Table of Contents
- Choosing To Take Credit or Deduction
- Why Choose the Credit?
- Who Can Take the Credit?
- What Foreign Taxes Qualify for the Credit?
- Foreign Taxes for Which You Cannot Take a Credit
- Taxes on Excluded Income
- Taxes for Which You Can Only Take an Itemized Deduction
- Taxes on Foreign Oil Related Income
- Taxes on Foreign Mineral Income
- Taxes From International Boycott Operations
- Taxes on Foreign Oil and Gas Extraction Income
- Taxes of U.S. Persons Controlling Foreign Corporations and Partnerships
- How To Figure the Credit
- Carryback and Carryover
- How To Claim the Credit
- Simple Example — Filled-In Form 1116
- Comprehensive Example — Filled-In Form 1116
- Foreign earned income.
- Employee business expenses.
- Forms 1116
- Computation of Taxable Income
- Part I—Taxable Income or Loss From Sources Outside the United States (for Category Checked Above)
- Part II—Foreign Taxes Paid or Accrued
- Part III—Figuring the Credit
- Part IV—Summary of Credits From Separate Parts III
- Unused Foreign Taxes
- How To Get Tax Help
You can choose each tax year to take the amount of any qualified foreign taxes paid or accrued during the year as a foreign tax credit or as an itemized deduction. You can change your choice for each year's taxes.
To choose the foreign tax credit, you generally must complete Form 1116 and attach it to your U.S. tax return. However, you may qualify for the exception that allows you to claim the foreign tax credit without using Form 1116. See How To Figure the Credit, later. To choose to claim the taxes as an itemized deduction, use Schedule A (Form 1040), Itemized Deductions.
Figure your tax both ways—claiming the credit and claiming the deduction. Then fill out your return the way that benefits you most. See Why Choose the Credit, later.As a general rule, you must choose to take either a credit or a deduction for all qualified foreign taxes.
If you choose to take a credit for qualified foreign taxes, you must take the credit for all of them. You cannot deduct any of them. Conversely, if you choose to deduct qualified foreign taxes, you must deduct all of them. You cannot take a credit for any of them.
See What Foreign Taxes Qualify for the Credit, later, for the meaning of qualified foreign taxes.
There are exceptions to this general rule, which are described next.
-
You paid the tax to a country for which a credit is not allowed because it provides support for acts of international terrorism, or because the United States does not have diplomatic relations with it or recognize its government,
-
You paid withholding tax on dividends from foreign corporations whose stock you did not hold for the required period of time,
-
You paid withholding tax on income or gain (other than dividends) from property you did not hold for the required period of time,
-
You paid withholding tax on income or gain to the extent you had to make related payments on positions in similar or related property,
-
You participated in or cooperated with an international boycott, or
-
You paid taxes in connection with the purchase or sale of oil or gas.
You can make or change your choice to claim a deduction or credit at any time during the period within 10 years from the regular due date for filing the return for the tax year for which you make the claim. You make or change your choice on your tax return (or on an amended return) for the year your choice is to be effective.
Example.
You paid foreign taxes for the last 13 years and chose to deduct them on your U.S. income tax returns. You were timely in both filing your returns and paying your U.S. tax liability. In February 2008, you file an amended return for tax year 1997 choosing to take a credit for your 1997 foreign taxes because you now realize that the credit is more advantageous than the deduction for that year. Because the regular due date of your 1997 return was April 15, 1998, this choice is timely (within 10 years).
Because there is a limit on the credit for your 1997 foreign tax, you have unused 1997 foreign taxes. Ordinarily, you first carry back unused foreign taxes arising in 1997 to, and claim them as a credit in, the 2 preceding tax years. If you are unable to claim all of them in those 2 years, you carry them forward to the 5 years following the year in which they arose.
Because you originally chose to deduct your foreign taxes and the 10-year period for changing the choice for 1995 and 1996 has passed, you cannot carry the unused 1997 foreign taxes back to tax years 1995 and 1996.
Because the 10-year periods have not passed for your 1998 through 2002 income tax returns, you can still choose to carry forward any unused 1997 foreign taxes. However, you must reduce the unused 1997 foreign taxes that you carry forward by the amount that would have been allowed as a carryback if you had timely carried back the foreign tax to tax years 1995 and 1996.
The foreign tax credit is intended to relieve you of the double tax burden when your foreign source income is taxed by both the United States and the foreign country. Generally, if the foreign tax rate is higher than the U.S. rate, there will be no U.S. tax on the foreign income. If the foreign tax rate is lower than the U.S. rate, U.S. tax on the foreign income will be limited to the difference between the rates. The foreign tax credit can only reduce U.S. taxes on foreign source income; it cannot reduce U.S. taxes on U.S. source income.
Although no one rule covers all situations, it is generally better to take a credit for qualified foreign taxes than to deduct them as an itemized deduction. This is because:
-
A credit reduces your actual U.S. income tax on a dollar-for-dollar basis, while a deduction reduces only your income subject to tax,
-
You can choose to take the foreign tax credit even if you do not itemize your deductions. You then are allowed the standard deduction in addition to the credit, and
-
If you choose to take the foreign tax credit, and the taxes paid or accrued exceed the credit limit for the tax year, you may be able to carry over or carry back the excess to another tax year. (See Limit on the Credit under How To Figure the Credit, later.)
Example 1.
For 2008, you and your spouse have adjusted gross income of $80,000, including $20,000 of dividend income from foreign sources. None of the dividends are qualified dividends. You file a joint return and can claim two $3,500 exemptions. You had to pay $2,000 in foreign income taxes on the dividend income. If you take the foreign taxes as an itemized deduction, your total itemized deductions are $15,000. Your taxable income then is $58,000 and your tax is $7,901.
If you take the credit instead, your itemized deductions are only $13,000. Your taxable income then is $60,000 and your tax before the credit is $8,201. After the credit, however, your tax is only $6,201. Therefore, your tax is $1,700 lower ($7,901 − $6,201) by taking the credit.
Example 2.
In 2008, you receive investment income of $5,000 from a foreign country, which imposes a tax of $3,500 on that income. You report on your U.S. return this income as well as $56,000 of income from U.S. sources. You are single, entitled to one $3,500 exemption, and have other itemized deductions of $7,100. If you deduct the foreign tax on your U.S. return, your taxable income is $46,900 ($5,000 + $56,000 − $3,500 − $7,100 − $3,500) and your tax is $8,075.
If you take the credit instead, your taxable income is $50,500 ($5,000 + $56,000 − $3,500 − $7,100) and your tax before the credit is $8,950. You can take a credit of only $734 because of limits discussed later. Your tax after the credit is $8,216 ($8,950 − $734), which is $141 ($8,216 − $8,075) more than if you deduct the foreign tax.
If you choose the credit, you will have unused foreign taxes of $2,766 ($3,500 − $734). When deciding whether to take the credit or the deduction this year, you will need to consider whether you can benefit from a carryback or carryover of that unused foreign tax.
You can claim the credit for a qualified foreign tax in the tax year in which you pay it or accrue it, depending on your method of accounting. “Tax year” refers to the tax year for which your U.S. return is filed, not the tax year for which your foreign return is filed.
Example.
Last year you took the credit based on taxes paid. This year you chose to take the credit based on taxes accrued. During the year you paid foreign income taxes owed for last year. You also accrued foreign income taxes for this year that you did not pay by the end of the year. You can base the credit on your return for this year on both last year's taxes that you paid and this year's taxes that you accrued.
U.S. income tax is imposed on income expressed in U.S. dollars, while the foreign tax is imposed on income expressed in foreign currency. Therefore, fluctuations in the value of the foreign currency relative to the U.S. dollar will affect the foreign tax credit.
-
You conduct the business primarily in dollars.
-
The principal place of business is located in the United States.
-
You choose to or are required to use the dollar as your functional currency.
-
The business books and records are not kept in the currency of the economic environment in which a significant part of the business activities is conducted.
Internal Revenue Service
International Section
P.O. Box 920
Bensalem, PA 19020-8518.
-
The foreign taxes are paid on or after the first day of the tax year to which they relate.
-
The foreign taxes are paid not later than 2 years after the close of the tax year to which they relate.
-
The foreign tax liability is not denominated in an inflationary currency. (This condition applies to taxes paid or accrued in tax years beginning after November 6, 2007.)
A foreign tax redetermination is any change in your foreign tax liability that may affect your U.S. foreign tax credit claimed.
The time of the credit remains the year to which the foreign taxes paid or accrued relate, even if the change in foreign tax liability occurs in a later year.
If a foreign tax redetermination occurs, a redetermination of your U.S. tax liability is required if any of the following conditions apply.
-
The accrued taxes when paid differ from the amounts claimed as a credit.
-
The accrued taxes you claimed as a credit in one tax year are not paid within 2 years after the end of that tax year.
If this applies to you, you must reduce the credit previously claimed by the amount of the unpaid taxes. You will not be allowed a credit for the unpaid taxes until you pay them. When you pay the accrued taxes, you must translate them into U.S. dollars using the exchange rate as of the date they were paid. The foreign tax credit is allowed for the year to which the foreign tax relates. See Rate of exchange for foreign taxes paid, earlier, under Foreign Currency and Exchange Rates.
-
The foreign taxes you paid are refunded in whole or in part.
-
For taxes taken into account when accrued but translated into dollars on the date of payment, the dollar value of the accrued tax differs from the dollar value of the tax paid because of fluctuations in the exchange rate between the date of accrual and the date of payment.
However, no redetermination is required if the change in foreign tax liability for each foreign country is less than the smaller of:
-
$10,000, or
-
2% of the total dollar amount of the foreign tax initially accrued for that foreign country for the U.S. tax year.
In this case, you must adjust your U.S. tax in the tax year in which the accrued foreign taxes are paid.
-
The notification requirements discussed here apply to foreign tax redeterminations occurring in:
-
2008 and later tax years.
-
2005, 2006, and 2007 if:
-
The redetermination reduced the amount of foreign taxes you paid or accrued for any tax year, and
-
As of November 7, 2007, you had not notified the IRS of the redetermination.
-
If you are required to notify the IRS about a redetermination of your U.S. tax liability for each tax year affected by the redetermination, you generally must file Form 1040X, Amended U.S. Individual Income Tax Return, with a revised Form 1116 and a statement that contains information sufficient for the IRS to redetermine your U.S. tax liability for the year or years affected. See Contents of statement later.
You are not required to attach Form 1116 for a tax year affected by a redetermination if:
-
The amount of your creditable taxes paid or accrued during the tax year is not more than $300 ($600 if married filing a joint return) as a result of the foreign tax redetermination, and
-
You meet the requirements listed under Exemption from foreign tax credit limit under How To Figure the Credit, later.
There are other exceptions to this requirement. They are discussed later under Due date of notification to IRS.
-
Your name, address, and taxpayer identification number.
-
The tax year or years that are affected by the foreign tax redetermination.
-
The date or dates the foreign taxes were accrued, if applicable.
-
The date or dates the foreign taxes were paid.
-
The amount of foreign taxes paid or accrued on each date (in foreign currency) and the exchange rate used to translate each amount.
-
Information sufficient to determine any interest due from or owing to you, including the amount of any interest paid to you by the foreign government and the dates received.
You have 10 years to file a claim for refund of U.S. tax if you find that you paid or accrued a larger foreign tax than you claimed a credit for. The 10-year period begins the day after the regular due date for filing the return for the year in which the taxes were actually paid or accrued.
You have 10 years to file your claim regardless of whether you claim the credit for taxes paid or taxes accrued. The 10-year period applies to claims for refund or credit based on:
-
Fixing math errors in figuring qualified foreign taxes,
-
Reporting qualified foreign taxes not originally reported on the return, or
-
Any other change in the size of the credit (including one caused by correcting the foreign tax credit limit).
The special 10-year period also applies to making or changing your choice of whether to claim a deduction or credit for foreign taxes. See Making or Changing Your Choice discussed earlier under Choosing To Take Credit or Deduction.
