IRC 904: Foreign Tax Credit Limitation, Basket Rules, OBBBA Section 904(b)(5), and the NCTI Basket -- Practitioner Guide

The foreign tax credit is one of the central mechanisms in U.S. international tax: it prevents double taxation by allowing a U.S. taxpayer to offset U.S. tax liability with income taxes paid or accrued to foreign governments. IRC 904 is the gatekeeper. It limits how much of that credit can actually be used -- and it requires taxpayers to do the computation separately for each category of foreign income, called a basket.

For 2026 and later tax years, IRC 904 is materially different from what practitioners have worked with through 2025. The One Big Beautiful Budget Act (OBBBA) replaced the GILTI basket with the NCTI basket and added new Section 904(b)(5), which directly restricts how interest expense and R&E expense are allocated against the NCTI basket when computing the FTC limitation. No Treasury regulations have been issued under Section 904(b)(5) as of July 2026. This guide is written for international tax attorneys, CPAs, and enrolled agents who need to understand the IRC 904 mechanics, the full basket structure, the OBBBA amendments, and the open questions that will govern 2026 FTC planning -- while recognizing that the regulatory framework is still developing. All statutory citations, regulatory references, example amounts, and positions must be verified at IRS.gov and against current Treasury regulations before reliance in any client matter. This guide is for informational purposes only and does not constitute legal or tax advice.

Section 1: The IRC 904(a) Limitation Formula -- Structure and Purpose

The Policy Behind the Limitation

Without a limitation on the foreign tax credit, the credit would allow a taxpayer to use high foreign taxes to shelter U.S.-source income from U.S. tax. A U.S. corporation earning $1,000 of domestic income and $1,000 of foreign income taxed abroad at 40% could, in theory, use the $400 of foreign taxes to offset the U.S. tax on the entire $2,000 -- including the $1,000 of domestic income. Congress enacted IRC 904 to prevent this outcome. The limitation caps the FTC at the amount of U.S. tax that would have been imposed on the foreign-source income alone, measured at U.S. effective tax rates.

The limitation does not prevent the credit from being used. It prevents the credit from exceeding the U.S. tax cost attributable to foreign-source income. A taxpayer with a foreign effective rate below the U.S. rate typically has excess limitation (more room to use credits than credits available). A taxpayer with a foreign effective rate above the U.S. rate typically has excess credits (more credits than limitation, requiring carryover). The interplay between the rate comparison and the basket structure drives most of the planning complexity in IRC 904.

The Formula Under IRC 904(a)

Under the current text of IRC 904(a) (verify at IRS.gov for the applicable tax year), the foreign tax credit limitation for each basket is computed as follows:

FTC Limitation (per basket) = [Foreign-Source Taxable Income in the Basket / Worldwide Taxable Income] x U.S. Pre-Credit Tax

Each element of the formula carries definitional complexity. "Foreign-source taxable income" for the numerator is determined after allocating and apportioning deductions under IRC 861-865, which often means that significant expenses (interest, R&E, and G&A) reduce the foreign-source numerator below the taxpayer's gross foreign income. "Worldwide taxable income" in the denominator is U.S. taxable income computed without regard to the credit itself. "U.S. pre-credit tax" is the taxpayer's regular U.S. income tax before any FTC, computed at applicable rates. Verify all terms, definitions, and applicable modifications against the current statutory text of IRC 904(a) and IRS.gov.

The Limitation Is Per-Basket, Not Global

A critical operational point: the formula in IRC 904(a) is applied separately for each basket defined in IRC 904(d). A taxpayer does not compute a single FTC limitation for all foreign income and then apply it across all foreign taxes. The taxpayer computes one limitation for the passive basket, a separate limitation for the general basket, another for the foreign branch basket, another for the NCTI basket, and so on. Foreign taxes from one basket cannot satisfy a limitation shortfall in another. Excess taxes in one basket carry over only within that basket. This basket-by-basket structure is the foundational discipline of every FTC computation and the source of most planning friction in high-tax jurisdictions.

Section 2: The IRC 904(d) Basket System -- Current Income Categories

IRC 904(d) defines the income categories for which separate FTC limitations are computed. The number and definition of baskets has changed over time. For tax years beginning after December 31, 2025, the basket structure under current law is as described below. Verify all current basket categories, definitions, and any additional baskets or sub-categories against IRC 904(d) and IRS.gov for the applicable tax year before reliance.

