Part III. Form 1116

Reduction in Foreign Taxes

Taxpayers cannot claim a foreign tax credit for taxes paid on excluded Puerto Rico source income.

The taxes allocated to the excluded Puerto Rico source income should be included in Part III, line 12 of Form 1116, as a reduction in foreign taxes.

Taxes paid on excluded income are not allowed as part of the foreign tax credit. To find the amount allocable to the excluded income, multiply the taxes paid or accrued to Puerto Rico by a fraction. The numerator of the fraction is the excluded income from Puerto Rico sources under IRC Section 933, less deductible expenses allocable to that income. The denominator is the total amount of income subject to Puerto Rico tax less deductible expenses allocable to that income. This fraction is multiplied by the tax paid or accrued to Puerto Rico.

Formula for reduction in foreign taxes:

Income from Puerto Rico sources not subject to federal tax under IRC Section 933 less deductible expenses allocable to that income

X Tax Paid or accrued to Puerto Rico = Reduction in foreign taxes Total Income subject to Puerto Rico tax, less deductible expenses allocable to that income

Foreign Tax Credit Redeterminations

If you claim a credit for foreign taxes paid, and you receive a refund of all or part of those taxes in a later year, you must file an amended return reducing the taxes credited by the amount refunded.

If you claim the foreign tax credit based on foreign taxes accrued instead of foreign taxes paid, your credit must be redetermined in any of the following situations.

1. Your accrued taxes when paid differ from the amount you claimed as a credit.

2. You do not pay the accrued taxes within 2 years after the close of the tax year to which they relate.

3. After you pay the accrued taxes, you receive a full or partial refund of them.

Starting 2021 Schedule C, Form 1116 is used to report Foreign Tax Credit Redetermination. This form is out of scope of VITA.

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Other Taxes

Earnings Subject to Self-Employment Tax

Includes

• Net earnings from self-employment (SE) from other than a church employee of $400 or more.

• Partnership income and guaranteed payments.

• Wages of employees of churches and other religious organizations (not ministers), if you earned at least $108.28.

• Services performed as a minister, member of a religious order who has not taken a vow of poverty, or a Christian Science practitioner (unless IRS approval for exemption has been obtained).

• Income from farm rental if you materially participated in the production or management of farm products on such land.

• Cash or a payment in kind from the Department of Agriculture for participating in a land diversion program.

• Fees and other payments received for services as a Director of a corporation.

• Income from the retail sale of newspapers if you were age 18 or older and kept the profits.

• Income received as a direct seller.

• Income of certain crew members of fishing vessels with crews of normally fewer than 10 people.

• Fees as a state or local government employee if you were paid only on a fee basis and the job was not covered under a federal-state social security coverage agreement.

• Fees received as a professional fiduciary, or as a non-professional fiduciary if the fees relate to active participation in the operation of the estate’s business, or the management of an estate that required extensive management activities over a long period of time.

Does Not Include

• Salaries, fees, etc subject to Social Security and Medicare withholding received for performing services as an employee.

• Fees received for services performed as a notary public.

• Income from real estate rental not in the course of a trade or business as a real estate broker.

• Income from farm rental if you did not materially participate in the production or management of farm products on such land.

• Dividend and interest income earned not in the course of a trade or business as a dealer in stocks and securities.

• Net operating losses from previous years.

• Gain or loss from the sale or exchange of capital assets, or other property not held as stock or inventory in a trade or business, or held primarily for sale in the course of an ordinary trade or business.

Neither the owner’s contribution for a Keogh plan nor the Self-Employed Health Insurance deduction are allowed for SE tax on Schedule SE or Form 1040 SS (sp).

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Overview of the Methods for Calculating Self-Employment Tax

There are three ways to figure your net earnings from self-employment:

1. The regular method

2. The non-farm optional method

3. The farm optional method

You must use the regular method unless you are eligible to use one or both of the optional methods.

Why use an optional method? You may want to use the optional methods when you have a loss or a small net profit and any of the following applies:

• You want to receive credit for Social Security benefit coverage.

• You are entitled to the additional child tax credit (An optional method may increase your earned income, which could increase your credit.)

• You incurred child or dependent care expenses for which you could claim a credit (An optional method may increase your earned income, which could increase your credit.)

