How To Claim
the Credit

You must file Form 1116 to claim the foreign tax credit unless you meet one of the following exceptions.

Exceptions.   If you meet the requirements discussed under Exemption from foreign tax limit, earlier, and choose to be exempt from the foreign tax credit limit, do not file Form 1116. Instead, enter your foreign taxes directly on line 45 of Form 1040.

If you are a shareholder of a controlled foreign corporation and chose to be taxed at corporate rates on the amount you must include in gross income from that corporation, use Form 1118 to claim the credit. See Controlled foreign corporation shareholder under You Must Have Paid or Accrued the Tax, earlier.

Form 1116

You must file a Form 1116 with your U.S. income tax return, Form 1040. You must file a separate Form 1116 for each of the following categories of income for which you claim a foreign tax credit.

1. Passive income.
2. High withholding tax interest.
3. Financial services income.
4. Shipping income.
5. Dividends from a DISC or former DISC.
6. Certain distributions from an FSC or former FSC.
7. Lump-sum distributions.
8. Section 901(j) income.
9. Income re-sourced by treaty.
10. General limitation income - all other income from sources outside the United States.

A Form 1116 consists of four parts as explained next.

1. Part I - Taxable Income or Loss From Sources Outside the United States (for Category Checked Above). Enter the gross amounts of your foreign or possession source income in the separate limit category for which you are completing the form. Do not include income you excluded on Form 2555 or Form 2555-EZ. From these, subtract the deductions that are definitely related to the separate limit income, and a ratable share of the deductions not definitely related to that income. If, in a separate limit category, you received income from more than one foreign country or U.S. possession, complete a separate column for each.
2. Part II - Foreign Taxes Paid or Accrued. This part shows the foreign taxes you paid or accrued on the income in the separate limit category in foreign currency and U.S. dollars. If you paid (or accrued) foreign tax to more than one foreign country or U.S. possession, complete a separate line for each.
3. Part III - Figuring the Credit. You use this part to figure the foreign tax credit that is allowable.
4. Part IV - Summary of Credits From Separate Parts III. You use this part on one Form 1116 to summarize the foreign tax credits figured on separate Forms 1116.

Records To Keep

You should keep the following records in case you are later asked to verify the taxes shown on your Form 1116 or Form 1040. You do not have to attach these records to your Form 1040.

• A receipt for each foreign tax payment.
• The foreign tax return if you claim a credit for taxes accrued.
• Any payee statement (such as Form 1099-DIV or Form 1099-INT) showing foreign taxes reported to you.

The receipt or return you keep as proof should be either the original, a duplicate original, a duly certified or authenticated copy, or a sworn copy. If the receipt or return is in a foreign language, you also should have a certified translation of it. Revenue Ruling 67-308 in Cumulative Bulletin 1967-2 discusses in detail the requirements of the certified translation. You can buy the Cumulative Bulletin from the Government Printing Office. Issues of the Cumulative Bulletin are also available in most IRS offices and you are welcome to read them there.

Alternative Minimum Tax

In addition to your regular income tax, you may be liable for the alternative minimum tax. A foreign tax credit may be allowed in figuring this tax. See the instructions for Form 6251, Alternative Minimum Tax - Individuals, for a discussion of the alternative minimum tax foreign tax credit.

Simple Example - Filled-In Form 1116

Betsy Wilson is single, under 65, and is a U.S. citizen. She earned $21,000 working as a night auditor in Pittsburgh. She owns 200 shares in XYZ mutual fund that invests in Country Z corporations. She received a dividend of $620 from XYZ, which withheld and paid tax of $93 to Country Z on her dividend. XYZ reported this information to her on Form 1099-DIV.

Betsy elects to be exempt from the foreign tax credit limit because her only foreign taxable income is passive income (dividend of $620) and the amount of taxes paid ($93) is not more than $300. To claim the $93 as a credit, Betsy enters $93 on line 45 of Form 1040. (She can claim her total taxes paid of $93 because it is less than her regular tax, shown on Form 1040 line 42.) She does not file Form 1116. However, she cannot carry any unused foreign taxes to this tax year.

If Betsy does not elect to be exempt from the foreign tax credit limit, she will need to complete a Form 1116 as follows.

Betsy fills in her name and social security number, and checks the box for passive income.

