Form 1116 Explanation Statement: What You Need to File
When filing Form 1116 to claim the Foreign Tax Credit, you will need to attach a statement explaining how you calculated the credit. Here’s what you need to know to complete your Form 1116 explanation statement.
- To claim the Foreign Tax Credit, you must demonstrate your calculation by attaching a Form 1116 explanation statement.
- This explanation statement usually consists of several documents with the details of your tax situation.
- You can also use a Form 1116 explanation statement to amend your previous Foreign Tax Credit claim.
The Foreign Tax Credit is one of the single most important tax benefits for any expat to know about. Using this credit, you can reduce your US tax bill—or erase it altogether—while living overseas. To claim the Foreign Tax Credit, you will have to complete IRS Form 1116 and attach a series of documents explaining how you calculated the credit. Those attached documents will serve as your Form 1116 explanation statement.
When Are Form 1116 Explanation Statements Necessary?
While several 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 for Part II of Form 1116.
What to Include in Your Form 1116 Explanation Statement
1. Taxpayer Information
When filling out a Form 1116 explanation statement, you should always include the following personal details:
- Taxpayer identification number
- The tax year
2. Foreign Tax Credit Calculation
You will also need to show your calculation for the Foreign Tax Credit. Show how you arrived at the numbers you entered on Part II of Form 1116. Remember: 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
3. Conversion Rates
Before calculating the Foreign Tax Credit, you must use a conversion rate to get all figures to a common currency. You’ll use a Form 1116 explanation statement to show the foreign exchange conversion you used and the date on which it was determined.
4. 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, attach your 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. If you have accrued foreign taxes but haven’t paid them yet, use the exchange rate from the last day of the applicable tax year.
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
Another common use for a Form 1116 explanation statement is to amend a Foreign Tax Credit you’ve claimed on a previous tax return. For example, if you claimed to have paid foreign taxes and then received an unexpected refund for any part of those taxes from the foreign government, you will need to issue an amended return recalculating your Foreign Tax Credit. In this case, you will file Form 1040-X and attach a Form 1116 explanation statement so the IRS can verify your updates to your US tax liability for the applicable tax years.
When amending a Foreign Tax Credit, the IRS will expect you to include the following information in your Form 1116 explanation statement:
- Taxpayer identification number
- Tax year that your amended Form 1116 will affect
- Amount paid in foreign taxes
- Dates the foreign taxes were accrued and paid
- Currency conversion used
The IRS will also require all the necessary information to determine any interest due.
Greenback Can Help You File Your Form 1116 Explanation Statement
At Greenback Expat Tax Services, we help Americans around the world manage their US taxes. Our team of expat-expert accountants can review your tax situation and file Form 1116 on your behalf—complete with a comprehensive explanation statement. If you’re ready to be matched with a Greenback accountant, click the get started button below. For general questions on expat taxes or working with Greenback, contact our Customer Champions.