• You are entitled to the earned income credit (An optional method may increase your earned income, which could increase your credit.)

Effects of using an optional method. Using an optional method could increase your SE tax. Paying more SE tax could result in you getting higher benefits when you retire.

If you use either or both optional methods, you must figure and pay the SE tax due under these methods even if you would have had a smaller tax or no tax using the regular method.

The optional methods may be used only to figure your SE tax. To figure income tax, include your actual earnings in gross income, regardless of which method you use to determine SE tax.

For VITA/TCE scope purposes, you will not be using the farm optional method.

Self-employment tax consists of Social Security tax (12.4%) and Medicare tax (2.9%) on earnings of workers who work for themselves and have no employer withholding.

For 2025, the maximum amount of self-employment income subject to social security is $176,100.

Medicare taxes are imposed at a flat tax rate of 2.9% on wages, salaries, and business or farming income earned by self-employed individuals.

If you expect to owe self-employment tax of $1,000 or more for 2025, you may need to make estimated tax payments. Use Form 1040-ES, to figure your required payments.

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Starting – New Return Flow Chart

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Use Publication 4696, VITA/TCEPuerto Rico Resource Guide to determine Residency Status

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Always use Form 1040, except for bona fide residents of Puerto Rico filing a U.S. return just to claim the additional child tax credit. Bona fide residents of Puerto Rico who are filing a federal tax return solely to

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Complete Form W-2 to report the salaries of federal employees working in Puerto Rico. Also, Form W-2 is

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Additional Child Tax Credit (ACTC)

A. Residents of Puerto Rico who files a Federal Tax Return just to claim the ACTC.

Edward Rico and Angelina Alta are married, both are 35 years old, Edward works for a private company in Puerto Rico and file a joint return only to claim the ACTC. His wages for this year were $25,000. Angela is a housewife who did not have an outside career. They have two qualifying children. (see Form 1040 -SS for Edward and Angelina on Page 38).

1. Select the Filing Status and Complete the Personal Information Section.

If the taxpayer is filing a U.S. tax return just to claim the Additional Child Tax Credit and the earned income is only from Puerto Rico souces, select Form 1040 SS (sp) or Form 1040 SS.

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3. Enter Dependent/Qualifying child

Wages.

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In order for Form 1040 SS or Form SS (sp) to calculate the Additional Child Tax Credit you must enter

11. Important : Input the Income derived from Puerto Rico sources

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Volunteer Protection Act of 1997

• Have you determined that the taxpayer has not release the claim for this dependent to another person?

• Did you review adequate information to determine that the taxpayer is eligible to claim the credit and in what amount?

The federal Volunteer Protection Act of 1997 (the VPA or the Act) aims to promote volunteerism by limiting, and in many cases completely eliminating, a volunteer’s risk of tort liability when acting for nonprofit organization organization or government entities. You are protected by the federal Volunteer Protection Act of 1997 as long as you are only preparing returns within the scope of the VITA/TCE programs.

Verify the listing of forms for the return, go to “Client Form Listing Summary”

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12. Since the Puerto Rico Health Insurance Code had previously incorporated their health coverage, the

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Additional Child Tax Credit – Form 1040 – SS (English version)

Edward Rico and Angelina Alta have two qualifying children (ages 3 and 9 years old) that entitled them to claim the additional child tax credit. Edward works for a private company in Puerto Rico and file a joint return only to claim the ACTC. His wages for this year were $25,000 (had Social Security and Medicare taxes withheld; $1,550 and $362.50, respectively). They have two qualifying children

All of the following tests must be met to claim someone as a qualifying child:

14. Relationship test Residency test Age test Support test Citizen, resident or national test

15. Type account numbers exactly as shown on check.

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For savings account obtain a statement from the financial institution to verify the routing number and

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B. Taxpayers with U.S. Taxable Earned Income file a Form 1040 along with Schedule 8812 to claim the ACTC

Francis Geneva and Dulce Carrizo are married, both are 23 years old, filing a joint return and have two children Elsa and Fabian who are 4 and 1 years old, respectively. The children qualify for claiming the ACTC. Francis is a federal employee in Puerto Rico who receives a Form W-2 showing $40,000 on box 1. Elsa is a housewife who did not have an outside career.

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Adjustments to Income

1. If the deduction is related to excluded income for U.S. income tax purposes, deductible part of selfemployment tax on line 15 can not be taken.

