If your small business generates income from overseas sources -- by selling products abroad, for example -- or if it has invested in income-producing assets located overseas, it may reduce its U.S. tax burden by claiming the federal income tax credit against taxes paid to foreign governments. A partnership, however, pays no federal income taxes. Instead, its income is attributed to the partners in proportion to their interest in the partnership. This means that individual partners can subtract some of the foreign taxes assessed against the partnership from their individual tax burdens.
Calculate your proportionate share of the partnership's foreign and domestic income using Form 1065 and Schedule K-1, if you are the managing partner (see Resources section). If you are not the managing partner, obtain a completed Form 1065 and a completed Schedule K-1 from him to calculate your share. This share is normally directly proportionate to your interest in the partnership.
Complete Form 1040 except for line 47 (the foreign tax credit) and line 76 (total tax due).
Download Form 1116 from the IRS website (see Resources section).
Determine your taxable foreign-source income by subtracting applicable deductions listed in Part I of Form 1116 from your share of the partnership's foreign-source income.
List foreign taxes paid in Part II of Form 1116 according to your pro-rata partnership share. You must break these down country by country.
Divide your foreign-source income by your modified adjusted gross income as listed in line 41 of Form 1040. List the result in line 18, Part III of Form 1116.
Multiply the figure you listed in line 18 of Form 1116 by your tax due in line 44 of Form 1040, and list the result in line 20, Part III of Form 1118. The result is your maximum foreign tax credit.
Compare your pro-rata share of foreign taxes paid with your maximum foreign tax credit. The smaller of the two is your foreign tax credit. Enter it in line 29, Part IV of Form 1118.
Enter your foreign tax credit in line 47 of Form 1040 and calculate your total tax due on line 76 of Form 1040.
- Schedule K-1
- Form 1116
- Form 1040
- The amount of foreign tax that qualifies for the foreign tax credit is not necessarily the amount withheld by the foreign government -- a bilateral tax treaty between the U.S. and that government might modify that amount for tax purposes.
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