Publication 514
taxmap/pubs/p514-005.htm#en_us_publink1000224482As already indicated, you can claim a foreign tax credit only
for foreign taxes on income, war profits, or excess profits, or taxes in lieu of
those taxes. In addition, there is a limit on the amount of the credit that you
can claim. You figure this limit and your credit on Form 1116. Your credit is
the amount of foreign tax you paid or accrued or, if smaller, the limit.
If you have foreign taxes available for credit but you cannot
use them because of the limit, you may be able to carry them back 1 tax year and
forward to the next 10 tax years. See
Carryback and Carryover, later.
Also, certain tax treaties have special rules that you must consider
when figuring your foreign tax credit. See
Tax Treaties,
later.
taxmap/pubs/p514-005.htm#en_us_publink1000224483You will not be subject to this limit and will be able to claim
the credit without using Form 1116 if the following requirements are met.
- Your only foreign source gross income for the tax year is
passive category income. Passive category income is defined later under
Separate Limit Income. However, for purposes of this rule, high taxed income and
export financing interest are also passive category income.
- Your qualified foreign taxes for the tax year are not more
than $300 ($600 if married filing a joint return).
- All of your gross foreign income and the foreign taxes are
reported to you on a payee statement (such as a Form 1099-DIV or 1099-INT).
- You elect this procedure for the tax year.
If you make this election, you cannot carry back or carry over
any unused foreign tax to or from this tax year.
 | This election exempts you only from the limit figured on
Form 1116 and not from the other requirements described in this publication. For
example, the election does not exempt you from the requirements discussed
earlier under
What Foreign Taxes Qualify for the Credit. |
taxmap/pubs/p514-005.htm#en_us_publink1000224485Your foreign tax credit cannot be more than your total U.S. tax
liability (Form 1040, line 44) multiplied by a fraction. The numerator of the
fraction is your taxable income from sources outside the United States. The
denominator is your total taxable income from U.S. and foreign sources.
To determine the limit, you must separate your foreign source
income into categories, as discussed under
Separate Limit Income
next. The limit treats all foreign income and expenses in each separate category
as a single unit and limits the credit to the U.S. income tax on the taxable
income in that category from all sources outside the United States.
taxmap/pubs/p514-005.htm#en_us_publink1000224486You must figure the limit on a separate Form 1116 for each of
the following categories of income.
- Passive category income.
- General category income.
- Section 901(j) income.
- Certain income re-sourced by treaty.
- Any lump sum distribution from an employer benefit plan for
which the special averaging treatment is used to determine your tax.
In figuring your separate limits, you must combine the income
(and losses) in each category from all foreign sources, and then apply the
limit.
taxmap/pubs/p514-005.htm#en_us_publink1000224487As a U.S. shareholder, certain income that you receive or accrue
from a controlled foreign corporation (CFC) is treated as separate limit income.
You are considered a U.S. shareholder in a CFC if you own 10% or more of the
total voting power of all classes of the corporation's voting stock.
Subpart F inclusions, interest, rents, and royalties from a CFC
are generally treated as separate limit income if they are attributable to the
separate limit income of the CFC. A dividend paid or accrued out of the earnings
and profits of a CFC is treated as separate limit income in the same proportion
that the part of earnings and profits attributable to income in the separate
category bears to the total earnings and profits of the CFC. For more
information, see section 904(d)(3) of the Internal Revenue Code and Regulations
section 1.904-5.
taxmap/pubs/p514-005.htm#en_us_publink1000224488In general, a partner's distributive share of partnership income
is treated as separate limit income if it is from the separate limit income of
the partnership. However, if the partner owns less than a 10% interest in the
partnership, the income is generally treated as passive income. For more
information, see Regulations section 1.904-5(h).
taxmap/pubs/p514-005.htm#en_us_publink1000224489Passive category income consists of passive income and specified
passive category income.
taxmap/pubs/p514-005.htm#en_us_publink1000224490Except as described earlier under
Income from controlled foreign corporations and
Partnership distributive share, passive income generally includes the following.
- Dividends.
- Interest.
- Rents.
- Royalties.
- Annuities.
- Net gain from the sale of non-income-producing investment
property or property that generates passive income.
- Net gain from commodities transactions, except for hedging
and active business gains or losses of producers, processors, merchants, or
handlers of commodities.
- Amounts you must include as foreign personal holding company
income under section 551(a) or 951(a) of the Internal Revenue Code.
- Amounts includible in income under section 1293 of the Internal
Revenue Code (relating to certain passive foreign investment companies).
If you receive foreign source distributions from a mutual fund
or other regulated investment company that elects to pass through to you the
foreign tax credit, the income is generally considered passive. The mutual fund
will provide you with a Form 1099-DIV or substitute statement showing the amount
of foreign taxes it elected to pass through to you.
taxmap/pubs/p514-005.htm#en_us_publink1000224491Passive income does not include any of the following.
- Gains or losses from the sale of inventory property or property
held mainly for sale to customers in the ordinary course of your trade or
business.
- Export financing interest.
- High-taxed income.
- Active business rents and royalties.
- Any income that is defined in another separate limit category.
This is interest derived from financing the sale or other disposition
of property for use outside the United States if:
- The property is manufactured, produced, grown, or extracted
in the United States by you or a related person, and
- 50% or less of the fair market value of the property is due
to imports into the United States.
This is passive income subject to foreign taxes that are higher
than the highest U.S. tax rate that can be imposed on the income. The high-taxed
income and the taxes imposed on it are moved from passive category income into
general category income. See Regulations section 1.904-4(c) for more
information.
taxmap/pubs/p514-005.htm#en_us_publink1000224494Specified passive income consists of:
- Dividends from a DISC (domestic international sales corporation)
or former DISC to the extent the dividends are treated as foreign source income,
and
- Distributions from a former FSC (foreign sales corporation)
out of earnings and profits that are attributable to:
- Foreign trade income, or
- Interest and carrying charges derived from a transaction
that results in foreign trade income.
General category income includes income from sources outside
the United States that is not passive category income or does not fall into one
of the other separate limit categories discussed later. It generally includes
active business income and wages, salaries, and overseas allowances of an
individual as an employee. General category income includes high-taxed income
that would otherwise be passive income. See
High-taxed income earlier under
What is not passive income.In general, financial services income is treated as general category
income if it is derived by a financial services entity. You are a financial
services entity if you are predominantly engaged in the active conduct of a
banking, insurance, financing, or similar business for any taxable year.
Financial services income of a financial services entity generally includes
income derived in the active conduct of a banking, financing, insurance or
similar business. Financial services income of a financial services entity also
includes passive income and certain incidental income.
If you qualify as a financial services entity because you treat
certain items of income as active financing income under Regulations section
1.904-4(e)(2)(i)(Y), you must show the type and amount of each item on an
attachment to Form 1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224497This is income earned from activities conducted in sanctioned
countries. Income derived from each sanctioned country is subject to a separate
foreign tax credit limitation. Therefore, you must use a separate Form 1116 for
income earned from each such country. See
Taxes Imposed By Sanctioned Countries (Section 901(j) Income) under
Taxes for Which You Can Only Take an Itemized Deduction, earlier.
If a sourcing rule in an applicable income tax treaty treats
any of the income listed below as foreign source, and you elect to apply the
treaty, the income will be treated as foreign source.
- Certain gains (section 865(h)).
- Certain income from a U.S.-owned foreign corporation (section
904(h)(10)). See Regulations section 1.904-5(m)(7) for an example.
You must compute a separate foreign tax credit limitation for
any such income for which you claim benefits under a treaty, using a separate
Form 1116 for each amount of re-sourced income from a treaty country.
| For tax years beginning after August 10, 2010, you must compute
a separate foreign tax limitation for any item of U.S. source income (not only
those listed above) that is re-sourced as foreign income under an income tax
treaty of which you claim benefits. You must use a separate Form 1116 for each
item. |
taxmap/pubs/p514-005.htm#en_us_publink1000224499If you receive a foreign source lump-sum distribution (LSD) from
a retirement plan, and you figure the tax on it using the special averaging
treatment for LSDs, you must make a special computation. Follow the Form 1116
instructions and complete the worksheet in those instructions to determine your
foreign tax credit on the LSD.
 | The special averaging treatment for LSDs is elected by filing
Form 4972, Tax on Lump-Sum Distributions. |
taxmap/pubs/p514-005.htm#en_us_publink1000224501Solely for purposes of allocating foreign taxes to separate limit
income categories, those separate limit categories include any U.S. source
income that is taxed by the foreign country or U.S. possession.
If you paid or accrued foreign income tax for a tax year on income
in more than one separate limit income category, allocate the tax to the income
category to which the tax specifically relates. If the tax is not specifically
related to any one category, you must allocate the tax to each category of
income.
You do this by multiplying the foreign income tax related to
more than one category by a fraction. The numerator of the fraction is the net
income taxed by the foreign country in a separate category. The denominator is
the total net income.
You figure net income by deducting from the gross income in each
category and from the total gross income taxed by the foreign country or U.S.
possession any expenses, losses, and other deductions definitely related to them
under the laws of the foreign country or U.S. possession. If the expenses,
losses, and other deductions are not definitely related to a category of income
under foreign law, they are apportioned under the principles of the foreign law.
