Passive income generally includes dividends, interest, royalties, rents, annuities, gain from the sale of property that produces such income or of non-income-producing investment property, and gains from foreign currency or commodities transactions. Capital gains not related to the active conduct of a trade or business are also generally passive income.

Passive income does not include high withholding tax interest, export financing interest, active business rents and royalties from unrelated persons, or high-taxed income (see High-Taxed Income on page 4).

Passive income also does not include gain from the sale of inventory or property held primarily for sale to customers in the ordinary course of your trade or business; gain from commodities hedging transactions; and active business gains or losses of producers, processors, merchants, or handlers of commodities. It may also not include dividends or interest received from a controlled foreign corporation (CFC) in which you are a U.S. shareholder who owns 10% or more of the total voting power of all classes of the corporation's stock.

In general, high withholding tax interest is foreign interest that is subject to a foreign withholding or other gross-basis tax of 5% or more.

Financial services income generally includes income derived by a financial services entity predominantly engaged in the active conduct of a banking, financing, insurance, or similar business. Financial services income of a financial services entity also includes passive income and certain incidental income; however, no part of the passive income that is financial services income is treated as high-taxed income (see High-Taxed Income on page 4).

If you qualify as a financial services entity because you treat certain items of income as active financing income under Regulations section 1.904-4(e)(2)(i)(Y), you must show the type and amount of each item on an attachment to Form 1116.

Shipping income generally includes income derived from, or in connection with, the use (or hiring or leasing for use) of any aircraft or vessel in foreign commerce, or income derived from space and ocean activities. Treat income that is both shipping income and financial services income as financial services income.

This category includes dividends from a DISC (domestic international sales corporation) or former DISC to the extent these dividends are treated as foreign sourced. See section 992(a).

This category includes distributions from a FSC (foreign sales corporation) or former FSC out of earnings and profits attributable to “foreign trade income.” Foreign trade income is the gross income of a FSC attributable to foreign trading gross receipts.

You may take a foreign tax credit for taxes you paid or accrued on a foreign source lump-sum distribution from a pension plan. Special formulas may be used to figure a separate tax on a qualified lump-sum distribution for the year in which the distribution is received. See Pub. 575 for more information.

If you are able to elect, and do elect, to figure your U.S. tax on a lump-sum distribution using Form 4972, Tax on Lump-Sum Distributions, a separate foreign tax credit limitation applies. Use a separate Form 1116. On this separate Form 1116, check box g above Part I. Skip Part I. Complete Part II showing only foreign taxes that are attributable to the lump-sum distribution. Then, complete the Worksheet for Lump-Sum Distributions, below, to figure the amounts to enter in Part III.

No credit is allowed for foreign taxes imposed by and paid or accrued to certain sanctioned countries. However, income derived from each such country is subject to a separate foreign tax credit limitation. Therefore, you must use a separate Form 1116 for income derived from each such country.

These countries are those designated by the Secretary of State as countries that repeatedly provide support for acts of international terrorism, countries with which the United States does not have diplomatic relations, or countries whose governments are not recognized by the United States. Pub. 514 contains a list of these countries.

If you paid taxes to a country that ceased to be a sanctioned country during the tax year, see Pub. 514 for details on how to figure the foreign tax credit for the period that begins after the end of the sanctions.

If a sourcing rule in an applicable income tax treaty treats any of the specific types of income described below as foreign source, and you elect to apply the treaty, the income will be treated as foreign source.

General limitation income is income that does not fall into one of the above categories. Common examples include:

In some cases, passive income and taxes must be treated as general limitation income and taxes. Generally, passive income and taxes must be placed in the general limitation income category if the foreign taxes you paid on the income (after allocation of expenses) exceed the highest U.S. tax that can be imposed on the income. However, no part of the passive income that is financial services income is treated as high-taxed income. See Regulations section 1.904-4(c) for more information.

Certain income received or accrued by you as a 10%-or-more U.S. shareholder in a controlled foreign corporation (CFC) is treated as income in one of the separate limitation categories listed under Categories of Income starting on page 3. For example, Subpart F inclusions, dividends, interest, rents, and royalties from a CFC are treated as separate limitation income to the extent they are attributable to separate limitation income of the CFC. See Regulations section 1.904-5 for more information.

If you received a 2003 Schedule K-1 from a partnership or S corporation that includes foreign tax information, use the rules below to report that information on Form 1116.

