Form 1118: Foreign Tax Credit—Corporations (2021)
What the Form Is For
Form 1118 is the IRS form that U.S. corporations use to calculate and claim the foreign tax credit for income, war profits, and excess profits taxes they paid or accrued to foreign countries or U.S. possessions. Think of it as the corporate version of accounting for taxes you've already paid to other countries, so you don't get taxed twice on the same income—once abroad and once in the United States.
The foreign tax credit helps prevent this double taxation by allowing corporations to offset their U.S. tax liability with qualifying foreign taxes. Instead of paying full taxes to both countries, corporations can claim a dollar-for-dollar credit (up to certain limits) for foreign taxes paid. This credit applies only to specific types of foreign income taxes and is subject to complex rules about how much can be claimed each year.
Corporations must elect annually whether to take a credit or a deduction for foreign taxes. Once you choose the credit for a tax year, you cannot deduct those same foreign taxes as a business expense in that year or any future year. The form includes multiple detailed schedules that break down income by category, calculate deemed-paid taxes from foreign subsidiaries, and apportion deductions across different types of income.
Foreign corporations conducting business in the United States can also use Form 1118, but only for income effectively connected with their U.S. trade or business activities. Additionally, individuals who make a special election under section 962 to be taxed at corporate rates on certain foreign income inclusions must file this form.
When You'd Use This Form (Including Late or Amended Returns)
You must file Form 1118 with your corporate income tax return if your corporation elects to claim the foreign tax credit for the year. Even if you're not claiming a credit, you still need to file Schedules A and J if you have any adjustments to overall foreign loss accounts, overall domestic loss accounts, or separate limitation loss accounts.
The election to claim the foreign tax credit can be made or changed at any time before the end of a special 10-year period described in Internal Revenue Code section 6511(d)(3). This extended timeframe gives corporations significant flexibility in deciding whether to claim a credit or deduction as their tax situation becomes clearer over time. However, be aware that while the election period is generous, the limitations period for refund claims related to a foreign tax deduction may expire earlier than the credit election period.
Amended returns are required when "foreign tax redeterminations" occur—situations where the amount of foreign tax you originally reported changes. Common redetermination triggers include: when accrued foreign taxes are actually paid and the amount differs from what you accrued; when accrued taxes remain unpaid 24 months after the close of the tax year; when you receive a refund of foreign taxes; or when changes in foreign tax liability affect your foreign income inclusions or distributions. When filing an amended return for a foreign tax redetermination, you must include a detailed statement explaining the changes, dates, amounts in foreign currency, exchange rates used, and other specific information.
If a foreign tax redetermination doesn't change your U.S. tax liability, you don't need to file an amended return. Instead, you can simply notify the IRS by attaching Schedule L to your original return for the tax year in which the redetermination occurs. If you're carrying back excess foreign tax credits to an earlier year, you'll need to file an amended return for that earlier year with a revised Form 1118 and schedules.
Key Rules You Need to Know
The foreign tax credit system operates on a "separate category" basis, meaning you must compute a separate credit limitation for each type of income. For 2021, the main categories include: general category income, passive category income, section 951A category income (related to Global Intangible Low-Taxed Income or GILTI), foreign branch category income, section 901(j) income from sanctioned countries, and various categories of U.S.-source income re-sourced by treaty as foreign source.
You must complete a separate Form 1118 for each applicable income category. This separation prevents corporations from using excess credits from high-taxed income to offset taxes on low-taxed income. Each category has its own limitation calculation, and credits generally cannot cross category boundaries.
Eligible foreign taxes include income taxes, war profits taxes, and excess profits taxes paid or accrued to foreign countries or U.S. possessions, as well as certain taxes deemed paid under section 960 and taxes paid "in lieu of" foreign income taxes. However, numerous taxes are specifically excluded from the credit, including taxes reduced under percentage depletion rules, taxes on income from international boycott participation, certain taxes on oil and gas income, taxes denied under various anti-abuse provisions, and taxes for which the minimum holding period wasn't met.
Excess foreign tax credits—amounts exceeding the limitation for a tax year—can be carried back one year and then carried forward ten years within the same income category. However, excess credits cannot be carried to a year when you claimed a deduction rather than a credit for foreign taxes. Importantly, this carryback and carryforward rule does not apply to foreign taxes assigned to section 951A category income.
Corporations aren't required to attach documentation of foreign tax payments when filing Form 1118, but they must maintain proof and produce it upon IRS request. The IRS may also require a surety bond using Form 1117 if you're claiming a credit for taxes accrued but not yet paid.
Step-by-Step: How to Complete Form 1118 (High-Level Overview)
Step 1: Determine your income categories.
Identify which separate categories of income apply to your corporation for the tax year. You'll need a separate Form 1118 for each category. Enter the appropriate category code at the top of page 1 of each form.
Step 2: Complete Schedule A for each category.
