Section 904 (Limitation on credit) caps the FOREIGN TAX CREDIT (FTC) at the US tax attributable to foreign source taxable income, applied SEPARATELY to each "BASKET" (separate limitation category). Formula: FTC LIMIT = US TAX × (FOREIGN SOURCE TAXABLE INCOME ÷ WORLDWIDE TAXABLE INCOME), computed per basket. Pre-TCJA - FIVE baskets (passive, general, §901(j), treaty resourced, lump-sum distributions). TCJA (P.L. 115-97 December 22, 2017) ADDED TWO baskets: §951A category (GILTI) and FOREIGN BRANCH category - bringing total to SEVEN. OBBBA (P.L. 119-21 July 4, 2025) effective for tax years beginning after December 31, 2025 - RENAMED §951A from GILTI to NCTI ("Net CFC Tested Income"); ELIMINATED QBAI 10% return on tangible assets; reduced §250 deduction from 50% to 40%; INCREASED §960 deemed-paid foreign tax credit on NCTI from 80% to 90% (10% haircut, down from 20%); allowed up to 50% of US-produced inventory sales income to be sourced FOREIGN; CFC look-through rules §954(c)(6) made PERMANENT; §958(b)(4) downward attribution REINSTATED with anti-abuse rules; FDII renamed FOREIGN-DERIVED DEDUCTION ELIGIBLE INCOME (FDDEI) with §250 deduction reduced 37.5% to 33.34% (effective rate ~14%); new §951B added. SEPARATE-BASKET LIMITATION prevents cross-crediting (high foreign tax on one type of income cannot offset US tax on another type). PASSIVE BASKET §904(d)(1) - generally passive investment income (dividends, interest, royalties, rents from passive use, capital gains on stock/securities). GENERAL BASKET §904(d)(1) - active business income, certain financial services income. SPECIFIC EXCLUSIONS from passive: high-taxed kick-out (income subject to foreign tax > highest US rate); export financing interest; high-taxed financial services. §904(d)(3) LOOK-THROUGH RULES - dividends/subpart F/interest/rents/royalties from CFCs assigned to basket based on underlying CFC income character (not character at recipient level). EXCESS LIMITATION CARRYOVER §904(c) - 1-year carryback + 10-year carryforward per basket, BUT NCTI/GILTI basket has NO CARRYOVER. §904(d)(2)(H) sourcing of NCTI - 100% foreign source. Foreign tax credit RULES: §901(b) - direct foreign income taxes; §901(j) - non-creditable taxes (boycott, terrorist countries); §903 - in lieu of foreign income tax; §904 - limitation; §960 - deemed-paid CFC taxes; §905 - timing of crediting. Form 1116 (individuals) / Form 1118 (corporations). Election to deduct vs credit annual.
The limit: FTC LIMIT = US tax × (foreign source taxable income / worldwide taxable income), per basket. Prevents cross-crediting between high-tax and low-tax foreign income types.
Seven baskets (post-TCJA): Passive | General | NCTI/GILTI (§951A) | Foreign Branch | §901(j) (sanctioned countries) | Treaty-resourced | Lump-sum distributions. NCTI/GILTI and Foreign Branch added by TCJA effective 2018.
OBBBA changes effective 2026: GILTI renamed NCTI; QBAI 10% return eliminated; §250 deduction reduced (NCTI 50%→40%, FDII 37.5%→33.34%); NCTI deemed-paid foreign tax credit 80%→90% (haircut 20%→10%); CFC look-through §954(c)(6) made permanent; §958(b)(4) downward attribution reinstated; new §951B added; 50% foreign sourcing allowed for US-produced inventory sales abroad.
Carryover: 1-year back + 10-year forward per basket; EXCEPT NCTI basket has NO carryover (use it or lose it annually).