U.S. citizens, resident aliens, and nonresident aliens who paid foreign income tax and are subject to U.S. tax on foreign source income may be able to take a foreign tax credit.
If you are a U.S. citizen, you are taxed by the United States on your worldwide income wherever you live. You are normally entitled to take a credit for foreign taxes you pay or accrue.
If you are a resident alien of the United States, you can take a credit for foreign taxes subject to the same general rules as U.S. citizens. If you are a bona fide resident of Puerto Rico for the entire tax year, you also come under the same rules.
Usually, you can take a credit only for those foreign taxes imposed on income you actually or constructively received while you had resident alien status.
For information on alien status, see Publication 519.
If you are a nonresident alien, you generally cannot take the credit. However, you may be able to take the credit if:
-
You were a bona fide resident of Puerto Rico during your entire tax year, or
-
You pay or accrue tax to a foreign country or U.S. possession on income from foreign sources that is effectively connected with a trade or business in the United States. But if you must pay tax to a foreign country or U.S. possession on income from U.S. sources only because you are a citizen or a resident of that country or U.S. possession, do not use that tax in figuring the amount of your credit.
For information on alien status and effectively connected income, see Publication 519.
Generally, the following four tests must be met for any foreign tax to qualify for the credit.
-
The tax must be imposed on you.
-
You must have paid or accrued the tax.
-
The tax must be the legal and actual foreign tax liability.
-
The tax must be an income tax (or a tax in lieu of an income tax).
Certain foreign taxes do not qualify for the credit even if the four tests are met. See Foreign Taxes for Which You Cannot Take a Credit, later.
You can claim a credit only for foreign taxes that are imposed on you by a foreign country or U.S. possession. For example, a tax that is deducted from your wages is considered to be imposed on you. You cannot shift the right to claim the credit by contract or other means.
Generally, you can claim the credit only if you paid or accrued the foreign tax to a foreign country or U.S. possession. However, the paragraphs that follow describe some instances in which you can claim the credit even if you did not directly pay or accrue the tax yourself.
The amount of foreign tax that qualifies is not necessarily the amount of tax withheld by the foreign country. Only the legal and actual foreign tax liability that you paid or accrued during the year qualifies for the credit.
Example.
You are a shareholder of a French corporation. You receive a $100 refund of the tax paid to France by the corporation on the earnings distributed to you as a dividend. The French government imposes a 15% withholding tax ($15) on the refund you received. You receive a check for $85. You include $100 in your income. The $15 of tax withheld is a qualified foreign tax.
Generally, only income, war profits, and excess profits taxes (income taxes) qualify for the foreign tax credit. Foreign taxes on wages, dividends, interest, and royalties generally qualify for the credit. Furthermore, foreign taxes on income can qualify even though they are not imposed under an income tax law if the tax is in lieu of an income, war profits, or excess profits tax. See Taxes in Lieu of Income Taxes, later.
Simply because the levy is called an income tax by the foreign taxing authority does not make it an income tax for this purpose. A foreign levy is an income tax only if it meets both of the following tests.
-
It is a tax; that is, you have to pay it and you get no specific economic benefit (discussed below) from paying it.
-
The predominant character of the tax is that of an income tax in the U.S. sense.
A foreign levy may meet these requirements even if the foreign tax law differs from U.S. tax law. The foreign law may include in income items that U.S. law does not include, or it may allow certain exclusions or deductions that U.S. law does not allow.
-
If there is a generally imposed income tax, the economic benefit is not available on substantially the same terms to all persons subject to the income tax, or
-
If there is no generally imposed income tax, the economic benefit is not available on substantially the same terms to the population of the foreign country in general.
-
Goods.
-
Services.
-
Fees or other payments.
-
Rights to use, acquire, or extract resources, patents, or other property the foreign country owns or controls.
-
Discharges of contractual obligations.
Internal Revenue Service
International Section
P.O. Box 920
Bensalem, PA 19020-8518.
A tax paid or accrued to a foreign country qualifies for the credit if it is imposed in lieu of an income tax otherwise generally imposed. A foreign levy is a tax in lieu of an income tax only if:
-
It is not payment for a specific economic benefit as discussed earlier, and
-
The tax is imposed in place of, and not in addition to, an income tax otherwise generally imposed.
A tax in lieu of an income tax does not have to be based on realized net income. A foreign tax imposed on gross income, gross receipts or sales, or the number of units produced or exported can qualify for the credit.
A soak-up tax (discussed earlier) generally does not qualify as a tax in lieu of an income tax. However, if the foreign country imposes a soak-up tax in lieu of an income tax, the amount that does not qualify for foreign tax credit is the lesser of the following amounts.
-
The soak-up tax.
-
The foreign tax you paid that is more than the amount you would have paid if you had been subject to the generally imposed income tax.
This part discusses the foreign taxes for which you cannot take a credit. These are:
-
Taxes on excluded income,
-
Taxes for which you can only take an itemized deduction,
-
Taxes on foreign oil related income,
-
Taxes on foreign mineral income,
-
Taxes from international boycott operations,
-
Taxes on foreign oil and gas extraction income, and
-
Taxes of U.S. persons controlling foreign corporations and partnerships.
You cannot take a credit for foreign taxes paid or accrued on income excluded from U.S. gross income.
You must reduce your foreign taxes available for the credit by the amount of those taxes paid or accrued on income that is excluded from U.S. income under the foreign earned income exclusion or the foreign housing exclusion. See Publication 54 for more information on the foreign earned income and housing exclusions.
Example.
You are a U.S. citizen and a cash basis taxpayer, employed by Company X and living in Country A. Your records show the following:
| Foreign earned income received | $120,000 |
| Unreimbursed business travel expenses | 20,000 |
| Income tax paid to Country A | 30,000 |
| Exclusion of foreign earned income and housing allowance |
87,600 |
Because you can exclude part of your wages, you cannot claim a credit for part of the foreign taxes. To find that part, do the following.
First, find the amount of business expenses allocable to excluded wages and therefore not deductible. To do this, multiply the otherwise deductible expenses by a fraction. That fraction is the excluded wages over your foreign earned income.
| $20,000 | × | $87,600 $120,000 |
= | $14,600 | |
Next, find the numerator of the fraction by which you will multiply the foreign taxes paid. To do this, subtract business expenses allocable to excluded wages ($14,600) from excluded wages ($87,600). The result is $73,000.
Then, find the denominator of the fraction by subtracting all your deductible expenses from all your foreign earned income ($120,000 − $20,000 = $100,000).
Finally, multiply the foreign tax you paid by the resulting fraction.
| $30,000 | × | $73,000 $100,000 |
= | $21,900 |
The amount of Country A tax you cannot take a credit for is $21,900.
If you have income from Puerto Rican sources that is not taxable, you must reduce your foreign taxes paid or accrued by the taxes allocable to the exempt income. For information on figuring the reduction, see Publication 570.
You cannot claim a foreign tax credit for foreign income taxes paid or accrued under the following circumstances. However, you can claim an itemized deduction for these taxes. See Choosing To Take Credit or Deduction, earlier.
You cannot claim a foreign tax credit for income taxes paid or accrued to any country if the income giving rise to the tax is for a period (the sanction period) during which:
-
The Secretary of State has designated the country as one that repeatedly provides support for acts of international terrorism,
-
The United States has severed or does not conduct diplomatic relations with the country, or
-
The United States does not recognize the country's government, unless that government is eligible to purchase defense articles or services under the Arms Export Control Act.
The following countries meet this description for 2008. Income taxes paid or accrued to these countries in 2008 do not qualify for the credit.
-
Cuba.
-
Iran.
-
Libya (but see Note later).
-
North Korea.
-
Sudan.
-
Syria.
Income that is paid through one or more entities is treated as coming from a foreign country listed above if the original source of the income is from one of the listed countries.
Example.
You lived and worked in Syria until August, when you were transferred to Italy. You paid taxes to each country on the income earned in that country. You cannot claim a foreign tax credit for the foreign taxes paid on the income earned in Syria. Because the income earned in Syria is a separate category of foreign income, you must fill out a separate Form 1116 for that income. You cannot take a credit for taxes paid on the income earned in Syria, but that income is taxable in the United States.
Example.
The sanctions against Country X ended on July 31. On August 19, you receive a distribution from a mutual fund of Country X income. The fund paid Country X income tax for you on the distribution. Because the distribution was made after the sanction ended, you may include the foreign tax paid on the distribution to compute your foreign tax credit.
| Number of nonsanctioned days in year Number of days in year |
Example.
You are a calendar year filer and received $20,000 of income from Country X in 2008 on which you paid tax of $4,500. Sanctions against Country X ended on July 11, 2008. You are unable to determine how much of the income or tax is for the nonsanctioned period. Because your tax year starts on January 1, and the Country X sanction ended on July 11, 2008, 173 days of your tax year are in the nonsanctioned period. You would compute the income for the nonsanctioned period as follows:
| 173 366 |
× | $20,000 | = | $9,454 | |
You would figure the tax for the nonsanctioned period as follows:
| 173 366 |
× | $4,500 | = | $2,127 | |
To figure your foreign tax credit, you would use $9,454 as the income from Country X and $2,127 as the tax.
You cannot claim a foreign tax credit for withholding tax (defined later) on dividends paid or accrued if either of the following applies to the dividends.
-
The dividends are on stock you held for less than 16 days during the 31-day period that begins 15 days before the ex-dividend date (defined later).
-
The dividends are for a period or periods totaling more than 366 days on preferred stock you held for less than 46 days during the 91-day period that begins 45 days before the ex-dividend date. If the dividend is not for more than 366 days, rule (1) applies to the preferred stock.
When figuring how long you held the stock, count the day you sold it, but do not count the day you acquired it or any days on which you were protected from risk or loss.
Regardless of how long you held the stock, you cannot claim the credit to the extent you have an obligation under a short sale or otherwise to make payments related to the dividend for positions in substantially similar or related property.
Example 1.
You bought common stock from a foreign corporation on November 3. You sold the stock on November 19. You received a dividend on this stock because you owned it on the ex-dividend date of November 5. To claim the credit, you must have held the stock for at least 16 days within the 31-day period that began on October 21 (15 days before the ex-dividend date). Because you held the stock for 16 days, from November 4 until November 19, you are entitled to the credit.
Example 2.
The facts are the same as in Example 1 except that you sold the stock on November 14. You held the stock for only 11 days. You are not entitled to the credit.
For income or gain (other than dividends) paid or accrued on property, you cannot claim a foreign tax credit for withholding tax (defined later):
-
If you have not held the property for at least 16 days during the 31-day period that begins 15 days before the date on which the right to receive the payment arises, or
-
To the extent you have to make related payments on positions in substantially similar or related property.
When figuring how long you held the property, count the day you sold it, but do not count the day you acquired it or any days on which you were protected from risk or loss.
You cannot claim a foreign tax credit for taxes paid or accrued to a foreign country in connection with the purchase or sale of oil or gas extracted in that country if you do not have an economic interest in the oil or gas, and the purchase price or sales price is different from the fair market value of the oil or gas at the time of purchase or sale.
You must reduce foreign taxes paid or accrued on foreign oil related income to the extent that the tax imposed by the foreign country on such income is considered to be materially greater than the tax imposed by that country on income other than foreign oil related income or foreign oil and gas extraction income (discussed later). See Regulations section 1.907(b)-1. The amount of tax not allowed as a credit under this rule is allowed as a business expense deduction.
You must reduce any taxes paid or accrued to a foreign country or possession on mineral income from that country or possession if you were allowed a deduction for percentage depletion for any part of the mineral income.
If you participate in or cooperate with an international boycott during the tax year, your foreign taxes resulting from boycott activities will reduce the total taxes available for credit. See the instructions for line 12 in the Form 1116 instructions to figure this reduction.
This rule generally does not apply to employees with wages who are working and living in boycotting countries, or to retirees with pensions who are living in these countries.
-
Kuwait.
-
Lebanon.
-
Libya.
-
Qatar.
