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. In order to qualify, you’ll need to attach a series of documents explaining how you calculated the credit, which we call the Form 1116 explanation statement. Find out what kind of Form 1116 explanation statements the IRS is expecting and how to correctly document everything to be eligible for the Foreign Tax Credit.
When Are Form 1116 Explanation Statements Necessary?
While several different situations may require a Form 1116 explanation statement to the IRS, the most common use is to explain your Foreign Tax Credit calculation. Any expat who wants to claim this tax credit must submit a statement that shows how the amount was calculated in Part II of Form 1116.
What to Include in Your Form 1116 Explanation Statement
1. Your Foreign Tax Credit Calculation
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.
The Foreign Tax Credit Formula:
(Foreign Source Taxable Income ÷ Total Taxable Income Before Exemptions) x Total US Tax = Foreign Sourced US Tax
2. Conversion Rates
Before calculating the Foreign Tax Credit, you have to use a conversion rate to get all figures to a common currency. You’ll use a Form 1116 explanation statement to show the converter you used and the date on which it was determined. Oanda.com is an excellent source for reliable conversion rates.
3. Dates for the Conversion Rates You Used
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.
Which Statements Do You Need to Submit with Form 1116?
Depending on your circumstances, you may need to include a variety of statements along with your expat tax return. Examples include 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.
Using Form 1116 Explanation Statements to Amend a Foreign Tax Credit
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, you will file a 1040X and attach a Form 1116 explanation statement so the IRS can redetermine your US tax liability for the applicable tax years.
What to Include in Your Revised Explanation Statement
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.
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