Basket 1: Passive Category Income (IRC 904(d)(1)(A))

The passive category basket covers dividends, interest, rents, royalties, and other passive-type income as defined in IRC 904(d)(2)(A). The basket exists because passive income is typically subject to low or zero foreign tax, while active business income is often subject to full foreign corporate rates. Without a separate passive basket, taxpayers could blend the high credits from their active income against the low-limitation passive income -- using foreign taxes to offset U.S. tax on income that the foreign country never taxed.

The passive basket has an important exception: the high-tax exception (HTE) under IRC 904(d)(2)(B). Passive income that is subject to foreign tax above the HTE threshold is removed from the passive basket and treated as general basket income instead. The HTE is discussed in detail in Section 8. Verify all passive category definitions, inclusions, exclusions, and the HTE threshold against IRC 904(d) and current IRS.gov resources.

Basket 2: General Category Income (IRC 904(d)(1)(B))

General category income is the catch-all basket: all income from foreign sources that is not assigned to another basket falls here. For most U.S. multinationals, general basket income is the largest basket and includes active business income of CFCs that is neither Subpart F income nor NCTI income, manufacturing and services income earned through foreign branches, and other ordinary operating income from foreign sources. Because the general basket contains a broad mix of income types -- including income from high-tax jurisdictions -- it is frequently the basket where taxpayers have excess limitation rather than excess credits. Verify general category definitions against IRC 904(d)(1)(B) and IRS.gov.

Basket 3: Foreign Branch Category Income (IRC 904(d)(1)(B)(ii))

The foreign branch category basket was added by the Tax Cuts and Jobs Act (TCJA) of 2017. It covers income of a U.S. person that is attributable to one or more foreign branches of that person. A "foreign branch" for this purpose is a qualified business unit (QBU) operating in a foreign country with foreign tax imposed on its income. The separate basket was created in part because branch income is taxed differently from CFC income and can mix unpredictably with other general basket income if not segregated. Verify the current definition of "foreign branch," the scope of attributable income, and all branch-related elections and limitations against IRC 904(d)(1)(B)(ii), applicable Treasury regulations (verify current citations at IRS.gov), and IRS.gov.

Basket 4: Income Resourced by Treaty (IRC 904(d)(6))

A separate basket exists for income that, under U.S. domestic law, is treated as U.S.-source income, but that a tax treaty with the relevant foreign country treats as foreign-source income. Without this basket, the treaty-resourced income would be mixed into the general basket and would benefit (or harm) the general basket FTC computation in ways that do not reflect the treaty intent. The treaty basket isolates the resourcing so that the treaty benefit -- being able to credit foreign taxes on income the treaty treats as foreign-source -- is evaluated only against the U.S. tax on that same treaty-sourced income. Verify the treaty basket mechanics, applicable treaties, and the scope of IRC 904(d)(6) at IRS.gov and against current tax treaty texts before reliance.

Basket 5: The NCTI Basket (Post-2025, Replacing the GILTI Basket)

Effective for tax years beginning after December 31, 2025, the OBBBA replaced the GILTI basket with the NCTI basket for FTC limitation purposes. Under the prior law (IRC 951A and IRC 904(d) as in effect through 2025), a separate GILTI basket existed for global intangible low-taxed income inclusions. Under the OBBBA, the new Net Controlled Taxable Income (NCTI) regime under IRC 951B generates inclusions that flow into the NCTI basket, with basket rules that apply in a manner parallel to how the GILTI basket operated. The NCTI basket is directly affected by new Section 904(b)(5)'s restrictions on expense allocation (see Section 4 of this guide).

The deemed-paid FTC for the NCTI basket is computed under IRC 960 and is subject to a haircut that differs from the 20% haircut that applied under the prior GILTI regime. Verify the precise current haircut percentage and all NCTI basket FTC mechanics against the OBBBA statutory text and IRS.gov for the applicable tax year. Do not rely on the pre-OBBBA GILTI basket rules for post-2025 NCTI computations without verification.

