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Free taxes online Tax Changes for Businesses Table of Contents 2001 ChangesNew 5-Year Carryback Rule for Net Operating Losses (NOLs) Electronic Form 1099 Tax Incentives for New York Liberty Zone Other 2001 Changes 2002 ChangesNonaccrual-Experience Method Issuance of Qualified Zone Academy Bonds Depletion Work Opportunity Credit Expanded in New York Liberty Zone Credit For Pension Plan Startup Costs Welfare-to-Work Credit Extended Work Opportunity Credit Extended Electric and Clean-Fuel Vehicles Renewable Electricity Production Credit Later ChangesSpecial Depreciation Allowance Extension of Placed in Service Date Special Liberty Zone Depreciation Allowance for New and Used Property Depreciation of Property Used on Indian Reservations Indian Employment Credit Extended 2001 Changes New 5-Year Carryback Rule for Net Operating Losses (NOLs) If you have an NOL from a tax year ending during 2001 or 2002, you must generally carry back the entire amount of the NOL to the 5 tax years before the NOL year (the carryback period). Free taxes online However, you can still choose to use the previous carryback period. Free taxes online You also can choose not to carry back an NOL and only carry it forward. Free taxes online Individuals, estates, and trusts can file Form 1045, Application for Tentative Refund. Free taxes online Corporations can file Form 1139, Corporation Application for Tentative Refund. Free taxes online The instructions for these forms will be revised to reflect the new law. Free taxes online Electronic Form 1099 For tax years ending after March 9, 2002, most Forms 1099 can be furnished electronically if the recipient consents, according to IRS regulations, to receive it that way. Free taxes online Tax Incentives for New York Liberty Zone New tax benefits are provided for the parts of New York City damaged in the terrorist attacks on September 11, 2001. Free taxes online These benefits apply to the newly created New York Liberty Zone, which is the area located on or south of Canal Street, East Broadway (east of its intersection with Canal Street), or Grand Street (east of its intersection with East Broadway), in the Borough of Manhattan. Free taxes online Tax benefits for the New York Liberty Zone include the following. Free taxes online A special depreciation allowance equal to 30% of the adjusted basis of qualified Liberty Zone property. Free taxes online It is allowed for the year the property is placed in service. Free taxes online No alternative minimum tax depreciation adjustment for qualified Liberty Zone property. Free taxes online Classification of Liberty Zone leasehold improvement property as 5-year property. Free taxes online Authorization of the issuance of tax-exempt New York Liberty bonds to finance the acquisition, construction, reconstruction, and renovation of nonresidential real property, residential rental property, and public utility property in the Liberty Zone. Free taxes online An increased section 179 deduction for certain Liberty Zone property. Free taxes online Extension of the replacement period from 2 years to 5 years for certain property involuntarily converted as a result of the terrorist attacks on September 11, 2001, but only if substantially all of the use of the replacement property is in New York City. Free taxes online For more information about involuntary conversions, see Postponement of Gain in Publication 547, Casualties, Disasters, and Thefts. Free taxes online In addition, for 2002 and 2003, the work opportunity credit is expanded by creating a new targeted group, consisting generally of employees who work in the Liberty Zone or, in certain cases, in New York City outside the Liberty Zone. Free taxes online For more information, see Work Opportunity Credit Expanded in New York Liberty Zone under 2002 Changes, later. Free taxes online For more information about the 30% special depreciation allowance, Liberty Zone leasehold improvement property, or increased section 179 deduction, see New York Liberty Zone Benefits, in chapter 5. Free taxes online In addition, the tax benefits for the Liberty Zone will be covered in a new edition of Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities, available later in 2002. Free taxes online Other 2001 Changes Other changes are discussed in the following chapters. Free taxes online Chapter 4 Car Expenses Chapter 5 Depreciation 2002 Changes Nonaccrual-Experience Method Under current law, if you perform services and use an accrual method of accounting, you do not accrue income which, based on experience, you expect to be uncollectible. Free taxes online Beginning in 2002, this rule only applies if you perform services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, and consulting, or your average annual gross receipts for the 3 prior tax years does not exceed $5,000,000. Free taxes online As under current law, the nonaccrual-experience method will not apply to amounts on which you charge interest or a late payment penalty. Free taxes online For more information, see Nonaccrual-Experience Method in chapter 11 of Publication 535, Business Expenses. Free taxes online Issuance of Qualified Zone Academy Bonds State and local governments issue qualified zone academy bonds to raise funds for the use of qualified zone academies. Free taxes online The amount of bonds that may be issued was limited to $400 million each year for 1998, 1999, 2000, and 2001. Free taxes online This provision has been extended to provide for an additional $400 million of bonds to be issued each year for 2002 and 2003. Free taxes online For more information about qualified zone academy bonds, see Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities. Free taxes online Depletion The suspension of the taxable income limit on percentage depletion from the marginal production of oil and natural gas that was scheduled to expire for tax years beginning after 2001 has been extended to tax years beginning before 2004. Free taxes online For more information on marginal production, see section 613A(c) of the Internal Revenue Code. Free taxes online Work Opportunity Credit Expanded in New York Liberty Zone The work opportunity credit is expanded to include a new targeted group consisting generally of employees who perform substantially all their services: In the New York Liberty Zone (defined earlier under Tax Incentives for New York Liberty Zone, under 2001 Changes), or Elsewhere in New York City for a business that relocated from the Liberty Zone due to the destruction or damage of its place of business by the September 11, 2001, terrorist attack. Free taxes online The credit is available to employers for wages paid to new employees and existing employees for work performed during 2002 or 2003. Free taxes online Certain limits apply. Free taxes online For more information about the work opportunity credit, see Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities. Free taxes online Credit For Pension Plan Startup Costs The credit for pension plan startup costs is now allowed for plans that become effective after December 31, 2001. Free taxes online Previously, the credit was only allowed for plans established after December 31, 2001. Free taxes online For more information on the credit, see Important Changes for 2002 in Publication 560, Retirement Plans for Small Business. Free taxes online Welfare-to-Work Credit Extended The welfare-to-work credit that was scheduled to expire for wages paid to individuals who began working for you after 2001 has been extended to include wages paid to qualified individuals who begin work for you in 2002 or 2003. Free taxes online For more information on the welfare-to-work credit, see Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities. Free taxes online Work Opportunity Credit Extended The work opportunity credit that was scheduled to expire for wages paid to individuals who began working for you after 2001 has been extended to include wages paid to qualified individuals who begin work for you in 2002 or 2003. Free taxes online For more information about the work opportunity credit, see Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities. Free taxes online Electric and Clean-Fuel Vehicles The maximum clean-fuel vehicle deduction and qualified electric vehicle credit were scheduled to be 25% lower for 2002 and both were scheduled to be phased out completely by 2005. Free taxes online The full deduction and credit are now allowed for qualified property placed in service in 2002 and 2003. Free taxes online The phaseout of the deduction and the credit will begin in 2004, and no deduction or credit will be allowed for property placed in service after 2006. Free taxes online For more information about electric and clean-fuel vehicles, see chapter 12 in Publication 535, Business Expenses. Free taxes online Renewable Electricity Production Credit The renewable electricity production credit is extended to include electricity produced by facilities placed in service after 2001 and before 2004. Free taxes online Later Changes Special Depreciation Allowance You can claim the special depreciation allowance (an additional 30% depreciation deduction) for new property that you acquire before September 11, 2004, and place in service for your business generally before January 1, 2005, if you meet the other requirements for qualified property covered in chapter 5. Free taxes online Accordingly, you will generally no longer be able to claim the special depreciation allowance for the qualified property if you acquire it after September 10, 2004, or place it in service for your business after December 31, 2004. Free taxes online However, you will be able to claim the special Liberty Zone depreciation allowance (an additional 30% depreciation deduction) for most qualified property if you place it in service in the Liberty Zone after December 31, 2004, and generally before January 1, 2007, provided you meet the other requirements for qualified Liberty Zone property covered in chapter 5. Free taxes online Extension of Placed in Service Date To qualify for the special depreciation allowance, your property must meet certain tests, including the placed in service date test, as well as the other requirements covered in chapter 5 of this publication. Free taxes online To meet the placed in service date test, your property must generally be placed in service for use in your trade or business or for the production of income after September 10, 2001, and before January 1, 2005. Free taxes online However, certain property placed in service before January 1, 2006, may meet this test. Free taxes online Transportation property and property with a recovery period of 10 years or longer meet the test if one of the following applies. Free taxes online The property has an estimated production period of more than 2 years. Free taxes online The property has an estimated production period of more than 1 year and it costs more than $1 million. Free taxes online Transportation property is any tangible personal property used in the trade or business of transporting persons or property. Free taxes online For property that qualifies for the special depreciation allowance solely because of the one-year extension of the placed in service date, only the part of the basis attributable to manufacture, construction, or production before September 11, 2004, is eligible for the special depreciation allowance. Free taxes online Special Liberty Zone Depreciation Allowance for New and Used Property You can claim the special Liberty Zone depreciation allowance (an additional 30% depreciation deduction) for used property that you acquire after September 10, 2001, if the property meets the requirements listed under Qualified Liberty Zone Property in chapter 5 of this publication. Free taxes online You will be able to claim the allowance for both new and used property that you acquire after September 10, 2004, provided the property meets the other requirements for qualified Liberty Zone property. Free taxes online Depreciation of Property Used on Indian Reservations The special depreciation rules that apply to qualified property used on an Indian reservation were scheduled to expire for property placed in service after 2003. Free taxes online These special rules have been extended to include property placed in service in 2004. Free taxes online For more information about these rules, see Publication 946, How To Depreciate Property. Free taxes online Indian Employment Credit Extended The Indian employment credit that was scheduled to expire for tax years beginning after 2003 has been extended to include a tax year beginning in 2004. Free taxes online For more information about this credit, see Publication 954, Tax Incentives for Empowerment Zones and Other Distressed Communities. Free taxes online Prev  Up  Next   Home   More Online Publications

Topic 305 - Recordkeeping

Well-organized records make it easier to prepare a tax return and help provide answers if your return is selected for examination, or to prepare a response if you receive an IRS notice.

