What Form 1118 Is For
Form 1118 helps corporations calculate the Foreign Tax Credit when they earn foreign income and pay foreign taxes to another country. It allows eligible foreign income taxes—including income, war profits, excess profits, and certain in-lieu-of taxes—to reduce a company’s U.S. tax liability. The form also separates income into required categories, such as passive, general, and branch baskets. Along with corporations, individuals making a Section 962 election may need this form when applying corporate-level foreign tax credit rules.
When You’d Use Form 1118
You use Form 1118 when your corporation earns foreign income and wants to claim the Foreign Tax Credit on its corporate income tax return. The form is filed with Form 1120 for the same tax year, following the standard deadline for calendar-year or fiscal-year corporations.
You also need the form when foreign events require an amended return, such as receiving a refund from a foreign government, completing a foreign tax audit, or carrying back excess credits. Form 1118 is required when accrued foreign taxes remain unpaid, as these situations result in foreign tax redeterminations that must be reported to the Internal Revenue Service.
Key Rules or Details for 2020
The 2020 version of Form 1118 follows rules shaped by the Tax Cuts and Jobs Act, which affect how corporations calculate the Foreign Tax Credit and determine how much of their foreign income taxes may offset U.S. tax. Corporations must separate foreign income into required categories, since each basket has its own limitation. The 2020 categories include:
- Section 951A income (GILTI)
- Foreign Branch Category Income
- Passive Category Income
- General Category Income
The allowable credit cannot exceed the amount calculated using the formula foreign source income ÷ worldwide income × U.S. tax liability, which prevents the credit from reducing tax owed on domestic income. Excess credits may be carried back one year and carried forward ten years, although GILTI credits cannot be carried at all.
Corporations must choose either the cash or accrual method for the tax year.
- The cash method credits taxes as they are paid.
- The accrual method credits taxes when they accrue, but if accrued taxes are not paid within twenty-four months, an amended return is required.
Some foreign taxes cannot be credited, including:
- Taxes tied to sanctioned countries under Section 901(j)
- Refundable taxes
- Taxes linked to excluded income
- Taxes affected by Section 901(m)
These rules determine which taxes qualify and the amount of credit that can be claimed. Learn how to correct missing or late corporate filings—significant when foreign tax refunds require amended Form 1118 submissions.
Step-by-Step (High Level)
Completing Form 1118 requires a precise sequence to ensure accurate reporting of foreign income and foreign taxes. The steps below summarize the process and help you understand how each part of the form fits together.
Step 1—Organize income categories
Sort foreign source income and related taxes into the required categories, such as general, passive, GILTI, and foreign branch, because each category has its own limitations.
Step 2—Complete Schedule A
Use Schedule A to report foreign-source gross income and allocable deductions for each income category, ensuring that each item is correctly assigned.
Step 3—Use Schedule H
Schedule H allocates shared deductions, such as interest and research expenses, between U.S. and foreign activities, which affects the calculation of the foreign tax credit.
Step 4—Address Schedule J, if needed
Schedule J applies when you have prior foreign losses or separate limitation loss accounts, and it determines how much current foreign income must be treated as U.S. source income.
Step 5—Calculate deemed-paid taxes
If you own controlled foreign corporations, compute deemed paid taxes using Schedules C, D, E, or the F-series schedules.
Step 6—Report taxes on Schedule B, Parts I–III
List all foreign taxes paid or accrued, apply the foreign tax credit limitation, and determine the allowable credit for each category.
Step 7—Maintain documentation
Keep complete records, including foreign tax returns, payment proof, and exchange rate details, because the Internal Revenue Service may request them.
Review how multinational payroll and expense allocations affect Schedule H and Schedule A deductions used in Form 1118 calculations.
Common Mistakes and How to Avoid Them
Completing Form 1118 can lead to errors if key rules are overlooked. The mistakes below are among the most common and can affect the Foreign Tax Credit allowed on your return.
- Claiming non-qualifying taxes: Certain foreign taxes cannot be credited, such as refundable amounts or taxes imposed on countries with which the United States has sanctions. Before claiming any tax, make sure it meets the requirements under Section 901.
- Mixing income categories: Each income category requires its own form. Mixing passive, general, branch, or GILTI income on a single Form 1118 can result in incorrect limits and may reduce the allowable credit.
- Using both cash and accrual methods: You must use one method for the entire tax year. Switching between cash and accrual creates inconsistencies, especially when foreign taxes remain unpaid.
- Missing foreign tax redeterminations: Events such as foreign tax refunds, audit adjustments, or unpaid accrued taxes must be reported. These changes necessitate an amended return to ensure accurate filings.
- Incorrect exchange rate use: Foreign taxes must be translated into U.S. dollars using the correct exchange rate. Using the wrong rate can change the credit amount.
View IRS payment plan options that help corporations cover balances resulting from foreign tax credit limitations or audit adjustments.
What Happens After You File
After you submit Form 1118 with your corporate income tax return, the Internal Revenue Service may review the credit calculations. The agency often requests supporting documents, such as foreign tax returns, payment proof, and allocation schedules. You must also monitor any foreign tax redeterminations, including refunds or audit changes from a foreign country, since these require an amended filing. Unused credits may carry over to other years, so accurate tracking is essential. Keep all records for at least ten years to support future reviews and audits.
FAQs
Do I need to file a separate Form 1118 for each foreign corporation in which I am a shareholder?
You submit a single Form 1118 for each income category, which encompasses all foreign corporations with the same type of income.
Can I claim both a deduction and a credit for the same foreign taxes?
You must choose either the deduction or the Foreign Tax Credit for the year, and you may change that choice later by filing an amended return.
What happens if my foreign taxes exceed the credit limit?
Excess credits may be carried back one year and forward ten years, except for GILTI credits, which cannot be carried at all.
Do I need to attach receipts or foreign tax returns to my submission?
You do not attach them when filing, but you must keep complete documentation in case the Internal Revenue Service requests it.
How do foreign tax refunds affect Form 1118?
A refund or adjustment creates a foreign tax redetermination, which requires an amended return to update your credit and pay any additional tax owed.