If the foreign law does not provide for apportionment, use the principles
covered in the U.S. Internal Revenue Code.
taxmap/pubs/p514-005.htm#en_us_publink1000224502You paid foreign income taxes of $3,200 to Country A on wages
of $80,000 and interest income of $3,000. These were the only items of income on
your foreign return. You also have deductions of $4,400 that, under foreign law,
are not definitely related to either the wages or interest income. Your total
net income is $78,600 ($83,000–$4,400).
Because the foreign tax is not specifically for either item of
income, you must allocate the tax between the wages and the interest under the
tax laws of Country A. For purposes of this example, assume that the laws of
Country A do this in a manner similar to the U.S. Internal Revenue Code. First
figure the net income in each category by allocating those expenses that are not
definitely related to either category of income.
You figure the expenses allocable to wages (general category
income) as follows.
$80,000 (wages)
$83,000 (total income)
| × | $4,400 | = | $4,241 |
| The net wages are $75,759 ($80,000 − $4,241). |
| | | | | |
You figure the expenses allocable to interest (passive category
income) as follows.
$3,000 (interest)
$83,000 (total income)
| × | $4,400 | = | $159 |
| The net interest is $2,841 ($3,000 − $159). |
| | | | | |
Then, to figure the foreign tax on the wages, you multiply the
total foreign income tax by the following fraction.
$75,759 (net wages)
$78,600 (total net income)
| × | $3,200 | = | $3,084 |
| | | | | |
| | | | | |
You figure the foreign tax on the interest income as follows.
$2,841 (net interest)
$78,600 (total net income)
| × | $3,200 | = | $116 |
If foreign taxes were paid or accrued on your behalf by a partnership
or an S corporation, you will figure your credit using certain information from
the Schedule K-1 you received from the partnership or S corporation. If you
received a 2010 Schedule K-1 from a partnership or an S corporation that
includes foreign tax information, see your Form 1116 instructions for how to
report that information.
taxmap/pubs/p514-005.htm#en_us_publink1000224508Before you can determine the limit on your credit, you must first
figure your total taxable income from all sources before the deduction for
personal exemptions. This is the amount shown on line 41 of Form 1040 or line 39
of Form 1040NR. Then for each category of income, you must figure your taxable
income from sources outside the United States.
Before you can figure your taxable income in each category from
sources outside the United States, you must first determine whether your gross
income in each category is from U.S. sources or foreign sources. Some of the
general rules for figuring the source of income are outlined in
Table 2.
The rules for determining whether income is from sources in a
U.S. possession are generally the same as those for determining whether income
is from U.S. sources. But exceptions apply. See Publication 570 for more
information.
taxmap/pubs/p514-005.htm#en_us_publink1000224510If you are an employee and receive compensation for labor or
personal services performed both inside and outside the United States, special
rules apply in determining the source of the compensation. Compensation (other
than certain fringe benefits) is sourced on a time basis. Certain fringe
benefits (such as housing and education) are sourced on a geographical basis.
Or, you may be permitted to use an alternative basis to determine
the source of compensation. See
Alternative basis later.
If you are self-employed, you determine the source of compensation
for labor or personal services from self-employment on the basis that most
correctly reflects the proper source of that income under the facts and
circumstances of your particular case. In many cases, the facts and
circumstances will call for an apportionment on a time basis as explained next.
taxmap/pubs/p514-005.htm#en_us_publink1000224511Use a time basis to figure your foreign source compensation (other
than the fringe benefits discussed later). Do this by multiplying your total
compensation (other than the fringe benefits discussed later) by the following
fraction:
| | Number of days you performed services in the foreign country
during the year | |
| | Total number of days you performed services during the year | |
You can use a unit of time less than a day in the above fraction,
if appropriate. The time period for which the compensation is made does not have
to be a year. Instead, you can use another distinct, separate, and continuous
time period if you can establish to the satisfaction of the IRS that this other
period is more appropriate.
taxmap/pubs/p514-005.htm#en_us_publink1000224513Christina Brooks, a U.S. citizen, worked 240 days for a U.S.
company during the tax year. She received $80,000 in compensation. None of it
was for fringe benefits. Christina performed services in the United States for
60 days and performed services in the United Kingdom for 180 days. Using the
time basis for determining the source of compensation, $60,000 ($80,000 ×
180/240) is her foreign source income.
taxmap/pubs/p514-005.htm#en_us_publink1000224514Rob Waters, a U.S. citizen, is employed by a U.S. corporation.
His principal place of work is in the United States. His annual salary is
$100,000. None of it is for fringe benefits. During the first quarter of the
year he worked entirely within the United States. On April 1, Rob was
transferred to Singapore for the remainder of the year. Rob is able to establish
that the first quarter of the year and the last 3 quarters of the year are two
separate, distinct, and continuous periods of time. Accordingly, $25,000 of
Rob's annual salary is attributable to the first quarter of the year (.25 ×
$100,000). All of it is U.S. source income because he worked entirely within the
United States during that quarter. The remaining $75,000 is attributable to the
last three quarters of the year. During those quarters, he worked 150 days in
Singapore and 30 days in the United States. His periodic performance of services
in the United States did not result in distinct, separate, and continuous
periods of time. Of his $75,000 salary, $62,500 ($75,000 ×
150/180) is foreign source income for the year.
taxmap/pubs/p514-005.htm#en_us_publink1000224515The source of multi-year compensation is generally determined
on a time basis over the period to which the compensation is attributable.
Multi-year compensation is compensation that is included in your income in one
tax year but that is attributable to a period that includes two or more tax
years.
You determine the period to which the compensation is attributable
based on the facts and circumstances of your case. For example, an amount of
compensation that specifically relates to a period of time that includes several
calendar years is attributable to the entire multi-year period.
The amount of compensation treated as from foreign sources is
figured by multiplying the total multi-year compensation by a fraction. The
numerator of the fraction is the number of days (or unit of time less than a
day, if appropriate) that you performed labor or personal services in the
foreign country in connection with the project. The denominator of the fraction
is the total number of days (or unit of time less than a day if appropriate)
that you performed labor or personal services in connection with the project.
taxmap/pubs/p514-005.htm#en_us_publink1000224516
Table 2. Source of Income
| Item of Income | Factor Determining Source |
| Salaries, wages, other compensation | Where services performed |
| Business income: | |
| Personal services | Where services performed |
| Sale of inventory—purchased | Where sold |
| Sale of inventory—produced | Allocation |
| Interest | Residence of payer |
| Dividends | Whether a U.S. or foreign corporation* |
| Rents | Location of property |
| Royalties: | |
| Natural resources | Location of property |
| Patent, copyrights, etc. | Where property is used |
| Sale of real property | Location of property |
| Sale of personal property | Seller's tax home (but see
Determining the Source of Income From the Sales or Exchanges
of Certain Personal Property, later, for exceptions)
|
| Pension distributions attributable to contributions | Where services were performed that earned the pension |
| Investment earnings on pension contributions | Location of pension trust |
| Sale of natural resources | Allocation based on fair market value of product at export
terminal. For more information, see Regulations section 1.863-1(b). |
* Exceptions include:
a) Dividends paid by a U.S. corporation are foreign source
if the corporation elects the American Samoa Economic Development Credit,
b) Part of a dividend paid by a foreign corporation is U.S.
source if at least 25% of the corporation's gross income is effectively
connected with a U.S. trade or business for the 3 tax years before the year in
which the dividends are declared.
|
taxmap/pubs/p514-005.htm#en_us_publink1000224519Compensation you receive as an employee in the form of the following
fringe benefits is sourced on a geographical basis.
- Housing.
- Education.
- Local transportation.
- Tax reimbursement.
- Hazardous or hardship duty pay.
- Moving expense reimbursement.
The amount of fringe benefits must be reasonable and you must
substantiate them by adequate records or by sufficient evidence. Table 3
summarizes the factors used for determining the source of these fringe benefits.
taxmap/pubs/p514-005.htm#en_us_publink1000224520
Table 3. Source of Fringe Benefits
| Fringe Benefit | Factor Determining Source |
| Housing, education, and local transportation | Location of your principal place of work |
| Tax reimbursement | Location of the jurisdiction that imposed the tax for which
you were reimbursed |
| Hazardous or hardship duty pay | Location of the hazardous or hardship duty zone for which
you received the pay |
| Moving expense reimbursement | Location of your new principal place of work* |
| *You can determine the source based on the location of your
former principal place of work if you have sufficient evidence that such
determination of source is more appropriate under the facts and circumstances of
your case.
|
The source of a housing fringe benefit is determined based on
the location of your principal place of work. A housing fringe benefit includes
payments to or on your behalf (and your family if your family resides with you)
only for the following:
- Rent.
- Utilities (except telephone charges).
- Real and personal property insurance.
- Occupancy taxes not deductible under section 164 or 216(a).
- Nonrefundable fees for securing a leasehold.
- Rental of furniture and accessories.
- Household repairs.
- Residential parking.
- Fair rental value of housing provided in kind by your employer.
A housing fringe benefit does not include:
- Deductible interest and taxes (including deductible interest
and taxes of a tenant-stockholder in a cooperative housing corporation),
- The cost of buying property, including principal payments
on a mortgage,
- The cost of domestic labor (maids, gardeners, etc.),
- Pay television subscriptions,
- Improvements and other expenses that increase the value or
appreciably prolong the life of property,
- Purchased furniture or accessories,
- Depreciation or amortization of property or improvements,
- The value of meals or lodging that you exclude from gross
income, or
- The value of meals or lodging that you deduct as moving expenses.