Section 3: OBBBA Amendment -- New Section 904(b)(5) and Expense Allocation to the NCTI Basket

What Section 904(b)(5) Does

New Section 904(b)(5), added by the OBBBA, restricts the allocation of interest expense and research and experimentation (R&E) expense to the NCTI basket for purposes of computing the FTC limitation. Under the prior GILTI framework, interest expense allocated to the GILTI basket under the Treas. Reg. 1.861-10 expense allocation regime could reduce the GILTI basket FTC limitation, often reducing the effective amount of creditable taxes in that basket. Section 904(b)(5) modifies this allocation regime for the NCTI basket in the post-OBBBA era.

The specific mechanics of Section 904(b)(5) -- including the exact method by which interest expense and R&E expense are restricted from flowing to the NCTI basket, and how the restricted amounts are reallocated to other baskets -- must be verified against the OBBBA statutory text and any pending Treasury regulations at IRS.gov. No Treasury regulations under Section 904(b)(5) have been issued as of July 2026. This is one of the five open questions in Section 11 of this guide.

Why This Matters for 2026 FTC Positions

Under the prior GILTI basket expense allocation framework, interest expense and R&E expense allocated into the GILTI basket reduced the basket's income (the numerator of the FTC limitation formula) and therefore reduced the GILTI basket FTC limitation. A smaller limitation meant less room to credit the deemed-paid FTC on GILTI inclusions, resulting in more excess GILTI credits. For taxpayers with CFCs in high-tax jurisdictions, expense allocation into the GILTI basket was a source of persistent FTC utilization pressure.

Section 904(b)(5) changes this dynamic for the NCTI basket. The effect on a specific taxpayer's FTC utilization depends on the magnitude of interest and R&E expenses that would otherwise have been allocated to the NCTI basket, the taxpayer's NCTI inclusion amount, and the deemed-paid foreign taxes available in the NCTI basket. Taxpayers with substantial interest expense and significant NCTI inclusions are the most directly affected. The impact on effective FTC utilization can be material and must be modeled using the post-OBBBA rules, not the prior framework. Verify all modeling against the OBBBA text and IRS.gov.

General Expense Allocation Framework (Pre- and Post-OBBBA Context)

The general framework for allocating and apportioning deductions to baskets is provided by IRC 861-865 and implementing Treasury regulations. Deductions must be assigned to the class of income they relate to and then apportioned between U.S.-source and foreign-source income within each basket. The two largest expense categories subject to allocation are:

• Interest expense: Allocated under the "asset method" in Treas. Reg. 1.861-9T (now also reflecting modifications under IRC 864(e)). Under the asset method, interest expense is allocated to baskets in proportion to the average tax book value (or fair market value, if elected) of the taxpayer's assets generating income in each basket. Verify all interest expense allocation mechanics against the current regulations and IRC 864(e) at IRS.gov.
• Research and experimentation (R&E) expense: Allocated under Treas. Reg. 1.861-17, which provides exclusive apportionment rules for R&E that were modified by the TCJA and are further affected by the OBBBA. Verify all R&E expense allocation mechanics, including any exclusive apportionment percentages applicable for 2026, against the current regulations at IRS.gov.

Section 904(b)(5) modifies how these allocations work specifically for the NCTI basket, layering a new statutory restriction on top of the existing regulatory framework. The interaction between Section 904(b)(5) and the existing IRC 861-865 regime is a key area awaiting regulatory guidance. Verify all allocation mechanics applicable to the NCTI basket against the OBBBA text and any Treasury regulations issued at IRS.gov.

Section 4: The OBBBA Deemed-Paid Credit Haircut Change for the NCTI Basket

Prior Law: The 20% Haircut Under the GILTI Regime

Under the pre-OBBBA GILTI regime (IRC 951A, in effect through 2025 for calendar-year taxpayers), the deemed-paid foreign tax credit available to a U.S. corporate shareholder with respect to a GILTI inclusion was subject to an 80% inclusion rate for purposes of the credit computation. In practical effect, only 80% of the CFC's net deemed-paid taxes attributable to the GILTI inclusion were treated as creditable -- a 20% reduction relative to what would have been creditable on a straight inclusion of the same income in the general basket. This 20% haircut reduced the effective FTC available in the GILTI basket and was a persistent driver of residual U.S. tax on high-taxed GILTI income, even after the IRC 250 GILTI deduction.