Explanation of Certain Line Items on Schedule K-1

Note:

In each instance that follows, the first line reference is to the Schedule K-1 for Form 1065 and the second line reference is to the Schedule K-1 for Form 1120S. (The Schedule K-1 for Form 1065-B includes all foreign tax information in an attachment for box 9.)

Line 17b or line 15b—Gross income from all sources.   Combine your distributive share of “gross income from all sources” with all of your other gross income and enter the total on line 3e. “Gross income from all sources” is a constant amount (that is, you will enter the same amount on line 3e of all Forms 1116 that you file).

Line 17c or line 15c—Gross income sourced at partner or shareholder level.   This line includes income from the sale of eligible personal property (most personal property other than inventory, depreciable property, and certain intangible property). See Pub. 514 for details.

  

  Although all income reported to you on this line of the Schedule K-1 has been apportioned to separate categories of income, you must nevertheless first determine (using the rules below) whether the income on this line is U.S. source income or foreign source income. Then, enter only foreign source income in Part I of each of the applicable Forms 1116 (that is, those Forms 1116 for each category of income you received from the partnership or S corporation).

  Use the following rules to source the income reported to you on this line of the Schedule K-1. If you are a U.S. resident (as defined below), the income is U.S. source income. If you are a nonresident (as defined below), the income is foreign source income.

U.S. resident.   A U.S. resident is a U.S. citizen or resident alien who does not have a tax home in a foreign country or a nonresident alien who has a tax home in the United States.

Tax home.   Generally, your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. If you do not have a regular or main place of business because of the nature of your work, then your tax home is the place where you regularly live. If you do not fit either of these categories, you are considered an itinerant and your tax home is wherever you work.

Nonresident.   A nonresident is any person who is not a U.S. resident. U.S. citizens and resident aliens with a foreign tax home will not be treated as nonresidents for a sale of eligible personal property unless a foreign tax of 10% or more was paid or accrued on the gain on the sale (or, in the case of a loss sale, a foreign tax of 10% or more would have been paid had the sale resulted in a gain).

Note:

To help you with these rules, the partnership has specifically identified the following.

• Gains on the sale of eligible personal property for which a foreign tax of 10% or more was paid or accrued.
• Losses on the sale of eligible personal property for which a foreign tax of 10% or more would have been paid had the sale resulted in a gain.

  Include foreign source income in Part I of the applicable Form 1116 (that is, the Form 1116 for each category of income provided to you for this line of the Schedule K-1). Do not include in Part I of Form 1116 income that you determined (using the above rules) to be U.S. source income.

  

  If the partnership or S corporation has specifically identified any capital gains or losses or unrecaptured section 1250 gain on this line (Schedule K-1, line 17c or 15c) and you have determined that those gains or losses are foreign source, see Foreign Qualified Dividends and Capital Gains (Losses) starting on page 6 before entering an amount in Part I of Form 1116.

Line 17d or line 15d—Foreign gross income sourced at partnership or S corporation level.   Income reported on this line has already been sourced for you by the partnership or S corporation. The partnership or S corporation has reported this income to you by country and by category of income. Include these amounts in Part I of each of the applicable Forms 1116 (that is, those Forms 1116 for each category of income you received).

Note:

You should disregard any information shown on your Schedule K-1 pertaining to gross income attributable to a foreign branch. It is intended only for corporate partners preparing Form 1118.

Line 17e(1) or line 15e(1)—Interest expense.   See the instructions for line 4b on page 12 to allocate and apportion the interest expense shown on this line of Schedule K-1. In applying those instructions, take into account your distributive share of the partnership's or S corporation's gross income (for purposes of the $5,000 threshold) or your pro rata share of the partnership's or S corporation's assets. However, if you were a limited partner or an S corporation shareholder who did not actively participate in the management of the S corporation and your interest in the partnership or S corporation was less than 10%, see the paragraph below. Include interest expense that you allocate to foreign source income on line 4b of the applicable Form 1116. Do not enter in Part I of Form 1116 any interest expense that you allocate to U.S. source income.

Less-than-10% limited partners and certain less-than-10% S corporation shareholders.   If you are a limited partner or an S corporation shareholder (who does not actively participate in the management of the S corporation) and you own (directly or indirectly) a less-than-10% interest (by value) in the partnership or S corporation, you may generally allocate your distributive share of interest expense from that partnership or S corporation to foreign or U.S. source income based on your distributive share of the gross foreign or U.S. source income of that partnership or S corporation. The interest expense you allocate to foreign source income generally may be apportioned exclusively to the passive income category. However, see Temporary Regulations section 1.861-9T(e)(4) for exceptions.