Records such as receipts, canceled checks, and other documents that support an item of income or a deduction, or a credit appearing on a return must be kept so long as they may become material in the administration of any internal revenue law, which generally will be until the period of limitation expires for that return. For assessment of tax you owe, this generally is 3 years from the date you filed the return. Returns filed before the due date are treated as filed on the due date.

There is no period of limitations to assess tax when a return is fraudulent or when no return is filed. If income that you should have reported is not reported, and it is more than 25% of the gross income shown on the return, the time to assess is 6 years from when the return is filed. For filing a claim for credit or refund, the period to make the claim generally is 3 years from the date the original return was filed (or the due date for filing the return if the return was filed before that date), or 2 years from the date the tax was paid, whichever is later. For filing a claim for an overpayment resulting from a bad debt deduction or a loss from worthless securities the time to make the claim is 7 years from when the return was due.

If you have employees, you must keep all your employment tax records for at least 4 years after the tax becomes due or is paid, whichever is later. For more information, see Publication 15, (Circular E), Employer's Tax Guide.

If you are in business, there is no particular method of bookkeeping you must use. However, you must use a method that clearly and accurately reflects your gross income and expenses. The records should substantiate both your income and expenses. Publication 583, Starting a Business and Keeping Records, and Publication 463, Travel, Entertainment, Gift, and Car Expenses, provide additional information on required documentation for taxpayers with business expenses. Publication 17, Your Federal Income Tax for Individuals, provides more information on recordkeeping requirements for individuals.

Page Last Reviewed or Updated: January 22, 2014

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Free taxes online Publication 514 - Main Content Table of Contents Choosing To Take Credit or DeductionChoice Applies to All Qualified Foreign Taxes Making or Changing Your Choice Why Choose the Credit?Credit for Taxes Paid or Accrued Foreign Currency and Exchange Rates Foreign Tax Redetermination Who Can Take the Credit?U. Free taxes online S. Free taxes online Citizens Resident Aliens Nonresident Aliens What Foreign Taxes Qualify for the Credit?Tax Must Be Imposed on You You Must Have Paid or Accrued the Tax Tax Must Be the Legal and Actual Foreign Tax Liability Tax Must Be an Income Tax (or Tax in Lieu of Income Tax) Foreign Taxes for Which You Cannot Take a CreditTaxes on Excluded Income Taxes for Which You Can Only Take an Itemized Deduction Taxes on Foreign Mineral Income Taxes From International Boycott Operations Taxes on Combined Foreign Oil and Gas Income Taxes of U. Free taxes online S. Free taxes online Persons Controlling Foreign Corporations and Partnerships Taxes Related to a Foreign Tax Credit Splitting Event How To Figure the CreditLimit on the Credit Separate Limit Income Allocation of Foreign Taxes Foreign Taxes From a Partnership or an S Corporation Figuring the Limit Qualified Dividends Capital Gains and Losses Allocation of Foreign and U. Free taxes online S. Free taxes online Losses Tax Treaties Carryback and CarryoverTime Limit on Tax Assessment Claim for Refund Taxes All Credited or All Deducted Married Couples How To Claim the CreditForm 1116 Records To Keep Simple Example — Filled-In Form 1116Part I—Taxable Income or Loss From Sources Outside the United States (for Category Checked Above) Part II—Foreign Taxes Paid or Accrued Part III—Figuring the Credit Part IV—Summary of Credits From Separate Parts III Comprehensive Example — Filled-In Form 1116Foreign earned income. Free taxes online Employee business expenses. Free taxes online Forms 1116 Computation of Taxable Income Part I—Taxable Income or Loss From Sources Outside the United States (for Category Checked Above) Part II—Foreign Taxes Paid or Accrued Part III—Figuring the Credit Part IV—Summary of Credits From Separate Parts III Unused Foreign Taxes How To Get Tax HelpLow Income Taxpayer Clinics Choosing To Take Credit or Deduction You can choose whether to take the amount of any qualified foreign taxes paid or accrued during the year as a foreign tax credit or as an itemized deduction. Free taxes online You can change your choice for each year's taxes. Free taxes online To choose the foreign tax credit, in most cases you must complete Form 1116 and attach it to your U. Free taxes online S. Free taxes online tax return. Free taxes online However, you may qualify for the exception that allows you to claim the foreign tax credit without using Form 1116. Free taxes online See How To Figure the Credit , later. Free taxes online To choose to claim the taxes as an itemized deduction, use Schedule A (Form 1040), Itemized Deductions. Free taxes online Figure your tax both ways—claiming the credit and claiming the deduction. Free taxes online Then fill out your return the way that benefits you more. Free taxes online See Why Choose the Credit, later. Free taxes online Choice Applies to All Qualified Foreign Taxes As a general rule, you must choose to take either a credit or a deduction for all qualified foreign taxes. Free taxes online If you choose to take a credit for qualified foreign taxes, you must take the credit for all of them. Free taxes online You cannot deduct any of them. Free taxes online Conversely, if you choose to deduct qualified foreign taxes, you must deduct all of them. Free taxes online You cannot take a credit for any of them. Free taxes online See What Foreign Taxes Qualify for the Credit , later, for the meaning of qualified foreign taxes. Free taxes online There are exceptions to this general rule, which are described next. Free taxes online Exceptions for foreign taxes not allowed as a credit. Free taxes online   Even if you claim a credit for other foreign taxes, you can deduct any foreign tax that is not allowed as a credit if: You paid the tax to a country for which a credit is not allowed because it provides support for acts of international terrorism, or because the United States does not have or does not conduct diplomatic relations with it or recognize its government and that government is not otherwise eligible to purchase defense articles or services under the Arms Export Control Act, You paid withholding tax on dividends from foreign corporations whose stock you did not hold for the required period of time, You paid withholding tax on income or gain (other than dividends) from property you did not hold for the required period of time, You paid withholding tax on income or gain to the extent you had to make related payments on positions in substantially similar or related property, You participated in or cooperated with an international boycott, You paid taxes in connection with the purchase or sale of oil or gas, or You paid or accrued taxes on income or gain in connection with a covered asset acquisition. Free taxes online Covered asset acquisitions include certain acquisitions that result in a stepped-up basis for U. Free taxes online S. Free taxes online tax purposes. Free taxes online For more information, see Internal Revenue Code section 901(m). Free taxes online The IRS intends to issue guidance that will explain this provision in greater detail. Free taxes online   For more information on these items, see Taxes for Which You Can Only Take an Itemized Deduction , later, under Foreign Taxes for Which You Cannot Take a Credit. Free taxes online Foreign taxes that are not income taxes. Free taxes online   In most cases, only foreign income taxes qualify for the foreign tax credit. Free taxes online Other taxes, such as foreign real and personal property taxes, do not qualify. Free taxes online But you may be able to deduct these other taxes even if you claim the foreign tax credit for foreign income taxes. Free taxes online   In most cases, you can deduct these other taxes only if they are expenses incurred in a trade or business or in the production of income. Free taxes online However, you can deduct foreign real property taxes that are not trade or business expenses as an itemized deduction on Schedule A (Form 1040). Free taxes online Carrybacks and carryovers. Free taxes online   There is a limit on the credit you can claim in a tax year. Free taxes online If your qualified foreign taxes exceed the credit limit, you may be able to carry over or carry back the excess to another tax year. Free taxes online If you deduct qualified foreign taxes in a tax year, you cannot use a carryback or carryover in that year. Free taxes online That is because you cannot take both a deduction and a credit for qualified foreign taxes in the same tax year. Free taxes online   For more information on the limit, see How To Figure the Credit , later. Free taxes online For more information on carrybacks and carryovers, see Carryback and Carryover , later. Free taxes online Making or Changing Your Choice You can make or change your choice to claim a deduction or credit at any time during the period within 10 years from the regular due date for filing the return (without regard to any extension of time to file) for the tax year in which the taxes were actually paid or accrued. Free taxes online You make or change your choice on your tax return (or on an amended return) for the year your choice is to be effective. Free taxes online Example. Free taxes online You paid foreign taxes for the last 13 years and chose to deduct them on your U. Free taxes online S. Free taxes online income tax returns. Free taxes online You were timely in both filing your returns and paying your U. Free taxes online S. Free taxes online tax liability. Free taxes online In February 2013, you file an amended return for tax year 2002 choosing to take a credit for your 2002 foreign taxes because you now realize that the credit is more advantageous than the deduction for that year. Free taxes online Because the regular due date of your 2002 return was April 15, 2003, this choice is timely (within 10 years). Free taxes online Because there is a limit on the credit for your 2002 foreign tax, you have unused 2002 foreign taxes. Free taxes online Ordinarily, you first carry back unused foreign taxes arising in 2002 to, and claim them as a credit in, the 2 preceding tax years. Free taxes online If you are unable to claim all of them in those 2 years, you carry them forward to the 10 years following the year in which they arose. Free taxes online Because you originally chose to deduct your foreign taxes and the 10-year period for changing the choice for 2000 and 2001 has passed, you cannot change your choice and carry the unused 2002 foreign taxes back to tax years 2000 and 2001. Free taxes online Because the 10-year periods for changing the choice have not passed for your 2003 through 2012 income tax returns, you can still choose to claim the credit for those years and carry forward any unused 2002 foreign taxes. Free taxes online However, you must reduce the unused 2002 foreign taxes that you carry forward by the amount that would have been allowed