A Delicate Balance: TCJA Changes Loom over FDII and IC-DISC Benefits

The Tax Cuts and Jobs Act (TCJA) of 2017 is one of the most significant overhauls of the United States tax code in decades. Among the changes implemented was the Foreign Derived Intangible Income (FDII) Deduction, introduced via PL 115-97, which grants C-Corporations the opportunity to lower the tax rate applied to their foreign-derived income.  

The FDII Deduction is calculated based on the deemed intangible income multiplied by the corporation’s foreign to total deduction-eligible income ratio. Originally intended to keep intellectual property-related income within the U.S., it is a powerful tax savings tool that effectively lowers a corporation tax rate on foreign-derived income to 13.125% — an arbitrage rate of 7.875% when compared to the tax rate of 21% currently reserved for C-Corporations.   

It’s crucial to note that the TCJA contains a sunset provision, which means that without further legislation, significant changes to the provisions introduced in this Act are imminent. Unlike several other provisions which are set to expire, the FDII deduction would simply decrease from 37.5% to 21.875% in 2026. 

While there is bipartisan support to expand the FDII deduction, the future is far from certain, and the end of TCJA does not weigh as heavily upon some taxpayers as it does on others. The same sunset provisions that threaten the FDII’s effectiveness could prove to be very beneficial for manufacturing companies that are currently, or would like to be, taking advantage of an IC-DISC.  

Another provision introduced by the TCJA is the Qualified Business Income (QBI) Deduction, which, unlike FDII, is set to expire should TCJA’s sunset provision come into effect. The QBI Deduction allows passthrough entities to deduct up to 20% of their qualified business income from taxable income, effectively lowering the tax rate from 37% to 29.6%. Should the QBI expire in 2026, many taxpayers will now face a significantly higher tax rate. Luckily, for passthrough entities potentially facing this hurdle, an IC-DISC can bring a sizable benefit that will help offset this tax burden. 

The IC-DISC commission effectively reclassifies a portion of a taxpayer’s Ordinary Income to Qualified Dividend income. This can be a powerful tool if utilized effectively. A current 5.8% arbitrage rate has the potential to rise significantly to 13.2% should QBI be factored out in the coming years. As businesses navigate the uncertainty of TCJA’s provisions over the next few years, leveraging IC-DISC structures effectively could offer significant advantages in optimizing tax liabilities and enhancing overall financial performance.

While the TCJA introduced significant changes aimed at promoting economic growth and competitiveness, it is important to look ahead. As businesses adapt to evolving tax policies and regulations, understanding the intricacies of these provisions and their implications is essential for maximizing tax efficiency and maintaining competitiveness in the global marketplace.  

With decades of experience across many sectors of international taxation, McGuire Sponsel’s Global Business team can help taxpayers navigate the ever-increasingly complex international tax landscape.