This schedule computes your corporation's income or loss before adjustments for each income category. You'll list different types of income—dividends, interest, rents, royalties, various inclusions under tax code sections—and make adjustments to arrive at your foreign source income for that category.
Step 3: Complete Schedule H (only once).
This schedule apportions deductions that cannot be directly allocated to a specific item or class of income. Schedule H has two main parts: Part I deals with research and experimentation expense apportionment, while Part II handles other deductions like interest expense and the foreign-derived intangible income deduction.
Step 4: Complete Schedules C, D, and E for each category (if applicable).
These schedules calculate "deemed paid" taxes—foreign taxes treated as if you paid them because your corporation owns foreign subsidiaries. Schedule C covers taxes deemed paid on section 951(a)(1) inclusions (traditional Subpart F income), Schedule D handles section 951A inclusions (GILTI), and Schedule E addresses distributions of previously taxed earnings and profits.
Step 5: Complete Schedule G for each category.
This schedule reports required reductions to your foreign tax credit, such as reductions under section 965(g) for transition tax amounts or section 245A for dividends eligible for the dividends-received deduction.
Step 6: Complete Schedule B for each category.
Parts I and II of Schedule B calculate your actual foreign tax credit limitation and determine your allowable credit for that category. Complete Part III only once—it summarizes your total credits across all categories and carries the final amount to your corporate tax return.
Step 7: Complete Schedule J (only once).
This schedule computes adjustments to separate limitation income or losses, year-end recharacterization balances, and overall foreign and domestic loss account balances.
Step 8: Complete Schedule K (only once).
This schedule reconciles your prior year foreign tax carryover with your current year carryover, tracking how unused credits move from year to year.
Step 9: Complete Schedule I (if applicable, for each category).
If you have foreign oil and gas income, use this schedule to compute required reductions of taxes on that income.
Step 10: Complete Schedule L (if applicable).
If foreign tax redeterminations occurred during the current year that relate to prior years, report them on Schedule L.
Remember that Schedules A, B (Parts I & II), C through G, I, and K must be completed separately for each income category, while Schedules B (Part III), H, and J are completed only once per tax return.
Common Mistakes and How to Avoid Them
Failing to provide complete information
Form 1118 must be carefully filled out with all required information and calculations. Review each schedule thoroughly before filing. Double-check that you've entered amounts in all required columns and that your calculations are accurate. Missing data or incomplete calculations are among the most common errors.
Not maintaining adequate documentation
While you don't need to attach receipts or foreign tax returns when you file, you must keep proof of all foreign taxes claimed and be ready to produce it if the IRS requests it. Maintain organized records of foreign tax payments, including payment dates, amounts in foreign currency, exchange rates used, and copies of foreign tax returns. Failure to substantiate credits when requested can result in disallowance.
Incorrectly categorizing income
Assigning income to the wrong separate category is a frequent and costly mistake. Understand the definitions of each category and carefully apply the look-through rules for dividends, interest, rents, and royalties from controlled foreign corporations. Each category has specific rules, and placing income in the wrong category can significantly distort your credit limitation.
Missing deadlines for foreign tax redeterminations
When foreign taxes you've accrued differ from what you actually pay, or when you receive refunds, you generally must file an amended return. Corporations sometimes fail to track these changes or miss the reporting requirements. Set up systems to monitor foreign tax payments, refunds, and adjustments, and file amended returns promptly when required.
Claiming credits for non-creditable taxes
Not all foreign taxes qualify for the credit. Carefully review the list of excluded taxes in the instructions. Common errors include claiming credits for taxes reduced under percentage depletion, taxes for which the minimum holding period wasn't met, or taxes imposed by sanctioned countries. Verify that each tax you're claiming actually qualifies.
Improper apportionment of expenses
Schedule H requires careful attention to how research and experimentation expenses, interest expense, and other deductions are apportioned among income categories. Errors in apportionment can affect your credit limitation. Follow the detailed regulations on expense allocation and keep documentation of your apportionment methodology.
Failing to reconcile carryovers on Schedule K
Schedule K tracks foreign tax credit carryovers from prior years and to future years. Mistakes in reconciling these amounts can cascade through multiple years. Ensure Schedule K properly reflects your beginning balance, current year changes, and ending balance for each category.
Not reporting required information for controlled foreign corporations
If you control a foreign corporation or partnership and fail to furnish required information under section 6038(a), your foreign tax credit will be reduced by 10%, with additional 5% reductions for each three-month period the failure continues after IRS notice. Stay current with all Form 5471, Form 8865, and other information reporting requirements.
What Happens After You File
After filing Form 1118, you should maintain all supporting documentation in case the IRS selects your return for examination. The IRS may request proof of foreign tax payments, foreign tax returns, documentation of exchange rates used, and supporting calculations for complex items like deemed-paid taxes or expense apportionment. Be prepared to produce this documentation promptly if requested.
