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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 2001, 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).
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 $78,000 of the wages earned in Country X.
Itemized deductions. Robert was entitled to the following itemized deductions.
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:
His employee business expense deduction is $880. This is the difference between his business expenses of $1,528 ($528 + $1,000 from U.S. business trip) and the 2%-of-ad- justed-gross-income limit ($648).
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 $22,000 (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 $24,320 figured as follows:
On each Form 1116, Robert enters $27,220 (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 $22,000 on line 1.
Line 2. The unreimbursed employee business expenses related to these foreign source wages included in income are $528, as shown earlier. Robert must determine which part of the 2%-of-adjusted-gross-income limit ($648) is allocable to these employee business expenses. He figures this as follows:
The denominator ($1,528) is the total allowable unreimbursed business expenses ($1,000 + $528). The amount of deductible expenses definitely related to $22,000 of taxable foreign wages is $304 ($528 - $224). He enters $304 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 $78,000 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.
Line 4a. Robert apportions his qualified home mortgage interest, $2,900, to general limitation income as follows:
Robert enters this amount, $1,969, on line 4a.
Line 6. Robert adds the amounts on lines 2, 3g, and 4a, and enters that total ($3,541) 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 $18,459 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 enters the $1,000 interest income and the $4,000 dividend income from Country X 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.
Line 4a. Robert apportions the qualified home mortgage interest to passive income as follows:
He enters this amount, $447, on line 4a.
Line 6. Robert adds the amounts on lines 3g and 4a and enters that total ($510) 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 $4,490 in this category. Robert enters this amount on line 7.
Part II--Foreign Taxes Paid or Accrued
Robert uses Part II, Form 1116, to report the foreign tax paid or accrued on income from foreign sources.
Form 1116--General limitation income. On this Form 1116, Robert enters the amount of foreign taxes paid, in foreign currency and in U.S. dollars, on the wages from Country X.
Form 1116--Passive income. On this Form 1116, Robert enters the amount of foreign taxes paid, in foreign currency and in U.S. dollars, on the interest and dividend income.
Part III--Figuring the Credit
Robert figures the amount of foreign tax credit in Part III on each Form 1116.
Form 1116--General limitation income. On this Form 1116, Robert figures the amount of foreign tax credit allowable for the foreign taxes paid on his wages from Country X.
Line 10. He has a carryover of $200 for unused foreign taxes paid in 2000 and enters that amount on line 10. He attaches a schedule showing how he figured his $200 carryover to 2001 after carrying back the unused $350 tax paid in 2000 to the 2 preceding tax years. (This schedule is shown in Table 4.) The unused foreign tax in 2000 and the excess limits in 1998 and 1999 are in the general limitation income category. The unused foreign tax of $200 is carried over to the general limitation income category in 2001.
Line 12. On line 12, Robert must reduce the total foreign taxes paid by the amount related to the wages he excludes as foreign earned income. To do this, he multiplies the $27,400 foreign tax he paid on his foreign wages by a fraction. The numerator of the fraction is his foreign earned income exclusion ($78,000) minus a proportionate part of his definitely related business expenses ($1,872). The denominator of the fraction is his total foreign wages ($100,000) minus his total definitely related business expenses ($2,400).
He enters the result, $21,372, on line 12.
Line 13. His total foreign taxes available for credit are $6,228 [$200 carryover from 2000 + $6,028 paid in 2001 ($27,400 - $21,372)].
Line 20. By completing the rest of Part III, Robert finds that his limit is 2,475.
Line 21. The foreign tax credit on the general limitation income is the lesser of the foreign tax available for credit, $6,228, or the limit, 2,475.
Form 1116--Passive income. Robert now figures the foreign tax credit allowable for the foreign taxes he paid on his interest and dividend income from Country X.
By completing Part III of Form 1116, he finds that the limit on his credit is $602.
The foreign tax credit is the lesser of the foreign tax paid, $600, or the limit, $602.
Part IV--Summary of Credits From Separate Parts III
Robert summarizes his foreign tax credits for the two types of income on Part IV of one Form 1116. He uses the Part IV of Form 1116--General limitation income.
Robert leaves line 32 blank because he did not participate in or cooperate with an international boycott during the tax year. The allowable foreign tax credit is $3,075 ($600 + $2,475), shown on line 33. He also enters this amount on line 43 of Form 1040.
Unused Foreign Taxes
Robert now determines if he has any unused foreign taxes that can be used as a carryback or carryover to other tax years.
General limitation income. Robert has 2001 unused foreign taxes of $3,553 ($6,028 - $2,475) and $200 of 2000 unused foreign taxes available as a carryover to 2002 and later years. (The foreign taxes related to his foreign earned income exclusion are not available for carryover.) He cannot carry back any part of the 2001 unused taxes to 1999 or 2000 as shown in Table 4.
Passive income. Since the tax Robert paid on his interest and dividend income is less than the amount for which he could have claimed a credit in 2001 under the limit for this separate income category, he has no unused tax and therefore no carryback or carryover to other tax years.