US citizens and resident aliens filing Form 1040 are required to pay taxes on their worldwide income. US citizens living abroad are required to pay US taxes regardless of income source. Form 1116 is used to avoid double taxation by providing the taxpayer a dollar-for-dollar credit to be applied against taxes owed.
The foreign tax credit can be claimed for tax paid to a foreign country on income that is also taxed by the United States, including income tax, war profits tax, excess profits tax, and taxes in lieu of income tax. Taxes paid to a foreign country, a political subdivision of a foreign country, Puerto Rico, and American Samoa qualify. The credit is lesser of foreign tax paid or U.S. tax allocated to foreign source income.
For a foreign tax to qualify for the credit, it must meet these four tests:
- It is an income tax or a tax imposed in lieu of an income tax.
- It is the legal and actual foreign tax liability.
- It was imposed on the taxpayer.
- It was paid or accrued by the taxpayer.
The taxpayer cannot take a credit for taxes paid that they don't legally owe, including taxes where it is reasonably certain that the amount will be refunded, credited, rebated, abated, or forgiven. Thus, the amount of tax to enter on the form is the lesser of the amount they paid or the amount they legally owe by treaty, if there is a treaty with the source country and if it contains a provision as to the tax rate for the source income.
Before completing Form 1116, check to see if the US has a tax treaty with the source country. If there is a tax treaty, read it to determine its tax rate for the particular source income so that you can determine the allowable amount of tax to be credited. See here for the countries with whom the US has tax treaties.
If the taxpayer paid more to the source country than they legally owed, they may have to file a tax return in the source country to recover the difference.
Any foreign taxes claimed on Form 1116 cannot also be deducted on Schedule A, and vice-versa. Also, don't use Form 1116 to calculate credit for taxes paid to the US Virgin Islands. Instead, use Form 8689, Allocation of Individual Income Tax to the U.S. Virgin Islands.
On Form 1116, all income and taxes are reported in US dollars except where specified otherwise in Part II. When converting to US dollars, use the conversion rate in effect on the day when foreign taxes were paid or withheld. See here for more information about foreign currency conversion.
Form AMT 1116
Form AMT 1116 is a version of Form 1116 used for the AMT calculation. If a return is subject to AMT, the form is produced automatically using the information in Form 1116. It can also be directly edited if necessary for the AMT calculation. (Its menu includes a delete command, but if the return is subject to AMT the form cannot be deleted, and attempting to do so has the effect of refreshing it.)
In the individual tax return (Form 1040) in TaxSlayer Pro, the AMT 1116 menu is here:
- 2021 and forward: Tax Computation
2020 and prior: Other Taxes
- Alternative Minimum Tax (6251)
- Alternative Minimum Tax Foreign Tax Credit
Election to claim the Foreign Tax Credit without filing Form 1116
A taxpayer may claim the foreign tax credit without filing Form 1116 if all of the following are true:
- All foreign source gross income is passive income. For the purposes of the foreign tax credit, passive income includes interest, dividends, royalties, rents, and annuities. Capital gains not related to the active content of a trade or business are also generally passive income.
- All the income and any foreign taxes paid on the income were reported to the taxpayer on a qualified payee statement such as Form 1099-DIV, Form 1099-INT, Schedule K-1, or similar substitute statements.
- The total creditable foreign taxes paid are not more than $300 ($600 for Married Filing Jointly).
If the taxpayer makes this election, any unused credit cannot be carried forward and prior year unused credit cannot be included, and you will enter the credit amount directly on the Foreign Tax Credit line of Schedule 3 (Form 1040).
To make this election in TaxSlayer Pro, from the Main Menu of the tax return (Form 1040) select:
- Foreign Tax Credit (1116)
- Foreign Tax Credit Not More than $300 / $600 - Enter the amount of the credit. The credit will be limited $600 for MFJ filing status, $300 for all others.
Election to claim the Foreign Tax Credit using Form 1116
On Form 1116, there are seven categories of source income, and a separate form needs to be completed for each category and for each country within the category. If you are uncertain about what category the income belongs to, refer to the Form 1116 instructions here. The form includes room for three countries, so a tax return with multiple categories and/or source countries may include multiple pages of the form with the total of all the forms carrying to the Foreign Tax Credit line on Schedule 3.
Entering the Foreign Tax Credit in TaxSlayer Pro
To complete Form 1116 in TaxSlayer Pro, from the Main Menu of the tax return (Form 1040) select:
- Foreign Tax Credit (1116)
- Complete Form 1116
- Select the category to which the income belongs, then complete the information for that category as follows:
- Country of Residence - Select the taxpayer's country of residence when the income was earned.
- Foreign Regulated Investment Company Source - Income from a foreign RIC as well as income reported on Form 8992 (U.S. Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI)) and on Form 965 (Inclusion of Deferred Foreign Income Upon Transition to Participation Exemption System) does not need to be reported on a country-by-country basis. Answer YES here if any of these apply, then indicate which applies. After doing so, "RIC", "965" or "951A" will be indicated as the "country" in Column A on the form.
