Special Rules

Source Rules for Income Determine income or (loss) for each separate category on Schedule A using the general source rules of sections 861 through 865 and related regulations, the special source rules of section 904(h) described below, and any applicable source rules contained in any applicable tax treaties.

Amounts That Do Not Constitute Income Under U.S. Tax Principles Creditable foreign taxes that are imposed on amounts that do not constitute income under U.S. tax principles are treated as imposed on income described in section 904(d) (1)(B). See section 904(d)(2)(H).

Look-Through Rules

CFCs. Generally, dividends, interest, rents, and royalties received or accrued by the taxpayer are passive category income. However, if these items are received or accrued by a 10% U.S. shareholder from a CFC, they may be assigned to other separate categories, or may be treated as passive category income under the look-through rules of section 904(d)(3). Dividends include any amount included in gross income under section 951(a)(1)(B).

Look-through rules also apply to subpart F inclusions under section 951(a)(1)(A) and GILTI inclusions under section 951A to the extent attributable to income of the CFC in the passive category.

Special source rules of section 904(h). Usually, the following income from a U.S.-owned foreign corporation, otherwise treated as foreign source income, must be treated as U.S. source income under section 904(h).

• Any subpart F income, foreign personal holding company income, GILTI, or income from a qualified electing fund that a U.S. shareholder is required to include in its gross income if such amount is attributable to the U.S.-owned foreign corporation’s U.S. source income.

For more information and examples, see section 904(d) (3) and Regulations section 1.904-5.

Noncontrolled 10%-owned foreign corporations. Generally, dividends received or accrued by the taxpayer are passive category income. However, dividends received or accrued from a noncontrolled 10%-owned foreign corporation may be assigned to other separate categories under the look-through rules of section 904(d) (4).

Certain amounts paid by a domestic corporation to a related corporation. Look-through rules also apply to foreign source interest, rents, and royalties paid by a domestic corporation to a related corporation. See Regulations section 1.904-5(g).

Other Rules

Certain transfers of intangible property. See section 367(d)(2)(C) for a rule that clarifies the treatment of certain transfers of intangible property.

Reporting Foreign Tax Information From Partnerships If you received a Schedule K-3 (Form 1065) or a Schedule K-3 (Form 8865) from a partnership that includes foreign tax information, use the rules below to report that information on Form 1118.

Schedule K-3, Part II, Section 1

Gross income sourced at partner level. This includes income from the sale of most personal property other than inventory, depreciable property, and certain intangible property sourced under section 865. This gross income will generally be U.S. source and therefore will not be reported on Form 1118.

Foreign gross income sourced at partnership level. Report on Schedule A.

• Interest that is properly allocable to the U.S.-owned foreign corporation’s U.S. source income.

• Dividends equal to the U.S. source ratio (defined in section 904(h)(4)(B)).

The rules regarding interest and dividends described above do not apply to a U.S.-owned foreign corporation if less than 10% of its E&P for the tax year is from U.S. sources.

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

Schedule K-3, Part II, Section 2

Deductions allocated and apportioned at partner lev- el and partnership level. Report on Schedule A or Schedule H.

Schedule K-3, Part III, Sections 1 Through 3

R&E expenses apportionment factors. Report on Schedule H, Part I.

Interest expense apportionment factors. Report on Schedule H, Part II.

Foreign-derived intangible income (FDII) deduction apportionment factors. Report on Schedule H, Part II.

Schedule K-3, Part III, Section 4

Total foreign taxes paid or accrued. Report on Schedule B.

Foreign tax redeterminations. Report on Schedule L.

Reduction in taxes available for credit. Report on Schedule G.

Schedule K-3 (Form 1065), Part VIII

Partner’s interest in foreign corporation income (sec- tion 960). Report on Schedule C or D, as applicable.

Note: Schedule K-3 (Form 8865) does not contain a part equivalent to Schedule K-3 (Form 1065), Part VIII.

Capital Gains Foreign source taxable income or (loss) before adjustments in all separate categories in the aggregate should include gain from the sale or exchange of capital assets only up to the amount of foreign source capital gain net income (which is the smaller of capital gain net income from sources outside the United States or capital gain net income). Therefore, if the corporation has capital gain net income from sources outside the United States in excess of the capital gain net income reported on its tax return, enter a pro rata portion of the net U.S. source capital loss on Schedule A, column 13(j), for each separate category with capital gain net income from sources outside the United States. To figure the pro rata portion of the net U.S. source capital loss attributable to a separate category, multiply the net U.S. source capital loss by the amount of capital gain net income from sources outside the United States in the separate category divided by the aggregate amount of capital gain net income from sources outside the United States in all separate categories with capital gain net income from sources outside the United States.

See section 904(b)(2)(B) for special rules regarding adjustments to account for capital gain rate differentials (as defined in section 904(b)(3)(D)) for any tax year. At the time these instructions went to print, there was no capital gain rate differential for corporations.