IRS Form 1118 (2012): Foreign Tax Credit for Corporations

What Form 1118 Is For

Corporations use Form 1118 to claim a credit for income taxes paid to foreign countries or U.S. possessions. This credit stops the same income from being taxed in both the U.S. and abroad. The form applies to several types of foreign income taxes and requires corporations to report them by category, such as passive income or general income. It also handles “deemed paid” taxes from controlled foreign corporations, allowing U.S. parent companies to claim a share of the foreign taxes paid by their subsidiaries. 

When You’d Use Form 1118

You use Form 1118 when your corporation pays foreign income taxes and wants to claim a credit instead of taking a deduction. The election is made each year, and the choice affects how your taxable income and overall tax liability are calculated. You may also need the form if foreign taxes relate to items such as capital gains or ordinary income earned abroad, including situations where a corporation may be subject to capital gains taxes in another country.

Form 1118 is also required when filing late or amended returns. These situations arise when foreign tax amounts change, such as receiving a refund, paying accrued taxes in a different amount, or adjusting figures tied to net capital gains or other income categories. In each case, a revised Form 1118 must be filed for every affected year. 

Visit our IRS Form Help Center for support with corporate forms that are often filed alongside Form 1118, particularly when foreign income or amended returns are involved.

Key Rules or Details for the 2012 Tax Year

Below are the key rules for using Form 1118 for the 2012 tax year, written in complete sentences and kept within 200 words while including all required keywords.

• Accounting Method: You must use one accounting method, either cash or accrual, and the accrual method generally applies to later years on the corporate tax return.
  
  
• Accrued Tax Reporting: You must show when foreign taxes accrued and when they were paid, especially when the foreign government later adjusts the amount.
  
  
• Legally Owed Taxes: You may claim the credit only for taxes that are legally owed, so you cannot deduct foreign taxes that could have been refunded or reduced.
  
  
• Income Categories: You must separate foreign income into categories, including passive income, general income, investment income, long-term capital gains, short-term capital gains, and items tied to net investment income.
  
  
• Limitation Rules: You must calculate the limitation using a ratio that compares foreign source income to total taxable income, which affects how you offset capital gains or income taxed at the ordinary income tax rate.
  
  
• Asset Tracking: You must track the adjusted basis of assets that generate foreign income to support accurate calculations.
  
  
• Sanctioned Countries: You must prepare separate forms for sanctioned countries, even though those taxes cannot reduce your U.S. tax bill.
  
  
• Carryovers: You may carry excess credits back one year or forward ten years, which can interact with capital gains tax rates and tools, such as a capital gains tax calculator, when estimating net capital gains held for more than a year.

Learn how to correct unfiled or late corporate returns when foreign tax credits or redeterminations require revised filings.

Step-by-Step (High Level)

Below is a high-level overview of how Form 1118 is generally completed for the 2012 tax year.

1. Identify Foreign Income and Taxes: Start by listing all foreign-source income for the year. Include the related foreign taxes that were paid or accrued.
2. Sort Income by Category and Country: Group the income and taxes by category, such as passive income or general income. Organize each category by the specific country where it was earned.
3. Complete Schedule A: Report all foreign gross income and the related deductions on Schedule A. This information is used to determine foreign-source taxable income.
4. Complete Schedule B and Schedules C–E: Enter the foreign taxes paid or accrued on Schedule B. Use Schedules C–E to calculate deemed-paid taxes from foreign subsidiaries.
5. Allocate Deductions and Apply Limitations: Use the appropriate schedules, including Schedule H, to allocate shared deductions and apply limitations. Apply the foreign tax credit limitations based on these allocations.
6. Summarize and Report on the Corporate Return: Total the allowable credit on Form 1118 and transfer the final amount to the appropriate line of the corporate tax return.

Common Mistakes and How to Avoid Them

Below are common issues that affect Form 1118 filings, presented in a clear, consistent format that includes all required keywords naturally and concisely.

• Mixing income categories: Keeping each category distinct helps ensure accurate reporting, especially when foreign rules classify a capital asset, short-term gains, or qualified dividends differently than U.S. rules.
• Not updating returns after foreign adjustments: Filing amended returns promptly after the foreign government changes the tax amount ensures the credit calculation remains accurate and avoids problems associated with foreign tax redeterminations.
• Incorrect handling of gains and losses: Reviewing how each jurisdiction treats investment income, offset gains, capital losses, and the capital gains rate reduces the risk of misreporting, especially when reporting activity linked to a net capital loss.
• Overlooking treaty requirements: Documenting all treaty-based positions under relevant tax treaties prevents errors that could result in double taxation.
• Skipping expert guidance: Complex items tied to filing status, such as married filing jointly or married filing separately, as well as issues involving tax-advantaged accounts, qualified small business stock, selling investments, a lower tax bracket, or losing money, often require input from a tax professional or financial advisor to ensure correct treatment.

Explore payment options for corporations that owe additional tax after foreign tax credit limitations or audit adjustments.

What Happens After You File

After Form 1118 is filed, the IRS may review the figures and request supporting documents, such as proof of foreign taxes paid or details used to calculate each income category. If foreign tax amounts change later, updated filings are required to reflect those adjustments. The IRS may also charge interest if the change creates a balance due. Any credits carried back or forward must be tracked carefully so they can be applied correctly in future years.

FAQs

How do capital gains affect Form 1118 reporting?

Capital gains earned in another country must be reported in the correct income category so the corporation can apply the proper limitation when completing Form 1118.

Can a corporation claim the foreign tax on capital gains taxes paid abroad?

A corporation may claim a foreign tax credit for qualifying foreign capital gains taxes, as long as the tax is legally owed and categorized adequately on the form.

How do capital losses impact the foreign tax credit calculation?

Capital losses can reduce foreign-source taxable income, which may affect the amount of credit allowed for the year.

Do capital gains tax rates matter when preparing Form 1118?

Capital gains tax rates may influence how foreign gains interact with U.S. rules, especially when comparing the foreign capital gains rate with U.S. treatment.

Can a capital gains tax calculator help estimate foreign adjustments?

A capital gains tax calculator may help estimate potential U.S. tax effects, but corporations still need accurate foreign tax records for Form 1118.