Instructions to Form 1116: Claiming the Foreign Tax Credit
Updated: Nov 6
Many U.S. citizens and resident aliens earning income abroad find themselves facing the complex challenge of double taxation. How can one mitigate the financial burden of being taxed by two different countries? Understanding Form 1116 and the Foreign Tax Credit (FTC) is crucial for those seeking relief from double taxation.
What Is IRS Form 1116?
IRS Form 1116, also known as the "Foreign Tax Credit" form, is used by taxpayers to claim a credit for taxes paid to foreign governments. This form is a key element for individuals who have income from outside the U.S. and are subject to taxation by both the U.S. and a foreign country. The foreign tax credit is intended to alleviate the burden of double taxation.
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Is Form 1116 Required to Be Filed?
Filing Form 1116 is required if you want to claim the foreign tax credit and you are a U.S. taxpayer who has paid or accrued certain taxes to a foreign country or U.S. possession. However, if the foreign tax paid is a small amount, you may be able to claim the credit without filing Form 1116, directly on your Form 1040.
What Are the Differences Between Form 1116 and Form 2555?
Form 1116 is used to claim the foreign tax credit, while Form 2555 is used to claim the foreign earned income exclusion. The choice between the two can significantly impact your tax situation.
Form 1116: Allows you to credit foreign taxes against your U.S. tax liability.
Form 2555: Enables you to exclude a certain amount of your foreign earnings from U.S. taxation altogether.
Choosing between the two forms depends on various factors, including the amount of foreign tax paid, your income level, and the specific tax laws of the foreign country. It's often beneficial to calculate your tax both ways to determine which form offers the greater tax advantage.
Carryback and Carryover
If the foreign taxes you've paid exceed the credit limit for the current year, you may carry back the excess for one year and then carry forward any remaining excess for up to 10 years. This provision ensures that you can benefit from the foreign tax credit even when the taxes paid exceed the limit in a given year.
Form 1116 Instructions
Filing Form 1116 involves several steps:
Identify Foreign Taxes Paid or Accrued: Determine the total amount of foreign taxes paid or accrued during the tax year.
Calculate the Taxable Income from Each Source: Separate the income from each foreign source and calculate the U.S. tax on that income.
Determine the Limits on the Credit: The credit cannot be more than the U.S. tax on the foreign income.
Complete the Appropriate Parts of Form 1116: Depending on the types of foreign income, you may need to fill out separate Parts I through IV for passive income, general category income, etc.
How to Calculate Form 1116
Calculating the foreign tax credit using Form 1116 involves several steps:
Figure Your Total Foreign Source Income: Add up all income earned from foreign sources.
Determine the Foreign Source Income on Which You Can Claim a Credit: Not all foreign income qualifies for the credit.
Calculate the Limit on the Credit: This is generally the amount of U.S. tax attributable to your foreign source income.
Apply the Limit to Your Qualified Foreign Taxes: The credit is the lesser of the total foreign taxes paid or the limit calculated.
Example Sarah is an American expatriate living in Berlin, Germany. She works as a freelance graphic designer. Last year, she earned $60,000 from various clients in Germany. Sara paid $12,000 in taxes from her earnings to Germany. Besides her income in Germany, Sarah does not have any other income for the year.
Here's how she would approach her U.S. tax filing using Form 1116:
Total Foreign Taxes Paid: Sarah has documentation showing that she paid $12,000 in German taxes.
Total Income: Her income for U.S. tax purposes is $60,000, all of which is foreign earned.
U.S. Tax Liability Before Credits: After accounting for her standard deduction and any allowable expenses related to her freelance work, Sarah's U.S. tax liability is calculated to be $8,000.
Sarah can claim the full $8,000 as her foreign tax credit, which is the lower of the two figures between her U.S. tax liability and the tax she paid in Germany. However, she has an excess of $4,000 ($12,000 - $8,000) in foreign taxes that she cannot claim in the current year. Sara can carryover the $4,000 for up to 10 years to utilize as a foreign tax credit on her US tax return.
Always consult U.S. tax treaties, as they may offer specific credits or exemptions that could influence your Form 1116 filing
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