Foreign Tax Redetermination: What You Need to Do

A foreign tax redetermination is a reconciliation between the foreign tax credit claimed on a U.S. tax return and the foreign tax ultimately paid. The U.S. system allows taxpayers to claim a credit for income taxes paid to other countries to mitigate double taxation. This process is necessary when a change to a taxpayer’s foreign tax obligation occurs after the foreign tax credit has been claimed on a filed U.S. return. It prevents taxpayers from benefiting from a credit for foreign taxes that were later refunded or adjusted downwards.

Events Triggering a Foreign Tax Redetermination

A foreign tax redetermination is initiated by several events that alter a previously reported foreign tax liability. The taxpayer is responsible for recognizing these triggers and notifying the IRS.

• A refund of foreign taxes is received. If a taxpayer claims a credit for a foreign income tax and later receives a full or partial refund of that tax, a redetermination is required to account for the returned amount.
• Additional foreign tax is paid for a prior year. This often occurs after an audit by a foreign tax authority concludes that more tax was owed for a previous period than was originally paid.
• A difference arises between accrued and paid foreign tax. For taxpayers using the accrual method, a redetermination is necessary if the final tax liability differs from the accrued estimate. This can result from adjustments to the foreign tax return or currency exchange rate fluctuations. A redetermination is also required if an accrued foreign tax is not paid within 24 months after the close of the taxable year to which it relates.
• A foreign country’s tax law changes retroactively. If a foreign government alters its tax laws in a way that applies to a prior year, it can change the taxpayer’s liability and require a redetermination.

Required Information and Form Completion

To complete a foreign tax redetermination, a taxpayer must first collect specific data. This includes the original U.S. tax year the credit was claimed, the foreign country, the category of income, the dates the foreign tax liability changed, and both the original and corrected foreign tax amounts. The currency exchange rates used on all relevant dates are also needed to translate foreign currency amounts into U.S. dollars.

Individuals must use Form 1116, Foreign Tax Credit, and corporations must use Form 1118, Foreign Tax Credit—Corporations. For reporting a redetermination, individuals complete Schedule C (Form 1116), and corporations use Schedule L (Form 1118).

On the appropriate schedule, the taxpayer must report the details of the redetermination event. This includes identifying the “relation-back” year, which is the tax year being adjusted. The forms require a detailed breakdown of the changes in foreign taxes, distinguishing between the amounts that were originally reported and the redetermined amounts. This provides the IRS with a clear record of the adjustment.

Notifying the IRS and Amending Your Return

The primary method for notifying the IRS is filing an amended U.S. tax return for the year the foreign tax credit was originally claimed. This is known as the relation-back year. Individuals must file Form 1040-X, Amended U.S. Individual Income Tax Return, while corporations use Form 1120-X, Amended U.S. Corporation Income Tax Return.

A complete submission package is required. The amended return serves as the cover document. Attached to it must be a recalculated Form 1116 or Form 1118 for the affected tax year, reflecting the corrected foreign tax credit amount. The submission must also include the completed informational schedule detailing the redetermination, which is either Schedule C (Form 1116) or Schedule L (Form 1118).

The completed package must be mailed to the IRS service center designated for processing amended returns, as specified in the form instructions. Once submitted, the IRS will review the filing and process the redetermination, resulting in an adjustment to the taxpayer’s account for the original tax year.

Impact on U.S. Tax Liability

A foreign tax redetermination requires a recalculation of the foreign tax credit and its limitation for the original tax year, which directly impacts the taxpayer’s U.S. tax liability. If the redetermination was triggered by a refund of foreign taxes, the amount of creditable taxes decreases. This results in a smaller foreign tax credit and increases the total U.S. tax liability for the original year, creating a tax deficiency.

If the redetermination was caused by an additional payment of foreign tax, the amount of creditable taxes increases. This leads to a larger foreign tax credit, which can reduce the U.S. tax liability for the original year and result in a refund.

Interest is a component of any redetermination that changes U.S. tax liability. If the redetermination results in a tax deficiency, the IRS charges interest on the underpayment from the original due date of the return until the additional tax is paid. If the redetermination leads to an overpayment, the IRS will pay interest to the taxpayer on the refunded amount.

Failure to notify the IRS of a required foreign tax redetermination can lead to penalties. A penalty is imposed if a taxpayer does not file the required notice, unless the failure is due to reasonable cause. The penalty starts at 5% of the tax deficiency from the redetermination and increases by an additional 5% for each month the failure continues, up to a maximum of 25% of the deficiency.