The source of an education fringe benefit for the education expenses
of your dependents is determined based on the location of your principal place
of work. An education fringe benefit includes payments only for the following
expenses for education at an elementary or secondary school.
- Tuition, fees, academic tutoring, special needs services for
a special needs student, books, supplies, and other equipment.
- Room and board and uniforms that are required or provided
by the school in connection with enrollment or attendance.
The source of a local transportation fringe benefit is determined
based on the location of your principal place of work. Your local transportation
fringe benefit is the amount that you receive as compensation for your local
transportation or that of your spouse or dependents at the location of your
principal place of work. The amount treated as a local transportation fringe
benefit is limited to actual expenses incurred for local transportation and the
fair rental value of any employer-provided vehicle used predominantly by you or
your spouse or dependents for local transportation. Actual expenses do not
include the cost (including interest) of any vehicle purchased by you or on your
behalf.
taxmap/pubs/p514-005.htm#en_us_publink1000224526The source of a foreign tax reimbursement fringe benefit is determined
based on the location of the jurisdiction that imposed the tax for which you are
reimbursed.
taxmap/pubs/p514-005.htm#en_us_publink1000224527The source of hazardous or hardship duty pay fringe benefit is
determined based on the location of the hazardous or hardship duty zone for
which the hazardous or hardship duty pay fringe benefit is paid. A hazardous or
hardship duty zone is any place in a foreign country which meets either of the
following conditions.
- The zone is designated by the Secretary of State as a place
where living conditions are extraordinarily difficult, notably unhealthy, or
where excessive physical hardships exist, and for which a post differential of
15 percent or more would be provided under section 5925(b) of Title 5 of the
U.S. Code to any officer or employee of the U.S. government at that place.
- The zone is where civil insurrection, civil war, terrorism,
or wartime conditions threaten physical harm or imminent danger to your health
and well-being.
Compensation is treated as a hazardous or hardship duty pay fringe
benefit only if your employer provides the hazardous or hardship duty pay fringe
benefit only to employees performing labor or personal services in a hazardous
or hardship duty zone.
The amount of compensation treated as a hazardous or hardship
duty pay fringe benefit cannot exceed the maximum amount that the U.S.
government would allow its officers or employees present at that location.
taxmap/pubs/p514-005.htm#en_us_publink1000224528The source of a moving expense reimbursement is generally based
on the location of your new principal place of work. However, the source is
determined based on the location of your former principal place of work if you
have sufficient evidence that such determination of source is more appropriate
under the facts and circumstances of your case. Sufficient evidence generally
requires an agreement between you and your employer, or a written statement of
company policy, which is reduced to writing before the move and which is entered
into or established to induce you or other employees to move to another country.
The written statement or agreement must state that your employer will reimburse
you for moving expenses that you incur to return to your former principal place
of work regardless of whether you continue to work for your employer after
returning to that location. It may contain certain conditions upon which the
right to reimbursement is determined as long as those conditions set forth
standards that are definitely ascertainable and can only be fulfilled prior to,
or through completion of, your return move to your former principal place of
work.
taxmap/pubs/p514-005.htm#en_us_publink1000224529If you are an employee, you can determine the source of your
compensation under an alternative basis if you establish to the satisfaction of
the IRS that, under the facts and circumstances of your case, the alternative
basis more properly determines the source of your compensation than the time or
geographical basis. If you use an alternative basis, you must keep (and have
available for inspection) records to document why the alternative basis more
properly determines the source of your compensation. Also, if your total
compensation from all sources was $250,000 or more, you must check the box on
Form 1116, line 1b, and attach a written statement to your tax return that sets
forth all of the following:
- Your name and social security number (written across the top
of the statement),
- The specific compensation income, or the specific fringe benefit,
for which you are using the alternative basis,
- For each item in (2), the alternative basis of allocation
of source used,
- For each item in (2), a computation showing how the alternative
allocation was computed, and
- A comparison of the dollar amount of the U.S. compensation
and foreign compensation sourced under both the alternative basis and the time
or geographical basis discussed earlier.
Generally, if personal property is sold by a U.S. resident, the
gain or loss from the sale is treated as U.S. source. If personal property is
sold by a nonresident, the gain or loss is treated as foreign source.
This rule does not apply to the sale of inventory, intangible
property, or depreciable property, or property sold through a foreign office or
fixed place of business. The rules for these types of property are discussed
later.
taxmap/pubs/p514-005.htm#en_us_publink1000224531The term "U.S. resident," for this purpose, means a U.S. citizen
or resident alien who does not have a tax home in a foreign country. The term
also includes a nonresident alien who has a tax home in the United States.
Generally, your tax home is the general area of your main place of business,
employment, or post of duty, regardless of where you maintain your family home.
Your tax home is the place where you are permanently or indefinitely engaged to
work as an employee or self-employed individual. If you do not have a regular or
main place of business because of the nature of your work, then your tax home is
the place where you regularly live. If you do not fit either of these
categories, you are considered an itinerant and your tax home is wherever you
work.
taxmap/pubs/p514-005.htm#en_us_publink1000224532A nonresident is any person who is not a U.S. resident.
U.S. citizens and resident aliens with a foreign tax home will
be treated as nonresidents for a sale of personal property only if an income tax
of at least 10% of the gain on the sale is paid to a foreign country.
This rule also applies to losses recognized after January 7,
2002, if the foreign country would have imposed a 10% or higher tax had the sale
resulted in a gain. You can choose to apply this rule to losses recognized in
tax years beginning after 1986. For details about making this choice, see
Regulations section 1.865-1(f)(2). For stock losses, see Regulations section
1.865-2(e).
taxmap/pubs/p514-005.htm#en_us_publink1000224533Income from the sale of inventory that you purchased is sourced
where the property is sold. Generally, this is where title to the property
passes to the buyer.
Income from the sale of inventory that you produced in the United
States and sold outside the United States (or vice versa) is sourced based on an
allocation. For information on making the allocation, see Regulations section
1.863-3.
taxmap/pubs/p514-005.htm#en_us_publink1000224534Intangibles include patents, copyrights, trademarks, and goodwill.
The gain from the sale of amortizable or depreciable intangible property, up to
the previously allowable amortization or depreciation deductions, is sourced in
the same way as the original deductions were sourced. This is the same as the
source rule for gain from the sale of depreciable property. See
Depreciable property next, for details on how to apply this rule.
Gain in excess of the amortization or depreciation deduction
is sourced in the country where the property is used if the income from the sale
is contingent on the productivity, use, or disposition of that property. If the
income is not contingent on the productivity, use, or disposition of the
property, the income is sourced according to the seller's tax home as discussed
earlier. Payments for goodwill are sourced in the country where the goodwill was
generated if the payments are not contingent on the productivity, use, or
disposition of the property.
taxmap/pubs/p514-005.htm#en_us_publink1000224535The gain from the sale of depreciable personal property, up to
the amount of the previously allowable depreciation, is sourced in the same way
as the original deductions were sourced. Thus, to the extent the previous
deductions for depreciation were allocable to U.S. source income, the gain is
U.S. source. To the extent the depreciation deductions were allocable to foreign
sources, the gain is foreign source income. Gain in excess of the depreciation
deductions is sourced the same as inventory.
If personal property is used predominantly in the United States,
treat the gain from the sale, up to the amount of the allowable depreciation
deductions, entirely as U.S. source income.
If the property is used predominantly outside the United States,
treat the gain, up to the amount of the depreciation deductions, entirely as
foreign source income.
A loss recognized after January 7, 2002, is sourced in the same
way as the depreciation deductions were sourced. However, if the property was
used predominantly outside the United States, the entire loss reduces foreign
source income. You can choose to apply this rule to losses recognized in tax
years beginning after 1986. For details about making this choice, see
Regulations section 1.865-1(f)(2).
Depreciation includes amortization and any other allowable deduction
for a capital expense that is treated as a deductible expense.
taxmap/pubs/p514-005.htm#en_us_publink1000224536Income earned by U.S. residents from the sale of personal property
through an office or other fixed place of business outside the United States is
generally treated as foreign source if:
- The income from the sale is from the business operations located
outside the United States, and
- At least 10% of the income is paid as tax to the foreign country.
If less than 10% is paid as tax, the income is U.S. source.
This rule also applies to losses recognized after January 7,
2002, if the foreign country would have imposed a 10% or higher tax had the sale
resulted in a gain. You can choose to apply this rule to losses recognized in
tax years beginning after 1986. For details about making this choice, see
Regulations section 1.865-1(f)(2). For stock losses, see Regulations section
1.865-2(e).
This rule does not apply to income sourced under the rules for
inventory property, depreciable personal property, intangible property (when
payments in consideration for the sale are contingent on the productivity, use,
or disposition of the property), or goodwill.
taxmap/pubs/p514-005.htm#en_us_publink1000224537To figure your taxable income in each category from sources outside
the United States, you first allocate to specific classes (kinds) of gross
income the expenses, losses, and other deductions (including the deduction for
foreign housing costs) that are definitely related to that income.
taxmap/pubs/p514-005.htm#en_us_publink1000224538A deduction is definitely related to a specific class of gross
income if it is incurred either:
- As a result of, or incident to, an activity from which that
income is derived, or
- In connection with property from which that income is derived.
