Instructions for Form 1118 | Foreign Tax
Credit—Corporations Checklist (2016 Tax Year)
Understanding Form 1118 Requirements
Form 1118 allows domestic corporations to claim a foreign tax credit for income taxes paid or accrued to foreign countries during the 2016 tax year. This foreign tax credit reduces United
States tax liability dollar-for-dollar based on foreign-source income taxes paid.
Before completing Form 1118, domestic corporations must confirm that creditable foreign taxes were paid during 2016. Under section 904, only taxes imposed on income qualify as creditable foreign taxes. Taxes on imports, payroll, property, or sales do not qualify for the credit. To be considered creditable, the foreign country must impose a tax that is substantially similar to the
United States income tax.
Separate Limitation Categories for 2016
For the 2016 tax year, domestic corporations filing Form 1118 use two separate limitation categories: passive category income and general category income. Each category requires its own limitation calculation on separate Form 1118 schedules under section 904.
Passive category income includes dividends, interest, royalties, rents, and annuities received from foreign sources. General category income consists of all other foreign source income not classified as passive.
Financial services income is treated as general category income for domestic corporations that are members of a financial services group or are predominantly engaged in banking, insurance, financing, or similar businesses. Commingling categories or misclassifying income reduces your overall credit and may trigger examination adjustments under section 904.
Computing Foreign Source Taxable Income
Domestic corporations must calculate foreign source taxable income separately for each limitation category under section 904. Start with foreign gross income, then subtract deductions allocable to foreign sources using the allocation and apportionment rules specified in the 2016
Form 1118 instructions.
Match deductions to the income they relate to using proper apportionment methods. Improper deduction allocation represents one of the most common errors on Form 1118 and typically results in correction notices during examination.
The 2016 allocation rules differ from the post-TCJA treatment of intangible deductions, so domestic corporations should carefully review the specific 2016 guidance. Calculate each category separately to ensure accurate limitation fractions for the credit computation.
Credit or Deduction Election
Domestic corporations may choose to take either a credit or a deduction for eligible foreign taxes paid or accrued. This choice is made annually by filing or not filing Form 1118 with the corporate return.
Attaching Form 1118 to the return establishes the election to claim the foreign tax credit.
Domestic corporations that elect the foreign tax credit for any tax year cannot claim a deduction for those same foreign taxes in that year.
For corporations using the accrual method for foreign taxes, the election should be documented on the return for the first year for which it is claimed. Corporations using the cash method may elect to claim credits for accrued taxes under section 905(a), and the election applies to all subsequent tax years.
Calculating the Limitation Amount
The United States tax liability limitation under section 904 prevents domestic corporations from claiming a credit larger than the United States tax attributable to foreign-source income.
Calculate your limitation by determining the United States tax before the foreign tax credit, then multiply by the fraction of foreign-source taxable income over worldwide taxable income.
Compute this fraction separately for each limitation category under section 904. Enter the total foreign income taxes paid or accrued during 2016 on the appropriate line of Schedule B.
Convert foreign currency amounts to United States dollars using the exchange rates specified in the 2016 instructions. Report only taxes that qualify as creditable foreign income taxes, and separately document other foreign levies on worksheets or attachments.
Carryback and Carryforward Provisions
When 2016 foreign taxes exceed the section 904 limitation for a category, the excess is treated as a carryback or carryforward. Under 2016 rules, domestic corporations may carry unused foreign tax credits back one year or forward ten years.
The excess is applied first to the earliest available year, then to the next earliest year in sequence. Domestic corporations cannot carry credits to a tax year in which they claimed a deduction rather than a credit for foreign taxes. If you elect to forgo the carryback, document this election with your return. Domestic corporations cannot claim a carryback after filing without obtaining Internal Revenue Service consent.
Required Schedules and Documentation
Complete schedules based on applicability to your specific situation. Schedule A is required for all domestic corporations filing Form 1118 to report gross income or loss from foreign sources.
Schedule B, Parts I and II, is required for all domestic corporations to report foreign taxes paid, accrued, and deemed paid. Schedules C through G are completed only when applicable based on deemed paid credits, foreign branches, or required tax reductions. Schedule H is required when domestic corporations apportion deductions that cannot be definitely allocated to specific income. Schedules I, J, and K are separate schedules completed only when applicable to your situation.
Attach complete worksheets showing tax calculations, rates, and category assignments for each jurisdiction where tax was paid. Missing country-by-country documentation represents a common deficiency that delays processing and may trigger examination.
Key 2016 Tax Year Provisions
The 2016 Form 1118 instructions reflect pre-Tax Cuts and Jobs Act rules. Global intangible low-taxed income, base erosion and anti-abuse tax, and foreign-derived intangible income did not apply to tax years before 2018.
Foreign branch income was an exempt limitation category under section 904 in 2016. Changes to separate limitation categories, subpart F treatment, and deemed paid credits occur in 2018, not 2016. Creditable foreign taxes must be identified separately by country and category using line-by-line documentation of each section 904 limitation computation. Domestic corporations
should transfer the allowable foreign tax credit from Form 1118 to Form 1120 or the applicable corporate return at the designated line.
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