Part I - Taxable Income or Loss From Sources Outside the United States (for Category Checked Above)

Betsy writes the name of the foreign country in column A and shows on line 1 the amount of income ($620) and type of income (dividends) she received from XYZ. Next, since Betsy does not itemize her deductions, she puts her standard deduction ($4,700) on line 3a and completes 3b and 3c. Her gross foreign source income (line 3d) is $620 and gross income from all sources (line 3e) is $21,620. She enters $135 on line 6. Line 7 is $485, the difference between lines 1 and 6.

Part II - Foreign Taxes Paid or Accrued

Betsy checks the Paid box and enters $93 on line A, columns (t) and (x), and on line 8.

Since the income was reported to Betty in U.S. dollars on Form 1099-DIV, she does not have to convert the amount shown into foreign currency. She enters 1099 taxes on line A, column (o).

Part III - Figuring the Credit

Betsy figures her credit as shown on the completed form. The computation shows that she may take only $51 of the amount paid to Country Z as a credit against her U.S. income tax. The remaining $42 is available for a carryback and/or carryover.

Part IV - Summary of Credits From Separate Parts III

Because this is the only Form 1116 that Betsy must complete, she does not need to fill in lines 22 through 30 of Part IV.

Form 1116, page 1 for Betsy Wilson

Form 1116, page 2 for Betsy Wilson

Comprehensive Example -
Filled-In Form 1116

Robert Smith, a U.S. citizen, is a salesman who lived and worked in Country X for all of 2002, except for one week he spent in the United States on business. He is single and under 65. He is a cash-basis taxpayer who uses the calendar year as his tax year.

During the year, Robert received income from sources within Country X and the United States.

Income from United States.   Robert received wages of $2,400 for services performed during the one week in the United States. He also received dividend income of $3,000 from sources within the United States.

Income from Country X.   Robert received the following income from Country X during the year and paid tax on the income to Country X on December 31. The conversion rate throughout the year was 2 pesos to each U.S. dollar (2:1).

	Income	Tax
	$100,000 wages	$27,400
	(200,000 pesos)	(54,800 pesos)
	$4,000 dividend income	$450
	(8,000 pesos)	(900 pesos)
	$1,000 interest income	$50
	(2,000 pesos)	(100 pesos)

Foreign earned income.   Robert is a bona fide resident of Country X and figures his allowable exclusion of foreign earned income on Form 2555, Foreign Earned Income (not illustrated). He excludes $80,000 of the wages earned in Country X.

Itemized deductions.   Robert was entitled to the following itemized deductions.

Interest on home mortgage	$2,900
Real estate tax	940
Charitable contribution	460
Employee business expenses (See the following discussion for computation.)	872
Total	$5,172

Employee business expenses.   Robert paid $3,400 of unreimbursed business expenses, of which $1,000 were definitely related to the wages earned in the United States and $2,400 were definitely related to wages earned in Country X.

Robert must prorate the business expenses related to the wages earned in Country X between the wages he includes on his U.S. tax return and the amount he excludes as foreign earned income. He cannot deduct the part of the expenses related to the income that he excludes. He figures his allowable expenses (related to the wages earned in Country X) as follows:

$20,000 $100,000

×

$2,400

=

$480

business trip) and the 2%-of-ad- justed-gross-income limit ($608).

Forms 1116

Robert must use two Forms 1116 to figure his allowable foreign tax credit. On one Form 1116, he will mark the block to the left of General limitation income, and figure his foreign tax credit on the wages of $20,000 (Country X wages minus excluded wages). On the other Form 1116, he will mark the block to the left of Passive income, and figure his foreign tax credit on his interest income of $1,000 and dividend income of $4,000.

Under the later discussions for each part on the Form 1116, Robert's computations are explained for each Form 1116 that must be completed. Both Forms 1116 are illustrated near the end of this publication.

Computation of
Taxable Income

Before making any entries on Form 1116, Robert must figure his taxable income on Form 1040.

His taxable income is $22,228 figured as follows:

Gross Income
Wages (Country X)	$100,000
Less: Foreign earned income exclusion	80,000
	$ 20,000
Wages (U.S.)	2,400
Interest income (Country X)	1,000
Dividend income (U.S.)	3,000
Dividend income (Country X)	4,000
Total (Adjusted gross income)	$30,400
Less: Total Itemized Deductions	5,172
Taxable income before the personal exemption	$25,228
Less: Personal Exemption	3,000
Taxable Income	$22,228

On each Form 1116, Robert enters $25,228 (his taxable income before the personal exemption) on line 17 of Part III.