Line 17e(2) or line 15e(2)—Other expenses.   This line includes expenses (other than interest expense) of the partnership or S corporation that must be allocated and apportioned at the partner or shareholder level (for example, research and experimental expenses).

  Combine your distributive share of these expenses with all of your other like expenses, if any, and then allocate and apportion them using the applicable rules (for example, for research and experimental expenses, the rules under Regulations section 1.861-17(f)).

  Include expenses that you allocate to foreign source income on line 2 of the applicable Form 1116. Expenses that you allocate to U.S. source income should not be entered on any line of Part I of Form 1116.

Line 17f or line 15f—Deductions allocated and apportioned at partnership or S corporation level to foreign source income.   The partnership or S corporation has already allocated these expenses to foreign source income and has reported them to you by country and by category of income. Include these amounts on line 2 of each of the applicable Forms 1116 (that is, those Forms 1116 for each category of income you received).

Note:

You should disregard any information shown on your Schedule K-1 pertaining to definitely allocable deductions attributable to a foreign branch. It is intended only for corporate partners preparing Form 1118.

Line 17g or line 15g—Total foreign taxes.   The partnership or S corporation has already allocated and apportioned total foreign taxes for you and has reported them to you by country and by category of income. Include these amounts in Part II of each of the applicable Forms 1116 (that is, those Forms 1116 for each category of income you received).

Line 17h or line 15h—Reduction in taxes available for credit.   The partnership or S corporation has already apportioned the reduction in taxes available for credit and has reported it to you by country and by category of income. Include these amounts on line 12 of each of the applicable Forms 1116 (that is, those Forms 1116 for each category of income you received).

If you have foreign source qualified dividends or foreign source capital gains (including any foreign source capital gain distributions) or losses, you may be required to make certain adjustments to those amounts before taking them into account on line 1 (qualified dividends and gains) or line 5 (losses). You may use the instructions in this section to determine those adjustments. If you choose not to use the rules outlined in this section, see sections 1(h)(11)(C)(iv) and 904(b)(2) to determine the adjustments you must make.

If you completed the Qualified Dividends and Capital Gain Tax Worksheet in the instructions for your tax return, see Qualified Dividends and Capital Gain Tax Worksheet (Individuals), next, to determine the adjustments you may be required to make. If you completed the Qualified Dividends Tax Worksheet in the instructions for Form 1041, see Qualified Dividends Tax Worksheet (Estates and Trusts), below, to determine the adjustments you may be required to make. If you are filing a Schedule D with your return, see Schedule D, on the next page, to determine the adjustments you may be required to make.

Qualified Dividends and Capital Gain Tax Worksheet (Individuals)

If you completed the Qualified Dividends and Capital Gain Tax Worksheet in the instructions for your tax return, you must adjust the amount of your foreign source qualified dividends and capital gain distributions if:

• Line 7 of the Qualified Dividends and Capital Gain Tax Worksheet is equal to or more than line 8 of that worksheet and
• Line 27 of the Qualified Dividends and Capital Gain Tax Worksheet is less than line 28 of that worksheet.

To adjust your foreign source qualified dividends, multiply your foreign source qualified dividends in each separate category by 0.4286. Include the results on line 1 of the applicable Form 1116.

Do not adjust the amount of any foreign source qualified dividends that you elected to include on line 4g of Form 4952.

To adjust your foreign source capital gain distributions, multiply your post-May 5 foreign source capital gain distributions in each separate category by 0.4286. Multiply your other foreign source capital gain distributions in each separate category by 0.5714. Include the results on line 1 of the applicable Form 1116.

If you are not required to adjust the amount of your foreign source qualified dividends or capital gain distributions, include the amount of your foreign source qualified dividends and capital gain distributions in each separate category (without adjustment) on line 1 of the applicable Form 1116.

Qualified Dividends Tax Worksheet (Estates and Trusts)

If you completed the Qualified Dividends Tax Worksheet in the instructions for Form 1041, you must adjust the amount of your foreign source qualified dividends if:

• Line 5 of the Qualified Dividends Tax Worksheet is equal to or more than line 6 of that worksheet and
• Line 15 of the Qualified Dividends Tax Worksheet is less than line 16 of that worksheet.