New Law: The Reduced Haircut Under the NCTI Regime

The OBBBA reduced the deemed-paid credit haircut for the NCTI basket. Under the new NCTI regime, the haircut on creditable foreign taxes attributable to NCTI inclusions is reduced relative to the prior 20% GILTI haircut. The precise current haircut percentage must be verified against the OBBBA statutory text and IRS.gov for the applicable tax year; this guide does not state a specific percentage as authoritative, because the correct figure is a matter of statutory text and pending regulatory interpretation. Practitioners who relied on the 20% GILTI haircut for pre-2026 planning models should verify the post-OBBBA haircut percentage before projecting 2026 NCTI basket FTC utilization.

The reduction in the haircut improves effective FTC utilization for taxpayers with high-taxed CFCs generating NCTI inclusions, all else equal. Combined with the Section 904(b)(5) expense allocation restriction (which may reduce the limitation numerator and constrain usable credits), the net effect on a specific taxpayer's NCTI basket FTC position will depend on the relative magnitudes of the haircut benefit and the expense allocation restriction. Both must be modeled using the post-OBBBA framework. Verify all NCTI basket FTC mechanics, including the applicable haircut rate and any modified inclusion percentages, against the OBBBA statutory text and IRS.gov.

Section 5: FTC Carrybacks and Carryforwards Under IRC 904(c)

The Carryover Mechanism

When a taxpayer's foreign taxes in a given basket exceed the FTC limitation for that basket in a particular tax year -- a condition called an "excess credit" year -- the excess credits are not simply lost. IRC 904(c) allows those excess credits to be carried back to the immediately preceding tax year and, if not fully absorbed by the carryback, carried forward for up to ten years. The carryover permits FTC utilization to be smoothed over time, which is important for businesses with fluctuating income levels or businesses that reorganize and shift the proportion of income earned in different jurisdictions.

Verify the current carryback period (generally one year) and carryforward period (generally ten years) against IRC 904(c) and IRS.gov for the applicable tax year. Congress has modified the carryover periods in the past and may do so again. Any modification applies prospectively to excess credits generated in years after the effective date of the change; existing carryover balances retain the period applicable to the year they were generated.

Basket-by-Basket Tracking Is Mandatory

A carryover of excess FTCs from one basket cannot be used against the limitation in a different basket. A taxpayer with $100,000 of excess general basket FTCs and a $200,000 limitation in the passive basket cannot apply the general basket excess to the passive basket headroom. Each basket's carryover pool is entirely separate. Practitioners maintaining FTC carryover schedules must track carryover vintage years and amounts separately for each basket, and must apply the applicable carryover period to each basket independently.

For taxpayers transitioning from the pre-2026 GILTI basket to the post-2025 NCTI basket, FTC carryovers accumulated in the GILTI basket in pre-2026 years present an unresolved question: whether those carryovers flow into the NCTI basket and can be used against NCTI basket limitation is addressed in Section 11 as an open question. This is not a minor administrative point; for taxpayers with large GILTI basket carryover balances, the answer directly affects how much legacy excess credit can be used after 2025. Monitor IRS.gov for guidance.

Excess Limitation Carryovers

The counterpart to excess credit carryovers is excess limitation: when a taxpayer's FTC limitation in a basket exceeds the foreign taxes available to credit in that basket in a given year (an "excess limitation" year), there is no formal carryover of unused limitation. Unused limitation for one year cannot be banked and used in a future year. Only credits carry over; limitation does not. Taxpayers with excess limitation in one year must simply pay the full U.S. tax on their foreign income in that year and hope that future years generate sufficient credits to absorb their carryovers. This asymmetry -- carryovers exist for credits but not for limitation -- is a fundamental feature of IRC 904 planning and a reason why consistent income and credit generation are valuable for FTC utilization.

Verify current carryover periods against IRC 904(c) and IRS.gov for the applicable tax year. All information is subject to legislative change.

Section 6: The High-Tax Exception for Passive Category Income

Why the High-Tax Exception Exists

The passive basket was designed to capture low-taxed passive income that would be hard to credit without a separate basket. But passive income is not always low-taxed: a foreign country may impose its full corporate rate on interest income earned by a foreign subsidiary, producing passive income with a very high foreign effective tax rate. Without an exception, this highly taxed passive income would be stuck in the passive basket with a low limitation (because the limitation reflects the U.S. tax on the income, not the foreign rate on it), producing a persistent excess credit situation that could never be absorbed.