Look-through §904(d)(3): CFC distributions categorized based on underlying CFC income character; prevents general-basket income converting to passive merely by being distributed as a dividend.
| Basket | Authority | Content |
|---|---|---|
| Passive Category | §904(d)(1)(B); §904(d)(2)(B) | Passive investment income - dividends, interest, royalties (passive), rents (passive use), capital gain on stock/securities; certain specified passive income categories |
| General Category | §904(d)(1)(D); §904(d)(2)(D) | Active business income; financial services income (not branch); income not falling in other baskets - default catchall |
| NCTI / GILTI Category §951A | §904(d)(1)(A); §904(d)(2)(A); TCJA addition | Net CFC Tested Income (renamed from GILTI by OBBBA effective 2026); CFC-level income subject to §951A inclusion; NO carryover under §904(c) |
| Foreign Branch Category | §904(d)(1)(B); §904(d)(2)(J); TCJA addition | Income attributable to foreign branch operations of US person; branches of US C-corps |
| §901(j) Sanctioned Country Income | §904(d)(1)(F); §901(j) | Income sourced from sanctioned countries (Iran, North Korea, Sudan, Syria, currently); foreign tax NOT creditable |
| Treaty-Resourced Income | §904(d)(6) | Income resourced under treaty - taxpayer elects to treat US source as foreign source per treaty article |
| Lump-Sum Distributions §402(e) | §904(d)(1)(E) | Specific category for certain pension distribution-related foreign tax |
| Step | Detail |
|---|---|
| Step 1 | Determine US tax before FTC = taxable income × applicable rates |
| Step 2 | Compute foreign source taxable income PER BASKET (gross foreign income less allocable deductions) |
| Step 3 | Compute worldwide taxable income |
| Step 4 | FTC limit per basket = US tax × (basket FSTI / WTI) |
| Step 5 | Credit allowed per basket = lesser of (a) foreign taxes paid/accrued in basket or (b) FTC limit for basket |
| Step 6 | Excess foreign tax credit per basket = foreign tax paid - FTC limit; carryover 1 year back + 10 forward (except NCTI - no carryover) |
| Expense allocation | Interest expense, R&E expenses, stewardship, general SG&A allocated to baskets per Reg §1.861-8 through §1.861-14 |
| §904(b)(4) adjustment | Expenses allocated to §245A-eligible income added back to worldwide TI denominator; OBBBA-affected; pending Treasury guidance |
| Separate-basket loss recapture §904(f) | Net loss in one basket reduces income in another; recaptured in later years |
| Overall foreign loss §904(f) | Foreign losses recaptured against future foreign source income |
| Overall domestic loss §904(g) | Domestic losses recaptured against future US source income |
| NCTI/GILTI Element | Pre-OBBBA (Through 2025) | Post-OBBBA (2026+) |
|---|---|---|
| Name | GILTI - Global Intangible Low-Taxed Income | NCTI - Net CFC Tested Income |
| Authority | §951A enacted by TCJA 2017 | §951A renamed by OBBBA P.L. 119-21 |
| QBAI 10% return on tangible assets | Reduced GILTI by 10% of QBAI | ELIMINATED - all CFC tested income subject to NCTI |
| §250 deduction | 50% deduction (effective rate 10.5%) | 40% deduction (effective rate 12.6%) |
| §960 deemed-paid foreign tax credit | 80% × CFC's foreign taxes attributable to tested income | 90% × CFC's foreign taxes (10% haircut, down from 20%) |
| FTC carryover | NO carryover | NO carryover |
| Expense allocation §904(b)(4) | Interest, R&E, SG&A allocated to NCTI basket - reduces FTC limit | OBBBA §70311(a) - interest and R&E NOT allocated to NCTI; SG&A only if "properly allocable"; reduces over-allocation |
| Effective US tax on NCTI | ~13.125% with full FTC; higher with disallowed taxes | ~14% with full FTC; reduced from 16.4% scheduled increase |
| Tested income basket | NCTI distributions allocated to NCTI basket | Same - NCTI inclusions in NCTI basket |