as a carryback if you had timely carried back the foreign tax to tax years 2000 and 2001. Free taxes online You cannot take a credit or a deduction for foreign taxes paid on income you exclude under the foreign earned income exclusion or the foreign housing exclusion. Free taxes online See Foreign Earned Income and Housing Exclusions under Foreign Taxes for Which You Cannot Take a Credit, later. Free taxes online Why Choose the Credit? The foreign tax credit is intended to relieve you of a double tax burden when your foreign source income is taxed by both the United States and the foreign country. Free taxes online In most cases, if the foreign tax rate is higher than the U. Free taxes online S. Free taxes online rate, there will be no U. Free taxes online S. Free taxes online tax on the foreign income. Free taxes online If the foreign tax rate is lower than the U. Free taxes online S. Free taxes online rate, U. Free taxes online S. Free taxes online tax on the foreign income will be limited to the difference between the rates. Free taxes online The foreign tax credit can only reduce U. Free taxes online S. Free taxes online taxes on foreign source income; it cannot reduce U. Free taxes online S. Free taxes online taxes on U. Free taxes online S. Free taxes online source income. Free taxes online Although no one rule covers all situations, in most cases it is better to take a credit for qualified foreign taxes than to deduct them as an itemized deduction. Free taxes online This is because: A credit reduces your actual U. Free taxes online S. Free taxes online income tax on a dollar-for-dollar basis, while a deduction reduces only your income subject to tax, You can choose to take the foreign tax credit even if you do not itemize your deductions. Free taxes online You then are allowed the standard deduction in addition to the credit, and If you choose to take the foreign tax credit, and the taxes paid or accrued exceed the credit limit for the tax year, you may be able to carry over or carry back the excess to another tax year. Free taxes online (See Limit on credit under How To Figure the Credit, later. Free taxes online ) Example 1. Free taxes online For 2013, you and your spouse have adjusted gross income of $80,300, including $20,000 of dividend income from foreign sources. Free taxes online None of the dividends are qualified dividends. Free taxes online You file a joint return and can claim two $3,900 exemptions. Free taxes online You had to pay $2,000 in foreign income taxes on the dividend income. Free taxes online If you take the foreign taxes as an itemized deduction, your total itemized deductions are $15,000. Free taxes online Your taxable income then is $57,500 and your tax is $7,736. Free taxes online If you take the credit instead, your itemized deductions are only $13,000. Free taxes online Your taxable income then is $59,500 and your tax before the credit is $8,036. Free taxes online After the credit, however, your tax is only $6,036. Free taxes online Therefore, your tax is $1,700 lower ($7,736 − $6,036) by taking the credit. Free taxes online Example 2. Free taxes online In 2013, you receive investment income of $5,000 from a foreign country, which imposes a tax of $1,500 on that income. Free taxes online You report on your U. Free taxes online S. Free taxes online return this income as well as $56,000 of U. Free taxes online S. Free taxes online source wages and an allowable $49,000 partnership loss from a U. Free taxes online S. Free taxes online partnership. Free taxes online Your share of the partnership's gross income is $25,000 and your share of its expenses is $74,000. Free taxes online You are single, entitled to one $3,900 exemption, and have other itemized deductions of $6,850. Free taxes online If you deduct the foreign tax on your U. Free taxes online S. Free taxes online return, your taxable income is a negative $250 ($5,000 + $56,000 − $49,000 − $1,500 − $6,850 − $3,900) and your tax is $0. Free taxes online If you take the credit instead, your taxable income is $1,250 ($5,000 + $56,000 − $49,000 − $3,900 − $6,850) and your tax before the credit is $126. Free taxes online You can take a credit of only $113 because of limits discussed later. Free taxes online Your tax after the credit is $13 ($126 − $113), which is $13 more than if you deduct the foreign tax. Free taxes online If you choose the credit, you will have unused foreign taxes of $1,387 ($1,500 − $113). Free taxes online When deciding whether to take the credit or the deduction this year, you will need to consider whether you can benefit from a carryback or carryover of that unused foreign tax. Free taxes online Credit for Taxes Paid or Accrued You can claim the credit for a qualified foreign tax in the tax year in which you pay it or accrue it, depending on your method of accounting. Free taxes online “Tax year” refers to the tax year for which your U. Free taxes online S. Free taxes online return is filed, not the tax year for which your foreign return is filed. Free taxes online Accrual method of accounting. Free taxes online   If you use an accrual method of accounting, you can claim the credit only in the year in which you accrue the tax. Free taxes online You are using an accrual method of accounting if you report income when you earn it, rather than when you receive it, and you deduct your expenses when you incur them, rather than when you pay them. Free taxes online   In most cases, foreign taxes accrue when all the events have taken place that fix the amount of the tax and your liability to pay it. Free taxes online Generally, this occurs on the last day of the tax year for which your foreign return is filed. Free taxes online Contesting your foreign tax liability. Free taxes online   If you are contesting your foreign tax liability, you cannot accrue it and take a credit until the amount of foreign tax due is finally determined. Free taxes online However, if you choose to pay the tax liability you are contesting, you can take a credit for the amount you pay before a final determination of foreign tax liability is made. Free taxes online Once your liability is determined, the foreign tax credit is allowable for the year to which the foreign tax relates. Free taxes online If the amount of foreign taxes taken as a credit differs from the final foreign tax liability, you may have to adjust the credit, as discussed later under Foreign Tax Redetermination . Free taxes online You may have to post a bond. Free taxes online   If you claim a credit for taxes accrued but not paid, you may have to post an income tax bond to guarantee your payment of any tax due in the event the amount of foreign tax paid differs from the amount claimed. Free taxes online   The IRS can request this bond at any time without regard to the Time Limit on Tax Assessment discussed later under Carryback and Carryover. Free taxes online Cash method of accounting. Free taxes online   If you use the cash method of accounting, you can choose to take the credit either in the year you pay the tax or in the year you accrue it. Free taxes online You are using the cash method of accounting if you report income in the year you actually or constructively receive it, and deduct expenses in the year you pay them. Free taxes online Choosing to take credit in the year taxes accrue. Free taxes online   Even if you use the cash method of accounting, you can choose to take a credit for foreign taxes in the year they accrue. Free taxes online You make the choice by checking the box in Part II of Form 1116. Free taxes online Once you make that choice, you must follow it in all later years and take a credit for foreign taxes in the year they accrue. Free taxes online   In addition, the choice to take the credit when foreign taxes accrue applies to all foreign taxes qualifying for the credit. Free taxes online You cannot take a credit for some foreign taxes when paid and take a credit for others when accrued. Free taxes online   If you make the choice to take the credit when foreign taxes accrue and pay them in a later year, you cannot claim a deduction for any part of the previously accrued taxes. Free taxes online Credit based on taxes paid in earlier year. Free taxes online   If, in earlier years, you took the credit based on taxes paid, and this year you choose to take the credit based on taxes accrued, you may be able to take the credit this year for taxes from more than one year. Free taxes online Example. Free taxes online Last year you took the credit based on taxes paid. Free taxes online This year you chose to take the credit based on taxes accrued. Free taxes online During the year you paid foreign income taxes owed for last year. Free taxes online You also accrued foreign income taxes for this year that you did not pay by the end of the year. Free taxes online You can base the credit on your return for this year on both last year's taxes that you paid and this year's taxes that you accrued. Free taxes online Foreign Currency and Exchange Rates U. Free taxes online S. Free taxes online income tax is imposed on income expressed in U. Free taxes online S. Free taxes online dollars, while in most cases the foreign tax is imposed on income expressed in foreign currency. Free taxes online Therefore, fluctuations in the value of the foreign currency relative to the U. Free taxes online S. Free taxes online dollar may affect the foreign tax credit. Free taxes online Translating foreign currency into U. Free taxes online S. Free taxes online dollars. Free taxes online   If you receive all or part of your income or pay some or all of your expenses in foreign currency, you must translate the foreign currency into U. Free taxes online S. Free taxes online dollars. Free taxes online How and when you do this depends on your functional currency. Free taxes online In most cases, your functional currency is the U. Free taxes online S. Free taxes online dollar unless you are required to use the currency of a foreign country. Free taxes online   You must make all federal income tax determinations in your functional currency. Free taxes online The U. Free taxes online S. Free taxes online dollar is the functional currency for all taxpayers except some qualified business units. Free taxes online A qualified business unit is a separate and clearly identified unit of a trade or business that maintains separate books and records. Free taxes online Unless you are self-employed, your functional currency is the U. Free taxes online S. Free taxes online dollar. Free taxes online   Even if you are self-employed and have a qualified business unit, your functional currency is the U. Free taxes online S. Free taxes online dollar if any of the following apply. Free taxes online You conduct the business primarily in dollars. Free taxes online The principal place of business is located in the United States. Free taxes online You choose to or are required to use the dollar as your functional currency. Free taxes online The business books and records are not kept in the currency of the economic environment in which a significant part of the business activities is conducted. Free taxes online   If your functional currency is the U. Free taxes online S. Free taxes online dollar, you must immediately translate into dollars all items of income, expense, etc. Free taxes online , that you receive, pay, or accrue