Part I - Figuring Taxable
Income or Loss From
Sources Outside the
United States (for Category
Checked Above)

In figuring the limit on both Forms 1116, Robert must separately determine his taxable income from Country X ( line 7 of Form 1116).

Form 1116 - General limitation income.   On this Form 1116, Robert figures his taxable income from Country X for income in the general limitation income category only. He does not include his passive income of interest and dividends.

Line 1.   Robert enters the wages earned in Country X of $20,000 on line 1.

Line 2.   The unreimbursed employee business expenses related to these foreign source wages included in income are $480, as shown earlier. Robert must determine which part of the 2%-of-adjusted-gross-income limit ($608) is allocable to these employee business expenses. He figures this as follows:

$480 $1,480

×

$608

=

$197

related to $20,000 of taxable foreign wages is $283 ($480 - $197). He enters $283 on line 2. He attaches this explanation to his Form 1116 that he files with his tax return. Line 3a-g.   Robert enters $1,400 on line 3a. This is the sum of his real estate tax ($940) and charitable contributions ($460), which are itemized deductions not definitely related to income from any source. Robert must prorate these itemized deductions by using the ratio of gross income from Country X in the general limitation category (line 3d) to his gross income from all sources (line 3e). For this purpose, gross income from Country X and gross income from all sources include the $80,000 of wages that qualify for the foreign earned income exclusion. He figures the ratable part of deductions, $1,268, as follows and enters it on line 3g.

$100,000 $110,400

×

$1,400

=

$1,268

Line 4a.   Robert apportions his qualified home mortgage interest, $2,900, to general limitation income as follows:

1.	Enter gross foreign source income of the type shown on Form 1116. Do not enter income excluded on Form 2555		$20,000
2.	Enter gross income from all sources. Do not enter income excluded on Form 2555		$30,400
3.	Divide line 1 by line 2 and enter the result as a decimal		.6579
4.	Enter deductible home mortgage interest (from Schedule A (Form 1040))		$ 2,900
5.	Multiply line 4 by line 3. Enter the result here and on Form 1116, line 4a		$ 1,908

Line 6.   Robert adds the amounts on lines 2, 3g, and 4a, and enters that total ($3,459) on line 6.

Line 7.   He subtracts the amount on line 6 from the amount on line 1 to arrive at foreign source taxable income of $16,541 in this category. Robert enters this amount on line 7.

Form 1116 - Passive income.   On this Form 1116, Robert determines the taxable income from Country X for passive interest and dividend income.

Line 1.   He adds the $1,000 interest income and the $4,000 dividend income ($5,000) from Country X and enters the total ($5,000) on line 1.

Line 3a-g.   Robert figures the part of his itemized deductions (real estate tax and charitable contributions) allocable to passive income as follows and enters the amount on line 3g.

$5,000 $110,400

×

$1,400

=

$63

Line 4a.   Robert apportions the qualified home mortgage interest to passive income as follows:

1.	Enter gross foreign source income of the type shown on Form 1116. Do not enter income excluded on Form 2555			$ 5,000
2.	Enter gross income from all sources. Do not enter income excluded on Form 2555			$30,400
3.	Divide line 1 by line 2 and enter the result as a decimal			.1645
4.	Enter deductible home mortgage interest (from Schedule A (Form 1040))			$ 2,900
5.	Multiply line 4 by line 3. Enter the result here and on Form 1116, line 4a			$   477

Line 6.   Robert adds the amounts on lines 3g and 4a and enters that total ($540) on line 6.

Line 7.   He subtracts the amount on line 6 from the amount on line 1 to arrive at foreign source taxable income of $4,460 in this category. Robert enters this amount on line 7.

Table 4. Robert's Schedule Showing Computation of His Carryover

	1999	2000	2001
Maximum credit allowable under limit	$450	$700	$1,200
Foreign tax paid in tax year	400	600	1,550
Unused foreign tax (+) to be carried over or excess of limit (-) over tax	- $50	- $100	+$350
Tax credit carried back from 2001	50	100
Net excess tax to be carried over to 2002	0	0	+$350
Less carrybacks to 1999 and 2000			150
Amount carried over to 2002			$200

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