Instructions for Form 1118 | Foreign Tax
Credit—Corporations Checklist 2014 Tax Year
Understanding Form 1118 and Corporate Eligibility
Domestic corporations use Form 1118 to compute their foreign tax credit for income taxes paid or accrued to foreign countries or U.S. possessions. The form applies to any corporation that elects the benefits of the foreign tax credit under section 901 of the Internal Revenue Code of
1986, while foreign corporations may also file under section 906 when claiming income credits effectively connected with U.S. business operations.
By 2014, the passive category income and general category income framework had been in effect for seven years following the implementation of the American Jobs Creation Act of 2004.
Corporations must calculate separate foreign tax credit limitations for each applicable income category rather than using a single combined limitation.
Income Categorization Requirements
Before calculating your credit limit, separate your foreign-source income into the required categories. Passive category income includes dividends, interest income, royalties, and certain rents from unrelated parties that would constitute foreign personal holding company income under section 954.
General category income includes foreign income that does not fall under the passive category, such as foreign branch business profits, manufacturing income, and earnings from active business operations. High-taxed passive income is treated differently under the high-tax kickout
rules in Regulations section 1.904-4(c), which reclassifies certain passive income to the general
category income when foreign income taxes exceed specific thresholds.
Essential Documentation and Record Retention
Gather comprehensive documentation before completing Form 1118 to support your foreign tax credit claim. You need copies of all foreign tax returns filed during the taxable year, official payment receipts showing dates and amounts paid, and tax certificates issued by the foreign government or governments where you conducted business.
Maintain records that clearly link foreign tax amounts to the related foreign source income within each category. Translate all foreign language documents into English to facilitate IRS review if requested, though the IRS does not require you to attach receipts or foreign tax returns to Form
1118 at filing.
Computing the Foreign Tax Credit Limitation
Each income category requires its own credit limitation calculation. Use the formula in Form
1118, Part I, to compute the limitation separately for passive category income and general category income. This calculation is based on the ratio of foreign source income in each category to your total worldwide taxable income, multiplied by your U.S. federal income tax liability.
Report foreign source income totals on the correct line for each category, ensuring passive and general income are correctly classified. According to the 2014 Form 1118 instructions, elections that combine specific categories must be clearly identified and can affect how limitations are calculated in future tax years.
Country-by-Country Tax Reporting
List each foreign country using the appropriate two-letter country code in Schedule A, column 1, along with the income tax amounts paid or accrued to each jurisdiction. Organize your reporting by income category, showing country-by-country foreign taxes withheld on dividends, interest income, and other passive category amounts in Form 1118, Part II.
Attach additional schedules when you paid taxes to more than ten foreign countries during the taxable year. You may claim foreign tax credits using either the cash method or the accrual method under section 901(a), but you cannot use both methods in the same year.
Managing Excess Credits and Carryover Periods
Compare your total foreign income taxes paid against the limitation calculated for each category.
Document excess amounts when foreign taxes exceed your limitation, as these unused credits qualify for carryback and carryforward treatment under the established rules for tax credits.
You may carry excess foreign tax credits back one year to offset taxes in the immediately preceding taxable year. Alternatively, you may have unused credits carried forward for 10 years
to offset taxes in the same category in future years, and the 2014 rules require separate tracking for passive and general category excess credits.
Filing Requirements and Form Integration
Attach Form 1118 to your corporate income tax return, which is typically Form 1120 for domestic corporations. Form 1118 covers both foreign country taxes and U.S. possession taxes within a single filing, eliminating the need for separate forms when claiming credits for taxes paid to
Puerto Rico or other U.S. possessions.
Complete Schedule F to report gross income and definitely allocable deductions from your foreign branches, and use Schedule H to apportion deductions that cannot be definitely allocated to specific income categories. Foreign branch reporting follows the standard procedures outlined in the form instructions without requiring separate reporting under international boycott provisions.
Controlled Foreign Corporation Considerations
Shareholders in a controlled foreign corporation must apply look-through rules under section
904(d)(3) when receiving dividends, interest, or royalties from their CFCs. These rules assign income to appropriate separate categories based on the earnings and profits from which the distributions or payments are made.
Section 951A addresses Global Intangible Low-Taxed Income inclusions for applicable CFC shareholders subject to specific foreign tax credit limitations. The Internal Revenue Code of
1986 provides detailed guidance on deemed paid credits under section 902 for dividends received from foreign corporations in which the domestic corporation holds sufficient ownership.
Record Maintenance and Audit Support
Maintain permanent records of all calculation worksheets, foreign tax documentation, and supporting schedules to provide audit support if the IRS examines your foreign tax credit claim.
Documentation must substantiate the source of income, the amount of foreign income taxes paid or accrued, and the proper categorization of income under passive or general category classifications.
Your records should trace foreign exchange rate conversions when translating amounts from foreign currencies into U.S. dollars for reporting purposes. The IRS may request proof of
payment or accrual at any time during the applicable statute of limitations period for your taxable year.
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