You must determine which of the following classes of gross income
your deductions are definitely related to.
- Compensation for services, including wages, salaries, fees,
and commissions.
- Gross income from business.
- Gains from dealings in property.
- Interest.
- Rents.
- Royalties.
- Dividends.
- Alimony and separate maintenance.
- Annuities.
- Pensions.
- Income from life insurance and endowment contracts.
- Income from cancelled debts.
- Your share of partnership gross income.
- Income in respect of a decedent.
- Income from an estate or trust.
When you allocate deductions that are definitely related to one
or more classes of gross income, you take exempt income into account for the
allocation. However, do not take exempt income into account to apportion
deductions that are not definitely related to a separate limit category.
taxmap/pubs/p514-005.htm#en_us_publink1000224541taxmap/pubs/p514-005.htm#en_us_publink1000224542If the class of gross income to which a deduction definitely
relates includes either:
- More than one separate limit category, or
- At least one separate limit category and U.S. source income,
you must apportion the definitely related deductions within
that class of gross income.
To apportion, you can use any method that reflects a reasonable
relationship between the deduction and the income in each separate limit
category. One acceptable method for many individuals is based on a comparison of
the gross income in a class of income to the gross income in a separate limit
income category.
Use the following formula to figure the amount of the definitely
related deduction apportioned to the income in the separate limit category:
Gross income in separate limit category
Total gross income in the class
| × | deduction |
Do not take exempt income into account when you apportion the
deduction. However, income excluded under the foreign earned income or foreign
housing exclusion is not considered exempt. You must, therefore, apportion
deductions to that income.
Generally, you apportion your interest expense on the basis of
your assets. However, certain special rules apply. If you have gross foreign
source income (including income that is excluded under the foreign earned income
exclusion) of $5,000 or less, your interest expense can be allocated entirely to
U.S. source income.
taxmap/pubs/p514-005.htm#en_us_publink1000224545Apportion interest incurred in a trade or business using the
asset method based on your business assets.
Under the asset method, you apportion the interest expense to
your separate limit categories based on the value of the assets that produced
the income. You can value assets at fair market value, the tax book value, or
the alternative book value. For more information about the asset method, see
Temporary Regulations section 1.861-9T(g).
If you use the tax book value method, you can elect to change
to the fair market value method at any time without IRS approval. If you elect
to use the fair market value method, you must continue to use that method unless
you have IRS approval to change methods.
taxmap/pubs/p514-005.htm#en_us_publink1000224546Apportion this interest on the basis of your investment assets.
taxmap/pubs/p514-005.htm#en_us_publink1000224547Apportion interest incurred in a passive activity on the basis
of your passive activity assets.
taxmap/pubs/p514-005.htm#en_us_publink1000224548General partners and limited partners with partnership interests
of 10% or more must classify their distributive shares of partnership interest
expense under the three categories listed above. They must apportion the
interest expense according to the rules for those categories by taking into
account their distributive share of partnership gross income or pro rata share
of partnership assets. For special rules that may apply, see Regulations section
1.861-9T(e).
taxmap/pubs/p514-005.htm#en_us_publink1000224549This is your deductible home mortgage interest (including points
and mortgage insurance premiums) from Schedule A (Form 1040). Apportion it under
a gross income method, taking into account all income (including business,
passive activity, and investment income), but excluding income that is exempt
under the foreign earned income exclusion. The gross income method is based on a
comparison of the gross income in a separate limit category with total gross
income.
The Instructions for Form 1116 have a worksheet for apportioning
your deductible home mortgage interest expense.
For this purpose, however, any qualified residence that is rented
is considered a business asset for the period in which it is rented. You
therefore apportion this interest under the rules for passive activity or
business interest.
taxmap/pubs/p514-005.htm#en_us_publink1000224550You are operating a business as a sole proprietorship. Your business
generates only U.S. source income. Your investment portfolio consists of several
less-than-10% stock investments. You have stocks with an adjusted basis of
$100,000. Some of your stocks (with an adjusted basis of $40,000) generate U.S.
source income. Your other stocks (with an adjusted basis of $60,000) generate
foreign passive income. You own your main home, which is subject to a mortgage
of $120,000. Interest on this loan is home mortgage interest. You also have a
bank loan in the amount of $40,000. The proceeds from the bank loan were divided
equally between your business and your investment portfolio. Your gross income
from your business is $50,000. Your investment portfolio generated $4,000 in
U.S. source income and $6,000 in foreign source passive income. All of your
debts bear interest at the annual rate of 10%.
The interest expense for your business is $2,000. It is apportioned
on the basis of the business assets. All of your business assets generate U.S.
source income; therefore, they are U.S. assets. This $2,000 is interest expense
allocable to U.S. source income.
The interest expense for your investments is also $2,000. It
is apportioned on the basis of investment assets. $800 ($40,000/$100,000 ×
$2,000) of your investment interest is apportioned to U.S. source income and
$1,200 ($60,000/$100,000 × $2,000) is apportioned to foreign source passive
income.
Your home mortgage interest expense is $12,000. It is apportioned
on the basis of all your gross income. Your gross income is $60,000, $54,000 of
which is U.S. source income and $6,000 of which is foreign source passive
income. Thus, $1,200 ($6,000/$60,000 × $12,000) of the home mortgage
interest is apportioned to foreign source passive income.
taxmap/pubs/p514-005.htm#en_us_publink1000224551State income taxes (and certain taxes measured by taxable income)
are definitely related and allocable to the gross income on which the taxes are
imposed. If state income tax is imposed in part on foreign source income, the
part of your state tax imposed on the foreign source income is definitely
related and allocable to foreign source income.
taxmap/pubs/p514-005.htm#en_us_publink1000224552If the state does not specifically exempt foreign income from
tax, the following rules apply.
- If the total income taxed by the state is greater than the
amount of U.S. source income for federal tax purposes, then the state tax is
allocable to both U.S. source and foreign source income.
- If the total income taxed by the state is less than or equal
to the U.S. source income for federal tax purposes, none of the state tax is
allocable to foreign source income.
If state law specifically exempts foreign income from tax, the
state taxes are allocable to the U.S. source income.
taxmap/pubs/p514-005.htm#en_us_publink1000224554Your total income for federal tax purposes, before deducting
state tax, is $100,000. Of this amount, $25,000 is foreign source income and
$75,000 is U.S. source income. Your total income for state tax purposes is
$90,000, on which you pay state income tax of $6,000. The state does not
specifically exempt foreign source income from tax. The total state income of
$90,000 is greater than the U.S. source income for federal tax purposes.
Therefore, the $6,000 is definitely related and allocable to both U.S. and
foreign source income.
Assuming that $15,000 ($90,000 − $75,000) is the foreign
source income taxed by the state, $1,000 of state income tax is apportioned to
foreign source income, figured as follows:
$15,000
$90,000
| × | $6,000 | = | $1,000 |
You must apportion to your foreign income in each separate limit
category a fraction of your other deductions that are not definitely related to
a specific class of gross income. If you itemize, these deductions are medical
expenses, general sales taxes, new motor vehicle taxes, and real estate taxes
for your home. If you do not itemize, this is your standard deduction. You
should also apportion any other deductions that are not definitely related to a
specific class of income, including deductions shown on Form 1040, lines 23-35.
The numerator of the fraction is your gross foreign income in
the separate limit category, and the denominator is your total gross income from
all sources. For this purpose, gross income includes income that is excluded
under the foreign earned income provisions but does not include any other exempt
income.
taxmap/pubs/p514-005.htm#en_us_publink1000224559Do not take the deduction for personal exemptions, including
exemptions for dependents, in figuring taxable income from sources outside the
United States.
taxmap/pubs/p514-005.htm#en_us_publink1000224560If you have any qualified dividends, you may be required to make
adjustments to the amount of those qualified dividends before you take them into
account on line 1a or line 17 of Form 1116. See
Foreign Qualified Dividends and Capital Gains (Losses)
in the Form 1116 instructions to determine the adjustments you
may be required to make before taking foreign qualified dividends into account
on line 1a of Form 1116. See the instructions for line 17 in the Form 1116
instructions to determine the adjustments you may be required to make before
taking U.S. or foreign qualified dividends into account on line 17 of Form 1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224561If you have capital gains (including any capital gain distributions)
or capital losses, you may have to make certain adjustments to those gains or
losses before taking them into account on line 1a (gains), line 5 (losses), or
line 17 (taxable income before subtracting exemptions) of Form 1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224562If you have foreign source capital gains or losses, you may be
required to make certain adjustments to those foreign source capital gains or
losses before you take them into account on line 1a or line 5 of Form 1116. Use
the instructions under
Foreign Qualified Dividends and Capital Gains (and Losses)
in the Instructions for Form 1116 to determine if you are required to make
adjustments. Also use the instructions under
Foreign Qualified Dividends and Capital Gains (and Losses)
in the Instructions for Form 1116 to determine if you can use those instructions
to make adjustments or if you must use the instructions in this publication to
make adjustments.
taxmap/pubs/p514-005.htm#en_us_publink1000224563If you have U.S. or foreign source capital gains, you may be
required to adjust the amount you enter on line 17 of Form 1116. Use the
instructions for line 17 in the Instructions for Form 1116 to determine whether
you are required to make an adjustment and to determine the amount of the
adjustment.
taxmap/pubs/p514-005.htm#en_us_publink1000224564You may have to make the following adjustments to your foreign
source capital gains and losses.