| Subpart F vs NCTI planning | Subpart F (general basket) often preferred to GILTI (no carryover) | Same planning consideration - subpart F more flexible |
| Foreign Branch Element | Detail |
|---|---|
| Authority | §904(d)(2)(J) - added by TCJA P.L. 115-97 |
| Effective date | Tax years beginning after December 31, 2017 |
| Definition | Income attributable to foreign branch of US person (typically US C-corp with foreign permanent establishment) |
| Branch determination | "Qualified business unit" (QBU) per §989(a)(2) - clear and separate set of books for foreign location |
| FTC limitation | Separate basket - foreign branch foreign tax cannot cross-credit other baskets |
| Sourcing | Generally foreign source per §865/§862 |
| Inventory sourcing OBBBA | OBBBA allows up to 50% of US-produced inventory sold abroad through foreign branch to be foreign source - more FTC capacity |
| Carryover | 1-year back + 10-year forward per §904(c) |
| Disregarded entity | Single-member foreign LLC owned by US C-corp - branch for tax purposes |
| Branch vs CFC structure | Branch - immediate US tax on all earnings; CFC - subpart F or NCTI inclusion only on tested income |
| Look-Through Element | Detail |
|---|---|
| Authority | §904(d)(3) - CFC look-through rules; CFC-to-CFC payments §954(c)(6) (now PERMANENT under OBBBA) |
| Purpose | Categorize income based on underlying CFC income character, not character in hands of US shareholder |
| Covered payments | Dividends, subpart F inclusions, GILTI/NCTI inclusions, interest, rents, royalties from CFC to US shareholder or related CFC |
| Categorization | Allocated to baskets based on CFC's underlying income; if CFC's income is general basket at CFC level, dividend distribution stays general at shareholder level |
| NCTI inclusions | Treated as passive only to extent attributable to passive tested income of CFC - rarely applies (most passive income is subpart F, excluded from tested income) |
| §954(c)(6) permanency | OBBBA made CFC-to-CFC look-through permanent (prevented sunset) |
| Coordination with high-tax exception | §954(b)(4) high-tax exception election removes subpart F from CFC level - then NCTI basket would apply to look-through |
| Tiered CFC structures | Look-through chains through multiple CFC levels |
| High-Tax Kick-Out Element | Detail |
|---|---|
| Authority | §904(d)(2)(B)(iii)(II); §954(b)(4); Reg §1.904-4(c) |
| Rule | Passive category income with foreign effective tax rate exceeding highest US rate is "kicked out" of passive basket and reclassified to general basket |
| 2026 highest US rate | 37% individual / 21% corporate |
| Test | Foreign tax > applicable highest US rate × pre-credit foreign source taxable income for category |
| Effect | Allows excess foreign tax (>US rate) to potentially cross-credit general basket income |
| Election under §954(b)(4) | CFC-level - elects out of subpart F if effective foreign tax rate exceeds 90% of highest US corporate rate (18.9% for 2026) |
| Subpart F GILTI/NCTI high-tax exception | Allows electing out of GILTI/NCTI inclusion if effective rate exceeds 90% threshold; income then NOT included in US shareholder's gross income |
| Planning tradeoff | HTKO removes income from passive basket - may help if passive basket has excess limit; but loses ability to defer FTC carryover separately |
| Carryover Element | Detail |
|---|---|
| Carryback | 1 year - elect to apply current year unused FTC to prior year |
| Carryforward | 10 years per basket |
| NCTI basket exception | NO carryover - use it or lose it annually |
| Per-basket tracking | Carryovers segregated by basket - cannot cross between baskets |
| Application order | Carrybacks first; then current year; then carryforwards (oldest first) |
| Election to credit vs deduct | Annual election - take all foreign income tax as credit OR as deduction; once election made, all-or-nothing for the year |
