Carryback & Carryover

If, because of the limit on the credit, you cannot use the full amount of qualified foreign taxes paid or accrued in the tax year, you are allowed a 2-year carryback and then a 5-year carryover of the unused foreign taxes.

This means that you can treat the unused foreign tax of a tax year as though the tax were paid or accrued in your 2 preceding and 5 succeeding tax years up to the amount of any excess limit in those years. A period of less than 12 months for which you make a return is considered a tax year.

The unused foreign tax in each category is the amount of qualified taxes paid or accrued minus the limit for that category. The excess limit in each category is the amount by which the limit is more than the qualified taxes paid or accrued for that category.

Figure your carrybacks or carryovers separately for each separate limit income category.

The mechanics of the carryback and carryover are illustrated by the following examples.

Example 1. All your foreign income is in the general limitation income category. The limit on your credit and the qualified foreign taxes paid on the income are as follows:

In 2000, you had unused foreign tax of $200 to carry to other years. You are considered to have paid this unused foreign tax first in 1998 (the second preceding tax year) up to the excess limit in that year of $50, and then in 1999 (the first preceding tax year) up to that year's excess limit of $100. You can then carry forward the remaining $50 of unused tax.

Example 2. All your foreign income is in the passive income category. In 1996, you had an unused foreign tax of $200. Since you had no foreign income in 1994 and 1995, you cannot carry back the unused foreign tax to those years. You can, however, carry forward the unused tax to 1997, 1998, 1999, 2000, and 2001. The limit on your credit and the qualified foreign taxes paid on passive income are as follows:

You cannot carry the $200 of unused foreign tax from 1996 to 1997 or 1998 since you have no excess limit in either of those years. Therefore, you carry the tax forward to 1999, up to the excess limit of $150. The carryover reduces your excess limit in that year to zero. The remaining unused foreign tax of $50 from 1996 can be carried to 2000. At this point, you have fully absorbed the unused foreign tax from 1996 and can carry it no further. You can also carry forward the unused foreign tax from 1997 and 1998.

Effect of bankruptcy or insolvency. If your debts are canceled because of bankruptcy or insolvency, you may have to reduce your unused foreign tax carryovers to or from the tax year of the debt cancellation by 33 1/3 cents for each $1 of canceled debt that you exclude from your gross income. Your bankruptcy estate may have to make this reduction if it has acquired your unused foreign tax carryovers. Also, you may not be allowed to carry back any unused foreign tax to a year before the year in which the bankruptcy case began. For more information, see Reduction of Tax Attributes in Publication 908, Bankruptcy Tax Guide.

Time Limit on Tax Assessment

When you carry back an unused foreign tax, IRS is given additional time to assess any tax resulting from the carryback. An assessment can be made up to the end of one year after the expiration of the statutory period for an assessment relating to the year in which the carryback originated.

Claim for Refund

If you have an unused foreign tax that you are carrying back to the first or the second preceding tax year, you should file Form 1040X for each earlier tax year to which you are carrying the unused foreign tax, and attach a revised Form 1116.

Taxes All Credited or All Deducted

In a given year, you must either claim a credit for all foreign taxes that qualify for the credit or claim a deduction for all of them. This rule is applied with the carryback and carryover procedure, as follows:

1. You cannot claim a credit carryback or carryover from a year in which you deducted qualified foreign taxes,
2. You cannot deduct unused foreign taxes in any year to which you carry them, even if you deduct qualified foreign taxes actually paid in that year, and
3. You cannot claim a credit for unused foreign taxes in a year to which you carry them unless you also claim a credit for foreign taxes actually paid or accrued in that year.
4. You cannot carry back or carry over any unused foreign taxes to or from a year for which you elect not to be subject to the foreign tax credit limit. See Exemption from foreign tax credit limit under How To Figure the Credit, earlier.

Unused taxes carried to deduction year. If you carry unused foreign taxes to a year in which you chose to deduct qualified foreign taxes, you must compute a foreign tax credit limit for the deduction year as if you had chosen to credit foreign taxes for that year. If the credit computation results in an excess limit (as defined earlier) for the deduction year, you must treat the unused foreign taxes carried to the deduction year as absorbed in that year. You cannot actually deduct or claim a credit for the unused foreign taxes carried to the deduction year. But, this treatment reduces the amount of unused foreign taxes that you can carry to another year.

Because you cannot deduct or claim a credit for unused foreign taxes treated as absorbed in a deduction year, you will get no tax benefit for them unless you file a timely refund claim or an amended return to reverse your choice from deducting the taxes to claiming the credit. You have ten years from the due date of the return for the deduction year to make this change. See Making or Changing Your Choice, under Choosing To Take Credit or Deduction, earlier.

Example. In 2000, you paid foreign taxes of $600 on income in the passive income category. You have a foreign tax credit carryover of $200 from the same category from 1999. For 2000, your foreign tax credit limit is $700.

If you choose to claim a credit for your foreign taxes in 2000, you would be allowed a credit of $700, consisting of $600 paid in 2000 and $100 of the $200 carried over from 1999. You will have a credit carryover to 2001 of $100, which is your unused 1999 foreign tax credit carryover.

If you choose to deduct your foreign taxes in 2000, your deduction will be limited to $600, which is the amount of taxes paid in 2000. You are not allowed a deduction for any part of the carryover from 1999. However, you must treat $100 of the credit carryover as used in 2000, because you have an unused credit limit of $100 ($700 limit minus $600 of foreign taxes paid in 1999). This reduces your carryover to later years.