-
Saudi Arabia.
-
Syria.
-
United Arab Emirates.
-
Republic of Yemen.
Internal Revenue Service
International Section
P.O. Box 920
Bensalem, PA 19020-8518
-
A foreign corporation in which you own 10% or more of the voting power of all voting stock but only if you own the stock of the foreign corporation directly or through foreign entities.
-
A partnership in which you are a partner.
-
A trust you are treated as owning.
You must reduce your foreign taxes by a portion of any foreign taxes imposed on foreign oil and gas extraction income. The amount of the reduction is the amount by which your foreign oil and gas extraction taxes exceed the amount of your foreign oil and gas extraction income multiplied by a fraction equal to your pre-credit U.S. tax liability (Form 1040, line 44) divided by your worldwide income. You may be entitled to carry over to other years taxes reduced under this rule. See Internal Revenue Code section 907(f).
If you had control of a foreign corporation or a foreign partnership for the annual accounting period of that corporation or partnership that ended with or within your tax year, you may have to file an annual information return. If you do not file the required information return, you may have to reduce the foreign taxes that may be used for the foreign tax credit. See Penalty for not filing Form 5471 or Form 8865, later.
-
Stock possessing more than 50% of the total combined voting power of all classes of stock entitled to vote, or
-
More than 50% of the total value of shares of all classes of stock of the foreign corporation.
As already indicated, you can claim a foreign tax credit only for foreign taxes on income, war profits, or excess profits, or taxes in lieu of those taxes. In addition, there is a limit on the amount of the credit that you can claim. You figure this limit and your credit on Form 1116. Your credit is the amount of foreign tax you paid or accrued or, if smaller, the limit.
If you have foreign taxes available for credit but you cannot use them because of the limit, you may be able to carry them back 1 tax year and forward to the next 10 tax years. See Carryback and Carryover, later.
Also, certain tax treaties have special rules that you must consider when figuring your foreign tax credit. See Tax Treaties, later.
-
Your only foreign source gross income for the tax year is passive category income. Passive category income is defined later under Separate Limit Income. However, for purposes of this rule, high taxed income and export financing interest are also passive category income.
-
Your qualified foreign taxes for the tax year are not more than $300 ($600 if married filing a joint return).
-
All of your gross foreign income and the foreign taxes are reported to you on a payee statement (such as a Form 1099-DIV or 1099-INT).
-
You elect this procedure for the tax year.
Your foreign tax credit cannot be more than your total U.S. tax liability (line 44 on Form 1040) multiplied by a fraction. The numerator of the fraction is your taxable income from sources outside the United States. The denominator is your total taxable income from U.S. and foreign sources.
To determine the limit, you must separate your foreign source income into categories, as discussed under Separate Limit Income next. The limit treats all foreign income and expenses in each separate category as a single unit and limits the credit to the U.S. income tax on the taxable income in that category from all sources outside the United States.
You must figure the limit on a separate Form 1116 for each of the following categories of income.
-
Passive category income.
-
General category income.
-
Section 901(j) income.
-
Certain income re-sourced by treaty.
-
Any lump sum distribution from an employer benefit plan for which the special averaging treatment is used to determine your tax.
In figuring your separate limits, you must combine the income (and losses) in each category from all foreign sources, and then apply the limit.
Passive category income consists of passive income and specified passive category income.
-
Dividends.
-
Interest.
-
Rents.
-
Royalties.
-
Annuities.
-
Net gain from the sale of non-income-producing investment property or property that generates passive income.
-
Net gain from commodities transactions, except for hedging and active business gains or losses of producers, processors, merchants, or handlers of commodities.
-
Amounts you must include as foreign personal holding company income under section 551(a) or 951(a) of the Internal Revenue Code.
-
Amounts includible in income under section 1293 of the Internal Revenue Code (relating to certain passive foreign investment companies).
If you receive foreign source distributions from a mutual fund or other regulated investment company that elects to pass through to you the foreign tax credit, the income is generally considered passive. The mutual fund will provide you with a Form 1099-DIV or substitute statement showing the amount of foreign taxes it elected to pass through to you.
-
Gains or losses from the sale of inventory property or property held mainly for sale to customers in the ordinary course of your trade or business.
-
Export financing interest.
-
High-taxed income.
-
Active business rents and royalties.
-
Any income that is defined in another separate limit category.
-
The property is manufactured, produced, grown, or extracted in the United States by you or a related person, and
-
50% or less of the fair market value of the property is due to imports into the United States.
-
Dividends from a DISC (domestic international sales corporation) or former DISC to the extent the dividends are treated as foreign source income, and
-
Distributions from a former FSC (foreign sales corporation) out of earnings and profits that are attributable to:
-
Foreign trade income, or
-
Interest and carrying charges derived from a transaction that results in foreign trade income.
-
General category income includes income from sources outside the United States that is not passive category income or does not fall into one of the other separate limit categories discussed later. It generally includes active business income and wages, salaries, and overseas allowances of an individual as an employee. General category income includes high-taxed income that would otherwise be passive income. See High-taxed income earlier under What is not passive income.
This is income earned from activities conducted in sanctioned countries. Income derived from each sanctioned country is subject to a separate foreign tax credit limitation. Therefore, you must use a separate Form 1116 for income earned from each such country. See Taxes Imposed By Sanctioned Countries (Section 901(j) Income) under Taxes for Which You Can Only Take an Itemized Deduction, earlier.
If a sourcing rule in an applicable income tax treaty treats any of the income listed below as foreign source, and you elect to apply the treaty, the income will be treated as foreign source.
-
Certain gains (section 865(h)).
-
Certain income from a U.S.-owned foreign corporation (section 904(h)(10)). See Regulations section 1.904-5(m)(7) for an example.
You must compute a separate foreign tax credit limitation for any such income for which you claim benefits under a treaty, using a separate Form 1116 for each amount of re-sourced income from a treaty country.
If you receive a foreign source lump-sum distribution (LSD) from a retirement plan, and you figure the tax on it using the special averaging treatment for LSDs, you must make a special computation. Follow the Form 1116 instructions and complete the worksheet in those instructions to determine your foreign tax credit on the LSD.
The special averaging treatment for LSDs is elected by filing Form 4972, Tax on Lump-Sum Distributions.If you paid or accrued foreign income tax for a tax year on income in more than one separate limit income category, allocate the tax to the income category to which the tax specifically relates. If the tax is not specifically related to any one category, you must allocate the tax to each category of income.
You do this by multiplying the foreign income tax related to more than one category by a fraction. The numerator of the fraction is the net income in a separate category. The denominator is the total net foreign income.
You figure net income by deducting from the gross income in each category and from the total foreign income any expenses, losses, and other deductions definitely related to them under the laws of the foreign country or U.S. possession. If the expenses, losses, and other deductions are not definitely related to a category of income under foreign law, they are apportioned under the principles of the foreign law. If the foreign law does not provide for apportionment, use the principles covered in the U.S. Internal Revenue Code.
Example.
You paid foreign income taxes of $3,200 to Country A on wages of $80,000 and interest income of $3,000. These were the only items of income on your foreign return. You also have deductions of $4,400 that, under foreign law, are not definitely related to either the wages or interest income. Your total net income is $78,600 ($83,000–$4,400).
Because the foreign tax is not specifically for either item of income, you must allocate the tax between the wages and the interest under the tax laws of Country A. For purposes of this example, assume that the laws of Country A do this in a manner similar to the U.S. Internal Revenue Code. First figure the net income in each category by allocating those expenses that are not definitely related to either category of income.
You figure the expenses allocable to wages (general category income) as follows.
| $80,000 (wages) $83,000 (total income) |
× | $4,400 | = | $4,241 |
| The net wages are $75,759 ($80,000 − $4,241). | ||||
You figure the expenses allocable to interest (passive category income) as follows.
| $3,000 (interest) $83,000 (total income) |
× | $4,400 | = | $159 |
| The net interest is $2,841 ($3,000 − $159). | ||||
Then, to figure the foreign tax on the wages, you multiply the total foreign income tax by the following fraction.
| $75,759 (net wages) $78,600 (total net income) |
× | $3,200 | = | $3,084 |
You figure the foreign tax on the interest income as follows.
| $2,841 (net interest) $78,600 (total net income) |
× | $3,200 | = | $116 |
If foreign taxes were paid or accrued on your behalf by a partnership or an S corporation, you will figure your credit using certain information from the Schedule K-1 you received from the partnership or S corporation. If you received a 2008 Schedule K-1 from a partnership or an S corporation that includes foreign tax information, see your Form 1116 instructions for how to report that information.
Before you can determine the limit on your credit, you must first figure your total taxable income from all sources before the deduction for personal exemptions. This is the amount shown on line 41 of Form 1040 (minus any amount shown on line 2 of Form 8914, Exemption Amount for Taxpayers Housing Midwestern Displaced Individuals). Then for each category of income, you must figure your taxable income from sources outside the United States.
Before you can figure your taxable income in each category from sources outside the United States, you must first determine whether your gross income in each category is from U.S. sources or foreign sources. Some of the general rules for figuring the source of income are outlined in Table 2.
See Determining the Source of Compensation for Labor or Personal Services and Determining the Source of Income From the Sales or Exchanges of Certain Personal Property for a more detailed discussion on determining the source of these types of income.
If you are an employee and receive compensation for labor or personal services performed both inside and outside the United States, special rules apply in determining the source of the compensation. Compensation (other than certain fringe benefits) is sourced on a time basis. Certain fringe benefits (such as housing and education) are sourced on a geographical basis.
Or, you may be permitted to use an alternative basis to determine the source of compensation. See Alternative basis later.
If you are self-employed, you determine the source of compensation for labor or personal services from self-employment on the basis that most correctly reflects the proper source of that income under the facts and circumstances of your particular case. In many cases, the facts and circumstances will call for an apportionment on a time basis as explained next.
| Number of days you performed services in the foreign country during the year | |||
| Total number of days you performed services during the year | |||
Example 1.
Christina Brooks, a U.S. citizen, worked 240 days for a U.S. company during the tax year. She received $80,000 in compensation. None of it was for fringe benefits. Christina performed services in the United States for 60 days and performed services in the United Kingdom for 180 days. Using the time basis for determining the source of compensation, $60,000 ($80,000 × ) is her foreign source income.
Example 2.
Rob Waters, a U.S. citizen, is employed by a U.S. corporation. His principal place of work is in the United States. His annual salary is $100,000. None of it is for fringe benefits. During the first quarter of the year he worked entirely within the United States. On April 1, Rob was transferred to Singapore for the remainder of the year. Rob is able to establish that the first quarter of the year and the last 3 quarters of the year are two separate, distinct, and continuous periods of time. Accordingly, $25,000 of Rob's annual salary is attributable to the first quarter of the year (.25 × $100,000). All of it is U.S. source income because he worked entirely within the United States during that quarter. The remaining $75,000 is attributable to the last three quarters of the year. During those quarters, he worked 150 days in Singapore and 30 days in the United States. His periodic performance of services in the United States did not result in distinct, separate, and continuous periods of time. Of his $75,000 salary, $62,500 ($75,000 × ) is foreign source income for the year.
Table 2.Source of Income
| Item of Income | Factor Determining Source |
| Salaries, wages, other compensation | Where services performed |
| Business income: | |
| Personal services | Where services performed |
| Sale of inventory—purchased | Where sold |
| Sale of inventory—produced | Allocation |
| Interest | Residence of payer |
| Dividends | Whether a U.S. or foreign corporation* |
| Rents | Location of property |
| Royalties: | |
| Natural resources | Location of property |
| Patent, copyrights, etc. | Where property is used |
| Sale of real property | Location of property |
| Sale of personal property | Seller's tax home (but see Determining the Source of Income From the Sales or Exchanges of Certain Personal Property, later, for exceptions) |
| Pension distributions attributable to contributions | Where services were performed that earned the pension |
| Investment earnings on pension contributions | Location of pension trust |
| Sale of natural resources | Allocation based on fair market value of product at export terminal. For more information, see Regulations section 1.863-1(b). |
| * Exceptions include: a) Dividends paid by a U.S. corporation are foreign source if the corporation elects the American Samoa Economic Development Credit, b) Part of a dividend paid by a foreign corporation is U.S. source if at least 25% of the corporation's gross income is effectively connected with a U.S. trade or business for the 3 tax years before the year in which the dividends are declared. |
-
Housing.