| Form 1116 Schedule B | Reconciliation of FTC carryovers per basket |
| Stacking | 10-year FCFs accumulate; may expire unused if foreign source income too small in basket |
| Major TCJA TCJA reset | TCJA effective dates - pre-2018 carryovers transitioned to new baskets via mapping rules |
| OBBBA Indirect Effect | Detail |
|---|---|
| §163(j) interest limitation modifications | Modified EBITDA add-back computation may affect interest allocation to foreign source income |
| §174 R&E retroactive expensing | OBBBA allowed retroactive 2022-2024 R&E expensing for domestic; affects R&E allocation in earlier §904 limits; Form 3115 §481(a) catch-up |
| §70311(a) NCTI expense allocation | Interest and R&E NOT allocated to NCTI for §904 purposes; SG&A only if "properly allocable" - reduces over-allocation |
| FDII / FDDEI rules parallel | OBBBA's FDDEI provisions (formerly FDII) - similar §904(b)(4) implications; pending guidance on stewardship/SG&A |
| BEAT increase | OBBBA increased BEAT rate; FTC interaction with BEAT requires modeling |
| §951B new | New CFC inclusion provision added by OBBBA; affects basket categorization |
| Inventory sourcing 50% | OBBBA allows up to 50% foreign sourcing for US-produced inventory sold abroad through foreign office/PE; increases foreign branch FTC capacity |
| §958(b)(4) downward attribution reinstated | OBBBA narrows CFC determinations - reduces incidental CFC classifications; affects FTC computations |
| PTEP haircut | 10% disallowance on FTC for §951A PTEP distributions on/after June 28, 2025 |
Facts: James (US citizen) for 2026:
Worldwide taxable income: $500,000
US source: $300,000
Foreign source - General basket: $100,000 (active foreign business income); foreign tax $35,000
Foreign source - Passive basket: $80,000 (foreign dividends); foreign tax $12,000
Foreign source - NCTI basket: $20,000 (CFC tested income inclusion); foreign tax $4,000
Pre-FTC US tax: $145,000 (effective rate 29%)
Step 1 - FTC limit per basket:
General: $145,000 × ($100,000 / $500,000) = $29,000
Passive: $145,000 × ($80,000 / $500,000) = $23,200
NCTI: $145,000 × ($20,000 / $500,000) = $5,800
Step 2 - Credit allowed per basket (lesser of tax paid or limit):
General: Tax $35,000; limit $29,000 → credit $29,000; excess $6,000 (carryback 1 / forward 10)
Passive: Tax $12,000; limit $23,200 → credit $12,000 (no excess; $11,200 unused limit)
NCTI: Tax $4,000; limit $5,800 → credit $4,000 (no excess; $1,800 unused limit; NO CARRYOVER)
Step 3 - Total FTC and US tax:
Total FTC: $29,000 + $12,000 + $4,000 = $45,000
US tax after FTC: $145,000 - $45,000 = $100,000
Effective US tax on $500,000: 20%
Step 4 - Carryover tracking:
General basket excess: $6,000 - elect to carry back to 2025 or forward through 2036
Passive unused limit: $11,200 - cannot be used by other baskets; carries forward as foreign tax shortfall (no benefit unless paid more foreign tax than limit in future year)
NCTI: $1,800 unused limit lost (no carryover)
Step 5 - High-tax kick-out test on passive:
Passive foreign rate: $12,000 / $80,000 = 15% - below 37% US rate → NO HTKO; stays passive
| Form 1116 Element | Detail |
|---|---|
| Filing | Individuals - one Form 1116 PER BASKET; multiple forms common |
| Part I | Taxable income from foreign source by basket |
| Part II | Foreign taxes paid or accrued |
| Part III | FTC computation with limitation |
| Part IV | Summary across baskets |
| Schedule B | FTC carryover/carryback reconciliation per basket |
| De minimis exception | Form 1116 not required if total foreign tax under $300 single / $600 MFJ AND all foreign tax shown on 1099-DIV/INT - take credit directly on Schedule 3 |
| Election to deduct | If FTC limit zero or unfavorable, elect to deduct foreign tax instead under §164 - on Schedule A or Schedule 1 |