- U.S. capital loss adjustment.
- Capital gain rate differential adjustment.
Before you make these adjustments, you must reduce your net
capital gain by the amount of any gain you elected to include in investment
income on line 4g of Form 4952, Investment Interest Expense Deduction. Your net
capital gain is the excess of your net long-term capital gain for the year over
any net short-term capital loss for the year. Foreign source gain you elected to
include on line 4g of Form 4952 must be entered directly on line 1a of Form 1116
without adjustment.
You must adjust the amount of your foreign source capital gains
to the extent that your foreign source capital gain exceeds the amount of your
worldwide capital gain (the "U.S. capital loss adjustment").
Your "foreign source capital gain" is the amount of your foreign
source capital gains in excess of your foreign source capital losses. If your
foreign source capital gains do not exceed your foreign source capital losses,
you do not have a foreign source capital gain and you do not need to make the
U.S. capital loss adjustment. See
Capital gain rate differential adjustment
later for adjustments you must make to your foreign source capital gains or
losses.
Your "worldwide capital gain" is the amount of your worldwide
(U.S. and foreign) capital gains in excess of your worldwide (U.S. and foreign)
capital losses. If your worldwide capital losses equal or exceed your worldwide
capital gains, your "worldwide capital gain" is zero.
Your U.S. capital loss adjustment is the amount of your foreign
source capital gain in excess of your worldwide capital gain. (If the amount of
your foreign source capital gain does not exceed the amount of your worldwide
capital gain, you do not have a U.S. capital loss adjustment.) See
Capital gain rate differential adjustment
later for adjustments you must make to your foreign source capital gains or
losses. If you have a U.S. capital loss adjustment, you must reduce your foreign
source capital gains by the amount of the U.S. capital loss adjustment. To make
this adjustment, you must allocate the total amount of the U.S. capital loss
adjustment among your foreign source capital gains using the following steps.
You must apportion the U.S. capital loss adjustment among your
separate categories that have a net capital gain. A separate category has a net
capital gain if the amount of foreign source capital gains in the separate
category exceeds the amount of foreign source capital losses in the separate
category. You must apportion the U.S. capital loss adjustment pro rata based on
the amount of net capital gain in each separate category.
taxmap/pubs/p514-005.htm#en_us_publink1000224567Alfie has a $300 foreign source capital gain that is passive
category income, a $1,000 foreign source capital gain that is general category
income, a $400 foreign source capital loss that is general category income, and
a $150 U.S. source capital loss. He figures his net gains and U.S. capital loss
adjustment as follows.
| | Foreign source capital gain = $900
(($1,000 + $300) − $400)
|
| | Worldwide capital gain = $750
(($1,000 + $300) − ($400 + $150))
|
| | U.S. capital loss adjustment = $150
($900 − $750)
|
| | |
Alfie must then apportion the U.S. capital loss adjustment ($150)
between the passive category income and the general category income based on the
amount of net capital gain in each separate category.
| | $50 apportioned to passive category income
($150 × $300/$900)
|
| | |
Alfie reduces his $300 net capital gain that is passive category
income by $50 and includes the resulting $250 on line 1a of the Form 1116 for
the passive category income.
| | $100 apportioned to general category income
($150 × $600/$900)
|
Alfie reduces his $600 of net capital gain that is general category
income by $100 and includes the resulting $500 on line 1a of the Form 1116 for
the general category income.
taxmap/pubs/p514-005.htm#en_us_publink1000224571If you apportioned any amount of the total U.S. capital loss
adjustment to a separate category with a net capital gain in more than one rate
group, you must further apportion the U.S. capital loss adjustment among the
rate groups in that separate category (separate category rate groups) that have
a net capital gain.
The
rate groups
are the 28% rate group, the 25% rate group, the 15% rate group,
the 0% rate group, and the short-term rate group. The 28% rate group, the 25%
rate group, the 15% rate group and the 0% rate group are "long term" rate
groups.
Table 4 explains the rate groups.
You must apportion the U.S. capital loss adjustment pro rata
based on the amount of net capital gain in each separate category rate group.
Your net capital gain in a separate category rate group is the amount of your
foreign source capital gains in that separate category in the rate group in
excess of your foreign source capital losses in that separate category in the
rate group. If your foreign source capital losses exceed your foreign source
capital gains, you have a net capital loss in the separate category rate group.
taxmap/pubs/p514-005.htm#en_us_publink1000224572
Table 4. Rate Groups
| A capital gain or loss is in the... | | IF... | |
| 28% rate group | | it is included on the 28%
Rate Gain Worksheet
in the instructions for
Schedule D.
| |
| 25% rate group | | it is included on line 1 through line 13 of the
Unrecaptured Section 1250 Gain Worksheet
in the instructions for Schedule D.
| |
| 15% rate group | | it is a long-term capital gain that is not in the 28% or
25% rate group and is taxed at a 15% rate
or
it is a long-term capital loss that is not in the 28% or 25% rate group.
| |
| 0% rate group | | it is a long-term capital gain that is not in the 25% or
28% rate group and is taxed at a rate of 0%. | |
| Short-term rate group | | it is a short-term capital gain or loss. | |
Dennis has a $300 U.S. source long-term capital loss. Dennis also has foreign
source capital gains and losses in the following categories.
| Income category | 28% rate | 15% rate | short-term |
| Passive | $200 | | ($100) | | $100 | |
| General | | | $700
($300)
| | | |
He figures his U.S. capital loss adjustment as follows.
| | Dennis' foreign source capital gain is $600.
(($200 + $700 + $100) − ($100 + $300))
|
| | Dennis' worldwide capital gain is $300.
(($200 + $700 + $100) − ($100 + $300 + $300))
|
| | Dennis' U.S. capital loss adjustment is $300.
($600 − $300)
|
| | |
Dennis must apportion his $300 U.S. capital loss adjustment between
passive category income and general category income based on the amount of net
capital gain in each separate category.
| | Dennis' net capital gain, passive category income is $200.
(($100 + $200) - $100)
Dennis apportions $100 to passive category income.
($300 × $200/$600)
|
| | | |
| | Dennis' net capital gain, general category income is $400.
($700 - $300)
Dennis apportions $200 to general category income.
($300 × $400/$600)
|
| | | |
Dennis has net capital gain in more than one rate group that
is passive category income. Therefore, the $100 apportioned to passive category
income must be further apportioned between the short-term rate group and the 28%
rate group based on the amount of net capital gain in each rate group.
| | Dennis apportions $33.33 to the short-term rate group.
($100 × $100/$300)
Dennis apportions $66.67 to the 28% rate group.
($100 × $200/$300)
|
| | | |
After the U.S. capital loss adjustment, Dennis has $100 of foreign
source 15% capital loss that is passive category income, $66.67 of foreign
source short-term capital gain that is passive category income, $133.33 of
foreign source 28% gain that is passive category income, and $200 of foreign
source 15% capital gain that is general category income, as shown in the
following table.
| Income category | 28% rate | 15% rate | short-term |
| Passive | $200.00
-66.67
$133.33 | | ($100) | | $100.00
–33.33
$66.67 | |
| General | | | $700.00
(300.00)
-200.00
$200.00
| | | |
taxmap/pubs/p514-005.htm#en_us_publink1000224580After you have made your U.S. capital loss adjustment, you must
make additional adjustments (capital gain rate differential adjustments) to your
foreign source capital gains and losses.
You must make adjustments to each separate category rate group
that has a net capital gain or loss. See
Step 2 under
U.S. capital loss adjustment, earlier, for instructions on how to determine whether you
have a net capital gain or loss in a separate category rate group.
taxmap/pubs/p514-005.htm#en_us_publink1000224581How you make the capital gain rate differential adjustment depends
on whether you have a net capital gain or net capital loss in a separate
category rate group.
taxmap/pubs/p514-005.htm#en_us_publink1000224582If you have a net capital gain in a separate category rate group,
you must do the following.
- First determine the amount of your net capital gain in each
separate category rate group that must be adjusted.
- Then make the capital gain rate differential adjustment. See
Capital gain rate differential adjustment for net capital
gains, later.
You must adjust the net capital gain in each separate category
long-term rate group that remains after the U.S. capital loss adjustment. You
must adjust the entire amount of that remaining net capital gain if you do not
have a net long-term capital loss from U.S. sources or you do not have any
short-term capital gains. If you have a net long-term capital loss from U.S.
sources and you have any short-term capital gains, you only need to adjust a
portion of the remaining net capital gain in each separate category long-term
rate group. In that case, the portion you must adjust is limited to the portion
of the remaining net capital gain in the separate category long-term rate group
in excess of the U.S. long term loss adjustment amount (if any) allocated to
that separate category long-term rate group. You have a net long-term capital
loss from U.S. sources if your long-term capital losses from U.S. sources exceed
your long-term capital gains from U.S. sources.
The U.S. long-term loss adjustment amount is the excess of your
net long-term capital loss from U.S. sources over the amount by which you
reduced your long-term capital gains from foreign sources under
U.S. capital loss adjustment
earlier. If only one separate category long-term rate group has a net capital
gain after the U.S. capital loss adjustment, your U.S. long-term loss adjustment
amount is allocated to that separate category long-term rate group. If more than
one separate category long-term rate group has a net capital gain after the U.S.
capital loss adjustment, you must allocate the U.S. long-term loss adjustment
amount among the separate category long-term rate groups pro rata based on the
amount of the remaining net capital gain in each separate category long-term
rate group.