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Deductions

Mike Gallatin and Maria Granite are U.S. citizens and bona fide residents of Puerto Rico for the entire year. They file a joint return and both are under age 65. This year, Mike earned $22,500 from Puerto Rico sources. Maria earned $67,500 from the U.S. Government. They have $21,000 of itemized deduc

• In most cases, your federal income tax will be less if you take the larger amount between standard deduction or itemized deductions.

Effect of Puerto Rico excluded income on itemized deductions:

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Foreign Tax Credit – Form 1116

Taxable Income or Loss from Sources Outside United States

3. If you can not segregate compensation for services or retirement income performed partly within and partly outside the United States, use the formula to compute the foreign gross income.

See Foreign Tax Credit section : Formula for allocation of income for services or retirement.

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FORM 1116 –“Standard Deduction – Example Continue - Mike and Maria”

If not itemizing, TaxSlayer enters the standard deduction in line 3a (margin).

To complete this line you must transfer the allowable portion from the margin to column A line 3a. TaxSlayer computes the modified standard deduction. It is important that in the Income Menu section Line 9 you enter the total amount of “Section 933 Excluded Income from Puerto Rico”.

Itemized deductions should be modified on Schedule A, only the allowable portion is included.

TaxSlayer computes the mortgage interest expenses on line 4a, automatically.

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Important TaxSlayer entries for taxpayer with excluded Puerto Rico income

4. Select Other Income

5. Select to whom the excluded Puerto Rico income belongs to: taxpayer or spouse.

6. Select Other Income.

7. Enter a description of the excluded income.

8. Enter the amount of excluded Puerto Rico income.

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Important entries for taxpayers with excluded Puerto Rico income

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Foreign Taxes Paid or Accrued

Cash Basis Taxpayers : Have the option to take the Foreign Tax Credit for their Puerto Rico taxes in the

tax was billed in one year but paid in another (“accrued”).

13. If the taxpayer takes the taxes paid, he/she can claim payments and withholding of taxes to the Puerto Rico government during 2025.

If the taxpayer takes the taxes accrued, then he/she can claim the entire Puerto Rico tax liability as of December 31, regardless of whether the taxes are paid the following year.

The taxpayer must continue to use the accrual method for the Foreign Tax Credit on all future returns.

All Puerto Rico taxes paid or accrued on both excluded and non-excluded income may be shown in Part II of Form 1116.

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Taxpayer without excluded income

This page shows how to figure out the foreign tax credit for a taxpayer without excluded income. Assume that the taxpayer is single, under age 65 and received $31,000 in wages taxable to U.S. from sources outside the United States (Puerto Rico) as federal employee, and the taxes paid to Puerto Rico were $1,470.

or the actual amount of foreign tax paid (after reductions on line 12), whichever is less. The Foreign

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Taxpayer with excluded income

Assume that the taxpayer is single under age 65 and a bona fide resident of Puerto Rico who receives $20,000 in wages taxable to U.S. from Puerto Rico sources and $5,000 excluded income under IRC Section 933. The Puerto Rico tax liability was $3,135.

Taxpayers cannot claim a foreign tax credit for taxes paid on excluded Puerto Rico source income.

15. The taxes allocated to the excluded Puerto Rico source income should be included in Part III, line 12, as a reduction in foreign taxes.

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Use Publication 1321 to calculate the reduction in Foreign Taxes.

To complete reduction in foreign taxes, line 12 of Form 1116:

• Taxes paid on excluded income are not allowed as part of the foreign tax credit. To find the amount allocable to the excluded income, multiply the taxes paid or accrued to Puerto Rico by a fraction. The numerator of the fraction is the excluded income from Puerto Rico sources under IRC Section 933, less deductible expenses allocable to that income. The denominator is the total amount of income subject to Puerto Rico tax less deductible expenses allocable to that income.

Formula for reduction in foreign taxes:

Income from Puerto Rico sources not subject to federal tax under IRC Section 933 less deductible expenses allocable to that income

X Tax Paid or accrued to Puerto Rico = Reduction in foreign taxes Total Income subject to Puerto Rico tax, less deductible expenses allocable to that income

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For more information contact your SPEC Relationship Manager to see if you should start a FSA or Virtual VITA site in your community.

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