| Form 1118 (corporations) | More complex; Schedule J for NCTI; Schedule K for foreign branch; Schedule M for high-tax kick-out |
| Form 8993 (FDII/FDDEI) | §250 deduction computation |
| Income Type | Sourcing Rule |
|---|---|
| Compensation §861(a)(3) | Where services performed |
| Interest §861(a)(1) | Residence of payor |
| Dividends §861(a)(2) | Residence of payor (US corp = US source; foreign corp = foreign source) |
| Royalties §861(a)(4) | Where intangible used |
| Rents from real property §861(a)(4) | Where property located |
| Sale of inventory §861(a)(6); §862(a)(6) | Title passage rule generally; manufactured inventory split rules; OBBBA - 50% foreign source for US-produced sold abroad through foreign office |
| Sale of personal property §865 | Generally residence of seller (US seller = US source); exceptions for inventory, intangibles, depreciable property |
| Sale of real property §861(a)(5); §862(a)(5) | Location of property |
| NCTI §904(d)(2)(H)(i) | 100% foreign source (post-OBBBA may have nuances) |
| Treaty resourcing | Election to treat US source as foreign source per treaty article |
Foreign tax on passive income (15-25%) cannot offset US tax on general basket income. Per-basket limitation strict. Common error - claiming all FTC against US tax broadly without basket tracking.
NCTI basket excess FTC LOST annually - no 10-year carryforward. Plan to use NCTI FTC currently or lose. Different from other baskets which carry forward 10 years.
2026 returns - GILTI is now NCTI. Form references and statutory citations need updating. Mechanics largely preserved but QBAI eliminated and §250 deduction reduced.
OBBBA eliminated QBAI 10% return on tangible assets effective 2026. Some software may still apply pre-OBBBA QBAI exclusion. Verify 2026 calculations.
2025: 50% NCTI / 37.5% FDII. 2026 (OBBBA): 40% NCTI / 33.34% FDDEI. Effective rates change from 13.125%/10.5% to ~14%/12.6%. Update calculations.
OBBBA §70311(a) - interest and R&E NOT allocated to NCTI; SG&A only if "properly allocable." Pre-OBBBA allocation rules over-allocated, reducing FTC. Confirm 2026 software updated.
Foreign branch - taxed currently; foreign branch basket. CFC - subpart F or NCTI inclusion only. Different baskets, different FTC mechanics. Get the structural determination right.
§904(d)(3) - dividends from CFC categorized based on UNDERLYING CFC income character. Pre-tested CFC distributions look through to CFC's underlying income; not the character of the dividend itself.
Passive category income with foreign tax > US highest rate kicked to general basket - allows cross-credit. Practitioners may miss the kick-out when foreign tax is very high.
CFC-level election to exclude high-taxed income from subpart F (and possibly GILTI/NCTI). Available if effective rate exceeds 90% of US corporate rate (18.9% for 2026). Major planning election.
§901(j) - taxes paid to sanctioned countries (Iran, North Korea, Sudan, Syria) NOT creditable. Tax on services performed in sanctioned country - non-creditable. Net Investment Tax (foreign equivalents to NIIT) generally creditable per Reg §1.901-2.
Annual election - all foreign tax as credit OR all as deduction. Election irrevocable for year. If basket excess limits FTC heavily, deduction may be better. Model both alternatives.
Total foreign tax under $300 single / $600 MFJ AND shown on 1099-DIV/INT - skip Form 1116; take credit directly. Simpler. Many practitioners file Form 1116 unnecessarily.
§904(d)(6) - treaty article allowing resource of US source income to foreign source for treaty country tax credit. Election required; one form Form 8833 disclosure. Common with US-Canada, US-Mexico treaty.
OBBBA - 10% FTC disallowance on §951A PTEP distributions on/after June 28, 2025. Reduces FTC on prior-year accumulated NCTI/GILTI when distributed.
