What Form 1118 Is For
Form 1118 helps corporations determine how much of their U.S. tax liability can be offset by foreign taxes paid on international income. The foreign tax credit prevents the same income from being taxed twice, both abroad and in the United States. Corporations use the form to report foreign-source income, identify foreign income taxes that qualify for the credit, and calculate limits for each income category. It applies to businesses with foreign activities, including those that own or work with controlled foreign corporations.
When You’d Use Form 1118
Corporations file Form 1118 when they want to claim a foreign tax credit on their corporate tax return. It is required anytime a business pays or accrues foreign income taxes and chooses to apply those amounts against its U.S. tax liability. You may also need it when reporting foreign-source income through controlled foreign corporations or other foreign activities.
Schedules A and J must be filed even if the credit is not taken, as long as there are changes to foreign and domestic loss account balances. An amended return is required when foreign tax redeterminations occur, such as when the amount of tax paid differs from what was initially reported or when a foreign country issues a refund. Review how the IRS Collection Process works when foreign tax adjustments or Form 1118 errors change a corporation’s U.S. tax liability.
Key Rules or Details for Tax Year 2021
Several rules apply to Form 1118 for the 2021 tax year. Corporations must complete a separate form for each income category. These include passive category income, foreign branch category income, Section 951A income, Section 901(j) income, and other types of foreign-source income. Each category has its own credit limit, reflecting the tax burden associated with that specific income group.
Qualified and Nonqualified Taxes
- Qualified: Only certain foreign income taxes may be used to compute the credit.
- Not qualified: Taxes tied to sanctioned countries, holding-period issues, or other rules that prevent the credit from being used in abusive situations cannot be included.
Carryback and Carryforward Rules
Excess foreign tax credits may be carried back one year and carried forward for up to ten years. These carryback and carryforward rules do not apply to Section 951A income.
Documentation and Schedules
The Internal Revenue Service may request proof of foreign taxes paid, exchange rate records, or details supporting deductions on Schedule H. Corporations may also need to report foreign oil and gas income on Schedule I and track adjustments or carryovers through Schedule K, Schedule G, Schedule B, or Schedule L.
Visit our IRS Form Help Center for support with related filings such as Form 5471, 1118 schedules, or amended corporate returns.
Step-by-Step (High Level)
Form 1118 is detailed, but you can think of the process in a few main stages.
- Identify your income categories: Determine whether your corporation has general category income, passive category income, foreign branch category income, Section 951A income, Section 901(j) income, or other foreign-source income. A separate Form 1118 is needed for each category.
- Complete Schedule A: For each category, use Schedule A to compute foreign source gross income and related adjustments.
- Complete allocation and limitation schedules: Use Schedule H to apportion shared deductions, then complete Schedule B to calculate the foreign tax credit limitation for each category.
- Add specialized schedules if required: Depending on your situation, you may also need to report reductions, oil and gas adjustments, loss accounts, and credit carryovers using Schedule G, Schedule I, Schedule J, Schedule K, or Schedule L.
- Transfer totals to your corporate tax return: After completing all schedules, carry the final credit amounts to the corresponding lines on your corporate tax return for the year.
Common Mistakes and How to Avoid Them
Many filing problems arise from how corporations report foreign taxes and categorize foreign-source income on Form 1118. The issues listed below often occur, along with practical steps to prevent them.
- Placing income in the wrong category: This affects the credit limit for each group. Review category definitions and confirm whether items fall under passive category income, foreign branch category income, or other required groups.
- Missing or incomplete documentation: Lack of proof for credits tied to controlled foreign corporations can cause delays during an Internal Revenue Service review.
Keep organized records of payments, exchange rates, and supporting calculations throughout the year. - Ignoring foreign tax redeterminations: Refunds or corrections from a foreign country may require amended filings. Track foreign tax changes regularly and review foreign statements before filing your return.
- Leaving schedules incomplete: Missing entries on Schedule B, Schedule H, or other schedules can lead to incorrect totals. Use a checklist to confirm that each required schedule is compiled in accordance with your corporation’s activities.
- Not tracking carryovers correctly: Mistakes on Schedule K can affect credits in later years. Compare opening and closing balances each year and verify that all carrybacks or carryforwards are documented.
Consistent review, accurate categorization, and maintaining detailed records can help prevent these issues. Discover how penalty abatement can help when missing information is returned or incorrect foreign tax categorizations result in IRS penalties.
What Happens After You File
After you submit Form 1118 with your corporate tax return, the Internal Revenue Service reviews your entries and may request proof of foreign taxes paid or records tied to foreign-source income. If a foreign country later changes the tax you paid, you may need to update your filing to reflect a foreign tax redetermination.
Any unused credits are carried back or carried forward according to the carryback or carryforward rules, and they should be tracked on Schedule K. Missing information returns connected to controlled foreign corporations can also result in penalties.
FAQs
Why are separate Forms 1118 required for each income category?
Each category, such as passive category income or foreign branch category income, has its own credit limit. Separate forms prevent higher-taxed income from offsetting U.S. taxes tied to lower-taxed income.
Can unused foreign tax credits be carried to other years?
Yes, excess credits can be carried back one year and carried forward for up to ten years. These adjustments should be tracked through Schedule K to maintain accurate balances for future filings.
When does a foreign tax redetermination require an amended return?
An amended return is needed when changes in foreign taxes affect your U.S. tax liability. This can occur when a foreign country issues a refund or when the amount paid differs from the amount originally reported.
Can foreign corporations use Form 1118?
Foreign corporations may file the form only when the income is connected to a U.S. trade or business. In such cases, the form helps calculate the foreign tax credit associated with that activity.
What happens if the required foreign information returns are not filed?
Missing filings related to controlled foreign corporations, such as Form 5471, can result in penalties and a reduction of available tax credits. The Internal Revenue Service may impose additional charges if the missing forms are not corrected promptly.