-
Education.
-
Local transportation.
-
Tax reimbursement.
-
Hazardous or hardship duty pay.
-
Moving expense reimbursement.
Table 3.Source of Fringe Benefits
| Fringe Benefit | Factor Determining Source |
| Housing, education, and local transportation | Location of your principal place of work |
| Tax reimbursement | Location of the jurisdiction that imposed the tax for which you were reimbursed |
| Hazardous or hardship duty pay | Location of the hazardous or hardship duty zone for which you received the pay |
| Moving expense reimbursement | Location of your new principal place of work* |
-
Rent.
-
Utilities (except telephone charges).
-
Real and personal property insurance.
-
Occupancy taxes not deductible under section 164 or 216(a).
-
Nonrefundable fees for securing a leasehold.
-
Rental of furniture and accessories.
-
Household repairs.
-
Residential parking.
-
Fair rental value of housing provided in kind by your employer.
-
Deductible interest and taxes (including deductible interest and taxes of a tenant-stockholder in a cooperative housing corporation),
-
The cost of buying property, including principal payments on a mortgage,
-
The cost of domestic labor (maids, gardeners, etc.),
-
Pay television subscriptions,
-
Improvements and other expenses that increase the value or appreciably prolong the life of property,
-
Purchased furniture or accessories,
-
Depreciation or amortization of property or improvements,
-
The value of meals or lodging that you exclude from gross income, or
-
The value of meals or lodging that you deduct as moving expenses.
-
Tuition, fees, academic tutoring, special needs services for a special needs student, books, supplies, and other equipment.
-
Room and board and uniforms that are required or provided by the school in connection with enrollment or attendance.
-
The zone is designated by the Secretary of State as a place where living conditions are extraordinarily difficult, notably unhealthy, or where excessive physical hardships exist, and for which a post differential of 15 percent or more would be provided under section 5925(b) of Title 5 of the U.S. Code to any officer or employee of the U.S. government at that place.
-
The zone is where civil insurrection, civil war, terrorism, or wartime conditions threaten physical harm or imminent danger to your health and well-being.
-
Your name and social security number (written across the top of the statement),
-
The specific compensation income, or the specific fringe benefit, for which you are using the alternative basis,
-
For each item in (2), the alternative basis of allocation of source used,
-
For each item in (2), a computation showing how the alternative allocation was computed, and
-
A comparison of the dollar amount of the U.S. compensation and foreign compensation sourced under both the alternative basis and the time or geographical basis discussed earlier.
Generally, if personal property is sold by a U.S. resident, the gain or loss from the sale is treated as U.S. source. If personal property is sold by a nonresident, the gain or loss is treated as foreign source.
This rule does not apply to the sale of inventory, intangible property, or depreciable property, or property sold through a foreign office or fixed place of business. The rules for these types of property are discussed later.
-
The income from the sale is from the business operations located outside the United States, and
-
At least 10% of the income is paid as tax to the foreign country.
To figure your taxable income in each category from sources outside the United States, you first allocate to specific classes (kinds) of gross income the expenses, losses, and other deductions (including the deduction for foreign housing costs) that are definitely related to that income.
-
As a result of, or incident to, an activity from which that income is derived, or
-
In connection with property from which that income is derived.
-
Compensation for services, including wages, salaries, fees, and commissions.
-
Gross income from business.
-
Gains from dealings in property.
-
Interest.
-
Rents.
-
Royalties.
-
Dividends.
-
Alimony and separate maintenance.
-
Annuities.
-
Pensions.
-
Income from life insurance and endowment contracts.
-
Income from cancelled debts.
-
Your share of partnership gross income.
-
Income in respect of a decedent.
-
Income from an estate or trust.
-
More than one separate limit category, or
-
At least one separate limit category and U.S. source income,
| Gross income in separate limit category Total gross income in the class |
× | deduction |
Example.
You are operating a business as a sole proprietorship. Your business generates only U.S. source income. Your investment portfolio consists of several less-than-10% stock investments. You have stocks with an adjusted basis of $100,000. Some of your stocks (with an adjusted basis of $40,000) generate U.S. source income. Your other stocks (with an adjusted basis of $60,000) generate foreign passive income. You own your main home, which is subject to a mortgage of $120,000. Interest on this loan is home mortgage interest. You also have a bank loan in the amount of $40,000. The proceeds from the bank loan were divided equally between your business and your investment portfolio. Your gross income from your business is $50,000. Your investment portfolio generated $4,000 in U.S. source income and $6,000 in foreign source passive income. All of your debts bear interest at the annual rate of 10%.
The interest expense for your business is $2,000. It is apportioned on the basis of the business assets. All of your business assets generate U.S. source income; therefore, they are U.S. assets. This $2,000 is interest expense allocable to U.S. source income.
The interest expense for your investments is also $2,000. It is apportioned on the basis of investment assets. $800 ($40,000/$100,000 × $2,000) of your investment interest is apportioned to U.S. source income and $1,200 ($60,000/$100,000 × $2,000) is apportioned to foreign source passive income.
Your home mortgage interest expense is $12,000. It is apportioned on the basis of all your gross income. Your gross income is $60,000, $54,000 of which is U.S. source income and $6,000 of which is foreign source passive income. Thus, $1,200 ($6,000/$60,000 × $12,000) of the home mortgage interest is apportioned to foreign source passive income.
-
If the total income taxed by the state is greater than the amount of U.S. source income for federal tax purposes, then the state tax is allocable to both U.S. source and foreign source income.
-
If the total income taxed by the state is less than or equal to the U.S. source income for federal tax purposes, none of the state tax is allocable to foreign source income.
| $15,000 $90,000 |
× | $6,000 | = | $1,000 |
Example.
You are single and have an adjusted gross income of $219,950. Your itemized deductions subject to the overall reduction (line 3 of the worksheet) total $20,000. $8,000 of these deductions are definitely related to the income on Form 1116, line 1a. The other $12,000 ($20,000 – $8,000) are real estate taxes, which are not definitely related.
The amount of the overall reduction on line 11 of the worksheet is $1,200. To figure the amount of the real estate taxes to include in the total for line 3a of Form 1116, divide the amount on line 11 ($1,200) by the amount on line 3 ($20,000). This is your reduction percentage (6%). You must reduce your $12,000 deduction by $720 (6% x $12,000). The reduced deduction of $11,280 ($12,000 – $720) is the amount to enter on line 3a of Form 1116. Make a similar computation to figure the amount of definitely related itemized deductions ($7,520) to enter on line 2.
If you have any qualified dividends, you may be required to make adjustments to the amount of those qualified dividends before you take them into account on line 1a or line 17 of Form 1116. See Foreign Qualified Dividends and Capital Gains (Losses) in the Form 1116 instructions to determine the adjustments you may be required to make before taking foreign qualified dividends into account on line 1a of Form 1116. See the instructions for line 17 in the Form 1116 instructions to determine the adjustments you may be required to make before taking U.S. or foreign qualified dividends into account on line 17 of Form 1116.
If you have capital gains (including any capital gain distributions) or capital losses, you may have to make certain adjustments to those gains or losses before taking them into account on line 1a (gains), line 5 (losses), or line 17 (taxable income before subtracting exemptions) of Form 1116.
You may have to make the following adjustments to your foreign source capital gains and losses.
-
U.S. capital loss adjustment.
-
Capital gain rate differential adjustment.
Before you make these adjustments, you must reduce your net capital gain by the amount of any gain you elected to include in investment income on line 4g of Form 4952, Investment Interest Expense Deduction. Your net capital gain is the excess of your net long-term capital gain for the year over any net short-term capital loss for the year. Foreign source gain you elected to include on line 4g of Form 4952 must be entered directly on line 1a of Form 1116 without adjustment.
Example 1.
Alfie has a $300 foreign source capital gain that is passive category income, a $1,000 foreign source capital gain that is general category income, a $400 foreign source capital loss that is general category income, and a $150 U.S. source capital loss. He figures his net gains and U.S. capital loss adjustment as follows.
| Foreign source capital gain = $900 (($1,000 + $300) − $400) |
|
| Worldwide capital gain = $750 (($1,000 + $300) − ($400 + $150)) |
|
| U.S. capital loss adjustment = $150 ($900 − $750) |
|
Alfie must then apportion the U.S. capital loss adjustment ($150) between the passive category income and the general category income based on the amount of net capital gain in each separate category.
| $50 apportioned to passive category income ($150 × $300/$900) |
|
Alfie reduces his $300 net capital gain that is passive category income by $50 and includes the resulting $250 on line 1a of the Form 1116 for the passive category income.
| $100 apportioned to general category income ($150 × $600/$900) |
Alfie reduces his $600 of net capital gain that is general category income by $100 and includes the resulting $500 on line 1a of the Form 1116 for the general category income.
Table 4. Rate Groups
| A capital gain or loss is in the... | IF... | ||
| 28% rate group | it is included on the 28% Rate Gain Worksheet in the instructions for Schedule D. |
||
| 25% rate group | it is included on line 1 through line 13 of the Unrecaptured Section 1250 Gain Worksheet in the instructions for Schedule D. | ||
| 15% rate group | it is a long-term capital gain that is not in the 28% or 25% rate group and is taxed at a 15% rate or it is a long-term capital loss that is not in the 28% or 25% rate group. | ||
| 0% rate group | it is a long-term capital gain that is not in the 25% or 28% rate group and is taxed at a rate of 0%. | ||
| Short-term rate group | it is a short-term capital gain or loss. |
Example 2.
Dennis has a $300 U.S. source long-term capital loss. Dennis also has foreign source capital gains and losses in the following categories.
| Income category | 28% rate | 15% rate | short-term | |||
| Passive | $200 | ($100) | $100 | |||
| General | $700 ($300) |
|||||
He figures his U.S. capital loss adjustment as follows.
| Dennis' foreign source capital gain is $600. (($200 + $700 + $100) − ($100 + $300)) |
|
| Dennis' worldwide capital gain is $300. (($200 + $700 + $100) − ($100 + $300 + $300)) |
|
| Dennis' U.S. capital loss adjustment is $300. ($600 − $300) |
|
Dennis must apportion his $300 U.S. capital loss adjustment between passive category income and general category income based on the amount of net capital gain in each separate category.
| Dennis' net capital gain, passive category income is $200. (($100 + $200) - $100) Dennis apportions $100 to passive category income. ($300 × $200/$600) |
||
| Dennis' net capital gain, general category income is $400. ($700 - $300) Dennis apportions $200 to general category income. ($300 × $400/$600) |
||
Dennis has net capital gain in more than one rate group that is passive category income. Therefore, the $100 apportioned to passive category income must be further apportioned between the short-term rate group and the 28% rate group based on the amount of net capital gain in each rate group.
| Dennis apportions $33.33 to the short-term rate group. ($100 × $100/$300) Dennis apportions $66.67 to the 28% rate group. ($100 × $200/$300) |
||
After the U.S. capital loss adjustment, Dennis has $100 of foreign source 15% capital loss that is passive category income, $66.67 of foreign source short-term capital gain that is passive category income, $133.33 of foreign source 28% gain that is passive category income, and $200 of foreign source 15% capital gain that is general category income, as shown in the following table.
| Income category | 28% rate | 15% rate | short-term | |||
| Passive | $200.00 -66.67 $133.33 |
($100) | $100.00 –33.33 $66.67 |
|||
| General | $700.00 (300.00) -200.00 $200.00 |
|||||
-
First determine the amount of your net capital gain in each separate category rate group that must be adjusted.
-
Then make the capital gain rate differential adjustment. See Capital gain rate differential adjustment for net capital gains, later.