To adjust your foreign source qualified dividends, multiply your foreign source qualified dividends in each separate category by 0.4286. Include the results on line 1 of the applicable Form 1116.

If you are not required to make adjustments to your foreign source qualified dividends, include your foreign source qualified dividends on line 1 of the applicable Form 1116 without adjustment.

Do not adjust the amount of any foreign source qualified dividends that you elected to include on line 4g of Form 4952.

Schedule D

Note:

Throughout these instructions, references to Schedule D (Form 1041) are for estates and trusts only.

Adjustments to foreign qualified dividends.   If you are filing Schedule D (Form 1040 or Form 1041) with your tax return, you must adjust the amount of your foreign source qualified dividends that you include on line 1 of Form 1116 if either of the following applies to you.

1. You figured your tax using Part IV of Schedule D (Form 1040), line 27 of Schedule D (Form 1040) is equal to or greater than line 28, and line 51 of Schedule D (Form 1040) is less than line 52. (For estates and trusts, line 24 of Schedule D (Form 1041) is equal to or greater than line 25 and line 48 is less than line 49.)
2. You figured your tax using the Schedule D Tax Worksheet (in the Schedule D (Form 1040) instructions or in the Form 1041 instructions), line 17 of the Schedule D Tax Worksheet is equal to or greater than line 15, and line 49 of the Schedule D Tax Worksheet is less than line 50.

  To adjust your foreign source qualified dividends, multiply your foreign source qualified dividends in each separate category by 0.4286. Include the results on line 1 of the applicable Form 1116.

  

  Do not adjust the amount of any foreign source qualified dividends that you elected to include on line 4g of Form 4952.

  Include on line 1 of Form 1116 the full amount of foreign source qualified dividends that you are not required to adjust.

Adjustments to foreign capital gains and losses.   You may use Worksheet A, Worksheet B, or the instructions for Capital Gains and Losses in Pub. 514 to determine the adjustments you must make to your foreign capital gains or losses. Use the instructions below to see if you qualify to use Worksheet A or Worksheet B. If you do not qualify to use Worksheet A or Worksheet B, or you choose not to use the worksheets, use the instructions for Capital Gains and Losses in Pub. 514 to determine the adjustments you must make.

  

  Before you complete Worksheet A or Worksheet B, you must reduce each foreign source long-term capital gain by the amount of that gain you elected to include on line 4g of Form 4952. The gain you elected to include on line 4g of Form 4952 must be entered directly on line 1 of the applicable Form 1116 without adjustment.

Worksheet A.   You may use Worksheet A on page 8 to determine the adjustments you must make to your foreign source capital gains or losses if you have foreign source capital gains or losses in no more than two separate categories and any of the following apply.

• Line 16 or 17a of the Schedule D (Form 1040) (or line 13 or 16a of the Schedule D (Form 1041)) you are filing with your tax return is zero or a loss.
• Line 27 of the Schedule D (Form 1040) you are filing with your tax return is less than line 28 of that Schedule D. (For estates and trusts, line 24 of the Schedule D (Form 1041) you are filing with your tax return is less than line 25 of that Schedule D.)
• Line 52 of the Schedule D (Form 1040) you are filing with your tax return is equal to or less than line 51 of that Schedule D. (For estates and trusts, line 49 of the Schedule D (Form 1041) you are filing with your tax return is equal to or less than line 48 of that Schedule D.)
• You figured your tax using the Schedule D Tax Worksheet (in the Schedule D (Form 1040) instructions or in the Form 1041 instructions) and line 17 of the Schedule D Tax Worksheet is smaller than line 15 or line 50 of the Schedule D Tax Worksheet is the same as or smaller than line 49.

  Complete Worksheet A only once, even if you have capital gains or losses in two separate categories. Retain the completed Worksheet A for your files. Do not file Worksheet A with your tax return.

Worksheet B.   If you do not qualify to use Worksheet A, use Worksheet B on page 9 to determine the adjustments you must make to your foreign source capital gains or losses if:

• You have foreign source capital gains or losses in only one separate category, and
• You did not complete the Unrecaptured Section 1250 Gain Worksheet or the 28% Rate Gain Worksheet in the Schedule D instructions.

  Retain the completed Worksheet B for your files. Do not file Worksheet B with your tax return.