What Form 1118 Is For
Form 1118 helps corporations claim the foreign tax credit for income taxes paid or accrued to a foreign country. It calculates how much of those foreign income taxes can be offset against the U.S. tax bill on the same income, helping to prevent double taxation. Corporations must complete a separate form for each category of foreign source income, such as passive or general income. It is attached to Form 1120. It supports the accurate reporting of foreign taxes, deductions, and related calculations.
When You’d Use Form 1118
Corporations file IRS Form 1118 (2013) when they pay or accrue foreign income taxes and want to claim the foreign tax credit instead of deducting those taxes. You would use the form in situations such as
- The corporation earns foreign-source income and must demonstrate how foreign tax paid or accrued affects its U.S. tax liability.
- The corporation needs to file a late or amended return, especially when earlier filings included estimates that later changed.
- A foreign tax redetermination occurs because the final taxes paid differ from the amounts initially claimed.
- The corporation must carry unused foreign tax credits back to a prior tax year or forward to a later tax year.
- The foreign country issues a refund or adjustment, requiring the corporation to update its accounting for foreign taxes.
- The corporation must reclassify income categories, such as passive or general income, under the separate limitation rules.
In all situations, the corporation must also keep supporting documentation showing how the foreign taxes were paid and accrued. Understand how penalty abatement may apply when late foreign tax redeterminations or amended filings lead to accuracy-related penalties.
Key Rules or Details for 2013
The Internal Revenue Service applies specific rules to determine how corporations claim the foreign tax credit on IRS Form 1118 (2013). These rules govern the calculation of foreign income taxes paid, the grouping of income, and which items qualify for the credit. Key requirements for the 2013 tax year include:
- Foreign tax credit limitation: This rule caps the credit at the share of U.S. tax tied to foreign taxable income, so the credit cannot offset U.S. income tax.
- Separate category reporting: Corporations must categorize income into distinct categories, such as general income, passive income, or income from a foreign branch, as each category has its own specific rules.
- Treatment of income items: Corporations must report dividends, interest, royalties, capital gains, wages, and services, since all items influence gross income and the limitation amount.
- Non-creditable taxes: Taxes tied to war profits, certain foreign oil activities, or amounts covered by the foreign earned income exclusion cannot be claimed because they are not subject to U.S. tax.
- Election to deduct foreign taxes: Corporations may choose to deduct foreign taxes; however, this decision affects how unused credits are carried forward.
- Deemed-paid taxes: Some foreign subsidiary taxes are treated as deemed paid, meaning they are considered paid on the corporation’s behalf.
- Required schedules: Corporations must complete the proper schedule, including Schedule I, to report adjustments and limitation details for the tax year.
These rules ensure consistent reporting and help taxpayers apply the credit correctly for the 2013 tax year. Learn how IRS transcripts help corporations confirm posted foreign tax payments, carryovers, and prior-year adjustments.
Step-by-Step (High Level)
These steps provide clear guidance on how corporations complete IRS Form 1118 (2013) and calculate the foreign tax credit:
- Identify income categories: Begin by grouping all foreign-source income, including any separately limited income, so that each category can be calculated correctly.
- Complete Schedule A: You should report foreign income and deductions for each applicable country and confirm that the figures match your internal records.
- Complete Schedule B: You must list all foreign taxes paid or accrued and tie each amount to the related type of foreign income.
- Complete Schedule C as needed: You should calculate deemed-paid taxes when the corporation owns foreign subsidiaries, using an example to verify that the computation is accurate.
- Apply the limitation formula: You must determine the allowable credit by applying the foreign tax credit rules to the corporation’s taxable income.
- Review excluded items: You should confirm that excluded items, such as Social Security benefits, are not included in the calculation because they are not necessarily taxable for these purposes.
- Attach required schedules: You must attach all applicable schedules, including any needed adjustments, when filing Form 1118 with the corporate return.
Common Mistakes and How to Avoid Them
Corporations often encounter issues when completing IRS Form 1118 (2013), but most problems can be avoided with careful review and accurate recordkeeping. The most frequent mistakes include:
- Combining income categories: Some filers place all foreign income on one form; however, it is recommended to prepare a separate Form 1118 for each category to ensure the credit is calculated correctly.
- Misclassifying income: Many errors stem from the incorrect application of look-through rules. Review how dividends, interest, and other payments flow from subsidiaries before assigning a category.
- Using the wrong exchange rates: Corporations sometimes apply inconsistent rates, so it is essential to confirm whether the tax was paid or accrued and use the correct rate for that specific situation.
- Incorrect subsidiary calculations: Errors often occur when tracking earnings and foreign tax pools. Maintain clear documentation for each entity before completing deemed-paid calculations.
- Missing required adjustments: Some filers skip limitation adjustments, so you should verify all deductions and loss recapture items before finalizing the credit amount.
Understand how the IRS collection process applies when corporate foreign tax credits are reduced, and additional tax becomes due.
What Happens After You File
Once the corporation files IRS Form 1118 (2013) with its return, the IRS reviews the foreign tax credit calculation to confirm that the reported amounts match the rules for foreign income and foreign taxes. Large or complex credit claims may result in a more thorough review of records, including country-level tax payments and subsidiary schedules. If foreign taxes change later, the corporation must update its filing through an amended return and adjust any related carryforwards.
FAQs
How does Form 1118 help with foreign-sourced income?
Form 1118 reports foreign-source income, allowing the corporation to demonstrate how that income relates to foreign income taxes and determine the correct credit under U.S. rules.
How does the foreign tax credit limitation affect the amount I can claim?
The foreign tax credit limitation caps the credit at the portion of U.S. tax attributable to foreign income, even when the foreign tax paid exceeds the allowed amount.
Can I claim the credit if my income qualifies for the Foreign Earned Income Exclusion?
No, income covered by the foreign earned income exclusion does not count toward the credit calculation because it is not included in foreign income for U.S. tax purposes.
What should I do if foreign tax redeterminations occur after filing?
You must file an amended Form 1118 when foreign tax redeterminations change the amount of foreign tax owed, refunded, or adjusted by the foreign country.
Are taxes tied to foreign oil activities eligible for the credit?
Some taxes connected to foreign oil activities may be limited or excluded, depending on how the foreign country applies its rules and how the income is reported.