in a foreign currency and that will affect computation of your income tax. Free taxes online If there is more than one exchange rate, use the one that most properly reflects your income. Free taxes online In most cases, you can get exchange rates from banks and U. Free taxes online S. Free taxes online Embassies. Free taxes online   If your functional currency is not the U. Free taxes online S. Free taxes online dollar, make all income tax determinations in your functional currency. Free taxes online At the end of the year, translate the results, such as income or loss, into U. Free taxes online S. Free taxes online dollars to report on your income tax return. Free taxes online    For more information, write to: Internal Revenue Service International Section Philadelphia, PA 19255-0725 Rate of exchange for foreign taxes paid. Free taxes online   Use the rate of exchange in effect on the date you paid the foreign taxes to the foreign country unless you meet the exception discussed next. Free taxes online If your tax was withheld in foreign currency, use the rate of exchange in effect for the date on which the tax was withheld. Free taxes online If you make foreign estimated tax payments, you use the rate of exchange in effect for the date on which you made the estimated tax payment. Free taxes online   The exchange rate rules discussed here apply even if the foreign taxes are paid or accrued with respect to a foreign tax credit splitting event (discussed later). Free taxes online Exception. Free taxes online   If you claim the credit for foreign taxes on an accrual basis, in most cases you must use the average exchange rate for the tax year to which the taxes relate. Free taxes online This rule applies to accrued taxes relating to tax years beginning after 1997 and only under the following conditions. Free taxes online The foreign taxes are paid on or after the first day of the tax year to which they relate. Free taxes online The foreign taxes are paid not later than 2 years after the close of the tax year to which they relate. Free taxes online The foreign tax liability is not denominated in an inflationary currency (defined in the Form 1116 instructions). Free taxes online (This condition applies to taxes paid or accrued in tax years beginning after November 6, 2007. Free taxes online )   For all other foreign taxes, you should use the exchange rate in effect on the date you paid them. Free taxes online Election to use exchange rate on date paid. Free taxes online   If you have accrued foreign taxes that you are otherwise required to convert using the average exchange rate, you may elect to use the exchange rate in effect on the date the foreign taxes are paid if the taxes are denominated in a nonfunctional foreign currency. Free taxes online If any of the accrued taxes are unpaid, you must translate them into U. Free taxes online S. Free taxes online dollars using the exchange rate on the last day of the U. Free taxes online S. Free taxes online tax year to which those taxes relate. Free taxes online You may make the election for all nonfunctional currency foreign income taxes or only those nonfunctional currency foreign income taxes that are attributable to qualified business units with a U. Free taxes online S. Free taxes online dollar functional currency. Free taxes online Once made, the election applies to the tax year for which made and all subsequent tax years unless revoked with the consent of the IRS. Free taxes online The election is available for tax years beginning after 2004. Free taxes online It must be made by the due date (including extensions) for filing the tax return for the first tax year to which the election applies. Free taxes online Make the election by attaching a statement to the applicable tax return. Free taxes online The statement must identify whether the election is made for all foreign taxes or only for foreign taxes attributable to qualified business units with a U. Free taxes online S. Free taxes online dollar functional currency. Free taxes online Foreign Tax Redetermination A foreign tax redetermination is any change in your foreign tax liability that may affect your U. Free taxes online S. Free taxes online foreign tax credit claimed. Free taxes online The year in which to claim the credit remains the year to which the foreign taxes paid or accrued relate, even if the change in foreign tax liability occurs in a later year. Free taxes online If a foreign tax redetermination occurs, a redetermination of your U. Free taxes online S. Free taxes online tax liability is required if any of the following conditions apply. Free taxes online The accrued taxes when paid differ from the amounts claimed as a credit. Free taxes online The accrued taxes you claimed as a credit in one tax year are not paid within 2 years after the end of that tax year. Free taxes online If this applies to you, you must reduce the credit previously claimed by the amount of the unpaid taxes. Free taxes online You will not be allowed a credit for the unpaid taxes until you pay them. Free taxes online When you pay the accrued taxes, a new foreign tax redetermination occurs and you must translate the taxes into U. Free taxes online S. Free taxes online dollars using the exchange rate as of the date they were paid. Free taxes online The foreign tax credit is allowed for the year to which the foreign tax relates. Free taxes online See Rate of exchange for foreign taxes paid , earlier, under Foreign Currency and Exchange Rates. Free taxes online The foreign taxes you paid are refunded in whole or in part. Free taxes online For taxes taken into account when accrued but translated into dollars on the date of payment, the dollar value of the accrued tax differs from the dollar value of the tax paid because of fluctuations in the exchange rate between the date of accrual and the date of payment. Free taxes online However, no redetermination is required if the change in foreign tax liability for each foreign country is solely attributable to exchange rate fluctuations and is less than the smaller of: $10,000, or 2% of the total dollar amount of the foreign tax initially accrued for that foreign country for the U. Free taxes online S. Free taxes online tax year. Free taxes online In this case, you must adjust your U. Free taxes online S. Free taxes online tax in the tax year in which the accrued foreign taxes are paid. Free taxes online Notice to the Internal Revenue Service (IRS) of Redetermination You are required to notify the IRS about a foreign tax credit redetermination that affects your U. Free taxes online S. Free taxes online tax liability for each tax year affected by the redetermination. Free taxes online In most cases, you must file Form 1040X, Amended U. Free taxes online S. Free taxes online Individual Income Tax Return, with a revised Form 1116 and a statement that contains information sufficient for the IRS to redetermine your U. Free taxes online S. Free taxes online tax liability for the year or years affected. Free taxes online See Contents of statement , later. Free taxes online You are not required to attach Form 1116 for a tax year affected by a redetermination if: The amount of your creditable taxes paid or accrued during the tax year is not more than $300 ($600 if married filing a joint return) as a result of the foreign tax redetermination, and You meet the requirements listed under Exemption from foreign tax credit limit under How To Figure the Credit, later. Free taxes online There are other exceptions to this requirement. Free taxes online They are discussed later under Due date of notification to IRS . Free taxes online Contents of statement. Free taxes online   The statement must include all of the following. Free taxes online Your name, address, and taxpayer identification number. Free taxes online The tax year or years that are affected by the foreign tax redetermination. Free taxes online The date or dates the foreign taxes were accrued, if applicable. Free taxes online The date or dates the foreign taxes were paid. Free taxes online The amount of foreign taxes paid or accrued on each date (in foreign currency) and the exchange rate used to translate each amount. Free taxes online Information sufficient to determine any interest due from or owing to you, including the amount of any interest paid to you by the foreign government and the dates received. Free taxes online   In the case of any foreign taxes that were not paid before the date two years after the close of the tax year to which those taxes relate, you must provide the amount of those taxes in foreign currency and the exchange rate that was used to translate that amount when originally claimed as a credit. Free taxes online   If any foreign tax was refunded in whole or in part, you must provide the date and amount (in foreign currency) of each refund, the exchange rate that was used to translate each amount when originally claimed as a credit, and the exchange rate for the date the refund was received (for purposes of computing foreign currency gain or loss under Internal Revenue Code section 988). Free taxes online Due date of notification to IRS. Free taxes online   If you pay less foreign tax than you originally claimed a credit for, in most cases you must file a notification by the due date (with extensions) of your original return for your tax year in which the foreign tax redetermination occurred. Free taxes online There is no limit on the time the IRS has to redetermine and assess the correct U. Free taxes online S. Free taxes online tax due. Free taxes online If you pay more foreign tax than you originally claimed a credit for, you have 10 years to file a claim for refund of U. Free taxes online S. Free taxes online taxes. Free taxes online See Time Limit on Refund Claims , later. Free taxes online   Exceptions to this due date are explained in the next two paragraphs. Free taxes online Multiple redeterminations of U. Free taxes online S. Free taxes online tax liability for same tax year. Free taxes online   Where more than one foreign tax redetermination requires a redetermination of U. Free taxes online S. Free taxes online tax liability for the same tax year and those redeterminations occur in the same tax year or within two consecutive tax years, you can file for that tax year one notification (Form 1040X with a Form 1116 and the required statement) that reflects all those tax redeterminations. Free taxes online If you choose to file one notification, the due date for that notification is the due date of the original return (with extensions) for the year in which the first foreign tax redetermination that reduced your foreign tax liability occurred. Free taxes online However, foreign tax redeterminations with respect to the tax year for which a redetermination of U. Free taxes online S. Free taxes online tax liability is required may occur after the due date for providing that notification. Free taxes online In this situation, you may have to file more than one Form 1040X for that tax year. Free taxes online Additional U. Free taxes online S. Free taxes online tax due eliminated by foreign tax credit carryback or carryover. Free taxes online   If a foreign tax redetermination requires a redetermination of U. Free taxes online S. Free taxes online tax liability that would otherwise result in an additional amount of U. Free taxes