Credit Limitations — 1225 Inst 1118 (PDF)

Taxes Eligible for a Credit

Credit or Deduction A corporation may choose to take either a credit or a deduction for eligible foreign income taxes paid or accrued. The choice is made annually. Generally, if a corporation elects the benefits of the foreign tax credit for

Domestic corporations. Generally, a domestic corporation may claim a foreign tax credit (subject to the limitation of section 904) for the following taxes.

Income, war profits, and excess profits taxes paid or accrued during the tax year to any foreign country or U.S. territory.
Taxes paid in lieu of income taxes as described in section 903.
Taxes deemed paid under section 960. Income, war profits, and excess profits taxes and in lieu of taxes are collectively referred to as foreign income taxes. See Regulations sections 1.901-2(a) and (b) and 1.903-1 for rules for determining whether a foreign tax qualifies as a foreign income tax.

Caution: Final foreign tax credit regulations issued on January 4, 2022 (T.D. 9959, 87 FR 374) revised the creditability requirements under Regulations sections 1.901-2 and 1.903-1, applicable for foreign taxes paid or accrued in tax years beginning on or after December 28, 2021. A Notice was subsequently released on July 21, 2023, providing taxpayers the option to apply modified rules in place of certain provisions of the new regulations. For more information, see Notice 2023-55, 2023-32 I.R.B. 427, available at IRS.gov/irb/2023-32_IRB#NOT-2023-55 . Some foreign taxes that are otherwise eligible for the foreign tax credit must be reduced. These reductions are reported on Schedule G.

Note: A corporation may not claim a foreign tax credit for foreign income taxes paid to a foreign country that the corporation does not legally owe, including amounts eligible for refund by the foreign country. If the corporation does not exercise its available remedies to reduce the amount of foreign income tax to what it legally owes, a credit is not allowed for the excess amount.

Foreign corporations. Foreign corporations are allowed (under section 906) a foreign tax credit for foreign income taxes paid or accrued to any foreign country or U.S. territory for income effectively connected with the conduct of a trade or business within the United States. The credit is not applicable, however, if a foreign country or U.S. territory imposes the tax on income from U.S. sources solely because the foreign corporation was created or organized under the law of the foreign country or U.S. territory or is domiciled there for tax purposes.

The credit may not be taken against any tax imposed on income not effectively connected with a U.S. business.

In computing the foreign tax credit limitation, the foreign corporation’s taxable income includes only the taxable income that is effectively connected with the conduct of a trade or business within the United States.

Instructions for Form 1118 (Rev. 12-2025) 5

any tax year, no portion of the foreign income taxes paid or accrued in such year will be allowed as a deduction in that year or any subsequent tax year.

Exceptions. However, a corporation that elects the credit for foreign income taxes may be allowed a deduction for certain taxes for which a credit was not allowed. These include the following.

Taxes for which the credit was denied because of the boycott provisions of section 908.
Certain taxes on the purchase or sale of oil or gas (section 901(f)).
Certain taxes used to provide subsidies (section 901(i)).
Taxes paid to certain foreign countries for which a credit was denied under section 901(j).
Certain taxes paid on dividends if the minimum holding period is not met with respect to the underlying stock, or if the corporation is obligated to make related payments with respect to positions in similar or related property (section 901(k)).
Certain taxes paid on gain and income other than dividends if the minimum holding period is not met with respect to the underlying property, or if the corporation is obligated to make related payments with respect to positions in similar or related property (see section 901(l)).
In the case of a covered asset acquisition (as defined in section 901(m)(2)), the disqualified portion of any tax determined with respect to the income or gain attributable to the relevant foreign assets (section 901(m)). Note: This rule generally applies to covered asset acquisitions after December 31, 2010. See Regulations sections 1.901(m)-1 through 1.901(m)-8 for additional information. Note that the rules contained in these regulations have later effective dates.

Carryback and Carryforward of Excess Foreign Taxes If the allowable foreign income taxes paid, accrued, or deemed paid in a tax year in a separate category exceed the foreign tax credit limitation for the tax year for that separate category, the excess is:

First, carried back 1 year to offset taxes imposed in the same category, then
Carried forward 10 years to offset taxes imposed in the same category.

The excess is applied first to the earliest of the years to which it may be carried, then to the next earliest year, etc. The corporation may not carry a credit to a tax year for which it claimed a deduction, rather than a credit, for foreign income taxes paid or accrued. Furthermore, the corporation must reduce the amount of any carryback or carryforward by the amount it would have used had it chosen to claim a credit rather than a deduction in that tax year. These carryover provisions do not apply to foreign income taxes assigned to section 951A category income. See section 904(c) and Regulations section 1.904-2 for more details.

How to claim the excess credit. If the corporation is carrying back the excess credit to an earlier year, file an amended tax return with a revised Form 1118 and schedules (including a revised Schedule K (Form 1118)).

Special rules apply to:

The carryback and carryforward of foreign income taxes paid or accrued on combined foreign oil and gas income or related taxes (see section 907(f)).
An excess foreign tax credit for which an excess limitation account exists under section 960(c)(2). See Regulations sections 1.960-4 through 1.960-6.
Taxes paid by an accrual-basis taxpayer that relate to a prior tax year in which the taxpayer elected to claim a deduction for foreign income taxes in that prior year. See Regulations section 1.901-1(c)(3).
Carryback of foreign income taxes paid or accrued in post-2017 foreign corporate tax years and carryforward of foreign income taxes paid or accrued in pre-2018 foreign corporate tax years. See Regulations section 1.904-2(j).