Robert Smith, a U.S. citizen, is a salesman who lived and worked in
Country X for all of 2000, 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).
| Income |
Tax |
| $100,000 wages |
$27,400 |
| (200,000 pesos) |
(54,800 pesos) |
| $4,000 dividend income |
$550 |
| (8,000 pesos) |
(1,100 pesos) |
| $1,000 interest income |
$50 |
| (2,000 pesos) |
(100 pesos) |
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
$76,000 of the wages earned in Country X.
Itemized deductions.
Robert was entitled to the following itemized deductions.
| Interest on home mortgage |
$2,900 |
| Real estate tax |
940 |
| Charitable contribution |
460 |
| Employee business expenses
(See the following discussion for computation.) |
888 |
| Total |
$5,188 |
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 $888. This is the difference between his business
expenses of $1,576 ($576 + $1,000 from U.S. business trip) and the
2%-of-ad- justed-gross-income limit ($688).
Forms 1116
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 $100,000. 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 $28,454 figured as follows:
| Gross Income |
| Wages (Country X) |
$100,000 |
| Less: Foreign earned income exclusion |
76,000 |
| $24,000 |
| Wages (U.S.) |
2,400 |
| Interest income (Country X) |
1,000 |
| Dividend income (U.S.) |
3,000 |
| Dividend income (Country X) |
4,000 |
| Total (Adjusted gross income) |
$34,400 |
| Less: Total Itemized Deductions |
5,188 |
| Taxable income before the personal
exemption |
$29,212 |
| Less: Personal Exemption |
2,800 |
| Taxable Income |
$26,412 |
On each Form 1116, Robert enters $29,212 (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 $24,000 (after
subtracting the foreign earned income exclusion) on line 1.
Line 2.
The unreimbursed employee business expenses related to these
foreign source wages included in income are $576, as shown earlier.
Robert must determine which part of the 2%-of-adjusted-gross-in- come
limit ($688) is allowable to these employee business expenses. He
figures this as follows:
The denominator ($1,576) is the total allowable
unreimbursed business expenses ($1,000 + $576). The amount of
deductible expenses definitely related to $24,000 of taxable foreign
wages is $325 ($576 - 251). He enters $325 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
$76,000 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:
| 1. |
Enter gross foreign source income of the type
shown on Form 1116. Do not enter income excluded on Form
2555 |
$24,000 |
| 2. |
Enter gross income from all sources. Do
not enter income excluded on Form 2555 |
$34,400 |
| 3. |
Divide line 1 by line 2 and enter the result
as a decimal |
.6977 |
| 4. |
Enter deductible home mortgage interest (from
Schedule A (Form 1040)) |
$2,900 |
| 5. |
Multiply line 4 by line 3. Enter the result
here and on Form 1116, line 4a |
$2,023 |
Robert enters this amount, $2,023, on line 4a.
Line 6.
Robert adds the amounts on lines 2, 3g, and 4a, and enters that
total ($3,616) 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 $20,384 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:
| 1. |
Enter gross foreign source income of the type
shown on Form 1116. Do not enter income excluded on Form
2555 |
$5,000 |
| 2. |
Enter gross income from all sources. Do
not enter income excluded on Form 2555 |
$34,400 |
| 3. |
Divide line 1 by line 2 and enter the result
as a decimal |
.1453 |
| 4. |
Enter deductible home mortgage interest (from
Schedule A (Form 1040)) |
$2,900 |
| 5. |
Multiply line 4 by line 3. Enter the result
here and on Form 1116, line 4a |
$422 |
He enters this amount, $422, on line 4a.
Line 6.
Robert adds the amounts on lines 3g and 4a and enters that total
($485) 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 $4,515 in this category.
Robert enters this amount on line 7.
Table 6. Robert's Schedule Showing Computation of His Carryover
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 1999
and enters that amount on line 10. He attaches a schedule showing how
he figured his $200 carryover to 2000 after carrying back the unused
$350 tax paid in 1999 to the 2 preceding tax years. (This schedule is
shown in Table 6.) The unused foreign tax in 1999 and the
excess limits in 1997 and 1998 are in the general limitation income
category. The unused foreign tax of $200 is carried over to the
general limitation income category in 2000.
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 ($76,000) minus a proportionate part of his
definitely related business expenses ($1,824). 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, $20,824, on
line 12.
Line 13.
His total foreign taxes available for credit are $6,776 [$200
carryover from 1999 + $6,576 paid in 2000 ($27,400 -
$20,824)].
Line 20.
By completing the rest of Part III, Robert finds that his limit is
2,782.
Line 21.
The foreign tax credit on the general limitation income is the
lesser of the foreign tax available for credit, $6,776, or the limit,
2,782.
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 $616.
The foreign tax credit is the lesser of the foreign tax paid, $600,
or the limit, $616.
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 $3,382 ($600 + $2,782), 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 2000 unused foreign taxes of $3,794 ($6,576 -
$2,782) and $200 of 1999 unused foreign taxes available as a carryover
to 2001 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 2000 unused taxes to 1998 or 1999 as shown
in Table 6.
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 2000
under the limit for this separate income category, he has no unused
tax and therefore no carryback or carryover to other tax years.
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