online S. Free taxes online tax due, but the additional tax is eliminated by a carryback or carryover of an unused foreign tax, you do not have to amend your tax return for the year affected by the redetermination. Free taxes online Instead, you can notify the IRS by attaching a statement to the original return for the tax year in which the foreign tax redetermination occurred. Free taxes online You must file the statement by the due date (with extensions) of that return. Free taxes online The statement must show the amount of the unused foreign taxes paid or accrued and a detailed schedule showing the computation of the carryback or carryover (including the amounts carried back or over to the year for which a redetermination on U. Free taxes online S. Free taxes online tax liability is required). Free taxes online Failure-to-notify penalty. Free taxes online   If you fail to notify the IRS of a foreign tax redetermination and cannot show reasonable cause for the failure, you may have to pay a penalty. Free taxes online   For each month, or part of a month, that the failure continues, you pay a penalty of 5% of the tax due resulting from a redetermination of your U. Free taxes online S. Free taxes online tax. Free taxes online This penalty cannot be more than 25% of the tax due. Free taxes online Foreign tax refund. Free taxes online   If you receive a foreign tax refund without interest from the foreign government, you will not have to pay interest on the amount of tax due resulting from the adjustment to your U. Free taxes online S. Free taxes online tax for the time before the date of the refund. Free taxes online   However, if you receive a foreign tax refund with interest, you must pay interest to the IRS up to the amount of the interest paid to you by the foreign government. Free taxes online The interest you must pay cannot be more than the interest you would have had to pay on taxes that were unpaid for any other reason for the same period. Free taxes online Interest also is owed from the time you receive a refund until you pay the additional tax due. Free taxes online Foreign tax imposed on foreign refund. Free taxes online   If your foreign tax refund is taxed by the foreign country, you cannot take a separate credit or deduction for this additional foreign tax. Free taxes online However, when you refigure the foreign tax credit taken for the original foreign tax, reduce the amount of the refund by the foreign tax paid on the refund. Free taxes online Example. Free taxes online You paid a foreign income tax of $3,000 in 2011, and received a foreign tax refund of $500 in 2013 on which a foreign tax of $100 was imposed. Free taxes online When you refigure your credit for 2011, you must reduce the $3,000 you paid by $400. Free taxes online Time Limit on Refund Claims You have 10 years to file a claim for refund of U. Free taxes online S. Free taxes online tax if you find that you paid or accrued a larger foreign tax than you claimed a credit for. Free taxes online The 10-year period begins the day after the regular due date for filing the return (without extensions) for the year in which the taxes were actually paid or accrued. Free taxes online You have 10 years to file your claim regardless of whether you claim the credit for taxes paid or taxes accrued. Free taxes online The 10-year period applies to claims for refund or credit based on: Fixing math errors in figuring qualified foreign taxes, Reporting qualified foreign taxes not originally reported on the return, or Any other change in the size of the credit (including one caused by correcting the foreign tax credit limit). Free taxes online The special 10-year period also applies to making or changing your choice to claim a deduction or credit for foreign taxes. Free taxes online See Making or Changing Your Choice discussed earlier under Choosing To Take Credit or Deduction. Free taxes online Who Can Take the Credit? U. Free taxes online S. Free taxes online citizens, resident aliens, and nonresident aliens who paid foreign income tax and are subject to U. Free taxes online S. Free taxes online tax on foreign source income may be able to take a foreign tax credit. Free taxes online U. Free taxes online S. Free taxes online Citizens If you are a U. Free taxes online S. Free taxes online citizen, you are taxed by the United States on your worldwide income wherever you live. Free taxes online You are normally entitled to take a credit for foreign taxes you pay or accrue. Free taxes online Resident Aliens If you are a resident alien of the United States, you can take a credit for foreign taxes subject to the same general rules as U. Free taxes online S. Free taxes online citizens. Free taxes online If you are a bona fide resident of Puerto Rico for the entire tax year, you also come under the same rules. Free taxes online Usually, you can take a credit only for those foreign taxes imposed on income you actually or constructively received while you had resident alien status. Free taxes online For information on alien status, see Publication 519. Free taxes online Nonresident Aliens If you are a nonresident alien, you cannot take the credit in most cases. Free taxes online However, you may be able to take the credit if: You were a bona fide resident of Puerto Rico during your entire tax year, or You pay or accrue tax to a foreign country or U. Free taxes online S. Free taxes online possession on income from foreign sources that is effectively connected with a trade or business in the United States. Free taxes online But if you must pay tax to a foreign country or U. Free taxes online S. Free taxes online possession on income from U. Free taxes online S. Free taxes online sources only because you are a citizen or a resident of that country or U. Free taxes online S. Free taxes online possession, do not use that tax in figuring the amount of your credit. Free taxes online For information on alien status and effectively connected income, see Publication 519. Free taxes online What Foreign Taxes Qualify for the Credit? In most cases, the following four tests must be met for any foreign tax to qualify for the credit. Free taxes online The tax must be imposed on you. Free taxes online You must have paid or accrued the tax. Free taxes online The tax must be the legal and actual foreign tax liability. Free taxes online The tax must be an income tax (or a tax in lieu of an income tax). Free taxes online Certain foreign taxes do not qualify for the credit even if the four tests are met. Free taxes online See Foreign Taxes for Which You Cannot Take a Credit, later. Free taxes online Tax Must Be Imposed on You You can claim a credit only for foreign taxes that are imposed on you by a foreign country or U. Free taxes online S. Free taxes online possession. Free taxes online For example, a tax that is deducted from your wages is considered to be imposed on you. Free taxes online You cannot shift the right to claim the credit by contract or other means. Free taxes online Foreign country. Free taxes online   A foreign country includes any foreign state and its political subdivisions. Free taxes online Income, war profits, and excess profits taxes paid or accrued to a foreign city or province qualify for the foreign tax credit. Free taxes online U. Free taxes online S. Free taxes online possessions. Free taxes online   For foreign tax credit purposes, all qualified taxes paid to U. Free taxes online S. Free taxes online possessions are considered foreign taxes. Free taxes online For this purpose, U. Free taxes online S. Free taxes online possessions include Puerto Rico and American Samoa. Free taxes online   When the term “foreign country” is used in this publication, it includes U. Free taxes online S. Free taxes online possessions unless otherwise stated. Free taxes online You Must Have Paid or Accrued the Tax In most cases, you can claim the credit only if you paid or accrued the foreign tax to a foreign country or U. Free taxes online S. Free taxes online possession. Free taxes online However, the paragraphs that follow describe some instances in which you can claim the credit even if you did not directly pay or accrue the tax yourself. Free taxes online Joint return. Free taxes online   If you file a joint return, you can claim the credit based on the total foreign income taxes paid or accrued by you and your spouse. Free taxes online Combined income. Free taxes online   If foreign tax is imposed on the combined income of two or more persons (for example, spouses), the tax is allocated among, and considered paid by, these persons on a pro rata basis in proportion to each person's portion of the combined income, as determined under foreign law and Regulations section 1. Free taxes online 901-2(f)(3)(iii). Free taxes online Combined income with respect to each foreign tax that is imposed on a combined basis (and combined income subject to tax exemption or preferential tax rates) is computed separately, and the tax on that combined income is allocated separately. Free taxes online   These rules apply to foreign taxes paid or accrued in tax years beginning after February 14, 2012. Free taxes online However, you can choose to apply the new rules to foreign taxes paid or accrued in tax years beginning after December 31, 2010, and before February 15, 2012. Free taxes online For more details, see paragraphs (f) and (h) of Regulations section 1. Free taxes online 901-2. Free taxes online For similar rules applicable to prior tax years, see Regulations section 1. Free taxes online 901-2 (revised as of April 1, 2011). Free taxes online Example. Free taxes online You and your spouse reside in Country X, which imposes income tax on your combined incomes. Free taxes online Both of you use the “u” as your functional currency. Free taxes online Country X apportions tax based on income. Free taxes online You had income of 30,000u and your spouse had income of 20,000u. Free taxes online Your filing status on your U. Free taxes online S. Free taxes online income tax return is married filing separately. Free taxes online You can claim only 60% (30,000u/50,000u) of the foreign taxes imposed on your income on your U. Free taxes online S income tax return. Free taxes online Your spouse can claim only 40% (20,000u/50,000u). Free taxes online Partner or S corporation shareholder. Free taxes online   If you are a member of a partnership, or a shareholder in an S corporation, you can claim the credit based on your proportionate share of the foreign income taxes paid or accrued by the partnership or the S corporation. Free taxes online These amounts will be shown on the Schedule K-1 you receive from the partnership or S corporation. Free taxes online However, if you are a shareholder in an S corporation that in turn owns stock in a foreign corporation, you cannot claim a credit for your share of foreign taxes paid by the foreign corporation. Free taxes online Beneficiary. Free taxes online   If you are a beneficiary of an estate or trust, you may be able to claim the credit based on your proportionate share of foreign income taxes paid or accrued by the estate or trust. Free taxes online This amount will be shown on the Schedule K-1 you receive from the estate or trust. Free taxes online However, you must show that the tax was imposed on income of the estate and not on income received by the decedent. Free