If you discover errors or changes occur to your foreign tax situation, you may need to take action. Foreign tax redeterminations that affect your U.S. tax liability require you to file an amended return with a revised Form 1118 and a detailed statement explaining the changes. Interest may be computed on any deficiency or overpayment resulting from the foreign tax adjustment.
The IRS will process your Form 1118 as part of your corporate tax return. Your foreign tax credit will reduce your U.S. tax liability on your Form 1120 or other applicable corporate return. If you have excess foreign tax credits that cannot be used in the current year, they will become carrybacks or carryforwards as shown on Schedule K. You can carry excess credits back one year and forward ten years, but only within the same income category.
Any unused carryback credit creates a refund opportunity—you should file an amended return for the prior year to claim the refund. Document the carryback carefully on Schedule K of both the carryback year return and your current year return. Carryforward credits should be tracked systematically because they expire after ten years if not used.
If the IRS examines your return and proposes adjustments to your foreign tax credit, you'll receive a notice explaining the changes. Common audit issues include documentation of foreign taxes paid, proper categorization of income, appropriate application of limitation rules, and verification of deemed-paid tax calculations. Respond promptly to any IRS correspondence and consider seeking professional assistance for complex foreign tax credit disputes.
Penalties can apply for various failures. A $10,000 penalty per entity applies for failure to supply information required under section 6038(b), with additional penalties if the failure isn't corrected within 90 days of IRS notice. Penalties under section 6689 apply for failure to comply with foreign tax redetermination reporting requirements. Additionally, your available foreign tax credits will be reduced by 10% (and potentially more) if you fail to file required information returns for controlled foreign corporations or partnerships.
FAQs
Can I switch between taking a credit and taking a deduction for foreign taxes in different years?
Yes, you make a fresh election each year. You can claim a credit in one year and a deduction in another year. However, once you elect to claim a credit for foreign taxes paid or accrued in a specific year, you cannot deduct any of those same taxes in that year or any subsequent year. The election can be made or changed within a special 10-year period, giving you significant flexibility as your tax situation evolves and you better understand which approach is more beneficial.
What should I do if the foreign tax I actually paid differs from the amount I accrued on my return?
This situation is called a foreign tax redetermination, and you generally must notify the IRS. If the change affects your U.S. tax liability, file an amended return with a revised Form 1118 and attach a detailed statement explaining the difference, including dates, amounts in foreign currency, exchange rates, and how the change affects your tax. If your U.S. tax liability doesn't change, you can simply attach Schedule L to your original return for the year the redetermination occurs, rather than filing an amended return.
Do I need to attach receipts or proof of foreign taxes when I file Form 1118?
No, documentation is not required to be attached to Form 1118 when you file. However, you must maintain proof of all foreign taxes claimed and be ready to present it if the IRS requests it. Keep organized records of payment receipts, foreign tax returns, documentation of exchange rates, and calculations supporting your credit claim. Failure to substantiate your credit when requested can result in disallowance.
Why do I need to complete a separate Form 1118 for each income category?
The foreign tax credit limitation is calculated separately for each category of income to prevent "cross-crediting"—using excess credits from high-taxed income to offset U.S. tax on low-taxed income. Each category (general, passive, section 951A, foreign branch, etc.) has its own limitation calculation, and credits generally cannot be moved between categories. This ensures that the foreign tax credit properly reflects the foreign tax burden on each type of income.
Can I use excess foreign tax credits from one year in another year?
Yes, through the carryback and carryforward provisions. If your foreign tax credits exceed the limitation in any year, you first carry the excess back one year, then carry any remaining excess forward up to ten years. However, carrybacks and carryforwards must stay within the same income category, and you cannot carry credits to a year when you claimed a deduction rather than a credit. Note that excess credits in the section 951A category cannot be carried back or forward at all.
Who qualifies to claim deemed-paid foreign taxes on Form 1118?
Deemed-paid taxes are foreign taxes paid by a foreign corporation that are treated as if you paid them because you own the corporation. Domestic corporations can claim deemed-paid taxes through Schedules C, D, and E when they have inclusions under section 951(a)(1) (Subpart F income), section 951A (GILTI), or receive distributions of previously taxed earnings and profits from controlled foreign corporations. The calculation depends on your ownership percentage and the amount of foreign taxes paid by the foreign corporation on the relevant income.
What happens if I fail to file required information returns for my foreign corporations?
Serious consequences apply. If you control a foreign corporation and fail to file Form 5471 or furnish required information under section 6038(a), your foreign tax credits will be automatically reduced by 10%. If you don't correct the failure within 90 days after receiving written notice from the IRS, your credits are reduced by an additional 5% for each three-month period the failure continues. Additionally, you face a separate $10,000 penalty per entity for each failure to file, with additional penalties possible if not corrected within 90 days of IRS notice.
This summary is based on the 2021 version of Form 1118 and its instructions. Tax laws and forms are subject to change. For the most current information and forms, visit IRS.gov/Form1118.
