American expats who run or own corporations overseas often face double taxation. The United States taxes worldwide income, including corporate income, and many foreign countries tax profits earned within their borders. Without planning, your corporation could pay taxes twice on the same income.
That’s where claiming the Foreign Tax Credit for corporations on IRS Form 1118 can be beneficial. This form lets qualifying US corporations reduce their US tax bill by the amount of corporation taxes paid to a foreign government. In short, this form can help American expats managing foreign subsidiaries or running their own corporations abroad avoid double taxation and financial headaches.
In this article, we provide an overview of what Form 1118 does, when to file it, and how to file it correctly to avoid double taxes on foreign business profits.
Form 1118 gives US corporations tax credits for the equivalent value as foreign corporate income taxes they’ve already paid. The credit applies to income, war profits, and excess profits taxes, but not to sales, value-added, property, or excise taxes.Its purpose is simple: to prevent double taxation on the same business income.
The IRS allows US corporations to either claim a credit or take a deduction for foreign taxes, but the credit is usually more beneficial, as it reduces your tax due, while a deduction only lowers your taxable income.
For example, if your US tax bill is $100,000 and you qualify for a $40,000 foreign tax credit, you’ll owe only $60,000. The savings can be substantial.
Any domestic corporation that pays or accrues foreign income taxes and wants to claim the Foreign Tax Credit (FTC) must file Form 1118. It’s strictly for corporations, not individuals or partnerships. Individuals can use Form 1116 instead.
Typically, these types of corporations can file Form 1118:
- US parent corporations with foreign subsidiaries – They often receive dividends or other income from entities that paid foreign taxes.
- US corporations operating foreign branches – Branch income is often taxed both locally and by the IRS.
- Controlled foreign corporations (CFCs) – When a CFC pays foreign tax, the US shareholder corporation may claim a deemed paid credit under Internal Revenue Code Sections 960 or 902.
Only US corporations can use Form 1118. Foreign corporations, even if owned by Americans, don’t qualify.
Form 1118 is filed along with Form 1120, the US Corporation Income Tax Return. The due date matches Form 1120’s, typically April 15 for calendar-year corporations.
The form includes multiple schedules that sort income into categories. Most corporations must complete several schedules, as different types of income are treated separately. Even if your company pays taxes to several foreign countries, you’ll still file just one Form 1118, breaking down the income and credits by country and income type.
Form 1118 divides income into specific categories, called baskets, each with its own limitation. Corporations must calculate credits for each basket separately.
Here are the most common ones:
- General limitation income – Covers active business income earned from normal operations.
- Passive category income – Includes dividends, interest, rents, and royalties that aren’t tied to active business activities.
- Foreign branch income – Refers to profits earned through a branch rather than a subsidiary.
- Global intangible low-taxed income (GILTI) – Applies to certain low-taxed profits from controlled foreign corporations.
- Section 901(j) income – Involves countries that the US restricts for tax purposes, such as sanctioned nations.
Each type must be tracked separately. Mixing categories can result in disallowed credits or unwanted IRS attention.
The corporation Foreign Tax Credit calculation and limitation
The IRS limits the credit so corporations can’t offset more than the US tax attributable to their foreign income. The formula is straightforward:
Foreign tax credit limit = (Foreign source taxable income / Total taxable income) × US tax before credits
This ensures that corporations don’t claim excessive credits. If foreign taxes exceed the calculated limit, the extra can be carried back one year or carried forward up to ten years.
Take this example: if your corporation earns $400,000 abroad and $600,000 in the US, total taxable income is $1 million. With $210,000 in total US tax, 40 percent ($84,000)can be claimed as a foreign tax credit. If you paid $100,000 in foreign taxes, you can claim $84,000 this year and carry the remaining $16,000 forward.
Supporting documentation
The IRS expects corporations to maintain clear records to support every figure provided on Form 1118. These typically include:
- Proof of tax payments – Receipts, assessments, or statements from the foreign tax authority.
- Foreign tax returns – Copies showing the calculations and amounts paid.
- Contracts and agreements – To confirm the source and type of income.
- Exchange rate details – Showing how taxes were converted to US dollars.
Accurate records protect your credit claim and provide crucial backup if the IRS requests verification.
Common foreign tax credit for corporations mistakes to avoid
Form 1118 is a complex form, and we recommend you seek professional assistance. We can help – get in touch if you need advice to minimize your business taxes. Here are some common errors filers make on Form 1118:
- Misclassifying income – Mixing active and passive income can distort calculations.
- Using the wrong exchange rate – The rate must reflect when the taxes were paid or accrued. Use the rate applicable to the payment or accrual date of the foreign tax.
- Claiming ineligible taxes – Only income-type taxes qualify. VAT or sales taxes paid by a business, for example, don’t count.
- Overlooking carrybacks and carryforwards – Unused credits can reduce taxes in other years.
- Leaving schedules incomplete – Each income category must have a corresponding schedule and attachments.
The role of tax treaties
US tax treaties can significantly affect your taxes on business income. Many treaties reduce withholding rates on dividends, interest, or royalties and outline which country has the main right to tax specific income.
For example, under the US-UK tax treaty, dividends from a UK subsidiary may face only 5 percent withholding instead of 15 percent. That lower rate changes the credit you can claim on Form 1118.
Expats should seek advice and review the treaty between the US and their country of residence before claiming the foreign tax credit for corporations.
Carrybacks and carryforwards
The carryback and carryforward rules can help make sure your corporation foreign tax credits don’t go to waste.
- Carryback one year – Apply unused credits to the previous year’s return for a potential refund.
- Carryforward ten years – Apply leftover credits to future tax years.
Tracking these amounts accurately is essential, especially for corporations with fluctuating income levels or irregular foreign operations. Note: excess credits must stay within the same category of income, although in some cases, “credit resourcing” can be used if the US and foreign country have a tax treaty.
Controlled Foreign Corporations (CFCs) and the foreign tax credit
Many expats own or control foreign corporations that qualify as Controlled Foreign Corporations (CFCs) under US law. Even though these companies are foreign, certain profits may still face US tax through Subpart F or GILTI rules.
Claiming the foreign tax credit on Form 1118 offsets that US liability. Without it, your corporation could pay full tax both abroad and at home, which can cost thousands each year. For expat entrepreneurs, the form is a safeguard against double taxation.
Professional help can save time and money
Form 1118 isn’t a form you want to rush through. It requires knowledge of tax treaties, corporate income types, and cross-border taxation. Many expat with corporations work with a US expat tax professional who is expert at international reporting.
An experienced expat tax advisor helps make sure that income categories are assigned correctly, credits are maximized and tracked across years, treaty benefits are used fully, and all documentation meets IRS standards.
Hiring the right expert can prevent costly errors, reduce your tax bill, and provide peace of mind that your Form 1118 filing is accurate and defensible.
When used correctly, IRS Form 1118 helps protect corporations from double taxation, improves cash flow, and supports global growth.
For expats running corporations abroad, understanding this form is essential. It’s about keeping more of what you earn and ensuring fair taxation on both sides of the border. The smartest move you can make is to keep thorough records, understand your income categories, and work with a professional who knows expat corporate tax inside and out.
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