Part VII. Used to determine your deemed paid taxes on

inclusions under section 951A or 951(a)(1). Shareholders making a section 962 election will use the information to figure a deemed paid foreign tax credit on Form 1118.

Identifying Information

Item E—Part applicability. The S corporation checked the “Yes” box to indicate the applicable parts of Schedule K-3. The S corporation checked the “No” box to indicate the inapplicable parts of Schedule K-3.

report information you use to figure the foreign tax credit. In general, a U.S. individual, or a U.S. citizen or U.S. resident individual beneficiary of certain domestic estates and trusts, may claim a credit for taxes paid or accrued, and in some cases deemed paid, to foreign countries or U.S. territories. The amount of foreign tax credit in a tax year is generally limited to the lesser of foreign taxes paid or accrued or U.S. tax on foreign source income. The limitation is figured by separate categories of foreign source income, including foreign branch category, passive category, and general category. A shareholder will use Form 1116 to figure its foreign tax credit, but, if the shareholder makes a section 962 election, it must also complete Form 1118 solely with respect to its computation of deemed paid credits for section 951(a) or section 951A inclusions. See the instructions for Forms 1116 and 1118, as well as Pub. 514, Foreign Tax Credit for Individuals, for a summary of the rules for determining the source and separate categories of income.

S corporation with limited or no foreign activity. In many instances, an S corporation with no foreign source income, no assets generating foreign source income, and no foreign taxes paid or accrued may have reported information on Schedule K-3. For example, if you claim the foreign tax credit, you generally need certain information from the S corporation in Schedule K-3, Parts II and III, to complete Form 1116. This information should have been reported to you in prior years, including before the Tax Cuts and Jobs Act, with or attached to the Schedules K-1, and is information you need to figure the foreign tax credit limitation, which determines the amount of foreign tax credit available to you.

Exceptions. You may not have received Schedule K-3 if the S corporation was eligible for an exception. See Domestic Filing Exception in the S Corporation Instructions for Schedules K-2 and K-3 (Form 1120-S). Also, if you (or, if you are a pass-through trust, your beneficiary) are eligible to claim a foreign tax credit, you did not need Schedule K-3, Parts II and III, if you or your beneficiaries are not required to

Instructions for Schedule K-3 (Form 1120-S) (2025) 3

complete Form 1116. This could be the case, for example, because you (or if you are a pass-through trust, your beneficiary) qualify for an exception to filing Form 1116. See section 904(j) and Form 1116 Exemption in the S Corporation Instructions for Schedules K-2 and K-3 (Form 1120-S). However, see reasons below for requesting the Schedule K-3 when you are required to file Form 1116.

Example 1. Domestic filing exception met—issuance of Schedule K-3 not required. A married couple, U.S. citizens, each own a 50% interest in SC, an S corporation. SC invests in a regulated investment company (RIC). SC receives a Form 1099 from the RIC reporting $100 of creditable foreign taxes paid or accrued on passive category foreign source income. SC does not have any foreign activity aside from that of the RIC. SC notifies the couple on an attachment to the Schedule K-1 that they will not receive the Schedule K-3 unless they so request. The married couple does not request Schedule K-3 from SC for tax year 2025. Because SC qualified for the domestic filing exception, SC did not complete Schedule K-3 for the couple.

Reasons to request Schedule K-3 from S corporations with limited or no foreign activity. Section 904 generally limits the foreign tax credit to the portion of U.S. tax liability attributable to foreign source taxable income. Foreign source taxable income is foreign source gross income less allocable expenses. In general, the S corporation completed the Schedule K-3, Parts II and III, because the S corporation’s gross income, gross receipts, expenses, assets, and foreign taxes paid may affect the foreign tax credit available to the shareholder. The source of certain gross income is determined by the shareholder. In addition, some expenses of the S corporation are allocated and apportioned by the shareholder.

Because of this shareholder determination, it is not possible for the shareholder to assume that all income of the S corporation is U.S. source and all expenses of the S corporation reduce U.S. source income. Also, the allocation and apportionment of certain shareholder expenses take into account shares of assets and income of the S corporation that are not otherwise reported on the Schedule K-1.

For example, for sourcing purposes, personal property sold by the S corporation is treated as sold by the shareholders; see section 865(i)(5) and section 1373(a). Generally, income from the sale of certain personal property (excluding inventory) is sourced according to the residence of the seller. In cases in which the shareholder is a pass-through entity, the S corporation might not know the ultimate residence of the first non-pass-through shareholder. The share of the S corporation’s gain on the sale of personal property is not separately stated on Schedule K-1, but is reported in Schedule K-3, Part II.

As another example, the shareholder’s R&E expense (which includes the share of the S corporation’s R&E expense) is allocated and apportioned by the shareholder; see Regulations section 1.861-17(f). R&E expense is allocated and apportioned based on the gross receipts by Standard Industrial Classification (SIC) code. The share of the R&E expense by SIC code is not separately stated on Schedule K-1, but is reported in Schedule K-3, Part II. Also, the shareholder needs Schedule K-3, Part III, Section 1, for the shareholder’s share of the S corporation’s gross receipts by SIC code for purposes of allocating and apportioning R&E expense.