You must adjust the portion of your net capital gain in a separate
category long-term rate group in excess of the U.S. long-term loss adjustment
amount you allocated to that separate category long-term rate group. See the
instructions later under
Capital gain rate differential adjustment for net capital gains.
The remaining portion of your net capital gain in the separate category
long-term rate group must be entered on line 1a of Form 1116 without adjustment.
taxmap/pubs/p514-005.htm#en_us_publink1000224584Mary has a $200 15% capital loss from U.S. sources, a $50 15%
capital gain from U.S. sources, and a $200 short-term capital gain from U.S.
sources. Mary also has a $300 28% capital gain and a $150 15% capital gain from
foreign sources that are passive category income.
Mary does not have a U.S. capital loss adjustment because her
foreign source capital gain ($450) does not exceed her worldwide capital gain
($500).
Mary's net long-term capital loss from U.S. sources is $150 ($200
- $50). Her U.S. long-term loss adjustment amount is $150 ($150 - $0). Mary
allocates the $150 between the 28% rate group and the 15% rate group as follows.
Mary allocates $100 ($150 x $300/$450) to the 28% rate group that is passive
category income. Therefore, $200 ($300 - $100) of her $300 28% capital gain must
be adjusted before it is included on line 1a. The remaining $100 of 28% capital
gain is included on line 1a without adjustment.
Mary allocates $50 ($150 x $150/$450) to the 15% rate group that is passive
category income. Therefore, only $100 ($150 - $50) of her $150 15% capital gain
must be adjusted before it is included on line 1a. The remaining $50 of 15%
capital gain is included on line 1a without adjustment.
taxmap/pubs/p514-005.htm#en_us_publink1000224585
Adjust your net capital gain (or the applicable portion of your net capital
gain) in each separate category long-term rate group as follows.
- For each separate category that has a net capital gain in
the 0% rate group, do not include the applicable amount on Form 1116.
- For each separate category that has a net capital gain in
the 15% rate group, multiply the applicable amount of the net capital gain by
0.4286.
- For each separate category that has a net capital gain in
the 25% rate group, multiply the applicable amount of the net capital gain by
0.7143.
- For each separate category that has a net capital gain in
the 28% rate group, multiply the applicable amount of the foreign source net
capital gain by 0.8.
Add each result to any net capital gain in the same long-term
separate category rate group that you were not required to adjust and include
the combined amounts on line 1a of the applicable Form 1116.
No adjustment is required if you have a net capital gain in a
short-term rate group. Include the amount of net capital gain in any short-term
rate group on line 1a of the applicable Form 1116 without adjustment.
taxmap/pubs/p514-005.htm#en_us_publink1000224586Beth has $200 of capital gains in the 28% rate group that are
general category income and no other items of capital gain or loss. Beth must
adjust the capital gain before she includes it on line 1a as follows.
Beth includes $160 of capital gain on line 1a of Form 1116 for
the general category income.
The facts are the same as
Example 3. Mary includes the following amounts of passive category income
on line 1a of Form 1116 for passive category income.
| | Mary includes $260 of the 28% capital gain
($200 × 0.8) + $100
|
| | Mary includes $92.86 of the 15% capital gain ($100 ×
0.4286) + $50 |
The facts are the same as
Example 2. After making the U.S. capital loss adjustment, Dennis has
the following:
| Income category | 28% rate | 15% rate | short-term |
| Passive | $133.33 | | ($100) | | $66.67 | |
| General | | | $200 | | | |
Dennis now determines the amount of the remaining net capital
gain in each separate category long-term rate group that must be adjusted.
Dennis' net long-term capital loss from U.S. sources is $300.
His U.S. long-term loss adjustment amount is $33.33 ($300 − $266.67).
Dennis must allocate this amount between the $133.33 of net capital gain
remaining in the 28% rate group that is passive category income and the $200 of
net capital gain remaining in the 15% rate group that is general category
income.
Dennis allocates $13.33 ($33.33 × $133.33 ÷ $333.33)
of the U.S. long-term loss adjustment to passive category income in the 28% rate
group. Therefore, Dennis must adjust $120 ($133.33 − $13.33) of the
$133.33 net capital gain remaining in the 28% rate group that is passive
category income. Dennis includes $109.33 (($120 × 0.8) + 13.33) of 28%
capital gain and $66.67 of short-term capital gain on line 1a of Form 1116 for
passive category income.
Dennis allocates $20 ($33.33 × $200 ÷ $333.33) to the
15% rate group for general category income. Therefore, Dennis must adjust $180
($200 − $20) of the $200 net capital gain remaining in the 15% rate group
that is general category income. Dennis includes $97.15 (($180 × 0.4286) +
$20) of 15% capital gain on line 1a of Form 1116 for general category income.
taxmap/pubs/p514-005.htm#en_us_publink1000224593taxmap/pubs/p514-005.htm#en_us_publink1000224594Use the following ordering rules to determine the rate group
of the capital gain offset by the net capital loss.
Determinations under the following ordering rules are made after
you have taken into account any U.S. capital loss adjustment. However,
determinations under the following ordering rules do not take into account any
capital gain rate differential adjustments that you made to any net capital gain
in a separate category rate group.
taxmap/pubs/p514-005.htm#en_us_publink1000224595Net capital losses from each separate category rate group are
netted against net capital gains in the same rate group in other separate
categories.
taxmap/pubs/p514-005.htm#en_us_publink1000224596U.S. source capital losses are netted against U.S. source capital
gains in the same rate group.
taxmap/pubs/p514-005.htm#en_us_publink1000224597Net capital losses from each separate category rate group in
excess of the amount netted against foreign source net capital gains in
Step 1
are netted against your remaining foreign source net capital gains and your U.S.
source net capital gains as follows.
- First, against U.S. source net capital gains in the same rate
group, and
- Next, against net capital gains in other rate groups (without
regard to whether such net capital gains are U.S. or foreign source net capital
gains) as follows.
- A foreign source net capital loss in the short-term rate
group is first netted against any net capital gain in the 28% rate group, then
against any net capital gain in the 25% rate group, then against any net capital
gain in the 15% rate group, and finally to offset capital gain net income in the
0% rate group.
- A foreign source net capital loss in the 28% rate group
is netted first against any net capital gain in the 25% rate group, then against
any net capital gain in the 15% rate group, and finally to offset capital gain
net income in the 0% rate group.
- A foreign source net capital loss in the 15% rate group
is netted first against any net capital gain in the 15% rate group, is netted
first against any net capital gain in the 0% rate group, then any net capital
gain in the 28% rate group, and finally against any net capital gain in the 25%
rate group.
The net capital losses in any separate category rate group are
treated as coming pro rata from each separate category that contains a net
capital loss in that rate group to the extent netted against:
- Net capital gains in any other separate category under
Step 1,
- Any U.S. source net capital gain under
Step 3(1), or
- Net capital gains in any other rate group under
Step 3(2).
After you have determined the rate group of the capital gain
offset by the net capital loss, you make the capital gain rate differential
adjustment by doing the following.
- To the extent a net capital loss in a separate category rate
group offsets capital gain in the 0% rate group, multiply the net capital loss
by zero.
- To the extent a net capital loss in a separate category rate
group offsets capital gain in the 15% rate group, multiply the capital loss by
0.4286.
- To the extent that a net capital loss in a separate category
rate group offsets capital gain in the 25% rate group, multiply that amount of
the net capital loss by 0.7143.
- To the extent that a net capital loss in a separate category
rate group offsets capital gain in the 28% rate group, multiply that amount of
the capital loss by 0.8.
Include the results on line 5 of the applicable Form 1116.
No adjustment is required to the extent a net capital loss offsets
short-term capital gains. Thus, a net capital loss is included on line 5 of the
applicable Form 1116 without adjustment to the extent the net capital loss
offsets net capital gain in the short-term rate group.
taxmap/pubs/p514-005.htm#en_us_publink1000224599The facts are the same as
Example 2. Dennis has a $100 foreign source 15% capital loss that is
passive category income.
This loss is netted against the $200 foreign source 15% capital
gain that is general category income according to
Step 1.
Dennis includes $42.86 of the capital loss on line 5 of the Form
1116 for general category income.
Dawn has a $20 net capital loss in the 15% rate group that is
passive category income, a $40 net capital loss in the 15% rate group that is
general category income, a $50 U.S. source net capital gain in the 15% rate
group, and a $50 net capital gain in the 28% rate group that is passive category
income, as shown in the following table.
| Income category | 28% rate | 15% rate |
Foreign
Passive
| $50 | ($20) |
Foreign
General
| | ($40) |
| U.S. Source | | $50 |
Of the total $60 of foreign source net capital losses in the
15% rate group, $50 is treated as offsetting the $50 U.S. source net capital
gain in the 15% rate group. (See
Step 3(1).)
| | $16.67 of the $50 is treated as coming from passive category
income.
($50 × $20/$60)
$33.33 of the $50 is treated as coming from general category
income.
($50 × $40/$60)
|
The remaining $10 of foreign source net capital losses in the
15% rate group are treated as offsetting net capital gain in the 28% rate group.
(See
Step 3(2)(c).)
| | $3.33 is treated as coming from passive category income.
