Details of Public Law 119-21, section 70321 , One Big Beautiful Bill Act

The provision modifies the deduction from gross income allowed to a domestic corporation for foreign-derived deduction eligible income, which is calculated as an amount equal to the sum of a percentage of the foreign-derived deduction eligible income of a domestic corporation in a taxable year plus a percentage of the net controlled foreign corporation (CFC) tested income included in gross income of that domestic corporation under Internal Revenue Code (IRC) section 951A for the taxable year and the gross-up amount treated as a dividend received under IRC section 78 for that domestic corporation for the taxable year. The provision decreases both percentages: 37.5 percent to 33.34 percent for the foreign-derived deduction eligible income and 50 percent to 40 percent for the net CFC tested income included in gross income under IRC section 951A and the gross-up amount treated as a dividend received under IRC section 78 for the taxable year. The overall impact would decrease the deduction amount allowed for taxable years beginning on or after December 31, 2025.

California does not conform to the changes to IRC section 250.

Worldwide Unitary Method

California corporate taxpayers doing business both within and without California are required to compute their California franchise or income tax using the worldwide unitary method. Under this method, a corporate taxpayer's business income from both domestic and foreign unitary operations is considered in the calculation of the taxpayer's tax base, and a share of that business income is then “apportioned” to California using a formula. Income apportioned to California is subject to California franchise or income tax. The formula measures relative levels of business activity in the state by using the amount of the taxpayer’s sales in California divided by the taxpayer's sales everywhere. This measure of activities is commonly called the “single sales-factor formula.” The amount of sales from both domestic and foreign activities are included in the calculation of the apportionment formula. Generally, dividends paid from one member to another within the unitary group from unitary earnings are eliminated from tax computations under Revenue and Taxation Code (RTC) section 25106.

California Water's-Edge Election

As an alternative to the worldwide unitary method, California law allows corporations to elect to determine the business income of their combined reporting group on a “water's-edge” basis. In general, the water’s-edge method excludes foreign corporations from the calculation of business income. An exception to this general rule is a CFC with subpart F income. The income and factors of the CFC are included in a water's-edge combined report based on the CFC's inclusion ratio. This ratio is equal to the CFC’s current year subpart F income divided by the CFC’s current year earnings and profits. While California does not conform to the subpart F scheme of the IRC, for purposes of computing the CFC's inclusion ratio under water's-edge, California incorporates the federal definitions of "subpart F income" and "earnings and profits" as applicable for federal income tax purposes for the same taxable year.

Generally, rather than computing a dividends-received deduction using federal dividends received deduction (DRD) provisions, dividends paid to the water's-edge combined reporting group from foreign affiliates are income on the water's-edge combined report and California taxpayers electing water's-edge treatment are generally entitled to a 75 percent DRD on such dividends under RTC section 24411.

As a result, California does not conform to the changes made by this provision.