How to Fill Out Form 1116 & Claim the FTC

While you may never have filed it while living within the United States, Form 1116 is a key component of many US expat tax returns. This form allows you to claim the Foreign Tax Credit (FTC), one of the most important tax breaks for Americans living abroad.

Many expats who pay taxes abroad find that the FTC helps them avoid double taxation by slashing their US tax bill down to little or nothing. In some cases, it can even give them surplus credits to use toward future tax bills. Given how much is at stake, it’s critical to complete and file Form 1116 correctly. That said, it’s not exactly the most straightforward form.

The good news? We’re here to explain it to you. As a dedicated US expat tax firm, at Bright!Tax we know Form 1116 inside and out. Below, we’ll go over what exactly the FTC is, how it works, how to file Form 1116 step by step, and more.

Understanding the Foreign Tax Credit (FTC)

Before we dive into the specifics of Form 1116, let’s delve into the FTC in a bit more detail.

What is the FTC?

The FTC is a tax break that gives Americans dollar-for-dollar US tax credits for any foreign income taxes they’ve paid. In essence, this lets you use your foreign tax bill to offset your US tax bill (although as we’ll go into later, it’s a bit more complex than that).

If you live in a country with higher tax rates than the US, the Foreign Tax Credit may not only eliminate your US tax bill, but also offer you surplus credits. You can then apply these credits to tax bills from one year prior, or up to ten years in the future.

FTC qualifications

To qualify for the Foreign Tax Credit, foreign taxes must be:

• Legal
• Paid or accrued
• Income-based
• Payable by you specifically

Taxes on certain types of income are ineligible for the FTC, such as:

• Social Security taxes
• Value-added taxes (VAT)
• Income that is already eligible for exclusion or deduction

FTC limits

The IRS imposes an FTC limit to ensure that the FTC does not offset US taxes on US-sourced income:

Example: Rosa is a dual US/Peruvian citizen who works remotely, spending ⅓ of her time in the US and the other ⅔ in Peru at her grandmother’s home. She earned $90,000 in tax year 2023 — $60,000 while in Peru, and $30,000 while in the US. Her total US tax liability before applying the FTC is $15,000.

She must calculate her FTC limit as follows: 

• Divide foreign-earned income ($60,000) by worldwide income ($90,000): ⅔, or roughly .67
• Multiply this figure (⅔) by her US tax liability ($15,000): $10,000

Therefore, Rosa can claim no more than $10,000 in US tax credits under the FTC.

Another limitation of the FTC is the high-tax kickout, which limits how much the FTC can reduce US tax liability when foreign passive income is taxed at a much higher tax rate than the top US rate. The exact way the IRS determines whether or not a tax is subject to the high-tax kickout is complex, but Form 1116 instructions will walk you through it if applicable.

When to file Form 1116

Individuals who want to claim the FTC must almost always file Form 1116. Corporations, on the other hand, will file Form 1118.

However, there are a few specific situations in which you can claim the FTC without filing the corresponding form. In this case, the typical FTC limit won’t apply to you either.

If you meet all three of the following conditions, you can claim the FTC without filing Form 1116:

• All of your foreign source gross income is classified as passive income, high-taxed income, or export financing interest, AND
• All of the income and foreign taxes you paid on it were reported on a qualified payee statement like Form 1099-DIV, Form 1099-INT, Schedule K-1 (Form 1041), Schedule K-3 (Form 1065), Schedule K-3 (Form 1120-S), or similar statements, AND
• Your foreign taxes do not exceed $300 (or $600 if you’re filing jointly)

To claim the FTC in this scenario, you’ll enter the credit in the appropriate field on your primary tax return (usually Form 1040).

Step-by-step guide to completing Form 1116

Now that you better understand what the FTC is and how it works, let’s get into how to complete Form 1116.

Up top, you’ll disclose your name, identifying number (usually your Social Security Number, or SSN),the income type you’re filing Form 116 for, and your country of residence. 

Note that there are seven different income categories:

1. Section 951A category income: Refers to Global Intangible Low-Taxed Income, aka GILTI
2. Foreign branch category income: Refers to income earned through a foreign branch of a US company
3. Passive category income: Refers to unearned income like royalties, rent, interest, and dividends
4. General category income: Typically refers to income earned through foreign business operations or services, provided that it does not fit into any of the other income categories
   • Note: This will be the main category relevant to most US expat employees and business owners.
5. Section 901(j) income: Refers to income earned from sanctioned countries or those with discriminatory tax systems
6. Certain income re-sourced by treaty: Refers to income that is treated as if it came from a different country than where it was earned due to a tax treaty
7. Lump-sum distributions: Refers to single, one-time payments, typically related to pensions and retirement plans 

Each of these are taxed differently, so it’s critical to know which category your income falls into.  Thorough documentation of your income throughout the year will help make this process easier. And remember — you must use a different Form 1116 for each income category. 

