Form 1116 Step by Step Guide for Expats
The purpose of the IRS for the Foreign Tax Credit is to help taxpayers offset the adverse effects of double taxation. The FTC is a money-saving credit. If you want to claim this credit, you need to fill out Form 1116. This two-page form has a 24-page set of instructions from the IRS. The following step by step guide will help you fill the form in no time, with less hassle and less money to spend.
Step one: Check your qualification for the Foreign Tax Credit
Here are the four conditions that you should satisfy before you can avail of the Foreign Tax Credit:
- You have paid or incurred a foreign tax liability.
- The tax must be assessed on income.
- The tax must be levied on you as an individual.
- The tax must have legally originated in a foreign country.
Step two: Find out what alternatives you have.
There are two options for you for the Foreign Tax Credit. You can lessen the taxes you have paid to your country of residence on your Federal Tax Return. You can also fill out Form 1116. Doing so will reduce the amount that you need to pay the United States in the dollar. If the amount credited to you is more than the amount you should pay, you can choose to carry that amount over. You can even use the amount for any taxes you may need to pay in the years to come!
Step three: Convert your taxes into U.S. dollars
You need to convert the value of the taxes you paid to your foreign country into U.S. dollars. Use the exchange rate during the transaction date. If that is hard to determine, you can use the annual foreign exchange rate on the IRS website. If you have accrued taxes and did not pay them yet, you should use the exchange rate on the last day of the applicable tax year.
Step four: Recognize the limitations.
The credit that you want to claim should not be more than the amount of tax you owe on foreign earned income. Use the following formula to determine the limitation on the foreign-sourced U.S. tax:
Foreign sourced taxable income divided by the total income that is taxable before exemptions. Multiply the quotient by total U.S. tax.
Other limits apply. For example, there are taxes which cannot be claimed. Among these are the taxes paid to a government supporting terrorism (defined by the Secretary of State), dividends from the 10-50 percent-owned foreign business, taxes associated with financial services income, shipping and aircraft income, domestic and international sales corporation dividends, foreign oil and gas extraction income, and foreign trade income of foreign sales corporations.
You should also remember that an income already excluded by the FEIE or Foreign Earned Income Exclusion is not eligible for the Foreign Tax Credit.
Step five: Accomplish Form 1116
The first portion of the form includes strict guidelines on income categories. You need to complete a different Form 1116 for each entry under the different categories of income. The general category may be adequate for most expats. Wages and business income are included in the general category. If you have a passive income, you need to accomplish another Form 1116. Other income requiring a separate Form 116 will be the Section 951A income, foreign branch income, Section 901(j) income, lump-sum distributions, and re-sourced treaty income.