taxes online Mutual fund shareholder. Free taxes online   If you are a shareholder of a mutual fund or other regulated investment company (RIC), you may be able to claim the credit based on your share of foreign income taxes paid by the fund if it chooses to pass the credit on to its shareholders. Free taxes online You should receive from the mutual fund or other RIC a Form 1099-DIV, or similar statement, showing your share of the foreign income, and your share of the foreign taxes paid. Free taxes online If you do not receive this information, you will need to contact the fund. Free taxes online Controlled foreign corporation shareholder. Free taxes online   If you are a shareholder of a controlled foreign corporation and choose to be taxed at corporate rates on the amount you must include in gross income from that corporation, you can claim the credit based on your share of foreign taxes paid or accrued by the controlled foreign corporation. Free taxes online If you make this election, you must claim the credit by filing Form 1118, Foreign Tax Credit—Corporations. Free taxes online Controlled foreign corporation. Free taxes online   A controlled foreign corporation is a foreign corporation in which U. Free taxes online S. Free taxes online shareholders own more than 50% of the voting power or value of the stock. Free taxes online You are considered a U. Free taxes online S. Free taxes online shareholder if you own, directly or indirectly, 10% or more of the total voting power of all classes of the foreign corporation's stock. Free taxes online See Internal Revenue Code sections 951(b) and 958(b) for more information. Free taxes online Tax Must Be the Legal and Actual Foreign Tax Liability The amount of foreign tax that qualifies is not necessarily the amount of tax withheld by the foreign country. Free taxes online Only the legal and actual foreign tax liability that you paid or accrued during the year qualifies for the credit. Free taxes online Foreign tax refund. Free taxes online   You cannot take a foreign tax credit for income taxes paid to a foreign country if it is reasonably certain the amount would be refunded, credited, rebated, abated, or forgiven if you made a claim. Free taxes online   For example, the United States has tax treaties with many countries allowing U. Free taxes online S. Free taxes online citizens and residents reductions in the rates of tax of those foreign countries. Free taxes online However, some treaty countries require U. Free taxes online S. Free taxes online citizens and residents to pay the tax figured without regard to the lower treaty rates and then claim a refund for the amount by which the tax actually paid is more than the amount of tax figured using the lower treaty rate. Free taxes online The qualified foreign tax is the amount figured using the lower treaty rate and not the amount actually paid, because the excess tax is refundable. Free taxes online Subsidy received. Free taxes online   Tax payments a foreign country returns to you in the form of a subsidy do not qualify for the foreign tax credit. Free taxes online This rule applies even if the subsidy is given to a person related to you, or persons who participated with you in a transaction or a related transaction. Free taxes online A subsidy can be provided by any means but must be determined, directly or indirectly, in relation to the amount of tax, or to the base used to figure the tax. Free taxes online   The term “subsidy” includes any type of benefit. Free taxes online Some ways of providing a subsidy are refunds, credits, deductions, payments, or discharges of obligations. Free taxes online Shareholder receiving refund for corporate tax in integrated system. Free taxes online   Under some foreign tax laws and treaties, a shareholder is considered to have paid part of the tax that is imposed on the corporation. Free taxes online You may be able to claim a refund of these taxes from the foreign government. Free taxes online You must include the refund (including any amount withheld) in your income in the year received. Free taxes online Any tax withheld from the refund is a qualified foreign tax. Free taxes online Example. Free taxes online You are a shareholder of a French corporation. Free taxes online You receive a $100 refund of the tax paid to France by the corporation on the earnings distributed to you as a dividend. Free taxes online The French government imposes a 15% withholding tax ($15) on the refund you received. Free taxes online You receive a check for $85. Free taxes online You include $100 in your income. Free taxes online The $15 of tax withheld is a qualified foreign tax. Free taxes online Tax Must Be an Income Tax (or Tax in Lieu of Income Tax) In most cases, only income, war profits, and excess profits taxes (income taxes) qualify for the foreign tax credit. Free taxes online Foreign taxes on wages, dividends, interest, and royalties qualify for the credit in most cases. Free taxes online Furthermore, foreign taxes on income can qualify even though they are not imposed under an income tax law if the tax is in lieu of an income, war profits, or excess profits tax. Free taxes online See Taxes in Lieu of Income Taxes , later. Free taxes online Income Tax Simply because the levy is called an income tax by the foreign taxing authority does not make it an income tax for this purpose. Free taxes online A foreign levy is an income tax only if it meets both of the following requirements. Free taxes online It is a tax; that is, you have to pay it and you get no specific economic benefit (discussed below) from paying it. Free taxes online The predominant character of the tax is that of an income tax in the U. Free taxes online S. Free taxes online sense. Free taxes online A foreign levy may meet these requirements even if the foreign tax law differs from U. Free taxes online S. Free taxes online tax law. Free taxes online The foreign law may include in income items that U. Free taxes online S. Free taxes online law does not include, or it may allow certain exclusions or deductions that U. Free taxes online S. Free taxes online law does not allow. Free taxes online Specific economic benefit. Free taxes online   In most cases, you get a specific economic benefit if you receive, or are considered to receive, an economic benefit from the foreign country imposing the levy, and: If there is a generally imposed income tax, the economic benefit is not available on substantially the same terms to all persons subject to the income tax, or If there is no generally imposed income tax, the economic benefit is not available on substantially the same terms to the population of the foreign country in general. Free taxes online   You are considered to receive a specific economic benefit if you have a business transaction with a person who receives a specific economic benefit from the foreign country and, under the terms and conditions of the transaction, you receive directly or indirectly all or part of the benefit. Free taxes online   However, see the exception discussed later under Pension, unemployment, and disability fund payments . Free taxes online Economic benefits. Free taxes online   Economic benefits include the following. Free taxes online Goods. Free taxes online Services. Free taxes online Fees or other payments. Free taxes online Rights to use, acquire, or extract resources, patents, or other property the foreign country owns or controls. Free taxes online Discharges of contractual obligations. Free taxes online   In most cases, the right or privilege merely to engage in business is not an economic benefit. Free taxes online Dual-capacity taxpayers. Free taxes online   If you are subject to a foreign country's levy and you also receive a specific economic benefit from that foreign country, you are a “dual-capacity taxpayer. Free taxes online ” As a dual-capacity taxpayer, you cannot claim a credit for any part of the foreign levy, unless you establish that the amount paid under a distinct element of the foreign levy is a tax, rather than a compulsory payment for a direct or indirect specific economic benefit. Free taxes online    For more information on how to establish amounts paid under separate elements of a levy, write to: Internal Revenue Service International Section Philadelphia, PA 19255-0725 Pension, unemployment, and disability fund payments. Free taxes online   A foreign tax imposed on an individual to pay for retirement, old-age, death, survivor, unemployment, illness, or disability benefits, or for substantially similar purposes, is not payment for a specific economic benefit if the amount of the tax does not depend on the age, life expectancy, or similar characteristics of that individual. Free taxes online    No deduction or credit is allowed, however, for social security taxes paid or accrued to a foreign country with which the United States has a social security agreement. Free taxes online For more information about these agreements, see Publication 54. Free taxes online Soak-up taxes. Free taxes online   A foreign tax is not predominantly an income tax and does not qualify for credit to the extent it is a soak-up tax. Free taxes online A tax is a soak-up tax to the extent that liability for it depends on the availability of a credit for it against income tax imposed by another country. Free taxes online This rule applies only if and to the extent that the foreign tax would not be imposed if the credit were not available. Free taxes online Penalties and interest. Free taxes online   Amounts paid to a foreign government to satisfy a liability for interest, fines, penalties, or any similar obligation are not taxes and do not qualify for the credit. Free taxes online Taxes not based on income. Free taxes online   Foreign taxes based on gross receipts or the number of units produced, rather than on realized net income, do not qualify unless they are imposed in lieu of an income tax, as discussed next. Free taxes online Taxes based on assets, such as property taxes, do not qualify for the credit. Free taxes online Taxes in Lieu of Income Taxes A tax paid or accrued to a foreign country qualifies for the credit if it is imposed in lieu of an income tax otherwise generally imposed. Free taxes online A foreign levy is a tax in lieu of an income tax only if: It is not payment for a specific economic benefit as discussed earlier, and The tax is imposed in place of, and not in addition to, an income tax otherwise generally imposed. Free taxes online A tax in lieu of an income tax does not have to be based on realized net income. Free taxes online A foreign tax imposed on gross income, gross receipts or sales, or the number of units produced or exported can qualify for the credit. Free taxes online In most cases, a soak-up tax (discussed earlier) does not qualify as a tax in lieu of an income tax. Free taxes online However, if the foreign country imposes a soak-up tax in lieu of an income tax, the amount that does not qualify for foreign tax credit is the lesser of the following amounts. Free taxes online The soak-up tax. Free taxes online The foreign tax you paid that is more than the amount you would have paid if you had been subject to the generally imposed income tax. Free taxes online Foreign Taxes for Which You Cannot Take a Credit This part discusses the foreign taxes for which you cannot take a