Form 1118 (Rev. December 2012) Checklist: Foreign Tax Credit—Corporations
Purpose and Overview
Form 1118 allows U.S. corporations to claim a credit for foreign income taxes paid or accrued on foreign-source income. The December 2012 revision tracks post-1986 and pre-1987 earnings separately under section 902 deemed-paid rules and requires disclosure of section 901(m) disqualified foreign taxes and section 909 suspension carryover amounts.
Key 2012 Reporting Requirements
The 2012 form introduces Schedule B, Part II, line 1b for reporting foreign taxes carried forward from prior years that were suspended under section 909. Section 909 applies to foreign taxes paid or accrued in taxable years beginning after December 31, 2010. It suspends foreign tax credits when there is a foreign tax credit splitting event until the related income is taken into account.
Schedule G, Part II requires corporations to answer whether they paid or accrued any foreign tax disqualified under section 901(m) or suspended under section 909. Section 901(m) was enacted on March 18, 2010, as part of the Hiring Incentives to Restore Employment Act and applies to covered asset acquisitions occurring after December 31, 2010.
Income Categorization Steps
You must separate income into distinct categories and file a separate Form 1118 for each applicable category. The categories include the following:
- Passive
- General
- Section 901(j) sanctioned country
- Income Resourced by Treaty
You must check only one box per Form 1118 to maintain proper separation of foreign source income. The 2012 instructions clarify that treaty income re-sourcing receives treatment distinct from the general category. You complete a separate foreign tax credit limitation for income sourced by treaty using a dedicated Form 1118 for each amount of sourced income from a treaty country.
Foreign Tax Reporting Method
You must check one box only on Part I, line 1, to indicate whether you claim the credit on a paid or accrued basis. The election applies consistently for all subsequent tax years unless you obtain IRS consent to change methods. You must convert all amounts to U.S. dollars using appropriate 2012 exchange rates and attach a schedule showing foreign currency amounts and the conversion rates you used.
Corporations claiming the credit on the accrual basis must generally use an average exchange rate for the tax year to translate foreign taxes into U.S. dollars. You must use the exchange rate on the date of payment if foreign taxes are paid more than two years after the close of the tax year to which they relate or if they are paid in a tax year before the year to which they relate.
Schedule Structure for Multi-Tier Calculations
The form uses three schedules to compute taxes deemed paid across multiple tiers of foreign corporations:
- Schedule C computes taxes deemed paid by the domestic corporation with respect to dividends from first-tier foreign corporations under section 902(a) and deemed inclusions under section 960(a).
- Schedule D computes taxes deemed paid by first-tier and second-tier foreign corporations, covering second-tier and third-tier foreign corporation dividends.
- Schedule E reports taxes deemed paid with respect to dividends from eligible post-1986 undistributed earnings of fourth-tier, fifth-tier, and sixth-tier controlled foreign corporations.
You must include column 10 results from Schedule C, Part I, in Schedule B, Part I, totals, and track functional currency conversions at each tier.
Post-1986 and Pre-1987 Earnings Calculations
For each controlled foreign corporation, you enter post-1986 undistributed earnings in functional currency on Schedule B. You compute tax deemed paid under section 902(a) by multiplying the opening post-1986 foreign income tax balance plus current-year taxes paid or deemed paid by the ratio of dividends or deemed inclusions to total post-1986 undistributed earnings.
Schedule B, Part II, requires dividends from pre-1987 accumulated profits computed under the former Section 902 rules that existed before the Technical and Miscellaneous Revenue Act. You must show functional currency amounts and U.S. dollar conversions separately and attach a schedule substantiating pre-1987 earnings and profits and foreign taxes.
High-Tax Kickout and Reclassification
You must reclassify income under high-tax kickout rules if any foreign tax rate exceeds the U.S. corporate tax rate. You enter reclassified tax amounts on Schedule B, Part II, line 4, and provide separate documentation of income and tax calculations supporting the kickout determination.
The 2012 instructions require you to aggregate all reclassifications of high-taxed income and report the total on a single line in Schedule A.
Deduction Apportionment Methods
Schedule H requires you to select one approved method for apportioning research and development and interest deductions not definitely allocable to specific income. You choose among the following methods:
- Sales Method
- Gross Income Method (Option 1 or Option 2)
- Fair Market Value and Tax Book Value Method
You must apportion total research and development and interest deductions among statutory groupings, including General, Passive, Section 901(j), and Treaty categories. You enter the final apportionment results in column 10 of Schedule A to properly allocate deductions across foreign source income categories. The apportionment ensures compliance with sections 861 through 865 allocation and apportionment regulations.
Filing and Documentation Standards
You must complete the following filing requirements:
- Attach Form 1118 to the corporation's income tax return when electing the benefits of the foreign tax credit under section 901.
- Fill in all required information and show calculations of credits as indicated on the form schedules.
- Present proof upon request to substantiate the credit claimed, even though the IRS does not require you to attach receipts or foreign tax returns to Form 1118.
You may carry excess foreign taxes back one year or forward ten years to offset taxes imposed in the same separate category. You file an amended return with a revised Form 1118 and schedules, including a revised Schedule K, if you carry the excess credit back to an earlier year.
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This checklist is for educational purposes only and does not constitute tax or legal advice. Always review official IRS instructions and consult a qualified professional for guidance.
