36.13 Foreign Tax Credit

de minimis exception applies; see below. You may not claim a foreign tax credit or deduction for taxes paid on income not subject to U.S. tax. If all of your foreign earned income is excluded, none of the foreign taxes paid on such income may be taken as a credit or deduction on your U.S. return. If you exclude only part of your foreign pay, you determine which foreign taxes are attributable to excluded income and thus barred as foreign tax credits by applying the fractional computation provided in the instructions to Form 1116 and IRS Publication 514.

In one tax year, you may not elect to deduct some foreign taxes and claim others as a credit. One method must be applied to all taxes paid or accrued during the tax year. If you are a cash-basis taxpayer, you may claim a credit for accrued foreign taxes, but you must consistently follow this method once elected.

Exemption from limit for de minimis foreign taxes.

If you have $300 or less of creditable foreign taxes, $600 if married filing jointly, you may elect to be exempt from the overall limitation on the credit, provided that your only foreign source income is qualified passive income and all the income and any foreign taxes paid on it were reported to you on a qualified payee statement such as Form 1099-DIV, Form 1099-INT, or Schedule K-1 of Form 1041, 1065, 1065-B, or 1120S. If the election is made, a foreign tax credit may be claimed directly on Line 47 of Form 1040 without filing Form 1116. See the instructions to Form 1116 for rules on making this election.

Credit disallowed.

The credit may not be claimed if:

• You are a nonresident alien. However, under certain circumstances, if you are a bona fide resident for an entire taxable year in Puerto Rico you may be able to claim the credit. Also, a nonresident alien engaged in a U.S. trade or business may be able to claim a credit if he or she receives foreign source income effectively connected to that U.S. business.
• You are a citizen of a U.S. possession (except Puerto Rico) but not a U.S. citizen or resident.

No credit is allowed for taxes imposed by a country designated by the government as engaging in terroristic activities; see IRS Publication 514 for a list of these countries.

Taxes qualifying for the credit.

The credit is allowed only for foreign income tax, excess profits taxes, and similar taxes in the nature of an income tax. It is not allowed for any taxes paid to foreign countries on sales, gross receipts, production, the privilege to do business, personal property, or export of capital. See the instructions to Form 1116 and IRS Publication 514 for other taxes that may qualify for the credit.

Reporting foreign income on your return.

You report the gross amount of your foreign income in terms of United States currency. You also attach a schedule showing how you figured the foreign income in United States currency.

Limit on credit.

Your 2012 credit for foreign income taxes paid or accrued is subject to a limitation on Form 1116 unless you qualify for and elect the exemption for de minimis taxes discussed above. The limitation is your total U.S. regular tax liability multiplied by a fraction: the numerator is your net foreign source taxable income (after required adjustments), and the denominator is your total taxable income from all sources. To determine the limit, you must separate your foreign source income into either the passive income category or the general income category. If you have both categories of foreign source income, you must figure the credit limit for each category on a separate Form 1116. If you have income from activities in sanctioned countries, or certain income re-sourced by treaty as foreign source income, or you paid taxes on a foreign source lump-sum distribution from a pension plan, a separate Form 1116 must be used to figure the limit for these categories as well. If you have more than one category of income, you combine the credits for the separate categories on Part IV of the Form 1116 with the largest credit. Part IV is not completed on the other Forms 1116, which are filed as attachments. See IRS Publication 514 and the instructions to Form 1116 for the details on these computations.

Carryback and carryover of excess foreign tax credit.

If you are unable to claim all of the qualified foreign taxes paid or accrued during the year because of the limit on the credit, the balance may be carried back one year and then carried forward 10 years. For further details, see IRS Publication 514 and the instructions to Form 1116.