credit. Free taxes online These are: Taxes on excluded income, Taxes for which you can only take an itemized deduction, Taxes on foreign mineral income, Taxes from international boycott operations, A portion of taxes on combined foreign oil and gas income, Taxes of U. Free taxes online S. Free taxes online persons controlling foreign corporations and partnerships who fail to file required information returns, and Taxes related to a foreign tax splitting event. Free taxes online Taxes on Excluded Income You cannot take a credit for foreign taxes paid or accrued on certain income that is excluded from U. Free taxes online S. Free taxes online gross income. Free taxes online Foreign Earned Income and Housing Exclusions You must reduce your foreign taxes available for the credit by the amount of those taxes paid or accrued on income that is excluded from U. Free taxes online S. Free taxes online income under the foreign earned income exclusion or the foreign housing exclusion. Free taxes online See Publication 54 for more information on the foreign earned income and housing exclusions. Free taxes online Wages completely excluded. Free taxes online   If your wages are completely excluded, you cannot take a credit for any of the foreign taxes paid or accrued on these wages. Free taxes online Wages partly excluded. Free taxes online   If only part of your wages is excluded, you cannot take a credit for the foreign income taxes allocable to the excluded part. Free taxes online You find the amount allocable to your excluded wages by multiplying the foreign tax paid or accrued on foreign earned income received or accrued during the tax year by a fraction. Free taxes online   The numerator of the fraction is your foreign earned income and housing amounts excluded under the foreign earned income and housing exclusions for the tax year minus otherwise deductible expenses definitely related and properly apportioned to that income. Free taxes online Deductible expenses do not include the foreign housing deduction. Free taxes online   The denominator is your total foreign earned income received or accrued during the tax year minus all deductible expenses allocable to that income (including the foreign housing deduction). Free taxes online If the foreign law taxes foreign earned income and some other income (for example, earned income from U. Free taxes online S. Free taxes online sources or a type of income not subject to U. Free taxes online S. Free taxes online tax), and the taxes on the other income cannot be segregated, the denominator of the fraction is the total amount of income subject to the foreign tax minus deductible expenses allocable to that income. Free taxes online Example. Free taxes online You are a U. Free taxes online S. Free taxes online citizen and a cash basis taxpayer, employed by Company X and living in Country A. Free taxes online Your records show the following: Foreign earned income received $125,000 Unreimbursed business travel expenses 20,000 Income tax paid to Country A 30,000 Exclusion of foreign earned  income and housing allowance 97,600     Because you can exclude part of your wages, you cannot claim a credit for part of the foreign taxes. Free taxes online To find that part, do the following. Free taxes online First, find the amount of business expenses allocable to excluded wages and therefore not deductible. Free taxes online To do this, multiply the otherwise deductible expenses by a fraction. Free taxes online That fraction is the excluded wages over your foreign earned income. Free taxes online   $20,000 × $97,600 $125,000 = $15,616             Next, find the numerator of the fraction by which you will multiply the foreign taxes paid. Free taxes online To do this, subtract business expenses allocable to excluded wages ($15,616) from excluded wages ($97,600). Free taxes online The result is $81,984. Free taxes online Then, find the denominator of the fraction by subtracting all your deductible expenses from all your foreign earned income ($125,000 − $20,000 = $105,000). Free taxes online Finally, multiply the foreign tax you paid by the resulting fraction. Free taxes online   $30,000 × $81,984  $105,000 = $23,424 The amount of Country A tax you cannot take a credit for is $23,424. Free taxes online Taxes on Income From Puerto Rico Exempt From U. Free taxes online S. Free taxes online Tax If you have income from Puerto Rican sources that is not taxable, you must reduce your foreign taxes paid or accrued by the taxes allocable to the exempt income. Free taxes online For information on figuring the reduction, see Publication 570. Free taxes online Possession Exclusion If you are a bona fide resident of American Samoa and exclude income from sources in American Samoa, you cannot take a credit for the taxes you pay or accrue on the excluded income. Free taxes online For more information on this exclusion, see Publication 570. Free taxes online Extraterritorial Income Exclusion You cannot take a credit for taxes you pay on qualifying foreign trade income excluded on Form 8873, Extraterritorial Income Exclusion. Free taxes online However, see Internal Revenue Code section 943(d) for an exception for certain withholding taxes. Free taxes online Taxes for Which You Can Only Take an Itemized Deduction You cannot claim a foreign tax credit for foreign income taxes paid or accrued under the following circumstances. Free taxes online However, you can claim an itemized deduction for these taxes. Free taxes online See Choosing To Take Credit or Deduction , earlier. Free taxes online Taxes Imposed By Sanctioned Countries (Section 901(j) Income) You cannot claim a foreign tax credit for income taxes paid or accrued to any country if the income giving rise to the tax is for a period (the sanction period) during which: The Secretary of State has designated the country as one that repeatedly provides support for acts of international terrorism, The United States has severed or does not conduct diplomatic relations with the country, or The United States does not recognize the country's government, and that government is not otherwise eligible to purchase defense articles or services under the Arms Export Control Act. Free taxes online The following countries meet this description for 2013. Free taxes online Income taxes paid or accrued to these countries in 2013 do not qualify for the credit. Free taxes online Cuba. Free taxes online Iran. Free taxes online Libya (but see Note later). Free taxes online North Korea. Free taxes online Sudan. Free taxes online Syria. Free taxes online Waiver of denial of the credit. Free taxes online   A waiver can be granted to a sanctioned country if the President of the United States determines that granting the waiver is in the national interest of the United States and will expand trade and investment opportunities for U. Free taxes online S. Free taxes online companies in the sanctioned country. Free taxes online The President must report to Congress his intentions to grant the waiver and his reasons for granting the waiver not less than 30 days before the date on which the waiver is granted. Free taxes online Note. Free taxes online Effective December 10, 2004, the President granted a waiver to Libya. Free taxes online Income taxes arising on or after this date qualify for the credit if they meet the other requirements in this publication. Free taxes online Limit on credit. Free taxes online   In figuring the foreign tax credit limit, discussed later, income from a sanctioned country is a separate category of foreign income unless a Presidential waiver is granted. Free taxes online You must fill out a separate Form 1116 for this income. Free taxes online This will prevent you from claiming a credit for foreign taxes paid or accrued to the sanctioned country. Free taxes online Example. Free taxes online You lived and worked in Iran until August, when you were transferred to Italy. Free taxes online You paid taxes to each country on the income earned in that country. Free taxes online You cannot claim a foreign tax credit for the foreign taxes paid on the income earned in Iran. Free taxes online Because the income earned in Iran is a separate category of foreign income, you must fill out a separate Form 1116 for that income. Free taxes online You cannot take a credit for taxes paid on the income earned in Iran, but that income is taxable by the United States. Free taxes online Figuring the credit when a sanction ends. Free taxes online    Table 1 lists the countries for which sanctions have ended or for which a Presidential waiver has been granted. Free taxes online For any of these countries, you can claim a foreign tax credit for the taxes paid or accrued to that country on the income for the period that begins after the end of the sanction period or the date the Presidential waiver was granted. Free taxes online Example. Free taxes online The sanctions against Country X ended on July 31. Free taxes online On August 19, you receive a distribution from a mutual fund of Country X income. Free taxes online The fund paid Country X income tax for you on the distribution. Free taxes online Because the distribution was made after the sanction ended, you may include the foreign tax paid on the distribution to compute your foreign tax credit. Free taxes online Amounts for the nonsanctioned period. Free taxes online   If a sanction period ends (or a Presidential waiver is granted) during your tax year and you are not able to determine the actual income and taxes for that period, you can allocate amounts to that period based on the number of days in the period that fall in your tax year. Free taxes online Multiply the income or taxes for the year by the following fraction to determine the amounts allocable to that period. Free taxes online   Number of nonsanctioned days in year  Number of days in year Example. Free taxes online You are a calendar year filer and received $20,000 of income from Country X in 2013 on which you paid tax of $4,500. Free taxes online Sanctions against Country X ended on July 11, 2013. Free taxes online You are unable to determine how much of the income or tax is for the nonsanctioned period. Free taxes online Because your tax year starts on January 1, and the Country X sanction ended on July 11, 2013, 173 days of your tax year are in the nonsanctioned period. Free taxes online You would compute the income for the nonsanctioned period as follows. Free taxes online 173 365 × $20,000 = $9,479             You would figure the tax for the nonsanctioned period as follows. Free taxes online 173 365 × $4,500 = $2,133 To figure your foreign tax credit, you would use $9,479 as the income from Country X and $2,133 as the tax. Free taxes online Further information. Free taxes online   The rules for figuring the foreign tax credit after a country's sanction period ends are more fully explained in Revenue Ruling 92-62, Cumulative Bulletin 1992-2, page 193. Free taxes online This Cumulative Bulletin can be found in many libraries and IRS offices. Free taxes online Table 1. Free taxes online Countries Removed From the Sanction List or Granted Presidential Waiver   Sanction Period Country Starting Date Ending Date Iraq February 1, 1991 June 27, 2004 Libya January 1, 1987 December 9, 2004* *Presidential waiver granted for qualified income taxes arising after December 9, 2004. Free taxes online