- Foreign Income High Taxed Kickout Source - This question only has relevance to passive category income. Passive income doesn't include "high-taxed income", and income is deemed high-taxed if the the foreign taxes paid on the income (after allocation of expenses) exceeds the highest US tax that can be imposed on the income. Answer YES here if this applies. If answered Yes, "HTKO" will be indicated as the "country" in Column A, and you will enter the income on the passive category form as a negative number and create an identical general category form with the income entered as a positive number and this question also answered YES.
- Column A - Part I & Part II
Column B - Part I & Part II
Column C - Part I & Part II - The form includes three columns for three different countries. Complete each column as needed.
- Part I
- Enter the Country the Income was received from - Indicate the country the income was received from.
- Gross Income from Country shown above - Select this line, enter a description for the type of income, and enter the income in one or more of the four menu lines. Income not entered in one of the qualified dividends / capital gains lines will go on the "All other income" line. The total income should include income that is tax-exempt in the foreign country but should not include earned income excluded on Form 2555.
- Enter the remaining items on the page if any apply.
- Part II - Indicate if foreign taxes were either paid or accrued and the date on which they were paid or accrued. If taxes were withheld on interest, dividends, or rents and royalties in the foreign currency, or paid or accrued in the foreign currency, enter the foreign currency amount in the appropriate menu line. Indicate the US dollar equivalent on the corresponding US dollars menu line. There must be a US dollar amount entered or no credit will calculate.
- Alternative Basis Used to Determine Part I Income Source - For income earned as an employee, the basis of the compensation is generally the time worked, and the basis of fringe benefits is generally the geographical location. However, a taxpayer might use an alternative basis to determine the source of their income if the facts and circumstances warrant it. Answer YES here if the taxpayer is using an alternative basis and their total employee compensation from all US and foreign sources is $250,000 or more. After doing so the check box on Line 1b will be checked. (Whether or not this box is checked, the taxpayer using an alternative basis must be able to demonstrate to the IRS how the alternative basis is better at determining the source of their income versus time and geography.) If the box is checked, you must attach a PDF statement to the return explaining the alternative basis. See Publication 514 for more information.
- Part III - Complete any of the menu items that may apply:
- Carryback or Carryover - If there is an unused credit amount being carried forward or back to this year, enter a description and the amount.
- Reduction in Foreign Taxes - There are a number of reasons why foreign taxes might be reduced. See the Form 1116 instructions for more information if any of these apply.
- Taxes on income excluded on Form 2555.
- Taxes on income from Puerto Rico that isn't taxable in the US.
- Taxes on income from American Samoa excluded on Form 4563.
- Taxes on combined foreign oil and gas income.
- Taxes on foreign mineral income.
- 10% reduction of all foreign taxes for failure to file Form 5471 if it is required.
- 10% reduction of all foreign taxes for failure to file Form 8865 if it is required.
- Reduction of taxes related to boycott operations.
- Taxes related to a foreign tax credit splitting event.
- Adjustments - There are a number of reasons why the taxable foreign income or loss might be adjusted. See the Form 1116 instructions for more information if any of these apply.
- Adjustment for disallowed business loss under section 461(l).
- Allocation of foreign losses (necessary if you have more than one Form 1116 and at least one of them indicates a loss on Line 15).
- Allocation of U.S. losses (net US-source loss needs to be allocated to each foreign income category).
- Recapture of prior year overall foreign loss accounts.
- Recapture of separate limitation loss accounts.
- Recapture of overall domestic loss accounts.
- Boycott Operations Reduction - The amount entered here is from Schedule A (Form 5713), a form that will need to be completed outside of TaxSlayer Pro and attached to the return. The amount entered here flows to Form 1116 Part III Line 34. Enter an amount here if the taxpayer is filing Form 5713 and can't determine the amount of tax specifically attributable to boycott operations. Don't enter the amount here if you only have one category of income; enter it on the reduction line.
- Edit Taxable Income Limitation - If the tax is being calculated using the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet, see the Form 1116 instructions for Line 18 to see if an entry is needed here. The amount entered will reduce Line 18 (which flows from Form 1040 Line 15, Taxable Income).
- Increase in Limitation (Section 960(c)) - Enter the amount of any increase to
the taxpayer's limitation as determined under the excess limitation rules of section 960(c).
Validation errors related to Form 1116
An electronically filed tax return that includes Form 1116 will reject if the form is incomplete. See here for a list of reasons why the form might reject and how to fix them.
To avoid a reject or validation error, pay attention to these fundamentals:
- If you select an income category in error, delete it. Otherwise a blank form will be prepared for that category.
- Ensure the country of residence has been entered.
- In Part I, don't forget to enter the country the income was received from.
- In Part II, don't forget to indicate if taxes were paid or accrued and the date on which they were paid or accrued.
- Part II must indicate a US dollar amount of taxes withheld and/or paid or accrued, otherwise no credit will calculate.
Note: This is a guide on entering Foreign Tax Credit into the TaxSlayer Pro program. This is not intended as tax advice.
IRS: Instructions for Form 1116, Foreign Tax Credit (Individual, Estate, or Trust)
IRS: Publication 514, Foreign Tax Credit for Individuals
IRS: Publication 54, Tax Guide for US Citizens and Resident Aliens Abroad