction.

For businesses that operate abroad through foreign corporations, or that claim the deduction for foreign-derived deduction eligible income (FDDEI), this preamble is required reading. Here is what it says, in plain terms, and what it means for planning going forward.

Why This Guidance Exists

The One, Big, Beautiful Bill Act (OBBBA), enacted July 4, 2025 (Public Law 119-21), rewrote two pieces of the international tax puzzle that determine how much foreign tax credit a company can actually use and how large its section 250 deduction can be:

· Section 250(b)(3)(A) — which defines a domestic corporation's deduction eligible income — was amended so that DEI is now reduced by expenses and deductions "other than interest expense and research or experimental expenditures" properly allocable to that income.

· Section 904(b)(5) — an entirely new provision — sets special rules for allocating and apportioning deductions to foreign source section 951A category income when calculating the foreign tax credit limitation under section 904(a).

Both changes apply to tax years beginning after December 31, 2025, but neither statutory provision spelled out the mechanics. The proposed regulations are Treasury's attempt to fill in those mechanics.

Change #1: Interest and R&E Expenses No Longer Shrink the FDII Deduction

Before the OBBBA, a domestic corporation computing its DEI (and, within that, its FDDEI) had to net out essentially all properly allocable deductions — including interest expense and research and experimental (R&E) expenditures — against its gross income. That netting shrank the section 250 deduction for companies carrying significant debt or R&E budgets.

Under amended section 250(b)(3)(A)(ii), interest expense and R&E expenditures are no longer taken into account when computing gross DEI and gross FDDEI. The proposed regulations implement this by:

· Updating proposed § 1.250(b)-1(a) to reflect that DEI and FDDEI are reduced only by properly allocable "expenses and other deductions" actually deducted in the year, excluding interest expense and R&E expenditures;

· Removing the reference to section 163(j) in § 1.250(b)-1(d)(2)(ii), since interest is no longer allocable to DEI/FDDEI at all; and

· Defining "interest expense" broadly (any amount deductible under section 163, including original issue discount) and "R&E expenditures" broadly (anything deducted, including as an amortization deduction, under section 174, 174A, or 59(e)(2)(B)).

Practically, this means the FDII deduction should get larger for many exporters and service providers that carry debt or invest heavily in R&E, because those costs no longer drag down the income base the deduction is calculated on. Treasury also noted that a separate project is coming to address other OBBBA changes to section 250, including the removal of the deemed tangible income return from the section 250(a)(1)(A) calculation.

Change #2: A New Three-Bucket Test for the Foreign Tax Credit Limitation

The bigger structural change is new section 904(b)(5), which controls how much of a company's deductions get allocated against foreign source section 951A category income when calculating the foreign tax credit limitation. The proposed regulations (new § 1.904(b)-4) sort deductions into three buckets:

1. Always allocated to foreign source 951A income: the section 250(a)(1)(B) deduction (the NCTI portion of the FDII/GILTI deduction) and the section 164(a)(3) deduction for state or local taxes imposed on that same income, using the existing allocation mechanics in §§ 1.861-8(e)(14) and (e)(6).

2. Never allocated to foreign source 951A income: interest expense and R&E expenditures — full stop, regardless of how they would otherwise be apportioned under the general section 861 rules.

3. Allocated only if "directly allocable": every other deduction, but only if it clears a materially higher bar than the everyday "properly allocable" standard.

That third bucket is where the preamble does the most interpretive work, because the statute never defines "directly allocable." Treasury concluded that the term requires a closer, more direct link between the deduction and the income than ordinary allocation-and-apportionment principles require. In practice, a deduction that is typically spread across income categories using a proxy — like the relative value of assets (the method used for interest expense) or relative gross receipts (the method used for R&E expenditures) — is not directly allocable, even if it isn't interest or R&E itself.

Using that test, the preamble gives concrete examples:

· Not directly allocable: stewardship expenses and legal expenses, because both are types of deductions that get apportioned by a relative-value proxy under the existing rules.

· Directly allocable: foreign currency loss under section 986(c) tied to a distribution of previously taxed earnings and profits (PTEP) assigned to the section 951A category, and a net operating loss (NOL) deduction under section 172 to the extent it is allocated to foreign source 951A income under the existing NOL sourcing rules.

What Happens to the Deductions That Don't Qualify

Deductions that fall into buckets two or three but fail the "directly allocable" test are not simply ignored — the second sentence of section 904(b)(5) reallocates them to U.S. source income instead. The proposed regulations implement this as a two-step process: first, allocate and apportion deductions to foreign source 951A income under the normal rules as if section 904(b)(5) didn't exist; then strip out (and reallocate to U.S. source income) whatever doesn't survive the statute's exclusions.

That reallocation is not just an accounting footnote it can affect several other calculations down the line, including:

· Whether a company has a domestic loss or an overall domestic loss (ODL) under section 904(g), which determines how much prior foreign tax credit benefit gets recaptured;

· Whether a company has an overall foreign loss (OFL) under section 904(f); and

· How separate limitation losses in the section 951A category are calculated and carried between years.

Treasury acknowledged it is still studying whether further changes to the section 904(f) and (g) regulations are needed to fully reflect this reallocation approach — a signal that more guidance may be coming.

Comment Requests and Applicability Dates

Treasury is not treating this as settled. The preamble specifically invites comments on:

· Whether further guidance is needed on applying section 904(b)(5) to deductions beyond the examples given; and

· The proposed approach of using existing allocation rules — including the current bar on allocating R&E expenditures to section 951A category income — to determine which deductions get reallocated to U.S. source income.

Written comments and requests for a public hearing are due November 10, 2026, submitted through the Federal eRulemaking Portal at regulations.gov referencing REG-117273-25.

On timing, both sets of proposed rules the section 250(b)(3) changes and the new section 904(b)(5)/§ 1.904(b)-4 rules are proposed to apply to tax years beginning after December 31, 2025. Taxpayers may rely on the proposed regulations now, before they are finalized, but only if they and their related parties follow each set of proposed rules in its entirety no cherry-picking favorable provisions while ignoring others.

Practical Takeaways

· Exporters and service providers with debt or R&E spend should revisit their FDII calculations for 2026 excluding interest and R&E expenditures from the DEI/FDDEI computation may meaningfully increase the section 250 deduction compared to pre-OBBBA years.

· Multinationals should map their deductions against the new three-bucket test before relying on the proposed rules, since stewardship and legal expenses are called out as failing the "directly allocable" standard while NOLs and section 986(c) currency losses tied to the 951A category are called out as passing it.

· Reliance is all-or-nothing. A taxpayer that wants the benefit of these proposed rules for a 2026 return must follow both the section 250 changes and the section 904(b)(5) changes in full — partial reliance is not permitted.

· Watch for a second wave of section 250 guidance. Treasury has flagged separate forthcoming regulations addressing other OBBBA changes to section 250(a)(1)(A), including removal of the deemed tangible income return.

· The comment window closes November 10, 2026. Businesses with a stake in how "directly allocable" gets defined — particularly around stewardship, legal, and other overhead-type deductions have a limited window to weigh in before these rules are finalized.

Bottom Line

REG-117273-25 gives multinational businesses their first real roadmap for two OBBBA changes that have been in effect on paper since the start of 2026 but lacked implementing mechanics: a larger, interest-and-R&E-free FDII deduction base, and a narrower, more literal "directly allocable" standard for deductions charged against GILTI/NCTI income for foreign tax credit purposes. Companies with existing FDII claims or CFC structures should model both changes now, while the comment period is open and reliance remains available for the 2026 tax year.

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