Taxes Imposed on Certain Dividends You cannot claim a foreign tax credit for withholding tax (defined later ) on dividends paid or accrued if either of the following applies to the dividends. Free taxes online The dividends are on stock you held for less than 16 days during the 31-day period that begins 15 days before the ex-dividend date (defined later). Free taxes online The dividends are for a period or periods totaling more than 366 days on preferred stock you held for less than 46 days during the 91-day period that begins 45 days before the ex-dividend date. Free taxes online If the dividend is not for more than 366 days, rule (1) applies to the preferred stock. Free taxes online When figuring how long you held the stock, count the day you sold it, but do not count the day you acquired it or any days on which you were protected from risk of loss. Free taxes online Regardless of how long you held the stock, you cannot claim the credit to the extent you have an obligation under a short sale or otherwise to make payments related to the dividend for positions in substantially similar or related property. Free taxes online Withholding tax. Free taxes online   For this purpose, withholding tax includes any tax determined on a gross basis. Free taxes online It does not include any tax which is in the nature of a prepayment of a tax imposed on a net basis. Free taxes online Ex-dividend date. Free taxes online   The ex-dividend date is the first date following the declaration of a dividend on which the purchaser of a stock is not entitled to receive the next dividend payment. Free taxes online Example 1. Free taxes online You bought common stock from a foreign corporation on November 3. Free taxes online You sold the stock on November 19. Free taxes online You received a dividend on this stock because you owned it on the ex-dividend date of November 5. Free taxes online To claim the credit, you must have held the stock for at least 16 days within the 31-day period that began on October 21 (15 days before the ex-dividend date). Free taxes online Because you held the stock for 16 days, from November 4 until November 19, you are entitled to the credit. Free taxes online Example 2. Free taxes online The facts are the same as in Example 1 except that you sold the stock on November 14. Free taxes online You held the stock for only 11 days. Free taxes online You are not entitled to the credit. Free taxes online Exception. Free taxes online   If you are a securities dealer who actively conducts business in a foreign country, you may be able to claim a foreign tax credit for qualified taxes paid on dividends regardless of how long you held the stock or whether you were obligated to make payments for positions in substantially similar or related property. Free taxes online See section 901(k)(4) of the Internal Revenue Code for more information. Free taxes online Taxes Withheld on Income or Gain (Other Than Dividends) For income or gain (other than dividends) paid or accrued on property, you cannot claim a foreign tax credit for withholding tax (defined later): If you have not held the property for at least 16 days during the 31-day period that begins 15 days before the date on which the right to receive the payment arises, or To the extent you have to make related payments on positions in substantially similar or related property. Free taxes online When figuring how long you held the property, count the day you sold it, but do not count the day you acquired it or any days on which you were protected from risk of loss. Free taxes online Withholding tax. Free taxes online   For this purpose, withholding tax includes any tax determined on a gross basis. Free taxes online It does not include any tax which is in the nature of a prepayment of a tax imposed on a net basis. Free taxes online Exception for dealers. Free taxes online   If you are a dealer in property who actively conducts business in a foreign country, you may be able to claim a foreign tax credit for qualified taxes withheld on income or gain from that property regardless of how long you held it or whether you have to make related payments on positions in substantially similar or related property. Free taxes online See section 901(I)(2) of the Internal Revenue Code for more information. Free taxes online Covered Asset Acquisition ???You cannot take a credit for the disqualified portion of any foreign tax paid or accrued in connection with a covered asset acquisition. Free taxes online A covered asset acquisition includes certain acquisitions that result in a stepped-up basis for U. Free taxes online S. Free taxes online tax purposes but not for foreign tax purposes. Free taxes online For more information, see Internal Revenue Code section 901(m). Free taxes online The IRS intends to issue guidance that will explain this provision in greater detail. Free taxes online Taxes in Connection With the Purchase or Sale of Oil or Gas You cannot claim a foreign tax credit for taxes paid or accrued to a foreign country in connection with the purchase or sale of oil or gas extracted in that country if you do not have an economic interest in the oil or gas, and the purchase price or sales price is different from the fair market value of the oil or gas at the time of purchase or sale. Free taxes online Taxes on Foreign Mineral Income You must reduce any taxes paid or accrued to a foreign country or possession on mineral income from that country or possession if you were allowed a deduction for percentage depletion for any part of the mineral income. Free taxes online For details, see Regulations section 1. Free taxes online 901-3. Free taxes online Taxes From International Boycott Operations If you participate in or cooperate with an international boycott during the tax year, your foreign taxes resulting from boycott activities will reduce the total taxes available for credit. Free taxes online See the instructions for line 12 in the Form 1116 instructions to figure this reduction. Free taxes online In most cases, this rule does not apply to employees with wages who are working and living in boycotting countries, or to retirees with pensions who are living in these countries. Free taxes online List of boycotting countries. Free taxes online   A list of the countries which may require participation in or cooperation with an international boycott is published by the Department of the Treasury. Free taxes online As of November 2013, the following countries are listed. Free taxes online Iraq. Free taxes online Kuwait. Free taxes online Lebanon. Free taxes online Libya. Free taxes online Qatar. Free taxes online Saudi Arabia. Free taxes online Syria. Free taxes online United Arab Emirates. Free taxes online Yemen. Free taxes online    For information concerning changes to the list, write to: Internal Revenue Service International Section Philadelphia, PA 19255-0725 Determinations of whether the boycott rule applies. Free taxes online   You may request a determination from the Internal Revenue Service as to whether a particular operation constitutes participation in or cooperation with an international boycott. Free taxes online The procedures for obtaining a determination from the Service are outlined in Revenue Procedure 77-9 in Cumulative Bulletin 1977-1. Free taxes online Cumulative Bulletins are available in most IRS offices and you are welcome to read them there. Free taxes online Public inspection. Free taxes online   A determination and any related background file is open to public inspection. Free taxes online However, your identity and certain other information will remain confidential. Free taxes online Reporting requirements. Free taxes online   You must file a report with the IRS if you or any of the following persons have operations in or related to a boycotting country or with the government, a company, or a national of a boycotting country. Free taxes online A foreign corporation in which you own 10% or more of the voting power of all voting stock but only if you own the stock of the foreign corporation directly or through foreign entities. Free taxes online A partnership in which you are a partner. Free taxes online A trust you are treated as owning. Free taxes online Form 5713 required. Free taxes online   If you have to file a report, you must use Form 5713, International Boycott Report, and attach all supporting schedules. Free taxes online See the Instructions for Form 5713 for information on when and where to file the form. Free taxes online Penalty for failure to file. Free taxes online   If you willfully fail to make a report, in addition to other penalties, you may be fined $25,000 or imprisoned for no more than one year, or both. Free taxes online Taxes on Combined Foreign Oil and Gas Income You must reduce your foreign taxes by a portion of any foreign taxes imposed on combined foreign oil and gas income. Free taxes online The amount of the reduction is the amount by which your foreign oil and gas taxes exceed the amount of your combined foreign oil and gas income multiplied by a fraction equal to your pre-credit U. Free taxes online S. Free taxes online tax liability (Form 1040, line 44) divided by your worldwide taxable income. Free taxes online You may be entitled to carry over to other years taxes reduced under this rule. Free taxes online See Internal Revenue Code section 907(f). Free taxes online Combined foreign oil and gas income means the sum of foreign oil related income and foreign oil and gas extraction income. Free taxes online Foreign oil and gas taxes are the sum of foreign oil and gas extraction taxes and foreign oil related taxes. Free taxes online Taxes of U. Free taxes online S. Free taxes online Persons Controlling Foreign Corporations and Partnerships If you had control of a foreign corporation or a foreign partnership for the annual accounting period of that corporation or partnership that ended with or within your tax year, you may have to file an annual information return. Free taxes online If you do not file the required information return, you may have to reduce the foreign taxes that may be used for the foreign tax credit. Free taxes online See Penalty for not filing Form 5471 or Form 8865 , later. Free taxes online U. Free taxes online S. Free taxes online persons controlling foreign corporations. Free taxes online   If you are a U. Free taxes online S. Free taxes online citizen or resident who had control of a foreign corporation for an uninterrupted period of at least 30 days during the annual accounting period of that corporation, you may have to file an annual information return on Form 5471, Information Return of U. Free taxes online S. Free taxes online Persons With Respect To Certain Foreign Corporations. Free taxes online Under this rule, you generally had control of a foreign corporation if at any time during your tax year you owned: Stock possessing more than 50% of the total combined voting power of all classes of stock entitled to vote, or More than 50% of the total value of shares of all classes of stock of the foreign corporation. Free taxes online U. Free taxes online S. Free taxes online persons controlling foreign partnerships. Free taxes online   If you are a U. Free taxes online S. Free taxes online citizen or resident who had control of a foreign partnership at any time during the partnership's tax year, you may have to file