Example 3.
Mary has a $200 15% capital loss from U.S. sources, a $50 15% capital gain from U.S. sources, and a $200 short-term capital gain from U.S. sources. Mary also has a $300 28% capital gain and a $150 15% capital gain from foreign sources that are passive category income.
Mary does not have a U.S. capital loss adjustment because her foreign source capital gain ($450) does not exceed her worldwide capital gain ($500).
Mary's net long-term capital loss from U.S. sources is $150 ($200 - $50). Her U.S. long-term loss adjustment amount is $150 ($150 - $0). Mary allocates the $150 between the 28% rate group and the 15% rate group as follows.
Mary allocates $100 ($150 x $300/$450) to the 28% rate group that is passive category income. Therefore, $200 ($300 - $100) of her $300 28% capital gain must be adjusted before it is included on line 1a. The remaining $100 of 28% capital gain is included on line 1a without adjustment.
Mary allocates $50 ($150 x $150/$450) to the 15% rate group that is passive category income. Therefore, only $100 ($150 - $50) of her $150 15% capital gain must be adjusted before it is included on line 1a. The remaining $50 of 15% capital gain is included on line 1a without adjustment.
-
For each separate category that has a net capital gain in the 0% rate group, do not include the applicable amount on Form 1116.
-
For each separate category that has a net capital gain in the 15% rate group, multiply the applicable amount of the net capital gain by 0.4286.
-
For each separate category that has a net capital gain in the 25% rate group, multiply the applicable amount of the net capital gain by 0.7143.
-
For each separate category that has a net capital gain in the 28% rate group, multiply the applicable amount of the foreign source net capital gain by 0.8.
Example 4.
Beth has $200 of capital gains in the 28% rate group that are general category income and no other items of capital gain or loss. Beth must adjust the capital gain before she includes it on line 1a as follows.
| $200 × 0.8 = $160 | |
Beth includes $160 of capital gain on line 1a of Form 1116 for the general category income.
Example 5.
The facts are the same as Example 3. Mary includes the following amounts of passive category income on line 1a of Form 1116 for passive category income.
| Mary includes $260 of the 28% capital gain ($200 × 0.8) + $100 |
| Mary includes $92.86 of the 15% capital gain ($100 × 0.4286) + $50 |
Example 6.
The facts are the same as Example 2. After making the U.S. capital loss adjustment, Dennis has the following:
| Income category | 28% rate | 15% rate | short-term | |||
| Passive | $133.33 | ($100) | $66.67 | |||
| General | $200 | |||||
Dennis now determines the amount of the remaining net capital gain in each separate category long-term rate group that must be adjusted.
Dennis' net long-term capital loss from U.S. sources is $300. His U.S. long-term loss adjustment amount is $33.33 ($300 − $266.67). Dennis must allocate this amount between the $133.33 of net capital gain remaining in the 28% rate group that is passive category income and the $200 of net capital gain remaining in the 15% rate group that is general category income.
Dennis allocates $13.33 ($33.33 × $133.33 ÷ $333.33) of the U.S. long-term loss adjustment to passive category income in the 28% rate group. Therefore, Dennis must adjust $120 ($133.33 − $13.33) of the $133.33 net capital gain remaining in the 28% rate group that is passive category income. Dennis includes $109.33 (($120 × 0.8) + 13.33) of 28% capital gain and $66.67 of short-term capital gain on line 1a of Form 1116 for passive category income.
Dennis allocates $20 ($33.33 × $200 ÷ $333.33) to the 15% rate group for general category income. Therefore, Dennis must adjust $180 ($200 − $20) of the $200 net capital gain remaining in the 15% rate group that is general category income. Dennis includes $97.15 (($180 × 0.4286) + $20) of 15% capital gain on line 1a of Form 1116 for general category income.
-
First determine the rate group of the capital gain offset by that net capital loss. See How to determine the rate group of the capital gain offset by the net capital loss, next.
-
Then make the capital gain rate differential adjustment. See Capital gain rate differential adjustment for net capital loss, later.
-
First, against U.S. source net capital gains in the same rate group, and
-
Next, against net capital gains in other rate groups (without regard to whether such net capital gains are U.S. or foreign source net capital gains) as follows.
-
A foreign source net capital loss in the short-term rate group is first netted against any net capital gain in the 28% rate group, then against any net capital gain in the 25% rate group, then against any net capital gain in the 15% rate group, and finally to offset capital gain net income in the 0% rate group.
-
A foreign source net capital loss in the 28% rate group is netted first against any net capital gain in the 25% rate group, then against any net capital gain in the 15% rate group, and finally to offset capital gain net income in the 0% rate group.
-
A foreign source net capital loss in the 15% rate group is netted first against any net capital gain in the 15% rate group, is netted first against any net capital gain in the 0% rate group, then any net capital gain in the 28% rate group, and finally against any net capital gain in the 25% rate group.
-
-
Net capital gains in any other separate category under Step 1,
-
Any U.S. source net capital gain under Step 3(1), or
-
Net capital gains in any other rate group under Step 3(2).
-
To the extent a net capital loss in a separate category rate group offsets capital gain in the 0% rate group, multiply the net capital loss by zero.
-
To the extent a net capital loss in a separate category rate group offsets capital gain in the 15% rate group, multiply the capital loss by 0.4286.
-
To the extent that a net capital loss in a separate category rate group offsets capital gain in the 25% rate group, multiply that amount of the net capital loss by 0.7143.
-
To the extent that a net capital loss in a separate category rate group offsets capital gain in the 28% rate group, multiply that amount of the capital loss by 0.8.
Example 7.
The facts are the same as Example 2. Dennis has a $100 foreign source 15% capital loss that is passive category income.
This loss is netted against the $200 foreign source 15% capital gain that is general category income according to Step 1.
Dennis includes $42.86 of the capital loss on line 5 of the Form 1116 for general category income.
| ($100 × 0.4286) | ||
Example 8.
Dawn has a $20 net capital loss in the 15% rate group that is passive category income, a $40 net capital loss in the 15% rate group that is general category income, a $50 U.S. source net capital gain in the 15% rate group, and a $50 net capital gain in the 28% rate group that is passive category income, as shown in the following table.
| Income category | 28% rate | 15% rate |
| Foreign Passive |
$50 | ($20) |
| Foreign General |
($40) | |
| U.S. Source | $50 |
Of the total $60 of foreign source net capital losses in the 15% rate group, $50 is treated as offsetting the $50 U.S. source net capital gain in the 15% rate group. (See Step 3(1).)
| $16.67 of the $50 is treated as coming from passive category income. ($50 × $20/$60) $33.33 of the $50 is treated as coming from general category income. ($50 × $40/$60) |
||
The remaining $10 of foreign source net capital losses in the 15% rate group are treated as offsetting net capital gain in the 28% rate group. (See Step 3(2)(c).)
| $3.33 is treated as coming from passive category income. ($10 × $20/$60) $6.67 is treated as coming from general category income. ($10 × $40/$60) |
||
Dawn includes $9.80 of the capital loss in the amount she enters on line 5 of Form 1116 for passive category income.
| This is $7.14 ($16.67 × 0.4286) plus $2.66. ($3.33 × 0.8) |
||
Dawn includes $19.63 of capital loss in the amount she enters on line 5 of Form 1116 for general category income.
| This is $14.29 ($33.33 × 0.4286) plus $5.34. ($6.67 × 0.8) |
||
Dawn also includes $40.00 ($50 × 0.8) of capital gain in the amount she enters on line 1a of Form 1116 for passive category income.
You must allocate foreign losses for any taxable year and U.S. losses for any taxable year (to the extent such losses do not exceed the separate limitation incomes for such year) among incomes on a proportionate basis.
If you have a foreign loss when figuring your taxable income in a separate limit income category, and you have income in one or more of the other separate categories, you must first reduce the income in these other categories by the loss before reducing income from U.S. sources.
Example.
You have $10,000 of passive category income and incur a loss of $5,000 of general category income. You must use the $5,000 loss to offset $5,000 of passive category income.
Example.
You have a $2,000 loss that is general category income, $3,000 of passive category income, and $2,000 of income re-sourced by treaty. You must allocate the $2,000 loss to the income in the other separate categories. 60% ($3,000/$5,000) of the $2,000 loss (or $1,200) reduces passive category income and 40% ($2,000/$5,000) or $800 reduces the income re-sourced by treaty.
You should allocate any net loss from sources in the United States among the different categories of foreign income after allocating all foreign losses as described earlier, and before any of the adjustments discussed later.
The amount of your net loss from sources in the United States is equal to the excess of (1) your foreign source taxable income in all of your separate categories in the aggregate, after taking into account any adjustments under Qualified Dividends and Adjustments to Foreign Source Capital Gains and Losses over (2) the amount of taxable income you enter on Form 1116, line 17.
If you have only losses in your separate limit categories, or if you have a loss remaining after allocating your foreign losses to other separate categories, you have an overall foreign loss. If you use this loss to offset U.S. source income (resulting in a reduction of your U.S. tax liability), you must recapture your loss in each succeeding year in which you have taxable income from foreign sources in the same separate limit category. You must recapture the overall loss regardless of whether you chose to claim the foreign tax credit for the loss year.
You recapture the loss by treating part of your taxable income from foreign sources in a later year as U.S. source income. In addition, if, in a later year, you sell or otherwise dispose of property used in your foreign trade or business, you may have to recognize gain and treat it as U.S. source income, even if the disposition would otherwise be nontaxable. See Dispositions, later. The amount you treat as U.S. source income reduces the foreign source income, and therefore reduces the foreign tax credit limit.
You must establish separate accounts for each type of foreign loss that you sustain. The balances in these accounts are the overall foreign loss subject to recapture. Reduce these balances at the end of each tax year by the loss that you recaptured. You must attach a statement to your Form 1116 to report the balances (if any) in your overall foreign loss accounts.
Example.
You are single and have gross dividend income of $10,000 from U.S. sources. You also have a greater-than-10% interest in a foreign partnership in which you materially participate. The partnership has a loss for the year, and your distributive share of the loss is $15,000. Your share of the partnership's gross income is $100,000, and your share of its expenses is $115,000. Your only foreign source income is your share of partnership income, which is general category income. You are a bona fide resident of a foreign country and you elect to exclude your foreign earned income. You exclude the maximum $87,600. You also have itemized deductions of $6,100 that are not definitely related to any item of income.
In figuring your overall foreign loss for general category income for the year, you must allocate a ratable part of the $6,100 in itemized deductions to the foreign source income. You figure the ratable part of the $6,100 that is for foreign source income, based on gross income, as follows:
| $100,000 (Foreign gross income) $110,000 (Total gross income) |
× | $6,100 | = | $5,545 | |
Therefore, your overall foreign loss for the year is $7,405, figured as follows:
| Foreign gross income | $100,000 | |||
| Less: Foreign earned income exclusion |
$87,600 | |||
| Allowable definitely related expenses ($12,400/ $100,000 × $115,000) |
14,260 | |||
| Ratable part of itemized deductions |
5,545 | 107,405 | ||
| Overall foreign loss | $7,405 | |||
-
Net operating loss deduction.
-
Foreign expropriation loss not compensated by insurance or other reimbursement.
-
Casualty or theft loss not compensated by insurance or other reimbursement.
-
The total amount of maximum potential recapture in all overall foreign loss accounts. The maximum potential recapture in any account for a category is the lesser of:
-
The current year taxable income from foreign sources in that category (the amount from Form 1116, line 14 less any adjustment for allocation of foreign losses and U.S. losses for that category, discussed earlier), or
-
The balance in the overall foreign loss account for that category.
-
-
50% (or more, if you choose) of your total taxable income from foreign sources.
| Maximum potential recapture amount for the overall foreign loss account in the separate category | |||
| Total amount of maximum potential recapture in all overall foreign loss accounts | |||
Example.
During 2007 and 2008, you were single and a 20% general partner in a partnership that derived its income from Country X. You also received dividend income from U.S. sources during those years.