The high-tax exception (HTE) under IRC 904(d)(2)(B) addresses this by allowing passive income that is highly taxed abroad -- above the applicable threshold -- to be treated as general category income instead. In the general basket, the taxpayer's overall limitation is typically larger and more easily absorbs the high foreign taxes. The HTE is therefore an elective mechanism (verify election requirements and consistency rules at IRS.gov) that can improve FTC utilization for taxpayers with passive income in high-tax jurisdictions.

The HTE Threshold

The HTE threshold for passive income is based on a comparison to the highest U.S. corporate income tax rate. Passive income is subject to the HTE if the foreign tax rate exceeds a specified multiple of the highest U.S. rate. Verify the precise HTE threshold computation, including the applicable multiplier and the current U.S. corporate rate used in the threshold calculation, against IRC 904(d)(2)(B) and current IRS.gov resources for the applicable tax year. Do not assume the threshold is fixed; it is tied to the U.S. corporate rate, which is itself subject to legislative change.

HTE Election and Consistency Requirements

The high-tax exception for the passive basket is elective. Once elected, there are consistency requirements that affect whether and how the election applies to different items of passive income. Practitioners should verify the election mechanics, scope, consistency requirements, and any interaction with the high-tax exception available under the Subpart F rules (IRC 954(b)(4)) and the NCTI basket rules against current Treasury regulations (verify citation at IRS.gov) and IRS.gov before making or revoking the election. An improperly made election or an election made without full analysis of its effect across all passive income items can produce unexpected results.

Section 7: Form 1118 -- Computing the FTC Limitation for Corporations

Form 1118 and Schedule A

Domestic corporations claim the foreign tax credit and compute the IRC 904 limitation on Form 1118 (Foreign Tax Credit -- Corporations). Individual taxpayers, estates, and trusts use Form 1116 (Foreign Tax Credit). This section focuses on the corporate computation; the principles are substantially the same for individuals, but Form 1116 has different schedules and line references. Verify the current version of Form 1118 and its instructions at IRS.gov for the applicable tax year before completing any return.

Schedule A of Form 1118 is where the FTC limitation for each basket is computed. The schedule requires the taxpayer to report foreign-source taxable income and worldwide taxable income in the applicable basket column, and then apply the limitation formula to derive the maximum creditable amount for the year. Separate Schedule A columns or separate Schedule A attachments are required for each basket. The results from Schedule A then flow to the Part II credit computation on Form 1118, where the actual credit claimed is determined by comparing the computed limitation to the foreign taxes available for crediting in each basket.

OBBBA Impact on Form 1118 Instructions for 2026

The OBBBA changes to Section 904 -- including the replacement of the GILTI basket with the NCTI basket and the addition of Section 904(b)(5) -- will require updated Form 1118 instructions for the 2026 tax year. As of July 2026, updated Form 1118 instructions addressing Section 904(b)(5) and the NCTI basket may not yet be finalized by the IRS. This is identified as an open question in Section 11. Practitioners should monitor IRS.gov for updated Form 1118 instructions before filing returns for tax years beginning after December 31, 2025. In the interim, the OBBBA statutory text governs; the pending form instructions will provide the IRS's administrative implementation of the statute.

FTC Carryover Tracking on Form 1118

Schedule B of Form 1118 is used to track FTC carryovers, organized by basket and by year. Maintaining accurate Schedule B records is essential for managing FTC carryover expiration (credits that have reached the end of their ten-year carryforward period and can no longer be used) and for documenting the available pool of excess credits in each basket. Carryover amounts from the GILTI basket that were generated in pre-2026 years must be tracked separately until the question of their treatment in the post-2026 NCTI basket framework is resolved. Verify all Schedule B reporting and carryover tracking mechanics against the current Form 1118 instructions at IRS.gov.

Section 8: Interaction with Form 5471 and PTEP -- CFC Income Inclusions and the IRC 904 Baskets

How CFC Inclusions Flow into the Basket System

U.S. shareholders of CFCs include amounts in gross income under Subpart F (IRC 951) and under the NCTI regime (IRC 951B, for post-2025 years). These inclusions are characterized for IRC 904 basket purposes based on the nature of the underlying CFC income. Subpart F income (which includes foreign personal holding company income, foreign base company sales income, and foreign base company services income, among others) generally falls into the passive basket or the general basket depending on the type of underlying income. NCTI inclusions flow into the NCTI basket. The basket characterization of each CFC inclusion directly affects the FTC limitation applicable to the deemed-paid credit under IRC 960.