OBBBA allows up to 50% foreign source for US-produced inventory sold abroad through foreign office or fixed place of business - increases foreign branch FTC capacity. Pre-OBBBA was more restrictive.
OBBBA Working Group submission - urging Treasury to confirm stewardship and SG&A not "properly allocable" to NCTI. Pending guidance. Conservative approach - continue allocating until guidance issued.
Primary authority: IRC §904 (Limitation on credit - foreign tax credit). §904(a) (general limitation formula). §904(b) (taxable income from sources without the United States). §904(b)(4) (§245A-eligible income/asset expense allocation - OBBBA affected). §904(c) (carryback and carryover - 1 year back, 10 forward; except NCTI no carryover). §904(d)(1) (separate application of section). §904(d)(1)(A) (NCTI/§951A category). §904(d)(1)(B) (foreign branch and passive category). §904(d)(1)(C) (NCTI/§951A category - renamed by OBBBA). §904(d)(1)(D) (general category - catchall). §904(d)(1)(E) (lump-sum distributions). §904(d)(1)(F) (§901(j) sanctioned country income). §904(d)(2) (categorization of income). §904(d)(2)(A) (passive category items). §904(d)(2)(B) (passive category income definition - high-tax kick-out). §904(d)(2)(D) (general category catchall). §904(d)(2)(H)(i) (NCTI sourcing - 100% foreign source). §904(d)(2)(J) (foreign branch income). §904(d)(3) (look-through rules - CFC distributions categorized based on underlying CFC income). §904(d)(6) (treaty-resourced income basket). §904(f) (overall foreign loss recapture). §904(g) (overall domestic loss recapture). §901 (taxes of foreign countries - credit allowed). §901(b) (foreign income taxes - direct credit). §901(j) (non-creditable taxes - sanctioned countries). §903 (in lieu of foreign income tax - certain compulsory payments). §905 (timing of crediting foreign taxes). §951A (Net CFC Tested Income - RENAMED by OBBBA from GILTI effective tax years beginning after December 31, 2025). §951B (NEW under OBBBA). §954(c)(6) (CFC look-through - made PERMANENT by OBBBA). §954(b)(4) (high-tax exception election). §958(b)(4) (downward attribution - REINSTATED by OBBBA with anti-abuse rules). §960 (deemed paid credit for taxes of CFC). §960(d) (NCTI deemed paid - 90% post-OBBBA, up from 80%). §250 (foreign-derived intangible income / FDDEI deduction - 40% NCTI, 33.34% FDDEI post-OBBBA). §245A (participation exemption - dividends received deduction). §163(j) (interest limitation - modified by OBBBA). §174 (R&E expensing - OBBBA retroactive 2022-2024 domestic). §59A (BEAT - rate increased by OBBBA). §861 (income from sources within US). §862 (income from sources without US). §865 (sale of personal property sourcing). §989 (qualified business unit definition). Reg §1.861-8 through §1.861-14 (expense allocation regulations). Reg §1.904-4 (separate categories of income - high-tax kick-out). Reg §1.904-4(c)(4) (passive grouping rules). Reg §1.904-5 (look-through rules). Reg §1.904-6 (allocation of CFC foreign taxes). Reg §1.901-2 (foreign income tax definition). Form 1116 (Foreign Tax Credit - individuals). Form 1118 (Foreign Tax Credit - corporations). Form 8993 (§250 deduction). Form 5471 (Information Return of US Persons With Respect to Certain Foreign Corporations). Schedule J (Form 5471) - earnings and profits / NCTI. Tax Cuts and Jobs Act P.L. 115-97 (December 22, 2017) - added NCTI/GILTI and foreign branch baskets; effective 2018. One Big Beautiful Bill Act P.L. 119-21 (July 4, 2025) §70311(a) - expense allocation to NCTI; §70312 - 90% deemed paid; FDII/FDDEI rate reduction; QBAI elimination; §954(c)(6) permanency; §958(b)(4) reinstatement; new §951B; 50% inventory foreign sourcing.