In some cases, the shareholder will be able to use the information reported in Parts II and III to increase the foreign tax credit limitation, and the amount of available foreign tax credit to the shareholder. For example, Schedule K-3, Part III, Section 2, provides the shareholder with the tax book value of the assets of the S corporation. In general, a shareholder apportions interest expense to reduce U.S. source gross income or foreign source gross income based on the tax book value of its assets, including the shareholder’s share of the S corporation’s interest expense and assets; see section 864(e)(2) and Regulations section 1.861-9(e). Taking into account the assets of an S corporation generating solely U.S. source income would result in more expense allocated to U.S. source gross income and less expense allocated to reduce foreign source gross income. Additional foreign source income increases the shareholder’s foreign tax credit limitation, and the ability of the shareholder to claim foreign tax credits. Schedule K-1 does not separately state the share of the S corporation’s interest expense, or the tax book value of the assets. See Regulations section 1.861-9(e). See the instructions for Part II, Section 2, lines 39 through 43; and Part III, Section 2, for further guidance.

Example 2. Parts II and III required for S corporation with no foreign activity. U.S. citizens A and B own equal interests in SC, an S corporation. SC has no foreign activity. In Year 1, A pays $2,000 of foreign income taxes on passive category income other than capital gains reported to A on a payee statement. A has interest expense of $5,000 and SC does not have interest expense. None of A’s interest expense is directly allocable. A does not have an overall domestic loss in tax year 2025.

Because A must complete Form 1116 to claim a foreign tax credit, A requests a Schedule K-3 by the 1-month date, and therefore the domestic filing exception does not apply to SC with respect to A. SC provided Parts II and III of Schedule K-3 to A. In Schedule K-3, Part III, Section 2, column (a), A’s share of the tax book value of SC’s assets is $50,000. Not including A’s share of the assets of SC, the tax book value of A’s assets is $50,000. Of A’s assets, $10,000 generates passive category foreign source income and $40,000 generates U.S. source income. A has passive category foreign source taxable income before interest expense of $8,000. A’s U.S. tax rate is 25%. A’s interest expense and SC’s assets are characterized in the same category under sections 163 and 469 for purposes of Temporary Regulations section 1.861-9T(d). A uses the tax book value (as opposed to the alternative tax book value) to allocate and apportion interest expense.

A’s interest expense is apportioned between U.S. source and foreign source income ratably based on the tax book value of A’s U.S. source and foreign source assets. Without taking into account the share of SC’s assets, the amount of A’s interest expense that would reduce foreign source gross income is $1,000 ($5,000 x $10,000/$50,000). Therefore, A’s foreign source taxable income would be $7,000 ($8,000 − $1,000). At a 25% U.S. tax rate, A may only use $1,750 (25% x $7,000) of the $2,000 of foreign taxes. See section 904.

Taking into account the share of SC’s assets, the amount of A’s interest expense that reduces passive category foreign source gross income is $500 ($5,000 x $10,000/$100,000). Therefore, A’s passive category foreign source taxable income would be $7,500 ($8,000 − $500). At a 25% U.S. tax rate, A may use $1,875 (25% x $7,500) of the $2,000 of foreign taxes—an additional foreign tax credit amount of

4 Instructions for Schedule K-3 (Form 1120-S) (2025)

$125 after taking into account A’s share of the tax book value of the S corporation assets.

B does not request a Schedule K-3 from SC for tax year 2025. Under the domestic filing exception, SC did not complete Schedule K-3 for B.

Example 3. Part II, not Part III, required for S corporation with no foreign activity. The facts are the same as in Example 2, except that A has $5,000 of expenses described in Regulations section 1.861-8(e)(9), and A and SC have no other expenses. Further, A’s share of SC’s gross income is $50,000. Not including A’s share of the income of SC, A’s gross income is $50,000. Of A’s gross income, $5,000 is passive category foreign source gross income and $45,000 is U.S. source gross income. SC does not have any gross income the source of which is determined by the shareholder.

A’s expenses must be ratably apportioned based on A’s gross income (including A’s share of the income of SC); see Regulations section 1.861-8(c)(3). Therefore, SC provided Schedule K-3, Part II, to A. Before taking into account the share of SC’s gross income, the amount of A’s expenses described in Regulations section 1.861-8(e)(9) that reduce foreign source gross income is $500 ($5,000 x $5,000/$50,000). Therefore, A’s foreign source taxable income would be $4,500 ($5,000 – $500). At a 25% U.S. tax rate, A may only use $1,125 (25% x $4,500) of the $2,000 of foreign taxes. See section 904.

Taking into account the share of SC’s gross income, the amount of A’s expenses described in Regulations section 1.861-8(e)(9) that reduce foreign source gross income is $250 ($5,000 x $5,000/$100,000). Therefore, A’s foreign source taxable income would be $4,750 ($5,000 – $250). At a 25% U.S. tax rate, A may use $1,187.50 (25% x $4,750) of the $2,000 of foreign taxes—an additional foreign tax credit amount of $62.50 after taking into account A’s share of the gross income of SC.

Because A and SC do not have R&E expense or interest expense, and because SC did not pay or accrue any foreign taxes, SC did not provide Schedule K-3, Part III, to A.

Note: A shareholder may need the share of the S corporation’s gross income for purposes of allocating and apportioning expenses other than those described in Regulations section 1.861-8(e)(9).