IRS Form 1118 (2015): Foreign Tax Credit for Corporations

What Form 1118 Is For

Form 1118 helps a U.S. corporation claim the Foreign Tax Credit for taxes paid or accrued to a foreign country. It determines the amount of foreign taxes that a corporation can use to offset its U.S. tax liability for the same income. It also separates income into passive and general categories to apply the credit limits correctly. Corporations attach it to their corporate income tax return to show how the credit was figured and to support the amount claimed.

When You’d Use Form 1118

Corporations use Form 1118 when they elect the Foreign Tax Credit instead of deducting foreign taxes on their federal income tax return. The form is required when a U.S. corporation earns foreign income that is taxed by another country and wants to reduce its U.S. tax liability using those payments. 

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It also applies when a corporation files a late or amended return due to foreign tax redeterminations, differences between accrued and paid taxes, or refunds from a foreign government. Corporations may also revisit their original choice within the IRS’s 10-year period for changing a credit or deduction election. Review circumstances where unresolved foreign tax discrepancies could lead to an IRS bank levy affecting corporate accounts.

Key Rules or Details for 2015

For the 2015 tax year, several rules guide how corporations calculate and support the Foreign Tax Credit on Form 1118. These rules help determine how much foreign tax can offset U.S. tax liability.

Key points include:

• Separate limitation categories: Corporations must apply the rules to each category, mainly the passive category income and the general category income. This prevents foreign taxes from one category from offsetting U.S. tax on another category.
  
  
• Cash vs. Accrual Method: Corporations may claim foreign income taxes using either the cash or accrual method. Once the accrual method is chosen, any future changes generally require approval from the IRS.
  
  
• Deemed-paid taxes: U.S. shareholders of a foreign corporation may claim foreign income taxes paid by that entity. These credits rely on earnings and tax pool calculations outlined in Section 901.
  
  
• Special considerations for 2015:
  
  
  
  • Certain foreign taxes cannot be credited, including those imposed on or related to countries that are subject to sanctions under Section 901(j) of the Internal Revenue Code.
    
    
  • Taxes that are refundable or not legally owed must be excluded.
    
    
  • Highly taxed income may be shifted from the passive to the general category, which affects the calculation of the credit.

Corporations must follow these rules carefully to support the credit and avoid reductions or disallowance during review.

Step-by-Step (High Level) 

Begin with a high-level plan before completing any lines on Form 1118. The steps below give a simple overview of the process for the 2015 tax year.

1. Identify income categories: Decide which separate limitation categories apply, such as passive category income or general category income. You will complete a separate Form 1118 for each category of foreign source income.
   
   
2. Complete Schedule A: List foreign-sourced gross income and related deductions by country. Use the correct country codes and separate income and deductions by category.
   
   
3. Complete Schedule B: Report foreign taxes paid or accrued for each category and compute the Foreign Tax Credit limitation. Compare the limitation to total foreign taxes to determine the allowable credit.
   
   
4. Review other schedules as needed: Use Schedules C, D, and E for deemed-paid taxes from foreign corporations, and Schedules G, H, and K for reductions, allocations, carrybacks, and carry-forwards.
   
   
5. Attach to the corporate return: Ensure that the completed Form 1118 and all required schedules are attached to the corporate income tax return filed with the Internal Revenue Service.

Understand how the IRS collection process applies when revised foreign tax data reduces the allowable credit and increases tax owed.

Common Mistakes and How to Avoid Them

When preparing Form 1118, corporations often face challenges, particularly when they fail to account for foreign taxes or income categories accurately. The items below outline common errors and practical steps to prevent them.

• Claiming foreign taxes that are not legally owed:  Some foreign taxes are refundable or exceed what the foreign government requires. Review local foreign tax rules, confirm whether refunds are available, and document all communications with the foreign country before claiming the credit.
  
  
• Missing amended returns after a foreign tax redetermination: A change in accrued or paid foreign taxes often requires an amended return. Track payment dates, keep notices from foreign tax authorities, and schedule periodic reviews of foreign tax accounts.
• Keeping incomplete or inconsistent documentation:  Missing details on exchange rates, foreign income taxes, or subsidiary earnings can lead to delays or disallowance during IRS review. Maintain organized files with supporting documents, such as receipts, foreign returns, currency conversions, and revenue and profit information.
• Not preparing separate Forms 1118 for each category of income: Passive category income and general category income must be reported on individual forms. Ensure that each source of foreign income is reviewed early in the process and assigned to the appropriate limitation category before completing the schedules.
  
  
• Errors in deemed-paid tax calculations for foreign corporations can lead to incorrect calculations that either overestimate or underestimate the credit. Use updated earnings and tax pool data, review prior-year balances, and verify each calculation before completing related schedules.

What Happens After You File

After a corporation files Form 1118 with its corporate income tax return, the Internal Revenue Service may review the form to confirm that the foreign taxes and income categories were reported correctly. The agency can request supporting documents such as foreign tax receipts, exchange-rate records, earnings and profits information, and details about controlled foreign corporations.

If the corporation carries back or carries forward unused credits, the IRS processes those adjustments based on the schedules attached to the return. If a foreign tax redetermination occurs after filing, the IRS may require an amended return and impose penalties if the change remains unreported. Corporations should also track carry-forward balances each year to apply them correctly in future filings. Learn how corporate tax issues tied to foreign tax reporting can result in wage garnishment for responsible officers in some instances.

FAQs

What does the Form 1118 report?

Form 1118 shows the foreign income taxes a corporation paid or accrued and calculates how much can be claimed as a Foreign Tax Credit.

Do I need multiple Forms 1118 for various countries?

No, you file separate forms for each income category, and you list all countries within the schedules.

Can a corporation switch between taking a credit and taking a deduction?

Yes, a corporation may change its choice within the IRS’s 10-year window, and the change applies to all foreign taxes for that year.

What happens if foreign taxes exceed the U.S. limit?

Excess credits may be carried back one year or carried forward for up to ten years.

What documentation should a corporation keep?

Corporations should keep receipts, foreign tax returns, exchange-rate records, and earnings information to support the amounts reported on the form.

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