Form 1116 Explanation Statement: What You Need to File With Your Foreign Tax Credit Application

The Foreign Tax Credit is one of the single most important things for an expat to know. When submitting your Federal Tax Return, you’ll want to send the Form 1116 along with it. And in order to qualify, you’ll need to attach a series of documents explaining how you reached certain conclusions, which we’ll call the Form 1116 explanation statement, from here on out. Find out what kind of Form 1116 explanation statements the IRS is expecting, and how to correctly document everything necessary to be eligible for the Foreign Tax Credit.

When Are Form 1116 Explanation Statements Necessary?

Several different situations require explanation statements to the IRS. In fact, depending on your circumstances, you may need statements for the following:

  • Alternative basis compensation source statement
  • Election to use exchange rate statement
  • Financial services active financing income statement
  • Foreign audit explanation statement
  • Foreign income related expenses statement
  • Foreign income net adjustment statement
  • Foreign tax credit carryback computation statement
  • Foreign tax reduction statement
  • Foreign tax withheld on dividends statement
  • Foreign tax withheld on interest statement
  • Foreign tax withheld on rents and royalties statement
  • Other currency tax paid statement
  • Other deductions not related statement

That’s a lot of statements. Luckily, only a few of these are routinely required.

For instance, in Part II of Form 1116, each taxpayer must submit a statement that shows how the tax credit was calculated. So, what does that look like? First, calculate the Foreign Tax Credit with the limitation guidelines. Your Foreign Tax Credit cannot exceed your total US tax obligation multiplied by a fraction. The fraction is your taxable foreign income divided by your total taxable income from US and foreign sources. To come up with those numbers, you have to use a conversion rate to get all figures to a common currency, so also attach a Form 1116 explanation statement that shows the converter you used, and the date on which it was determined. Oanda.com is an excellent source for reliable conversion rates. Then, also document the formula you used and all relevant amounts.

If you want to use the exchange rate on the date that you were paid, you can simply make that election on your Federal Tax Return. To do so, just attach your Form 1116 explanation statement explaining your preference to use the currency conversion on the date you were paid, and ensure that your taxes are filed by the deadline.

Foreign Tax Redeterminations and Form 1116 Explanation Statements

If you claim to have paid foreign taxes and then receive an unexpected refund for any part of those taxes by the foreign government, you will need to issue an amended return recalculating your Foreign Tax Credit. In this case, not only would you file a 1040X, but you will attach a Form 1116 explanation statement that includes all necessary information for the IRS to redetermine your US tax liability for the applicable tax years. The IRS will expect your name, address, and taxpayer identification number, the tax year this info will affect, the dates the foreign taxes were accrued and paid, the amount paid and the currency conversion used. They will also require all the necessary information to determine interest due.

Greenback Can Help You File Form 1116

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Free Guide: The 25 Things Every Expat Needs to Know About Taxes

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