($10 × $20/$60)
$6.67 is treated as coming from general category income.
($10 × $40/$60)
|
Dawn includes $9.80 of the capital loss in the amount she enters
on line 5 of Form 1116 for passive category income.
| | This is $7.14
($16.67 × 0.4286)
plus $2.66
($3.33 × 0.8)
|
Dawn includes $19.63 of capital loss in the amount she enters
on line 5 of Form 1116 for general category income.
| | This is $14.29
($33.33 × 0.4286)
plus $5.34
($6.67 × 0.8)
|
Dawn also includes $40.00 ($50 × 0.8) of capital gain in
the amount she enters on line 1a of Form 1116 for passive category income.
You must allocate foreign losses for any taxable year and U.S.
losses for any taxable year (to the extent such losses do not exceed the
separate limitation incomes for such year) among incomes on a proportionate
basis.
taxmap/pubs/p514-005.htm#en_us_publink1000224608If you have a foreign loss when figuring your taxable income
in a separate limit income category, and you have income in one or more of the
other separate categories, you must first reduce the income in these other
categories by the loss before reducing income from U.S. sources.
taxmap/pubs/p514-005.htm#en_us_publink1000224609taxmap/pubs/p514-005.htm#en_us_publink1000224610You have $10,000 of passive category income and incur a loss
of $5,000 of general category income. You must use the $5,000 loss to offset
$5,000 of passive category income.
taxmap/pubs/p514-005.htm#en_us_publink1000224611You must allocate foreign losses among the separate limit income
categories in the same proportion as each category's income bears to total
foreign income.
taxmap/pubs/p514-005.htm#en_us_publink1000224612You have a $2,000 loss that is general category income, $3,000
of passive category income, and $2,000 of income re-sourced by treaty. You must
allocate the $2,000 loss to the income in the other separate categories. 60%
($3,000/$5,000) of the $2,000 loss (or $1,200) reduces passive category income
and 40% ($2,000/$5,000) or $800 reduces the income re-sourced by treaty.
taxmap/pubs/p514-005.htm#en_us_publink1000224613If you have a loss remaining after reducing the income in other
separate limit categories, use the remaining loss to reduce U.S. source income.
For this purpose, the amount of your U.S. source income is your taxable income
from U.S. sources increased by the amount of capital losses from U.S. sources
that reduced foreign source capital gains as part of a U.S. capital loss
adjustment. See
U.S. capital loss adjustment earlier under
Adjustments to Foreign Source Capital Gains and Losses.
When you use a foreign loss to offset U.S. source income, you must recapture the
loss as explained later under
Recapture of Prior Year Overall Foreign Loss Accounts.
You should allocate any net loss from sources in the United States
among the different categories of foreign income
after allocating all foreign losses as described earlier, and
before any of the adjustments discussed later.
The amount of your net loss from sources in the United States
is equal to the excess of (1) your foreign source taxable income in all of your
separate categories in the aggregate, after taking into account any adjustments
under
Qualified Dividends and
Adjustments to Foreign Source Capital Gains and Losses over (2) the amount of taxable income you enter on Form 1116,
line 17.
If you have only losses in your separate limit categories, or
if you have a loss remaining after allocating your foreign losses to other
separate categories, you have an overall foreign loss. If you use this loss to
offset U.S. source income (resulting in a reduction of your U.S. tax liability),
you must recapture your loss in each succeeding year in which you have taxable
income from foreign sources in the same separate limit category. You must
recapture the overall loss regardless of whether you chose to claim the foreign
tax credit for the loss year.
You recapture the loss by treating part of your taxable income
from foreign sources in a later year as U.S. source income. In addition, if, in
a later year, you sell or otherwise dispose of property used in your foreign
trade or business, you may have to recognize gain and treat it as U.S. source
income, even if the disposition would otherwise be nontaxable. See
Dispositions, later. The amount you treat as U.S. source income reduces
the foreign source income, and therefore reduces the foreign tax credit limit.
You must establish separate accounts for each type of foreign
loss that you sustain. The balances in these accounts are the overall foreign
loss subject to recapture. Reduce these balances at the end of each tax year by
the loss that you recaptured. You must attach a statement to your Form 1116 to
report the balances (if any) in your overall foreign loss accounts.
taxmap/pubs/p514-005.htm#en_us_publink1000224616You have an overall foreign loss if your gross income from foreign
sources for a tax year is less than the sum of your expenses, losses, or other
deductions that you allocated and apportioned to foreign income under the rules
explained earlier under
Determining Taxable Income From Sources Outside the United
States. But see
Losses not considered, later, for exceptions.
You are single and have gross dividend income of $10,000 from
U.S. sources. You also have a greater-than-10% interest in a foreign partnership
in which you materially participate. The partnership has a loss for the year,
and your distributive share of the loss is $15,000. Your share of the
partnership's gross income is $100,000, and your share of its expenses is
$115,000. Your only foreign source income is your share of partnership income,
which is general category income. You are a bona fide resident of a foreign
country and you elect to exclude your foreign earned income. You exclude the
maximum $91,500. You also have itemized deductions of $6,100 that are not
definitely related to any item of income.
In figuring your overall foreign loss for general category income
for the year, you must allocate a ratable part of the $6,100 in itemized
deductions to the foreign source income. You figure the ratable part of the
$6,100 that is for foreign source income, based on gross income, as follows:
$100,000 (Foreign gross income)
$110,000 (Total gross income)
| × | $6,100 | = | $5,545 |
| | | | | | |
Therefore, your overall foreign loss for the year is $6,820 figured
as follows:
| Foreign gross income | | $100,000 |
Less:
Foreign earned income
exclusion
| $91,500 | | |
Allowable definitely related
expenses ($8,500/
$100,000 × $115,000)
| 9,775 | | |
Ratable part of itemized
deductions
| 5,545 | | 106,820 |
| Overall foreign loss | | $ 6,820 |
You do not consider the following in figuring an overall foreign
loss in a given year.
- Net operating loss deduction.
- Foreign expropriation loss not compensated by insurance or
other reimbursement.
- Casualty or theft loss not compensated by insurance or other
reimbursement.
If you have an overall foreign loss for any tax year and use
the loss to offset U.S. source income, part of your foreign source taxable
income (in the same separate limit category as the loss) for each succeeding
year is treated as U.S. source taxable income. The part that is treated as U.S.
source taxable income is the smaller of the following:
- The total amount of maximum potential recapture in all overall
foreign loss accounts. The maximum potential recapture in any account for a
category is the lesser of:
- The current year taxable income from foreign sources in
that category (the amount from Form 1116, line 14, less any adjustment for
allocation of foreign losses and U.S. losses for that category, discussed
earlier), or
- The balance in the overall foreign loss account for that
category.
- 50% (or more, if you choose) of your total taxable income
from foreign sources.
If the total foreign income subject to recharacterization is
the amount described in
1
above, then for each separate category the recapture amount is the maximum
potential recapture amount for that category. If the total foreign income
subject to recharacterization is the amount described in
2
above, then for each separate category the recapture amount is computed by
multiplying the total recapture amount by the following fraction:
| | Maximum potential recapture amount for the overall foreign
loss account in the separate category | |
| | Total amount of maximum potential recapture in all overall
foreign loss accounts | |
During 2009 and 2010, you were single and a 20% general partner
in a partnership that derived its income from Country X. You also received
dividend income from U.S. sources during those years.
For 2009, the partnership had a loss and your share was $20,000,
consisting of $110,000 gross income less $130,000 expenses. Your net loss from
the partnership was $1,983, after deducting the foreign earned income exclusion
and definitely related allowable expenses. This loss is related to general
category income. Your U.S. dividend income was $20,000. Your itemized deductions
totaled $6,000 and were not definitely related to any item of income. In
figuring your taxable income for 2009, you deducted your share of the
partnership loss from Country X from your U.S. source income.
During 2010, the partnership had net income from Country X. Your
share of the net income was $40,000, consisting of $100,000 gross income less
$60,000 expenses. Your net income from the partnership was $14,900, after
deducting the foreign earned income exclusion and the definitely related
allowable expenses. This is general category income. You also received dividend
income of $20,000 from U.S. sources. Your itemized deductions were $6,000, which
are not definitely related to any item of income. You paid income taxes of
$4,000 to Country X on your share of the partnership income.
When figuring your foreign tax credit for 2010, you must find
the foreign source taxable income that you must treat as U.S. source income
because of the foreign loss recapture provisions.
You figure the foreign taxable income that you must recharacterize
as follows:
| A. | Determination of 2009 Overall Foreign Loss |
| 1) | Partnership loss from Country X | | $1,983 |
| 2) | Add: Part of itemized deductions
allocable to gross income from
Country X
| | |
$110,000
$130,000
| × | $6,000 | = | $5,077 |
| 3) | Overall foreign loss for 2009 | | $7,060 |
| B. | Amount of Recapture for 2010 |
| 1) | Balance for general category
income foreign loss account
| | $7,060 |
| 2) | Taxable general category income after allocation of foreign
losses—General category income | $14,900 | | |
| | Less: Itemized deductions
allocable to that income
($100,000/$120,000
× $6,000)
| 5,000 | | |
| | General category taxable
income less allocated
foreign losses ($9,900 − 0)
| | $9,900 |
| 3) | Total amount of maximum potential recapture in all foreign
loss accounts (smaller of (1) or (2)) | | $7,060 |
| 4) | Foreign source net income | $14,900 | | |
| | Less: Itemized deductions
allocable to foreign source
net income ($100,000/
$120,000 × $6,000)
| 5,000 | | $9,900 |
| 5) | 50% of foreign source taxable income subject to recharacterization | | $4,950 |
| 6) | Recapture for 2010 (smaller of
(3) or (5))
| | $4,950 |
The amount of the recapture is shown on line 15, Form 1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224627If you want to make an election or change a prior election to
recapture a greater part of the balance of an overall foreign loss account than
is required (as discussed earlier), you must attach a statement to your Form
1116. If you change a prior year's election, you should file Form 1040X.
The statement you attach to Form 1116 must show:
- The percentage and amount of your foreign taxable income that
you are treating as U.S. source income, and
- The percentage and amount of the balance (both before and
after the recapture) in the overall foreign loss account that you are
recapturing.
