U.S. Taxation of Foreign Business Income
For purposes of this discussion, a “U.S. person” generally includes a U.S. citizen, lawful permanent resident (green card holder), an individual who satisfies the substantial presence test, and a domestic corporation, partnership, trust, or estate.
When a U.S. person owns an interest in a foreign operating company, several layers of taxation and reporting may apply. These can include the corporate income tax imposed by the foreign country, foreign withholding taxes on distributions, U.S. federal income tax, state income tax in certain jurisdictions, and extensive international information-reporting requirements.
One of the most important—and frequently misunderstood—features of the U.S. international tax system is that the United States does not necessarily wait until foreign earnings are distributed to the U.S. owner.
Under the anti-deferral provisions of the Internal Revenue Code, principally Subpart F and Section 951A, profits earned inside certain foreign corporations can be taxable to a U.S. shareholder in the year the income is earned, even if the foreign corporation makes no distribution to the shareholder.
Beginning with taxable years of foreign corporations beginning after December 31, 2025, the Section 951A regime changed significantly. The legislation enacted on July 4, 2025, commonly referred to as the One Big Beautiful Bill Act (“OBBBA”), replaced the familiar concept of Global Intangible Low-Taxed Income (“GILTI”) with Net CFC Tested Income (“NCTI”).
Although NCTI retains much of the framework of GILTI, several important changes can materially affect U.S. owners of foreign businesses.
Controlled Foreign Corporations
Both GILTI and NCTI operate through the Controlled Foreign Corporation (“CFC”) rules.
Generally, a foreign corporation is a CFC when more than 50 percent of the corporation’s total combined voting power or total value is owned by “United States shareholders.”
For this purpose, a United States shareholder generally is a U.S. person that owns at least 10 percent of the foreign corporation’s voting power or value.
Determining ownership can be more complicated than simply examining the shareholder register. U.S. tax law applies direct, indirect, and constructive ownership rules, including attribution among certain family members and related entities. As a result, CFC status can exist even when a taxpayer does not believe that he or she directly controls the foreign company.
Entity classification is also determined under U.S. federal tax principles rather than solely by the entity’s classification under foreign law. Depending on the circumstances and available elections, a foreign entity may be treated for U.S. tax purposes as a corporation, partnership, or disregarded entity.
GILTI
GILTI was introduced by the Tax Cuts and Jobs Act of 2017.
Under the former regime, U.S. shareholders of CFCs generally were required to include their share of the CFCs’ “tested income,” subject to statutory exclusions and adjustments.
One particularly important feature was the Qualified Business Asset Investment (“QBAI”) exclusion. GILTI generally permitted a deemed 10 percent return on certain depreciable tangible property used in the foreign business, subject to adjustments including certain interest expense.
The practical result was that businesses with substantial investments in factories, machinery, hotels, agricultural equipment, and other tangible assets could potentially reduce their GILTI exposure through the QBAI calculation.
For an eligible domestic corporation, Section 250 generally provided a 50 percent deduction for GILTI, resulting in an effective federal corporate tax rate of approximately 10.5 percent before foreign tax credits.
In addition, a domestic corporate shareholder generally could claim a deemed-paid foreign tax credit for 80 percent of qualifying foreign income taxes attributable to the GILTI inclusion.
Now Beginning in 2026 NCTI Changes
NCTI retains the basic Section 951A anti-deferral structure but significantly changes the calculation.
The QBAI Exclusion Is Gone
Perhaps the most significant conceptual change is the elimination of the deemed tangible-asset return.
Under NCTI, the former QBAI-based reduction no longer applies. This means tested income is no longer reduced by a deemed 10 percent return on qualified tangible business assets.
The change can be particularly significant for capital-intensive foreign businesses, including manufacturers, hotels, agricultural operations, transportation companies, and businesses with substantial machinery or equipment.
The Section 250 Deduction Is Reduced
For eligible domestic corporations, the Section 250 deduction applicable to NCTI is 40 percent, rather than the former 50 percent GILTI deduction.
At the current 21 percent corporate income tax rate, this produces an effective federal rate of approximately 12.6 percent on NCTI before taking foreign tax credits into account.
Foreign Tax Credit Relief Improves
At the same time, the deemed-paid foreign tax credit percentage increases.
Under the former GILTI regime, only 80 percent of qualifying foreign taxes were generally creditable. Under the new NCTI rules, that percentage increases to 90 percent.
As a simplified mathematical matter, a 12.6 percent U.S. effective rate divided by a 90 percent credit percentage produces a break-even foreign tax rate of approximately 14 percent, although the actual result depends on the taxpayer’s facts, foreign tax credit limitation, expense allocation, and other applicable rules.
The new law also modifies the allocation of expenses for purposes of the Section 951A foreign tax credit limitation. In particular, interest expense and research and experimental expenditures generally are not allocated to the NCTI category in the same manner as under prior law. For some multinational groups, this can significantly increase the amount of usable foreign tax credits and reduce or eliminate residual U.S. tax.
There is an important counterpoint. The new rules generally disallow a foreign tax credit for 10 percent of certain foreign taxes imposed on distributions of previously taxed Section 951A earnings, including qualifying previously taxed earnings and profits (“PTEP”). Thus, foreign withholding taxes imposed when previously taxed NCTI or GILTI earnings are later distributed require careful analysis.
The Timing Rules Are Broader
OBBBA also significantly changed who bears a CFC inclusion when ownership changes during the year.
