How to Complete Form 1116 for General Category Income

The U.S. foreign tax credit relieves the burden of double taxation that occurs when foreign-source income is taxed by both the United States and a foreign country. Since U.S. citizens and resident aliens are taxed on their worldwide income, this credit offsets foreign income taxes against their U.S. tax liability. The document for individuals to claim this benefit is Form 1116, Foreign Tax Credit.

Using this form involves categorizing foreign income, calculating a limitation based on that income, and reporting the foreign taxes paid or accrued. This guide focuses on completing Form 1116 for the general income category, a common classification for many types of foreign earnings.

Defining General Category Income

The IRS requires foreign income to be sorted into distinct categories, and a separate Form 1116 must be filed for each one. Besides the general category, other categories include passive income and foreign branch income. The general category is a broad classification for active, earned income that does not fit into more specialized categories, making it relevant for many individuals working abroad.

Common examples of general category income include wages, salaries, and other compensation for services performed as an employee in a foreign country. It also includes income from the active conduct of a trade or business abroad.

Conversely, certain income does not belong in the general category. Passive income streams like most interest, dividends, royalties, and rents have their own category and require a separate Form 1116. An exception is the “high-tax kickout” rule, where passive income taxed by a foreign country at a rate higher than the top U.S. rate can be reclassified as general category income.

Information and Documentation for Form 1116

Before beginning Form 1116, you must collect specific financial information and documents. You will need to identify all gross foreign source income that qualifies for the general category. This income must be reported on a country-by-country basis.

You must have proof of foreign taxes paid or accrued, such as foreign tax receipts or returns. Only foreign income taxes are eligible for the credit. Taxes that are refundable or that you were not legally obligated to pay do not qualify.

All financial figures on Form 1116 must be in U.S. dollars. Amounts paid in a foreign currency must be translated using an accepted exchange rate. Use the rate in effect on the day the foreign tax was paid or, for accrued taxes, the average exchange rate for the tax year.

A portion of your deductions must be allocated against your foreign source income, reducing the income subject to the credit calculation. Expenses directly related to your foreign general category income are deducted in full. Other deductions not directly tied to a specific income source, like certain itemized deductions or the standard deduction, must be apportioned between U.S. and foreign sources.

Calculating the Foreign Tax Credit Limitation

The foreign tax credit is limited to prevent taxpayers from using it to reduce U.S. tax liability on U.S. source income. The allowable credit is the lesser of the actual foreign income tax paid or accrued, or the calculated limitation amount.

The limitation is determined using the following formula: (Foreign Source Taxable Income ÷ Total Taxable Income Before Exemptions) × U.S. Tax Before Credits. This calculation ensures the credit only offsets the U.S. tax attributable to your foreign source income.

Foreign source taxable income is your gross foreign source income minus allocable deductions. Total taxable income is your worldwide income from all sources, derived from your Form 1040. The U.S. tax before credits is the tax liability on your total taxable income, also found on your Form 1040 before credits are applied.

If your foreign taxes paid or accrued exceed this limit, you may not use the full amount in the current year. These unused credits can be carried back to the previous tax year and then carried forward for up to ten years to offset U.S. tax in those periods.

Completing Form 1116 for General Category Income

When filling out Form 1116, check the box for “General category income” at the top. This step ensures the IRS correctly classifies the earnings and applies the appropriate rules.

In Part I, “Taxable Income or Loss From Sources Outside the United States,” enter your gross income from general category sources on a country-by-country basis. You will then report the related expenses and your pro-rata share of other deductions to arrive at your net foreign source taxable income.

In Part II, “Foreign Taxes Paid or Accrued,” list the foreign income taxes for each country. Report these amounts in both the foreign currency and their U.S. dollar equivalent, along with the date paid or accrued. The total creditable foreign taxes are then calculated.

Part III, “Figuring the Credit,” computes the final credit by applying the limitation formula. You will enter figures from Part I and Part II, as well as your total taxable income and U.S. tax liability from your Form 1040. The result is your allowable foreign tax credit, which is the smaller of the taxes paid or the calculated limitation.

Part IV, “Summary of Credits from all Forms 1116,” totals the credits if you are filing for multiple income categories. If you are only filing for general category income, this section will reflect your final credit amount. This amount is then transferred to Schedule 3 (Form 1040) to reduce your U.S. tax liability.