Part I: Taxable Income or Loss from Sources Outside the United States

In this section, you’ll record all income from foreign sources. If you’ve paid taxes in more than one foreign country, you must allocate the income across columns A, B, and C accordingly. If you paid taxes in more than three countries, you must attach a separate sheet with a similar format to Part 1 (but not an extra copy of Form 1116).

Tips:

• Include all foreign income, even if all or some is not taxable by a foreign government
• Convert all foreign currency into US dollars using a reliable source
  • Note: When converting currency in your tax return, you must include a statement showing the IRS how you made your calculation
• Adjust gross income (line 1a) for any foreign income that you’ve excluded with Form 2555 (aka the Foreign Earned Income Exclusion, or FEIE)

You’ll also need to input the amount in deductions you used to reduce your taxable income. This can include either the standard deduction or itemized deductions (e.g. home mortgage interest, foreign-sourced tax losses).

Part II: Foreign Taxes Paid or Accrued

In Part II, you’ll describe the amount of foreign tax you either paid or accrued in the current tax year on the income you reported in Part I.

Part III: Figuring the Credit

In this section, you’ll calculate your personal Foreign Tax Credit. This won’t necessarily be equal to the amount you paid in taxes in your country of residence, however. Instead, it’s the amount of tax you would have paid if the income had been earned and taxed according to the US tax code.

We’ve filled this section out to illustrate a hypothetical scenario:

1️⃣ Let’s say you work in Italy, where you earned an annual salary equivalent to $100,000 in 2023. Your Italian tax payment, meanwhile, came out to $25,000. Remember, though, that this isn’t equal to the amount you can claim under the FTC.

2️⃣ Your total deductions for the year were $15,000 — therefore, your taxable income is $85,000 ($100,000 – $15,000).

3️⃣ Finally, let’s assume that your US tax liability for $85,000 would be $13,000. This is the amount that you can apply toward your US tax bill, NOT the $25,000 you paid in Italy.

Annual Salary	$100,000
US Tax Deductions	($15,000)
US Taxable Income	$85,000
US Tax	$13,000
Italian Taxes	$25,000
Foreign Tax Credit	$13,000

Part IV: Summary of Credits from Separate Parts III

In the last section, you’ll calculate your total Foreign Tax Credit by adding up the credits for each individual income category and making adjustments as necessary. 

Other expat tax benefits

While the FTC can be a powerful tax break for US expats, it’s not the only one available. A couple of other expat-specific tax breaks include the:

Foreign Earned Income Exclusion (FEIE)

The Foreign Earned Income Exclusion, or FEIE, lets expats exclude a certain amount of their foreign-earned income from taxation. Note that this does not include unearned/passive income like income from rental properties, dividends, interest, or pension income. The FEIE threshold for 2023 is $120,000, which increases to $126,500 for tax year 2024 to account for inflation.

To be eligible for the FEIE, you must meet one of two tests:

• The Physical Presence Test: Be physically present outside the US for at least 330 days in a 365-day period overlapping the tax year
• The Bona Fide Residence Test: Have resided in another country for at least the entire tax year and be able to prove it through official documentation (ID cards, rental contract, utility bills, etc.) if necessary

If you qualify, you can claim the FEIE by filing Form 2555. 

How the FTC interacts with the FEIE

One big caveat to keep in mind is that you cannot apply the FEIE and the FTC to the same income. You can, however, apply them to separate items of income.

Example: Jonah lives in Canada, where he earns a salary equivalent to $80,000 US dollars. He also rents out a room in the apartment that he owns in Vancouver for $850 (USD) per month — an annual total of $10,200. Jonah excludes his entire salary under the FEIE, and claims the FTC on the taxes he has paid on rental income in Canada.

Foreign Housing Exclusion or Deduction FHE/FHD

If you qualify for the FEIE, you also automatically qualify for the Foreign Housing Exclusion (if you’re an employee) or Foreign Housing Deduction (if you’re self-employed). Both of these may help you offset the cost of certain foreign housing costs, like rent, utilities, parking, and more. 

Just as with the FEIE, you cannot claim the FTC on the same income you’ve applied the FHE/FHD to. To claim the FHE/FHD, you’ll use the same form as the FEIE: Form 2555.

Resources:

1. HTKO: High-Tax KickOut (Detailed Example)
2. Instructions for Form 1116 (2023)