Under the former rules, a U.S. shareholder generally needed to own CFC stock on the last relevant day of the foreign corporation’s taxable year to have the corresponding Subpart F or GILTI inclusion.
Beginning under the new rules, a U.S. shareholder can have an inclusion based on the portion of the CFC year during which the shareholder owned the stock while the foreign corporation was a CFC.
This change is particularly important in mergers, acquisitions, and sales of foreign businesses.
A seller generally can no longer assume that selling the CFC stock before year-end eliminates the current-year inclusion. Purchase agreements involving CFC stock should therefore address the allocation of Subpart F and NCTI exposure between buyers and sellers.
The Treasury Department and IRS have already issued proposed guidance addressing these revised pro rata share rules.
The One-Month CFC Deferral Election Was Repealed
OBBBA also repealed the one-month deferral election previously available under Section 898(c)(2).
Foreign corporations that previously used the election—often resulting in a November 30 year-end where the majority U.S. shareholder used a calendar year—may have a short taxable year as they transition to the required year.
IRS Notice 2025-72 provided interim guidance addressing the allocation of foreign income taxes affected by this transition, and the Treasury Department and IRS subsequently issued proposed regulations addressing the allocation rules.
The transition should be reviewed carefully because the Section 898 amendments and the new Section 951A rules have different effective-date provisions.
Other Important International Tax Changes
OBBBA made several related changes that should be considered together with NCTI.
The Section 954(c)(6) CFC look-through rule, which generally permits qualifying dividends, interest, rents, and royalties received from related CFCs to avoid treatment as foreign personal holding company income, was made permanent.
The former Foreign-Derived Intangible Income (“FDII”) terminology was also replaced with Foreign-Derived Deduction Eligible Income (“FDDEI”). For taxable years beginning after December 31, 2025, the Section 250 deduction for qualifying FDDEI is 33.34 percent, producing an effective federal corporate tax rate of approximately 14 percent at the current 21 percent corporate rate.
Individual Shareholders and the Section 962 Election
The 12.6 percent NCTI rate described above applies to eligible domestic corporate shareholders. The treatment of an individual shareholder can be dramatically different.
An individual who owns CFC shares directly generally does not automatically receive the Section 250 deduction or the indirect foreign tax credit available to a domestic corporation. Without additional planning, a Section 951A inclusion can therefore be taxed at ordinary individual income tax rates.
Section 962 can change that result. An individual who holds shares directly or through a partnership or S corporation receives no Section 250 deduction and no credit for the corporate-level foreign taxes. The inclusion is taxed as ordinary income at graduated rates reaching thirty-seven percent.
An election under Section 962 allows an individual to be taxed as though a domestic corporation stood in the chain, capturing the forty percent deduction and the ninety percent credit, at the cost of additional tax when the earnings are ultimately distributed; that later distribution can qualify for the 20 percent dividend rate if the CFC is resident in a treaty country.
Whether that election helps depends on the foreign rate, the distribution policy, treaty status, and the owner’s other income.Where the CFC’s foreign effective rate exceeds 18.9 percent, the high-tax exclusion may remove the income from NCTI altogether.
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This post is for general information only and is not legal or tax advice. The application of these rules depends on the specific facts. Please contact us to discuss your situation.
Sources:
Public Law 119-21 (July 4, 2025), One Big Beautiful Bill Act (OBBBA) — particularly §§ 70321–70323 and related international tax provisions. The statute changes the §250 deduction to 40% for NCTI, replaces GILTI terminology with NCTI, and eliminates the former QBAI/deemed tangible-income return. Congress.gov
Public Law 119-21 — Full TextInternal Revenue Code §951A — Net CFC Tested Income — principal statutory provision governing current inclusions of NCTI by U.S. shareholders of CFCs, as amended by OBBBA. Congress.gov
Internal Revenue Code §250 — FDDEI and NCTI Deduction — provides the 40% deduction for qualifying NCTI and 33.34% deduction for FDDEI for applicable post-2025 taxable years. Congress.gov
Internal Revenue Code §§951, 957, 958 and 960 — governing Subpart F inclusions, CFC status, stock ownership and attribution, pro rata shares, and deemed-paid foreign tax credits.
IRS Notice 2025-72, 2025-51 I.R.B. — guidance concerning repeal of the §898(c)(2) one-month deferral election and allocation of foreign income taxes during the transition. IRS
IRS Notice 2025-722026 Proposed Regulations under §§951, 951A and 6038 — Treasury and IRS guidance addressing the new pro rata share rules and NCTI provisions for post-2025 taxable years. IRS
IRS Internal Revenue Bulletin 2026-39IRS Form 5471 and Instructions — reporting requirements for certain U.S. persons with interests in foreign corporations, including CFC reporting and the post-2025 §898 year-end rules. IRS
IRS Instructions for Form 5471IRS Form 8992 — Calculation of Net Controlled Foreign Corporation Tested Income (NCTI) and Form 8993 — Section 250 Deduction for FDDEI and NCTI. The IRS's 2026 draft forms expressly incorporate the new NCTI terminology and calculations. IRS
IRS 2026 Draft Tax FormsIRS FATCA Guidance / Form 8938 — reporting requirements and penalties concerning specified foreign financial assets; Form 8938 reporting is separate from FBAR reporting. IRS
IRS FATCA Information for Individuals
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