For 2007, the partnership had a loss and your share was $20,000, consisting of $110,000 gross income less $130,000 expenses. Your net loss from the partnership was $8,600, after deducting the foreign earned income exclusion and definitely related allowable expenses. This loss is related to general category income. Your U.S. dividend income was $20,000. Your itemized deductions totaled $6,000 and were not definitely related to any item of income. In figuring your taxable income for 2007, you deducted your share of the partnership loss from Country X from your U.S. source income.
During 2008, the partnership had net income from Country X. Your share of the net income was $40,000, consisting of $100,000 gross income less $60,000 expenses. Your net income from the partnership was $12,560, after deducting the foreign earned income exclusion and the definitely related allowable expenses. This is general category income. You also received dividend income of $20,000 from U.S. sources. Your itemized deductions were $6,000, which are not definitely related to any item of income. You paid income taxes of $4,000 to Country X on your share of the partnership income.
When figuring your foreign tax credit for 2008, you must find the foreign source taxable income that you must treat as U.S. source income because of the foreign loss recapture provisions.
You figure the foreign taxable income that you must recapture as follows:
| A. | Determination of 2007 Overall Foreign Loss | |||
| 1) | Partnership loss from Country X | $8,600 | ||
| 2) | Add: Part of itemized deductions allocable to gross income from Country X |
|||
| $110,000 $130,000 |
× | $6,000 | = | $5,077 |
| 3) | Overall foreign loss for 2007 | $13,677 | ||
| B. | Amount of Recapture for 2008 | |||
| 1) | Balance for general category income foreign loss account |
$13,677 | ||
| 2) | Taxable general category income after allocation of foreign losses—General category income | $12,560 | ||
| Less: Itemized deductions allocable to that income ($100,000/$120,000 × $6,000) |
5,000 | |||
| General category taxable income less allocated foreign losses ($7,560 − 0) |
$7,560 | |||
| 3) | Total amount of maximum potential recapture in all foreign loss accounts (smaller of (1) or (2)) | $7,560 | ||
| 4) | Foreign source net income | $12,560 | ||
| Less: Itemized deductions allocable to foreign source net income ($100,000/ $120,000 × $6,000) |
5,000 | $7,560 | ||
| 5) | 50% of foreign source taxable income subject to recapture | $3,780 | ||
| 6) | Recapture for 2008 (smaller of (3), or (5)) |
$3,780 | ||
-
The percentage and amount of your foreign taxable income that you are treating as U.S. source income, and
-
The percentage and amount of the balance (both before and after the recapture) in the overall foreign loss account that you are recapturing.
-
The balance in the applicable overall foreign loss account, or
-
The foreign source taxable income of the same separate limit category that resulted in the overall foreign loss minus the foreign taxes imposed on that income.
-
The fair market value of the property that is more than your adjusted basis in the property, or
-
The remaining amount of the overall foreign loss not recaptured in prior years or in the current year as described earlier under Recapture provision and Recapturing more overall foreign loss than required.
-
Your foreign source taxable income in the same separate limit category as the overall foreign loss, or
-
100% of your total foreign source taxable income for the year.
-
A sale, exchange, distribution, or gift of property.
-
A transfer upon the foreclosure of a security interest (but not a mere transfer of title to a creditor or debtor upon creation or termination of a security interest).
-
An involuntary conversion.
-
A contribution to a partnership, trust, or corporation.
-
A transfer at death.
-
Any other transfer of property whether or not gain or loss is normally recognized on the transfer.
-
A disposition of property that is not a material factor in producing income. (This exception does not apply to the disposition of stock in a controlled foreign corporation (CFC) to which Internal Revenue Code section 904(f)(3)(D) applies.)
-
A transaction in which gross income is not realized.
If, in a prior tax year, you reduced your foreign taxable income in the separate limit category by a pro rata share of a loss from another category, you must recharacterize in 2008 all or part of any income you receive in 2008 in that loss category. If you have separate limitation loss accounts in the loss category relating to more than one other category and the total balances in those loss accounts exceed the income you receive in 2008 in the loss category, then income in the loss category is recharacterized as income in those other categories in proportion to the balances of the separate limitation loss accounts for those other categories. You recharacterize the income by:
-
Increasing foreign taxable income (adjusted by any of the other adjustments previously mentioned) for each of the separate categories (other than the loss category) previously reduced by any recharacterized income, and
-
Decreasing foreign taxable income (adjusted by any of the other adjustments previously mentioned) for the loss category by the amount of recharacterized income.
Example.
In 2007, you had a $2,000 loss that was general category income, $3,000 of passive category income, and $2,000 of income re-sourced by treaty. You had to allocate the $2,000 loss to the income in the other separate categories. 60% ($3,000 ÷ $5,000) of the $2,000 loss (or $1,200) reduced passive category income and 40% ($2,000 ÷ $5,000) or $800 reduced the income re-sourced by treaty.
In 2008, you have $4,000 of passive category income, $1,000 of income re-sourced by treaty, and $5,000 of general category income. Because $1,200 of the general category loss was used to reduce your passive category income in 2007, $1,200 of the current year's general category income of $5,000 must be recharacterized as passive category income. This makes the current year's total passive category income $5,200 ($4,000 + $1,200). Similarly, because $800 of the general category loss was used to reduce your income re-sourced by treaty, $800 of the general category income must be recharacterized as income re-sourced by treaty. This makes the current year's total of income re-sourced by treaty $1,800 ($1,000 + $800). The total general category income is $3,000 ($5,000 − $1,200 − $800).
If you have an overall domestic loss for any tax year beginning after 2006, you create, or increase the balance in, and overall domestic loss account and you must recharacterize a portion of your U.S. source taxable income as foreign source taxable income in succeeding years for purposes of the foreign tax credit.
The part that is treated as foreign source taxable income for the tax year is the smaller of:
-
The total balance in your overall domestic loss account in each separate category (less amounts recaptured in earlier years), or
-
50% of your U.S. source taxable income for the tax year.
You must establish and maintain separate overall domestic loss accounts for each separate category in which foreign source income is offset by the domestic loss. The balance in each overall domestic loss account is the amount of the overall domestic loss subject to recapture. The recharacterized income is allocated among and increases foreign source income in separate categories in proportion to the balances of the overall domestic loss accounts for those separate categories.
For more information, see the Instructions for Form 1116.
The United States is a party to tax treaties that are designed, in part, to prevent double taxation of the same income by the United States and the treaty country. Many treaties do this by allowing you to treat U.S. source income as foreign source income. Certain treaties have special rules you must consider when figuring your foreign tax credit if you are a U.S. citizen residing in the treaty country. These rules generally allow an additional credit for part of the tax imposed by the treaty partner on U.S. source income. It is separate from, and in addition to, your foreign tax credit for foreign taxes paid or accrued on foreign source income. The treaties that provide for this additional credit include those with Australia, Austria, Bangladesh, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Israel, Japan, Luxembourg, Mexico, the Netherlands, New Zealand, Portugal, Slovenia, South Africa, Sweden, Switzerland, and the United Kingdom. There is a worksheet at the end of this publication to help you figure the additional credit. But do not use this worksheet to figure the additional credit under the treaties with Australia and New Zealand. Also, do not use this worksheet for income that is in the “Income Re-Sourced By Treaty” category discussed earlier under Separate Limit Income.
You can get more information, and the worksheet to figure the additional credit under the Australia and New Zealand treaties, by writing to:Internal Revenue Service
International Section
P.O. Box 920
Bensalem, PA 19020-8518.
You can also contact the United States Tax Attaché at the U.S. Embassies in London or Paris, or the U.S. consulate in Frankfurt, as appropriate, for assistance.
If, because of the limit on the credit, you cannot use the full amount of qualified foreign taxes paid or accrued in the tax year, you are allowed a 1-year carryback and then a 10-year carryover of the unused foreign taxes.
This means that you can treat the unused foreign tax of a tax year as though the tax were paid or accrued in your first preceding and 10 succeeding tax years up to the amount of any excess limit in those years. A period of less than 12 months for which you make a return is considered a tax year.
The unused foreign tax in each category is the amount by which the qualified taxes paid or accrued are more than the limit for that category. The excess limit in each category is the amount by which the limit is more than the qualified taxes paid or accrued for that category.
Figure your carrybacks or carryovers separately for each separate limit income category.
The mechanics of the carryback and carryover are illustrated by the following examples.
Example 1.
All of your foreign income is general category income for 2007 and 2008. The limit on your credit and the qualified foreign taxes paid on the income are as follows:
| Your limit |
Tax paid |
Unused foreign tax (+) or excess limit (−) |
||||
| 2007 | $200 | $100 | −100 | |||
| 2008 | $300 | $500 | +200 | |||
In 2008, you had unused foreign tax of $200 to carry to other years. You are considered to have paid this unused foreign tax first in 2007 (the first preceding tax year) up to the excess limit in that year of $100. You can then carry forward the remaining $100 of unused tax.
Example 2.
All your foreign income is general category income for 2007, 2008, and 2009. Before 2007, all of your foreign income was in the general limitation income category. In 2004, you had an unused foreign tax of $200. Because you had no foreign income in 2002 and 2003, you cannot carry back the unused foreign tax to those years. (The carryback period for unused foreign taxes arising in tax years beginning before October 23, 2004, is 2 years.) However, you may be able to carry forward the unused tax to the next 10 years. The limit on your credit and the qualified foreign taxes paid on general limitation income for 2004–2006 (general category income for 2007, 2008 and 2009) are as follows:
| Your limit |
Tax paid |
Unused foreign tax (+) or excess limit (−) |
||||
| 2004 | $600 | $800 | +200 | |||
| 2005 | $600 | $700 | +100 | |||
| 2006 | $500 | $700 | +200 | |||
| 2007 | $550 | $400 | −150 | |||
| 2008 | $800 | $700 | −100 | |||
| 2009 | $500 | $550 | +50 | |||
You cannot carry the $200 of unused foreign tax from 2004 to 2005 or 2006 because you have no excess limit in either of those years. Therefore, you carry the tax forward to 2007, up to the excess limit of $150. The carryover reduces your excess limit in that year to zero. The remaining unused foreign tax of $50 from 2004 can be carried to 2008. At this point, you have fully absorbed the unused foreign tax from 2004 and can carry it no further. You can also carry forward the unused foreign tax from 2005 and 2006.
When you carry back an unused foreign tax, the IRS is given additional time to assess any tax resulting from the carryback. An assessment can be made up to the end of one year after the expiration of the statutory period for an assessment relating to the year in which the carryback originated.
If you have an unused foreign tax that you are carrying back to the first preceding tax year, you should file Form 1040X for that tax year and attach a revised Form 1116.
In a given year, you must either claim a credit for all foreign taxes that qualify for the credit or claim a deduction for all of them. This rule is applied with the carryback and carryover procedure, as follows.
-
You cannot claim a credit carryback or carryover from a year in which you deducted qualified foreign taxes.
-
You cannot deduct unused foreign taxes in any year to which you carry them, even if you deduct qualified foreign taxes actually paid in that year.
-
You cannot claim a credit for unused foreign taxes in a year to which you carry them unless you also claim a credit for foreign taxes actually paid or accrued in that year.
-
You cannot carry back or carry over any unused foreign taxes to or from a year for which you elect not to be subject to the foreign tax credit limit. See Exemption from foreign tax credit limit under How To Figure the Credit, earlier.
Example.
In 2008, you paid foreign taxes of $600 on general category income. You have a foreign tax credit carryover of $200 from the same category from 2007. For 2008, your foreign tax credit limit is $700.
If you choose to claim a credit for your foreign taxes in 2008, you would be allowed a credit of $700, consisting of $600 paid in 2008 and $100 of the $200 carried over from 2007. You will have a credit carryover to 2009 of $100, which is your unused 2007 foreign tax credit carryover.