Domestic corporations with CFC interests use Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations) to report CFC income, E&P, and PTEP. Schedule I of Form 5471 reports the U.S. shareholder's share of Subpart F income and NCTI inclusions by income type, which informs basket assignment on Form 1118. Schedule P of Form 5471 tracks the PTEP account balances by PTEP group and by basket, which is essential for correctly characterizing deemed-paid credits and PTEP distributions in the IRC 904 framework. Verify all Form 5471 reporting requirements and Schedule I and P mechanics against the current Form 5471 instructions at IRS.gov.

The Deemed-Paid Credit Under IRC 960

When a U.S. corporate shareholder includes Subpart F income or NCTI under IRC 951 or 951B, it is entitled to a deemed-paid foreign tax credit under IRC 960 for the foreign income taxes paid by the CFC on the included income. The deemed-paid credit is then reported on Form 1118 in the basket corresponding to the inclusion. For NCTI inclusions, the deemed-paid credit is subject to the haircut discussed in Section 4, reduced from the prior 20% GILTI haircut as discussed above. Verify all IRC 960 deemed-paid credit mechanics, haircut percentages, and basket assignment rules against the current text of IRC 960 and IRS.gov.

PTEP Distributions and the IRC 904 Baskets

When a CFC distributes PTEP to its U.S. shareholder, the distribution is excluded from the U.S. shareholder's gross income under IRC 959. Because the PTEP distribution is excluded from income, it does not generate a new FTC inclusion -- and no additional FTC is available to the U.S. shareholder with respect to the distributed PTEP. The FTC associated with those earnings was already claimed at the time of the Subpart F or NCTI inclusion that created the PTEP. Practitioners should confirm that any PTEP distribution from a CFC is correctly identified and excluded under IRC 959 so that neither the income nor any spurious additional FTC is reported on Form 1118. Verify all PTEP distribution exclusion mechanics against IRC 959 and IRS.gov.

Section 9: Illustrative FTC Limitation Computation

Importance of Deduction Allocation in the Limitation Numerator

The illustrative example above uses $3,000,000 of foreign-source taxable income in the numerator. In a real computation, that number reflects gross foreign-source income of the basket reduced by the deductions allocated and apportioned to that basket under the IRC 861-865 framework. A company with $5,000,000 of gross general basket income but $2,000,000 of allocated expenses (interest, R&E, G&A) would have only $3,000,000 of foreign-source taxable income in the numerator -- and a correspondingly lower limitation. This is why deduction allocation is not a back-office detail but a primary driver of FTC planning. The Section 904(b)(5) restriction on expense allocation to the NCTI basket is a direct legislative intervention in this dynamic, designed to ensure that the NCTI basket limitation is computed on a basis that does not reflect the full allocation of interest and R&E that applied under the prior GILTI framework.

Section 10: FCFC Inclusions and IRC 904 Basket Assignment -- An Open Question

The FCFC Framework Under the OBBBA

The OBBBA created the Foreign-Controlled Foreign Corporation (FCFC) category under IRC 951B as part of the broader NCTI framework. An FCFC is a foreign corporation that is controlled by a Foreign-Controlled U.S. Shareholder (FCUS) rather than by a standard domestic U.S. shareholder. FCFCs generate NCTI inclusions for FCUSes under the OBBBA framework in a manner intended to parallel how standard CFCs generate NCTI inclusions for their U.S. shareholders. For background on the FCFC and FCUS framework, see the companion guide: IRC 951B FCUS: Foreign-Controlled U.S. Shareholder OBBBA Practitioner Guide.

The Unresolved Basket Question for FCFC Inclusions

Whether the IRC 904(d) basket rules for FCFC-sourced NCTI inclusions function identically to those applicable to standard CFC NCTI inclusions is an open and unresolved question as of July 2026. The OBBBA statutory text established the FCFC category and the NCTI inclusion rules for FCUSes, but no IRS guidance -- including proposed regulations, notices, or revenue procedures -- has specifically addressed basket assignment for FCFC inclusions.