You must recapture part (or all, if applicable) of an overall
foreign loss in tax years in which you deduct, rather than credit, your foreign
taxes. You recapture the lesser of:
- The balance in the applicable overall foreign loss account,
or
- The foreign source taxable income of the same separate limit
category that resulted in the overall foreign loss minus the foreign taxes
imposed on that income.
If you dispose of appreciated trade or business property used
predominantly outside the United States, and that property generates foreign
source taxable income of the same separate limit category that resulted in an
overall foreign loss, the disposition is subject to the recapture rules.
Generally, you are considered to recognize foreign source taxable income in the
same separate limit category as the overall foreign loss to the extent of the
lesser of:
This rule applies to a disposition whether or not you actually
recognized gain on the disposition and irrespective of the source (U.S. or
foreign) of any gain recognized on the disposition.
This rule also generally applies to a gain on the disposition
of stock in a controlled foreign corporation (CFC) if you owned more than 50%
(by vote or value) of the stock right before you disposed of it. See Internal
Revenue Code section 904(f)(3)(D) for more information.
All of the foreign source taxable income that you are considered
to recognize under these rules is generally subject to recharacterization as
U.S. source income. See Regulation section 1.904(f)-2(d).
If you actually recognized foreign source gain in the same separate
limit category as the overall foreign loss on a disposition of property
described earlier, you must reduce the foreign source taxable income in that
separate limit category by the amount of gain you are required to
recharacterize. If you recognized foreign source gain in a different separate
limit category than the overall foreign loss on a disposition of property
described earlier, you are required to reduce your foreign source taxable income
in that separate limit category for gain that is considered foreign source
taxable income in the overall foreign loss category and subject to
recharacterization. If you did not otherwise recognize gain on a disposition of
property described earlier, you must include in your U.S. source income the
foreign source taxable income you are required to recognize and recharacterize.
taxmap/pubs/p514-005.htm#en_us_publink1000224630Property is used predominantly outside the United States if it
was located outside the United States more than 50% of the time during the
3-year period ending on the date of disposition. If you used the property fewer
than 3 years, count the use during the period it was used in a trade or
business.
taxmap/pubs/p514-005.htm#en_us_publink1000224631A disposition includes the following transactions.
- A sale, exchange, distribution, or gift of property.
- A transfer upon the foreclosure of a security interest (but
not a mere transfer of title to a creditor or debtor upon creation or
termination of a security interest).
- An involuntary conversion.
- A contribution to a partnership, trust, or corporation.
- A transfer at death.
- Any other transfer of property whether or not gain or loss
is normally recognized on the transfer.
The character of the income (for example, as ordinary income
or capital gain) recognized solely because of the disposition rules is the same
as if you had sold or exchanged the property.
However, a disposition does not include either of the following:
- A disposition of property that is not a material factor in
producing income. (This exception does not apply to the disposition of stock in
a controlled foreign corporation (CFC) to which Internal Revenue Code section
904(f)(3)(D) applies.)
- A transaction in which gross income is not realized.
If gain is recognized on a disposition solely because of an overall
foreign loss account balance at the time of the disposition, the recipient of
the property must increase its basis by the amount of gain deemed recognized. If
the property was transferred by gift, its basis in the hands of the donor
immediately prior to the gift is increased by the amount of gain deemed
recognized.
taxmap/pubs/p514-005.htm#en_us_publink1000224633If, in a prior tax year, you reduced your foreign taxable income
in the separate limit category by a pro rata share of a loss from another
category, you must recharacterize in 2010 all or part of any income you receive
in 2010 in that loss category. If you have separate limitation loss accounts in
the loss category relating to more than one other category and the total
balances in those loss accounts exceed the income you receive in 2010 in the
loss category, then income in the loss category is recharacterized as income in
those other categories in proportion to the balances of the separate limitation
loss accounts for those other categories. You recharacterize the income by:
- Increasing foreign taxable income (adjusted by any of the
other adjustments previously mentioned) for each of the separate categories
(other than the loss category) previously reduced by any separate limitation
loss, and
- Decreasing foreign taxable income (adjusted by any of the
other adjustments previously mentioned) for the loss category by the amount of
recharacterized income.
In 2009, you had a $2,000 loss that was general category income,
$3,000 of passive category income, and $2,000 of income re-sourced by treaty.
You had to allocate the $2,000 loss to the income in the other separate
categories. 60% ($3,000 ÷ $5,000) of the $2,000 loss (or $1,200) reduced
passive category income and 40% ($2,000 ÷ $5,000) or $800 reduced the
income re-sourced by treaty.
In 2010, you have $4,000 of passive category income, $1,000 of
income re-sourced by treaty, and $5,000 of general category income. Because
$1,200 of the general category loss was used to reduce your passive category
income in 2009, $1,200 of the 2010 general category income of $5,000 must be
recharacterized as passive category income. This makes the 2010 total passive
category income $5,200 ($4,000 + $1,200). Similarly, because $800 of the general
category loss was used to reduce your income re-sourced by treaty, $800 of the
general category income must be recharacterized as income re-sourced by treaty.
This makes the 2010 total of income re-sourced by treaty $1,800 ($1,000 + $800).
The total general category income is $3,000 ($5,000 − $1,200 −
$800).
| If you dispose of appreciated property that generates, or
would generate, gain in a separate limitation loss account, the disposition is
subject to recapture rules similar to those applicable to overall foreign loss
accounts. See Internal Revenue Code section 904(f)(5)(F). |
taxmap/pubs/p514-005.htm#en_us_publink1000224635If you have an overall domestic loss for any tax year beginning
after 2006, you create, or increase the balance in, an overall domestic loss
account and you must recharacterize a portion of your U.S. source taxable income
as foreign source taxable income in succeeding years for purposes of the foreign
tax credit.
The part that is treated as foreign source taxable income for
the tax year is the smaller of:
- The total balance in your overall domestic loss account in
each separate category (less amounts recaptured in earlier years), or
- 50% of your U.S. source taxable income for the tax year.
You must establish and maintain separate overall domestic loss
accounts for each separate category in which foreign source income is offset by
the domestic loss. The balance in each overall domestic loss account is the
amount of the overall domestic loss subject to recapture. The recharacterized
income is allocated among and increases foreign source income in separate
categories in proportion to the balances of the overall domestic loss accounts
for those separate categories.
For more information, see the Instructions for Form 1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224636The United States is a party to tax treaties that are designed,
in part, to prevent double taxation of the same income by the United States and
the treaty country. Many treaties do this by allowing you to treat U.S. source
income as foreign source income. Certain treaties have special rules you must
consider when figuring your foreign tax credit if you are a U.S. citizen
residing in the treaty country. These rules generally allow an additional credit
for part of the tax imposed by the treaty partner on U.S. source income. The
treaties that provide for this additional credit include those with Australia,
Austria, Bangladesh, Belgium, Bulgaria, Canada, Denmark, Finland, France,
Germany, Iceland, Ireland, Israel, Italy (new treaty), Japan, Luxembourg,
Mexico, the Netherlands, New Zealand, Portugal, Slovenia, South Africa, Sweden,
Switzerland, and the United Kingdom. There is a
Worksheet
at the end of this publication to help you figure the additional credit. But do
not use this worksheet to figure the additional credit under the treaties with
Australia and New Zealand. Also, do not use this worksheet for income that is
described under "Income Re-Sourced By Treaty" discussed earlier under
Separate Limit Income.
| The worksheet does not apply for tax years beginning after
August 10, 2010. The IRS intends to issue guidance to explain how taxpayers
compute the separate foreign tax limitation for items subject to resourcing
under a treaty in those tax years. |
 | You can get more information, and the worksheet to figure
the additional credit under the Australia and New Zealand treaties, by writing
to:
Internal Revenue Service
International Section
Philadelphia, PA 19255-0725
|
You can also contact the United States Tax Attaché at the
U.S. Embassies in Beijing, London or Paris, or the U.S. consulate in Frankfurt,
as appropriate, for assistance.
taxmap/pubs/p514-005.htm#en_us_publink1000224638You may have to report certain information with your return if
you claim a foreign tax credit under a treaty provision. For example, if a
treaty provision allows you to take a foreign tax credit for a specific tax that
is not allowed by the Internal Revenue Code, you must report this information
with your return. To report the necessary information, use Form 8833,
Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b).
If you do not report this information, you may have to pay a
penalty of $1,000.
| You do not have to file Form 8833 if you are claiming the
additional foreign tax credit (discussed previously). |
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