If you choose to deduct your foreign taxes in 2008, your deduction will be limited to $600, which is the amount of taxes paid in 2008. You are not allowed a deduction for any part of the carryover from 2007. However, you must treat $100 of the credit carryover as used in 2008, because you have an unused credit limit of $100 ($700 limit minus $600 of foreign taxes paid in 2008). This reduces your carryover to later years.
If you claimed the deduction for 2008 and later decided you wanted to receive a benefit for that $100 part of the 2007 carryover, you could reverse the choice of a deduction for 2008. You would have to claim a credit for those taxes by filing an amended return for 2008 within the time allowed.
For a tax year in which you and your spouse file a joint return, you must figure the unused foreign tax or excess limit in each separate limit category on the basis of your combined income, deductions, taxes, and credits.
For a tax year in which you and your spouse file separate returns, you figure the unused foreign tax or excess limit by using only your own separate income, deductions, taxes, and credits. However, if you file a joint return for any other year involved in figuring a carryback or carryover of unused foreign tax to the current tax year, you will need to make an allocation, as explained under Allocations Between Husband and Wife, later.
Please click here for the text description of the image.
){kind=link}
Figure A. Allocation Between Husband and Wife
You may have to allocate an unused foreign tax or excess limit for a tax year in which you and your spouse filed a joint return. This allocation is needed in the following three situations.
-
You and your spouse file separate returns for the current tax year, to which you carry an unused foreign tax from a tax year for which you and your spouse filed a joint return.
-
You and your spouse file separate returns for the current tax year, to which you carry an unused foreign tax from a tax year for which you and your spouse filed separate returns, but through a tax year for which you and your spouse filed a joint return.
-
You and your spouse file a joint return for the current tax year, to which you carry an unused foreign tax from a tax year for which you and your spouse filed a joint return, but through a tax year for which you and your spouse filed separate returns.
These three situations are illustrated in Figure A. In each of the situations, 2008 is the current year.
-
Figure a percentage for each separate income category by dividing the taxable income of each spouse from sources outside the United States in that category by the joint taxable income from sources outside the United States in that category. Then, apply each percentage to its category's joint foreign tax credit limit to find the part of the limit allocated to each spouse.
-
Figure the part of the unused foreign tax, or of the excess limit, for each separate income category allocable to each spouse. You do this by comparing the allocated limit (figured in (1)), with the foreign taxes paid or accrued by each spouse on income in that category. If the foreign taxes you paid or accrued for that category are more than your part of its limit, you have an unused foreign tax. If, however, your part of that limit is more than the foreign taxes you paid or accrued, you have an excess limit for that category.
Example.
A Husband (H) and Wife (W) filed joint returns for 2004, 2006, and 2007, and separate returns for 2005 and 2008. Neither H nor W had any unused foreign tax or excess limit for any year before 2004. For the tax years involved, the income, unused foreign tax, excess limits, and carrybacks and carryovers are general category income (general limitation income for 2004, 2005, and 2006) are shown in Table 5.
Table 5.Carryback/Carryover
| Tax year | 2004 | 2005 | 2006 | 2007 | 2008 |
| Return | Joint | Separate | Joint | Joint | Separate |
| H's unused foreign tax to be carried back or over, or excess limit* (enclosed in parentheses) | $50 | $25 | ($65) | $104 | ($50) |
| W's unused foreign tax to be carried back or over, or excess limit* (enclosed in parentheses) | $30 | ($20) | ($20) | $69 | ($10) |
| Carryover absorbed: | |||||
| W's from 2004 | — | 20W | 10W | — | — |
| H's from 2004 | — | — | 50H | — | — |
| H's from 2005 | — | — | 15H | — | — |
| " | — | — | 10W | — | — |
| W's from 2007 | — | — | — | — | 10W |
| H's from 2007 | — | — | — | — | 50H |
| W = Absorbed by W's excess limit H = Absorbed by H's excess limit |
W's allocated part of the unused foreign tax from 2004 ($30) is partly absorbed by her separate excess limit of $20 for 2005, and then fully absorbed by her allocated part of the joint excess limit for 2006 ($20). H's allocated part of the unused foreign tax from 2004 ($50) is fully absorbed by his allocated part of the joint excess limit ($65) for 2006.
H's separate unused foreign tax from 2005 ($25) is partly absorbed (up to $15) by his remaining excess limit in 2006, and then fully absorbed by W's remaining part of the joint excess limit for 2006 ($10). Each spouse's excess limit on the 2006 joint return is reduced by:
-
Each spouse's carryover from earlier years (W's carryover of $10 from 2004 and H's carryovers of $50 from 2004 and $15 from 2005).
-
The other spouse's carryover. (H's carryover of $10 from 2005 is absorbed by W's remaining excess limit.)
W's allocated part of the unused foreign tax of $69 from 2007 is partly absorbed by her excess limit in 2008 ($10), and the remaining $59 will be a carryover to general category income for 2009 and the following 8 years unless absorbed sooner. H's allocated part of the unused foreign tax of $104 from 2007 is partly absorbed by his excess limit in 2008 ($50), and the remaining $54 will be a carryover to 2009 and the following 8 years unless absorbed sooner.
When you file a joint return in a deduction year, and carry unused foreign tax through that year from the prior year in which you and your spouse filed separate returns, the amount absorbed in the deduction year is the unused foreign tax of each spouse deemed paid or accrued in the deduction year up to the amount of that spouse's excess limit in that year. You cannot reduce either spouse's excess limit in the deduction year by the other's unused foreign taxes in that year.
You must file Form 1116 to claim the foreign tax credit unless you meet one of the following exceptions.
You must file a Form 1116 with your U.S. income tax return, Form 1040 or Form 1040NR. You must file a separate Form 1116 for each of the following categories of income for which you claim a foreign tax credit.
-
Passive category income.
-
General category income.
-
Section 901(j) income.
-
Income re-sourced by treaty.
-
Lump-sum distributions.
A Form 1116 consists of four parts as explained next.
-
Part I—Taxable Income or Loss From Sources Outside the United States (for Category Checked Above). Enter the gross amounts of your foreign or possession source income in the separate limit category for which you are completing the form. Do not include income you excluded on Form 2555 or Form 2555-EZ. From these, subtract the deductions that are definitely related to the separate limit income, and a ratable share of the deductions not definitely related to that income. If, in a separate limit category, you received income from more than one foreign country or U.S. possession, complete a separate column for each. You do not need to report income passed through from a regulated investment company (RIC) on a country by country basis. Aggregate all income passed through from a RIC in a single column in Part I. Enter “RIC” on line g of Part I.
-
Part II—Foreign Taxes Paid or Accrued. This part shows the foreign taxes you paid or accrued on the income in the separate limit category in foreign currency and U.S. dollars. If you paid (or accrued) foreign tax to more than one foreign country or U.S. possession, complete a separate line for each. If you receive income passed through from a RIC, aggregate all income on a single line in Part II.
-
Part III—Figuring the Credit. You use this part to figure the foreign tax credit that is allowable.
-
Part IV—Summary of Credits From Separate Parts III. You use this part on one Form 1116 (the one with the largest amount entered on line 21) to summarize the foreign tax credits figured on separate Forms 1116.
-
A receipt for each foreign tax payment.
-
The foreign tax return if you claim a credit for taxes accrued.
-
Any payee statement (such as Form 1099-DIV or Form 1099-INT) showing foreign taxes reported to you.
Betsy Wilson is single, under 65, and is a U.S. citizen. She earned $45,000 working as a night auditor in Pittsburgh. She owns 200 shares in XYZ mutual fund that invests in Country Z corporations. She received a dividend of $620 from XYZ, which withheld and paid tax of $93 to Country Z on her dividend. XYZ reported this information to her on Form 1099-DIV.
Betsy elects to be exempt from the foreign tax credit limit because her only foreign taxable income is passive income (dividend of $620) and the amount of taxes paid ($93) is not more than $300. To claim the $93 as a credit, Betsy enters $93 on Form 1040, line 47. (She can claim her total taxes paid of $93 because it is less than her “regular tax,” shown on Form 1040 line 44.) She does not file Form 1116. However, she cannot carry any unused foreign taxes to this tax year.
If Betsy does not elect to be exempt from the foreign tax credit limit, she will need to complete a Form 1116 as follows.
Betsy fills in her name and social security number, and checks the box for passive category income.
Betsy enters the name of the foreign country in column A and shows on line 1a the amount of income ($620) and type of income (dividends) she received from XYZ. None of the dividends are qualified dividends. Next, because Betsy does not itemize her deductions, she puts her standard deduction ($5,450) on line 3a and completes 3b and 3c. Her gross foreign source income (line 3d) is $620 and gross income from all sources (line 3e) is $45,620. She enters $74 on line 6. Line 7 is $546, the difference between lines 1a and 6.
Betsy checks the “Paid” box and enters $93 on line A, columns (o) and (s), and on line 8.
Because the income was reported to Betsy in U.S. dollars on Form 1099-DIV, she does not have to convert the amount shown into foreign currency. She enters “1099 taxes” on line A, column (j).
Betsy figures her credit as shown on the completed form. The computation shows that she may take only $75 of the amount paid to Country Z as a credit against her U.S. income tax. The remaining $18 is available for a carryback and/or carryover.
Robert Smith, a U.S. citizen, is a salesman who lived and worked in Country X for all of 2008, except for one week he spent in the United States on business. He is single and under 65. He is a cash-basis taxpayer who uses the calendar year as his tax year.
During the year, Robert received income from sources within Country X and the United States.
| Income | Tax | |
| $100,000 wages | $27,400 | |
| (200,000 pesos) | (54,800 pesos) | |
| $4,000 dividend income | $450 | |
| (8,000 pesos) | (900 pesos) | |
| $1,000 interest income | $50 | |
| (2,000 pesos) | (100 pesos) |
| Interest on home mortgage | $5,900 |
| Real estate tax | 1,500 |
| Charitable contribution | 460 |
| Employee business expenses (See the following discussion for computation.) |
849 |
| Total | $8,709 |
| $12,400 $100,000 |
× | $2,400 | = | $298 |
Robert must use two Forms 1116 to figure his allowable foreign tax credit. On one Form 1116, he will mark the block to the left of General category income, and figure his foreign tax credit on the wages of $12,400 (Country X wages minus excluded wages). On the other Form 1116, he will mark the block to the left of Passive category income, and figure his foreign tax credit on his interest income of $1,000 and dividend income of $4,000.
Under the later discussions for each part on the Form 1116, Robert's computations are explained for each Form 1116 that must be completed. Both Forms 1116 are illustrated near the end of this publication.
Before making any entries on Form 1116, Robert must figure his taxable income on Form 1040.
His taxable income is $10,591 figured as follows:
| Gross Income | |
| Wages (Country X) | $100,000 |
| Less: Foreign earned income exclusion | 87,600 |
| $12,400 | |
| Wages (U.S.) | 2,400 |
| Interest income (Country X) | 1,000 |
| Dividend income (U.S.) | 3,000 |
| Dividend income (Country X) | 4,000 |
| Total (Adjusted gross income) | $22,800 |
| Less: Total Itemized Deductions | 8,709 |
| Taxable income before the personal exemption |
$14,091 |
| Less: Personal Exemption | 3,500 |
| Taxable Income | $10,591 |
On each Form 1116, Robert enters $14,091 (his taxable income before the personal exemption) on line 17 of Part III.