The practical consequences of this open question are significant. If FCFC inclusions flow into the NCTI basket in the same manner as standard CFC NCTI inclusions, the IRC 904(b)(5) expense allocation restriction would apply to FCFC inclusions as well, and the deemed-paid credit haircut would be the same as for standard CFCs. If FCFC inclusions are treated differently -- or if they are not clearly assigned to any existing basket -- the FTC limitation computation for FCFC-generated income would be uncertain.

Section 11: Outstanding Guidance and Open Questions

The following issues are unresolved or insufficiently addressed by IRS guidance as of July 2026. Each represents an area of meaningful uncertainty for practitioners computing FTC limitations under IRC 904. The absence of guidance does not mean a position cannot be taken; it means any position carries elevated risk and requires additional documentation, professional judgment, and in most cases consultation with qualified international tax counsel.

1. Treasury Regulations Under New Section 904(b)(5) -- Unresolved as of July 2026

No Treasury regulations have been issued under new Section 904(b)(5) as of July 2026. The statute restricts allocation of interest expense and R&E expense to the NCTI basket, but the specific mechanism -- including how the restriction is computed, how restricted amounts are reallocated to other baskets, and how the restriction interacts with the existing Treas. Reg. 1.861-9T and 1.861-17 expense allocation frameworks -- is not yet governed by regulations. Practitioners must proceed on the basis of the statutory text alone, with heightened documentation. Monitor IRS.gov and the Treasury Department's Priority Guidance Plan for Section 904(b)(5) regulations.

2. Treatment of Pre-2026 GILTI Basket FTC Carryovers in the Post-OBBBA NCTI Basket -- Unresolved as of July 2026

Taxpayers with FTC carryovers accumulated in the GILTI basket in pre-2026 tax years face an unresolved question about whether those carryovers can be applied against the NCTI basket limitation in post-2025 years. The GILTI basket no longer exists as a current-year basket after December 31, 2025. Whether existing GILTI carryovers automatically migrate to the NCTI basket, remain frozen as a separate carryover category with no current-year basket to absorb them, or are treated in some other manner has not been addressed in any IRS guidance, proposed regulations, or notices as of the date of this guide. This is a high-stakes open question for taxpayers with large GILTI basket carryover balances. Monitor IRS.gov for guidance and model the range of outcomes.

3. Updated Form 1118 Instructions for Section 904(b)(5) -- Unresolved as of July 2026

As of July 2026, the IRS has not published updated Form 1118 instructions reflecting the OBBBA amendments to IRC 904, including the NCTI basket, the Section 904(b)(5) expense allocation restriction, and the modified deemed-paid credit haircut. The 2026 tax year Form 1118 and its instructions may not be finalized until late 2026 or early 2027. Practitioners should not assume that existing (pre-OBBBA) Form 1118 instructions are adequate for 2026 tax year filings. Monitor IRS.gov for the release of updated 2026 Form 1118 instructions and for any transition-year guidance addressing how to report NCTI basket computations before final instructions are issued.

4. Basket Assignment for FCFC Inclusions -- Unresolved as of July 2026

As described in Section 10, the basket assignment for NCTI inclusions generated by FCFCs for FCUSes under the OBBBA framework has not been addressed in any IRS guidance as of July 2026. Whether FCFC inclusions flow into the NCTI basket under the same rules applicable to standard CFC NCTI inclusions, or whether different rules apply, is unresolved. Practitioners with clients who have FCFC relationships must document this open question and take a disclosed return position for 2026 filings in the absence of guidance. Monitor IRS.gov for guidance.

5. Interaction of Section 904(b)(5) with a Future U.S. QDMTT Offset -- Unresolved as of July 2026

The Pillar Two Global Minimum Tax framework developed by the OECD includes a Qualified Domestic Minimum Top-up Tax (QDMTT) mechanism, under which countries can enact domestic top-up taxes that are treated as qualifying under the Pillar Two rules. As of July 2026, the United States has not enacted a QDMTT. The question of how Section 904(b)(5) and the NCTI basket expense allocation restriction would interact with a future U.S. QDMTT -- if one is enacted -- is a purely legislative open question at this stage. Practitioners who advise clients on Pillar Two compliance should monitor Congressional activity on a potential U.S. QDMTT and assess how new Section 904(b)(5) would fit into that regime if enacted. No position can be taken on this question until and unless legislation is enacted.