If you claimed the deduction for 2000 and later decided you wanted to receive a benefit for that $100 part of the 1999 carryover, you could reverse the choice of a deduction for 2000. You would have to claim a credit for those taxes by filing an amended return for 2000 within the time allowed.

Married Couples

For a tax year in which you and your spouse file a joint return, you must figure the unused foreign tax or excess limit in each separate limit category on the basis of your combined income, deductions, taxes, and credits.

For a tax year in which you and your spouse file separate returns, you figure the unused foreign tax or excess limit by using only your own separate income, deductions, taxes, and credits. However, if you file a joint return for any other year involved in figuring a carryback or carryover of unused foreign tax to the current tax year, you will need to make an allocation, as explained under Allocations Between Husband and Wife, later.

Figure A. Allocation Between Husband and Wife

Continuous use of joint return. If you and your spouse file a joint return for the current tax year, and file joint returns for each of the other tax years involved in figuring the carryback or carryover of unused foreign tax to the current tax year, you figure the joint carryback or carryover to the current tax year using the joint unused foreign tax and the joint excess limits.

Joint and separate returns in different years. If you and your spouse file a joint return for the current tax year, but file separate returns for all the other tax years involved in figuring the carryback or carryover of the unused foreign tax to the current tax year, your separate carrybacks or carryovers will be a joint carryback or carryover to the current tax year.

In other cases in which you and your spouse file joint returns for some years and separate returns for other years, you must make the allocation described in Allocations Between Husband and Wife.

Table 5. Carryback/Carryover

Allocations Between Husband and Wife

You may have to allocate an unused foreign tax or excess limit for a tax year in which you and your spouse filed a joint return. This allocation is needed in the following three situations.

1. You and your spouse file separate returns for the current tax year, to which you carry an unused foreign tax from a tax year for which you and your spouse filed a joint return.
2. You and your spouse file separate returns for the current tax year, to which you carry an unused foreign tax from a tax year for which you and your spouse filed separate returns, but through a tax year for which you and your spouse filed a joint return.
3. You and your spouse file a joint return for the current tax year, to which you carry an unused foreign tax from a tax year for which you and your spouse filed a joint return, but through a tax year for which you and your spouse filed separate returns.

These three situations are illustrated in Figure A. In each of the situations, 2000 is the current year.

Method of allocation. For a tax year in which you must allocate the unused foreign tax or the excess limit for your separate income categories between you and your spouse, you must take the following steps.

1. Figure a percentage for each separate income category by dividing the taxable income of each spouse from sources outside the United States in that category by the joint taxable income from sources outside the United States in that category. Then, apply each percentage to its category's joint foreign tax credit limit to find the part of the limit allocated to each spouse.
2. Figure the part of the unused foreign tax, or of the excess limit, for each separate income category allocable to each spouse. You do this by comparing the allocated limit (figured in (1)), with the foreign taxes paid or accrued by each spouse on income in that category. If the foreign taxes you paid or accrued for that category are more than your part of its limit, you have an unused foreign tax. If, however, your part of that limit is more than the foreign taxes you paid or accrued, you have an excess limit for that category.

Allocation of the carryback and carryover. The mechanics of the carryback and carryover, when allocations between husband and wife are needed, are illustrated by the following example.

Example. A Husband (H) and Wife (W) filed joint returns for 1996, 1998, and 1999 and separate returns for 1997 and 2000. Neither H nor W had any unused foreign tax or excess limit for any year before 1996. For the tax years involved, the income, unused foreign tax, excess limits, and carrybacks and carryovers are in the general limitation income category and are shown in Table 5.

W's allocated part of the unused foreign tax from 1996 ($30) is partly absorbed by her separate excess limit of $20 for 1997, and then fully absorbed by her allocated part of the joint excess limit for 1998 ($20). H's allocated part of the unused foreign tax from 1996 ($50) is fully absorbed by his allocated part of the joint excess limit ($65) for 1998.

H's separate unused foreign tax from 1997 ($25) is partly absorbed (up to $15) by his remaining excess limit in 1998, and then fully absorbed by W's remaining part of the joint excess limit for 1998 ($10). Each spouse's excess limit on the 1998 joint return is reduced by:

1. Each spouse's carryover from earlier years (W's carryover of $10 from 1996 and H's carryovers of $50 from 1996 and $15 from 1997).
2. The other spouse's carryover. (H's carryover of $10 from 1997 is absorbed by W's remaining excess limit.)

W's allocated part of the unused foreign tax of $69 from 1999 is partly absorbed by her excess limit in 2000 ($10), and the remaining $59 will be a carryover to the general limitation income category for 2001 and the following 3 years unless absorbed sooner. H's allocated part of the unused foreign tax of $104 from 1999 is partly absorbed by his excess limit in 2000 ($50), and the remaining $54 will be a carryover to 2001 and the following 3 years unless absorbed sooner.

Joint Return Filed in a Deduction Year

When you file a joint return in a deduction year, and carry unused foreign tax through that year from the prior year in which you and your spouse filed separate returns, the amount absorbed in the deduction year is the unused foreign tax of each spouse deemed paid or accrued in the deduction year up to the amount of that spouse's excess limit in that year. You cannot reduce either spouse's excess limit in the deduction year by the other's unused foreign taxes in that year.

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