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IRS foreign tax credit rules — The IRS and Treasury Department are proposing new rules for allocating deductions when certain U.S. companies calculate foreign tax credits and deductions connected to foreign-derived income. DK_STUDIO29/Shutterstock

U.S. companies doing business overseas could face updated rules for calculating important international tax deductions and foreign tax credits under a new proposal from the Internal Revenue Service and Treasury Department.

The proposed regulations, published September 11, are intended to implement international tax changes Congress enacted in the 2025 One, Big, Beautiful Bill Act.

For most individual taxpayers, the proposal won’t change how they prepare their federal income tax returns. Instead, the rules primarily matter to domestic corporations claiming a deduction connected to foreign-derived income and taxpayers operating abroad through foreign corporations.

What Is the IRS Proposing?

At the center of the proposal is a complicated but important tax question: When a company has income from both U.S. and foreign sources, which expenses and deductions should be assigned to each?

That calculation matters because assigning a deduction to one category of income rather than another can change the amount of income used to calculate certain tax benefits.

The proposed regulations address two areas.

The first involves the calculation of deduction eligible income, or DEI, used in determining a domestic corporation’s deduction for foreign-derived deduction eligible income, commonly abbreviated FDDEI.

The second involves the foreign tax credit limitation for foreign-source Section 951A category income. That category generally relates to income U.S. shareholders recognize from controlled foreign corporations.

The IRS proposal provides detailed rules for deciding how deductions should be allocated and apportioned when companies make those calculations.

The Rules Stem From the 2025 Tax Law

Congress changed both areas as part of the One, Big, Beautiful Bill Act, which was signed into law July 4, 2025.

The changes generally apply to taxable years beginning after December 31, 2025.

For deduction eligible income, the amended law changed which deductions reduce gross income when calculating DEI.

Under the new framework, deductions—including certain taxes—that are properly allocable to the relevant gross income generally reduce DEI. However, interest expense and research or experimental expenditures are excluded from that reduction.

The proposed Treasury regulations provide instructions for applying those statutory changes.

Foreign Tax Credit Calculations Are Changing Too

The foreign tax credit is designed, broadly speaking, to reduce the potential for U.S. taxpayers to be taxed twice on qualifying foreign income.

But determining how much foreign tax credit a taxpayer can use involves a limitation calculation, and that requires determining how much taxable income belongs in different foreign-income categories.

The 2025 law added special rules under Section 904(b)(5) for deductions associated with foreign-source Section 951A category income.

Under those rules, certain deductions—including the Section 250 deduction associated with net CFC tested income and certain taxes—are allocated to that foreign-source income.

Interest expenses and research and experimental expenditures, meanwhile, aren’t allocated to foreign-source Section 951A category income under the new rules.

Other deductions generally go to that foreign-source category only when they are directly allocable to it. Otherwise, they’re allocated to U.S.-source income.

The proposed regulations provide additional details for putting those rules into practice.

Who Actually Needs to Pay Attention?

This isn’t a proposal that the typical employee, retiree or small household needs to factor into a Form 1040.

Treasury and the IRS say the regulations would primarily affect taxpayers operating in foreign countries through foreign corporations and domestic corporations claiming the deduction for foreign-derived deduction eligible income.

That means companies with foreign subsidiaries, significant international operations or qualifying foreign-derived income—and the tax professionals advising them—have much more reason to study the proposal closely.

The allocation rules can affect both the amount of income used in calculating the FDDEI deduction and the limitation on foreign tax credits.

Because international corporate tax calculations can involve multiple entities, income categories and jurisdictions, affected businesses should evaluate the proposal based on their particular structures rather than relying on a simplified example.

Companies May Be Able to Use the Proposed Rules Before They’re Final

One noteworthy part of the proposal is that affected taxpayers don’t necessarily have to wait for Treasury to publish final regulations before relying on the new guidance.

The proposed rules generally apply to taxable years beginning after December 31, 2025.

Treasury and the IRS also say taxpayers may rely on the proposed Section 250 rules before final regulations are published if they follow the applicable proposed regulations in their entirety.