Section 12: Practitioner Checklist for IRC 904 FTC Limitation Analysis

The following checklist covers the key steps in a complete IRC 904 FTC limitation analysis for a domestic corporation filing for a tax year beginning after December 31, 2025. All items must be verified at IRS.gov and against applicable Treasury regulations before reliance in any client matter. This checklist is not exhaustive and does not substitute for engagement of qualified international tax counsel.

• Identify all baskets applicable for the tax year. Confirm the current basket categories under IRC 904(d) and IRS.gov for the tax year. For tax years beginning after December 31, 2025, the GILTI basket has been replaced by the NCTI basket. Verify that no additional baskets or sub-baskets have been added by legislation or regulation after the date of this guide.
• Assign all foreign-source income to the correct basket. Classify each item of foreign-source income (Subpart F inclusions, NCTI inclusions, branch income, passive income, treaty-resourced income, and general basket income) to the appropriate IRC 904(d) basket. Verify basket assignment for each type of income against IRC 904(d) and IRS.gov. For FCFC inclusions, document the open question on basket assignment and the position taken on the return.
• Apply the high-tax exception for passive income if applicable. Determine whether any passive basket income qualifies for the IRC 904(d)(2)(B) high-tax exception and should be reclassified to the general basket. Verify the HTE threshold (tied to the highest U.S. corporate rate) at IRS.gov. Confirm election requirements and consistency rules before making or relying on an HTE election.
• Allocate and apportion deductions to each basket under IRC 861-865. Apply the asset method for interest expense (Treas. Reg. 1.861-9T; verify current citation and modifications under IRC 864(e)) and the exclusive apportionment rules for R&E expense (Treas. Reg. 1.861-17; verify current citation). Reduce each basket's foreign-source taxable income by the allocated deductions to compute the limitation numerator. For the NCTI basket, apply new Section 904(b)(5) restrictions on interest and R&E allocation; verify the statutory text and monitor IRS.gov for regulations.
• Compute the IRC 904(a) FTC limitation for each basket. Apply the limitation formula (foreign-source taxable income in the basket / worldwide taxable income x U.S. pre-credit tax) separately for each basket. Verify the current corporate rate and any applicable modifications against IRS.gov. The limitation for each basket is the ceiling on creditable taxes in that basket for the year.
• Identify the deemed-paid credit under IRC 960 for each CFC inclusion basket. For each NCTI or Subpart F inclusion, compute the deemed-paid credit under IRC 960 using the post-OBBBA haircut applicable to the NCTI basket. Verify the precise current haircut percentage against the OBBBA text and IRS.gov. Report the deemed-paid credit in the correct basket column on Form 1118.
• Compare available credits to limitation in each basket; identify excess credits or excess limitation. For each basket, compare foreign taxes paid or accrued (plus any deemed-paid credits from CFC inclusions) to the computed limitation. Excess credits are carried back one year and forward ten years within the basket; verify current carryover periods at IRS.gov. Excess limitation expires.
• Apply carryovers from prior years in each basket. Add prior-year excess FTC carryovers (from the same basket) to the available credits. Apply carryovers to the current-year limitation in the carryover order prescribed by IRC 904(c). For pre-2026 GILTI basket carryovers, document the open question on transition treatment and the position taken. Verify carryover mechanics at IRS.gov.
• Report the FTC computation on Form 1118 (corporations) or Form 1116 (individuals). Complete Schedule A (limitation computation) and Schedule B (carryover tracking) for each basket. Verify current form instructions at IRS.gov, including any updated instructions reflecting the OBBBA amendments. For 2026, monitor IRS.gov for updated Form 1118 instructions addressing the NCTI basket and Section 904(b)(5), which may not be finalized as of the date of this guide.
• Document open questions and positions taken. For any position taken in an area of unresolved guidance (Section 904(b)(5) mechanics, GILTI basket carryover transition, FCFC basket assignment), document the open question, the range of positions, the position taken, and the basis for the position. Consider disclosure requirements under Treasury Circular 230 and the substantial authority and more-likely-than-not standards for uncertain tax positions under Treas. Reg. 1.6662-4 (verify current citation at IRS.gov).