In figuring the limit on both Forms 1116, Robert must separately determine his taxable income from Country X (Form 1116, line 7).
| $298 $1,298 |
× | $456 | = | $105 |
| $100,000 $110,400 |
× | $1,500 | = | $1,359 |
| 1. | Enter gross foreign source income of the type shown on Form 1116. Do not enter income excluded on Form 2555 | $12,400 | |
| 2. | Enter gross income from all sources. Do not enter income excluded on Form 2555 | $22,800 | |
| 3. | Divide line 1 by line 2 and enter the result as a decimal |
.5439 | |
| 4. | Enter deductible home mortgage interest (from Schedule A (Form 1040)) | $5,900 | |
| 5. | Multiply line 4 by line 3. Enter the result here and on Form 1116, line 4a |
$3,209 | |
| $5,000 $110,400 |
× | $1,500 | = | $68 |
| 1. | Enter gross foreign source income of the type shown on Form 1116. Do not enter income excluded on Form 2555 | $5,000 | ||
| 2. | Enter gross income from all sources. Do not enter income excluded on Form 2555 | $22,800 | ||
| 3. | Divide line 1 by line 2 and enter the result as a decimal |
.2193 | ||
| 4. | Enter deductible home mortgage interest (from Schedule A (Form 1040)) | $5,900 | ||
| 5. | Multiply line 4 by line 3. Enter the result here and on Form 1116, line 4a | $1,294 | ||
Robert uses Part II, Form 1116, to report the foreign tax paid or accrued on income from foreign sources.
Robert figures the amount of foreign tax credit in Part III on each Form 1116.
| $27,400 | × | $87,600–$2,102 $100,000–$2,400 |
= | $24,003 |
Robert summarizes his foreign tax credits for the two types of income on Part IV of the Form 1116 with the largest amount on line 21. He uses the Part IV of Form 1116—General category income.
Robert leaves line 28 blank because he did not participate in or cooperate with an international boycott during the tax year. The allowable foreign tax credit is $2,101($500 + $1,601), shown on line 29. He also enters this amount on Form 1040, line 47.
Table 6.Robert's Schedule Showing Computation of His Carryover
| 2006 | 2007 | |
| Maximum credit allowable under limit | $750 | $1,200 |
| Foreign tax paid in tax year | 600 | 1,550 |
| Unused foreign tax (+) to be carried over or excess of limit (-) over tax | −$150 | +$350 |
| Tax credit carried back from 2007 | 150 | |
| Net excess tax to be carried over to 2008 | 0 | +$350 |
| Less carrybacks to 2006 | 150 | |
| Amount carried over to 2008 | $200 | |
Form 1116, page 1 for Betsy Wilson
Form 1116, page 2 for Betsy Wilson
Form 1116, page 1 for Robert Smith
Form 1116, page 2 for Robert Smith
Form 1116, page 1 for Robert Smith
Form 1116, page 2 for Robert Smith
Robert now determines if he has any unused foreign taxes that can be used as a carryback or carryover to other tax years.
You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get information from the IRS in several ways. By selecting the method that is best for you, you will have quick and easy access to tax help.
www.aarp.org/money/taxaide. For more information on these programs, go to www.irs.gov and enter keyword “VITA” in the upper right-hand corner.
-
E-file your return. Find out about commercial tax preparation and e-file services available free to eligible taxpayers.
-
Check the status of your 2008 refund. Go to www.irs.gov and click on Where's My Refund. Wait at least 72 hours after the IRS acknowledges receipt of your e-filed return, or 3 to 4 weeks after mailing a paper return. If you filed Form 8379 with your return, wait 14 weeks (11 weeks if you filed electronically). Have your 2008 tax return available so you can provide your social security number, your filing status, and the exact whole dollar amount of your refund.
-
Download forms, instructions, and publications.
-
Order IRS products online.
-
Research your tax questions online.
-
Search publications online by topic or keyword.
-
View Internal Revenue Bulletins (IRBs) published in the last few years.
-
Figure your withholding allowances using the withholding calculator online at
www.irs.gov/individuals. -
Determine if Form 6251 must be filed by using our Alternative Minimum Tax (AMT) Assistant.
-
Sign up to receive local and national tax news by email.
-
Get information on starting and operating a small business.
-
Ordering forms, instructions, and publications. Call 1-800-829-3676 to order current-year forms, instructions, and publications, and prior-year forms and instructions. You should receive your order within 10 days.
-
Asking tax questions. Call the IRS with your tax questions at 1-800-829-1040.
-
Solving problems. You can get face-to-face help solving tax problems every business day in IRS Taxpayer Assistance Centers. An employee can explain IRS letters, request adjustments to your account, or help you set up a payment plan. Call your local Taxpayer Assistance Center for an appointment. To find the number, go to
www.irs.gov/localcontacts or look in the phone book under United States Government, Internal Revenue Service. -
TTY/TDD equipment. If you have access to TTY/TDD equipment, call 1-800-829-4059 to ask tax questions or to order forms and publications.
-
TeleTax topics. Call 1-800-829-4477 to listen to pre-recorded messages covering various tax topics.
-
Refund information. To check the status of your 2008 refund, call 1-800-829-1954 during business hours or 1-800-829-4477 (automated refund information 24 hours a day, 7 days a week). Wait at least 72 hours after the IRS acknowledges receipt of your e-filed return, or 3 to 4 weeks after mailing a paper return. If you filed Form 8379 with your return, wait 14 weeks (11 weeks if you filed electronically). Have your 2008 tax return available so you can provide your social security number, your filing status, and the exact whole dollar amount of your refund. Refunds are sent out weekly on Fridays. If you check the status of your refund and are not given the date it will be issued, please wait until the next week before checking back.
-
Other refund information. To check the status of a prior year refund or amended return refund, call 1-800-829-1954.
-
Products. You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and publications. Some IRS offices, libraries, grocery stores, copy centers, city and county government offices, credit unions, and office supply stores have a collection of products available to print from a CD or photocopy from reproducible proofs. Also, some IRS offices and libraries have the Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes.
-
Services. You can walk in to your local Taxpayer Assistance Center every business day for personal, face-to-face tax help. An employee can explain IRS letters, request adjustments to your tax account, or help you set up a payment plan. If you need to resolve a tax problem, have questions about how the tax law applies to your individual tax return, or you are more comfortable talking with someone in person, visit your local Taxpayer Assistance Center where you can spread out your records and talk with an IRS representative face-to-face. No appointment is necessary—just walk in. If you prefer, you can call your local Center and leave a message requesting an appointment to resolve a tax account issue. A representative will call you back within 2 business days to schedule an in-person appointment at your convenience. If you have an ongoing, complex tax account problem or a special need, such as a disability, an appointment can be requested. All other issues will be handled without an appointment. To find the number of your local office, go to www.irs.gov/localcontacts or look in the phone book under United States Government, Internal Revenue Service.
Internal Revenue Service
1201 N. Mitsubishi Motorway
Bloomington, IL 61705-6613
-
Current-year forms, instructions, and publications.
-
Prior-year forms, instructions, and publications.
-
Tax Map: an electronic research tool and finding aid.
-
Tax law frequently asked questions.
-
Tax Topics from the IRS telephone response system.
-
Internal Revenue Code—Title 26 of the U.S. Code.
-
Fill-in, print, and save features for most tax forms.
-
Internal Revenue Bulletins.
-
Toll-free and email technical support.
-
Two releases during the year.
– The first release will ship the beginning of January 2009.
– The final release will ship the beginning of March 2009.
www.irs.gov/cdorders for $30 (no handling fee) or call 1-877-233-6767 toll free to buy the DVD for $30 (plus a $6 handling fee). Small Business Resource Guide 2009. This online guide is a must for every small business owner or any taxpayer about to start a business. This year's guide includes:
-
Helpful information, such as how to prepare a business plan, find financing for your business, and much more.
-
All the business tax forms, instructions, and publications needed to successfully manage a business.
-
Tax law changes for 2009.
-
Tax Map: an electronic research tool and finding aid.
-
Web links to various government agencies, business associations, and IRS organizations.
-
“Rate the Product” survey—your opportunity to suggest changes for future editions.
-
A site map of the guide to help you navigate the pages with ease.
-
An interactive “Teens in Biz” module that gives practical tips for teens about starting their own business, creating a business plan, and filing taxes.
Worksheet. Additional Foreign Tax Credit on U.S. income*
| I. U.S. tax on U.S. source income | COL. A | COL. B | ||||
|---|---|---|---|---|---|---|
| (U.S. source rules) | ||||||
| 1. | Dividends | |||||
| 2. | Interest | |||||
| 3. | Royalties | |||||
| 4. | Capital gain | |||||
| 5. | a. | Gross earned income | ||||
| b. | Allocable employee business expenses | |||||
| c. | Net compensation. Subtract line 5b from line 5a | |||||
| 6. | a. | Gross rent, real property | ||||
| b. | Direct expenses | |||||
| c. | Net rent. Subtract line 6b from line 6a | |||||
| 7. | Other | |||||
| 8. | Add lines 1–5a, 6a and 7 in columns A and lines 1–4, 5c, 6c and 7 in column B | |||||
| 9. | Enter tax from Form 1040 (see instructions) | |||||
| 10. | Enter adjusted gross income (AGI) from line 37, Form 1040 | |||||
| 11. | Divide line 9 by line 10. Enter the result as a decimal. This is the average tax rate on your AGI. | |||||
| 12. | Multiply line 11 by line 8 (column B). This is your estimated U.S. tax on your U.S. source income. | |||||
| II. Tax at source allowable under treaty | ||||||
| A. | Items fully taxable by U.S. | |||||
| 13. | a. | Identify | ||||
| b. | Multiply line 13a by line 11 | |||||
| B. | Items partly taxable by U.S. | |||||
| 14. | a. | Identify | ||||
| b. | Treaty rate | |||||
| c. | Allowable tax at source (Multiply line 14a by line 14b) | |||||
| 15. | a. | Identify | ||||
| b. | Treaty rate | |||||
| c. | Allowable tax at source (Multiply line 15a by line 15b) | |||||
| 16. | Total (Add lines 13b, 14c, and 15c) | |||||
| C. | Identify each item of U.S. source income from Col. A, Step I, on which the U.S. may not, under treaty, tax residents of the other country who are not U.S. citizens |
|||||
| III. Additional credit | ||||||
| 17. | Residence country tax on U.S. source income before foreign tax credit | |||||
| 18. | Foreign tax credit allowed by residence country for U.S. income tax paid | |||||
| 19. | Maximum credit. Subtract the greater of line 16 or line 18 from line 12. | |||||
| 20. | a. | Enter the amount from line 17 | ||||
| b. | Enter the greater of line 16 or line 18 | |||||
| c. | Subtract line 20b from line 20a | |||||
| 21. | Additional credit. Enter the smaller of line 19 or line 20c. Add this amount to line 29 of Part IV Form 1116. | |||||
| * See the discussion on Tax Treaties for information on when you should use this worksheet. |
Worksheet Instructions.Additional Foreign Tax Credit on U.S. Income
| STEP I | |
| Figure the estimated tax on U.S. source income using U.S. source rules. | |
| Lines 1–7 — Enter the gross amount for each type of income in Column A, and the net amount in Column B. | |
| Line 9 — Enter the amount from Form 1040, line 44. | |
| STEP II | |
| Determine the amount of tax that the United States is allowed to collect at source under the treaty on income of residents of the other country who are not U.S. citizens. | |
| PART A — Income fully taxable by the United States. Identify the type and amount on line 13a. | |
| PART B — Income for which treaty limits U.S. tax at source. | |
| Lines 14–15 — Identify each type and amount of income. Use the specified treaty rate. (See Publication 901, U.S. Tax Treaties.) | |
| PART C — Identify the items not taxable at source by the United States under the treaty. | |
| STEP III | |
| Figure the amount of the additional credit for foreign taxes paid or accrued on U.S. source income. The additional credit is limited to the difference between the estimated U.S. tax (Step I) and the greater of the allowable U.S. tax at source (Step II) or the foreign tax credit allowed by the residence country (line 18). | |
| Line 17 — Enter the amount of the residence country tax on your U.S. source income before reduction for foreign tax credits. If possible, use the fraction of the pre-credit residence country tax which U.S. source taxable income bears to total taxable income. Otherwise, report that fraction of the pre-credit foreign tax which gross U.S. income bears to total gross income for foreign tax purposes. | |
| Line 21 — This amount may be claimed as a foreign tax credit on Form 1116. Complete Form 1116 according to the instructions. Add the additional credit to line 29, Part IV, of Form 1116 and report that total on your Form 1040. File this worksheet with your Form 1040 as an attachment to Form 1116. | |
| More Online Publications |