Similar reliance is available for the proposed rules addressing Section 904(b)(5) and related deduction allocation, again provided taxpayers follow those proposed provisions in their entirety.

That can give businesses and their tax advisers a framework for dealing with the statutory changes while the formal rulemaking process continues.

IRS Wants Comments by November 10

These regulations aren’t final yet.

The IRS is accepting written and electronic comments on the proposal, along with requests for a public hearing, through November 10, 2026.

Electronic comments can be submitted through the federal rulemaking portal by referencing REG-117273-25.

Treasury and the IRS will consider those comments before moving ahead with final regulations.

For most consumers, there is no immediate tax action required because of this proposal. Businesses with controlled foreign corporations, foreign-derived income or significant cross-border operations, however, may want their tax professionals to review the rules now because the underlying statutory changes already apply to taxable years beginning after December 31, 2025.

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Amanda Blankenship

Amanda Blankenship is the Chief Editor for District Media. With a BA in journalism from Wingate University, she frequently writes for a handful of websites and loves to share her own personal finance story with others. When she isn’t typing away at her desk, she enjoys spending time with her daughter, son, husband, and dog. During her free time, you’re likely to find her with her nose in a book, hiking, or playing RPG video games.

What the IRS Compliance Assurance Process Does

The IRS Large Business and International Division launched CAP as a pilot program in 2005, and the program became permanent in 2011. According to the IRS Compliance Assurance Process overview, participating taxpayers work with the agency to identify and resolve tax issues before filing their returns. The approach is intended to increase return accuracy, provide taxpayers with greater certainty about their tax positions, and reduce the need for extensive post-filing examinations.

That doesn’t mean participating companies receive a pass on IRS scrutiny.

CAP relies on what the agency describes as transparent and cooperative interaction between the taxpayer and the IRS. Companies must make timely disclosures, respond to information requests, and work with the agency to resolve material tax issues. Participation is also something taxpayers must apply for each year.

Not Every Corporation Can Apply

The program is aimed at large corporate taxpayers, and the IRS eligibility requirements set a significant financial threshold. Applicants generally must have assets of at least $10 million and cannot be under an investigation or involved in litigation with the IRS or another government agency if the situation would limit the IRS’s access to current corporate tax records.

Eligible taxpayers include U.S. publicly traded C corporations required to file Forms 10-K, 10-Q, and 8-K with the Securities and Exchange Commission. Qualifying privately held C corporations, including foreign-owned corporations, may also participate. Those companies must meet financial-statement requirements, including providing audited annual financial statements and unaudited quarterly statements. The IRS expanded CAP eligibility to privately held U.S. C corporations beginning with the 2026 program year.

New and Returning Applicants Face Different Requirements

The application isn’t identical for every corporation. The IRS application and selection guidance shows that both new and returning applicants must submit Form 14234, the CAP application, along with several other required documents. New applicants have additional requirements, including a Material Intercompany Transactions Template, Tax Control Framework Questionnaire, and Cross Border Activities Questionnaire. Open tax years can also affect eligibility.

Current CAP participants generally cannot have more than one filed return and one unfiled return open on the first day of the applicant’s CAP tax year, although the IRS provides several exceptions. New applicants may have up to three tax years open for examination on the first day of their CAP tax year. However, the examination team must determine that those years can reasonably be closed within 12 months after the first day of the CAP tax year.

The IRS says it is making no substantive changes to CAP application requirements or eligibility criteria for the 2027 application period.

October 30 Is the Key Date for Interested Corporations

Corporations considering CAP participation have until October 30, 2026, to submit their applications. Returning applicants submit their application to their assigned account coordinator or case manager. New applicants are instructed to email their application to the IRS CAP program mailbox using “CAP Application” and the applicable tax year in the subject line.

Companies accepted into the program will receive a CAP Memorandum of Understanding that must be signed and returned to secure participation.

For corporate tax departments and advisors working with businesses that meet the $10 million asset threshold, the approaching deadline provides a reason to review eligibility now rather than waiting until late October. Because CAP requires extensive cooperation and disclosure but can provide greater certainty about tax positions before a return is filed, companies should evaluate whether that tradeoff fits their tax compliance strategy before applying.