What Form 1118 Is For
Form 1118 is used to claim a credit for Foreign Income Taxes that a corporation paid or accrued overseas. This credit lowers the corporation’s U.S. Corporate Tax on the same income. Without it, the corporation may face double taxation.
To use the form, the filer reports Foreign Taxable Income, identifies the source of the income, and lists the foreign taxes tied to that income. Form 1118 calculates the allowable credit under IRS limits and ensures the correct column headings and income categories are reported. Corporations with several foreign activities often must file multiple Forms 1118, one for each income category.
When You’d Use Form 1118
Corporations attach Form 1118 to Form 1120 when they want to claim the foreign tax credit instead of deducting foreign taxes as an expense. This form is required whenever a corporation has foreign income and chooses to apply the credit.
Form 1118 is also needed when foreign tax amounts change after the original filing year. These events, referred to as foreign tax “redeterminations,” include refunds, corrections, or delayed payments. If a redetermination occurs, the corporation must file an amended return with a revised Form 1118. Missing these deadlines may result in penalties, primarily when the changes affect multiple item files or involve carryovers.
Key Rules or Details for 2014
- Income Categories: Corporations must separate foreign income into passive, general, and section 901(j) categories, and each category must be calculated on its own schedule.
- Credit Limitation Formula: The foreign tax credit limit is based on a formula that compares foreign income to worldwide income, preventing credits from being used across unrelated categories.
- Carrybacks and Carryforwards: Foreign taxes that exceed the limit may be carried back one year or carried forward ten years, and all carryover activity must stay within the original income category.
- Qualifying Taxes: Only income taxes qualify for the foreign tax credit under IRS rules; therefore, sales taxes and property taxes cannot be included on the form.
- Sanctioned Country Rules: Income from sanctioned countries must be reported separately, and such taxes do not generate credits for the corporation.
- Deemed Paid Credits: Corporations with repatriated income from foreign subsidiaries may need to calculate considered-to-be-paid credits using the schedules provided in Form 1118.
Step-by-Step (High Level)
Determine Applicable Income Categories
Create a list of all your foreign-earned income and categorize it accordingly. This early step establishes the structure for the remainder of the filing.
Complete Schedule A
Schedule A reports gross foreign-source income and the deductions tied to that income. After subtracting directly allocable expenses, the corporation arrives at the taxable amount for each category.
Complete Schedule B
Schedule B lists foreign taxes paid or accrued and calculates the credit limit. This is where you determine whether the allowable credit matches the taxes paid. When reviewing line 3 or similar fields, verify that the amounts match the supporting documents.
Schedules C–E (If Applicable)
These apply when the corporation claims “deemed paid” credits for taxes paid by foreign subsidiaries. They must be closely monitored both domestically and internationally. In the U.S., Multinational Corporations often rely on them when reporting dividends or specific inclusions.
Schedules F–H and J–K
These schedules support additional adjustments:
- Schedule F reports foreign branch income.
- Schedule G displays any required reductions that result from penalties or suspended taxes.
- Schedule H allocates expenses that cannot be attributed to a specific country or activity.
- Schedule J adjusts for overall foreign or domestic losses.
- Schedule K tracks carryovers from earlier years and helps calculate the final credit on Schedule B.
These schedules work together to produce the final credit, which is then transferred to the primary corporate return.
Common Mistakes and How to Avoid Them
Many corporations encounter difficulties when completing Form 1118 because the rules are detailed and the calculations rely on accurate records. The points below highlight the most frequent errors and offer simple steps to avoid them.
- Incorrect Income Grouping: Ensure that each foreign income item is carefully reviewed and accurately assigned to the corresponding category before completing any schedules.
- Claiming Non-Qualifying Taxes: Ensure that each foreign tax is final and nonrefundable before including it in the credit calculation.
- Reference ID Errors: Maintain a consistent ID system and update internal records promptly whenever a subsidiary merges, closes, or undergoes restructuring.
- Missed Redeterminations: Track foreign tax payments and refunds throughout the year and set reminders to review changes before filing.
- Exchange Rate Errors: Follow IRS rules for each tax type and document the rate source used for every entry.
- Poor Recordkeeping: Keep detailed foreign tax receipts, payment confirmations, rate records, and schedules in a centralized filing system.
What Happens After You File
If the foreign tax credit exceeds the limit, the excess may be carried back or carried forward to the next tax year. The corporation updates these figures in Schedule K and tracks them across categories. The IRS may ask for documentation to support the foreign tax credit. This may include Item Files, receipts, foreign returns, or records used to calculate exchange rates. In certain situations, the IRS may require a bond to secure unpaid taxes that have accrued.
When a foreign tax refund is issued, the corporation must file an amended return and adjust its future carryovers accordingly. Changes for foreign subsidiaries may also affect earnings pools tied to repatriated income.
FAQs
Can a corporation choose between claiming a credit and taking a deduction?
Yes, a corporation may claim a credit or deduct foreign taxes, but the choice applies to the entire tax year.
What happens if foreign taxes exceed the credit limitation?
The excess may be carried back one year and carried forward ten years within the same income category.
Do small corporations still need to file Form 1118?
Yes, even a single foreign tax payment requires Form 1118 to claim the credit.
Can I claim credit for accrued but unpaid foreign taxes?
Accrual-basis corporations may claim them, but the IRS may require a bond until the taxes are paid.
How do deemed paid taxes work for foreign subsidiaries?
These credits apply when a corporation owns a sufficient amount of a foreign subsidiary to meet the ownership requirements and reports certain dividends or income inclusions.
What if I receive a refund of foreign taxes claimed in a prior year?
To modify the credit and fix carryovers, an amended return is needed.
How is income from sanctioned countries handled?
Section 901(j) rules apply, and the income must be reported separately and does not generate credits.
