What foreign taxes are NOT included in calculating foreign tax credit on Form 1116?

Foreign taxes that are NOT eligible for the foreign tax credit on Form 1116 include several specific categories as defined by IRS regulations and Form 1116 instructions. These are taxes that either are not legally owed, are offset by other credits, or are imposed under certain conditions that disqualify them from creditability.

Foreign Taxes Not Eligible for Credit

• Taxes you don’t legally owe: If you are entitled to a refund from the foreign country (e.g., due to a tax treaty), only the amount you actually owe is creditable. For example, if Country X withholds $25 but you legally owe only $15 under a treaty, only $15 is eligible for the credit, regardless of whether you file for a refund.
• Taxes offset by foreign tax credits: If foreign taxes are reduced by a tax credit (e.g., a refundable credit that requires offsetting liability first), the reduced amount is not fully creditable. However, if the credit is fully refundable at your option without offsetting liability, the full tax may be creditable.
• Taxes imposed solely because of U.S. tax credit eligibility: Taxes imposed by a foreign country only because you can claim a foreign tax credit against U.S. tax liability are not creditable.
• Taxes paid to sanctioned countries: Taxes paid to countries designated by the Secretary of State as supporting terrorism, or with which the U.S. has no diplomatic relations, are not eligible. See Pub. 514 for the list.
• Dividend withholding taxes with insufficient holding period: If you did not hold the stock for at least 16 days within the 31-day period beginning 15 days before the ex-dividend date, the withholding tax is not creditable. This rule applies with greater strictness for preferred stock dividends.
• Dividend taxes where you must pass through payments: If you receive a dividend subject to foreign withholding tax and are obligated to pay an equal amount to someone else (e.g., in a pass-through arrangement), you cannot claim the credit for that tax.
• Taxes on non-dividend income with insufficient holding period: For income or gain (other than dividends) from property, if you did not hold the property for at least 16 days within the 31-day period beginning 15 days before the payment date, the tax is not creditable.
• Taxes used to subsidize you or related parties: Foreign taxes that directly or indirectly subsidize you, a related person or business, or any party transacting with you are not creditable.
• Taxes on oil/gas transactions without economic interest: If you do not have an economic interest in oil or gas extracted in a foreign country and the purchase/sale price differs from fair market value, those taxes are not creditable.
• Taxes on income excluded via Form 8873: Foreign taxes paid on income for which you claim an exclusion on Form 8873 (Extraterritorial Income Exclusion) are not creditable, except for certain withholding taxes under section 943(d).
• Disqualified portion of taxes from covered asset acquisitions: The disqualified portion of foreign taxes paid in connection with certain acquisitions (e.g., those resulting in stepped-up basis) is not creditable. See section 901(m) and T.D. 9895.
• Taxes disallowed under section 965(g): Foreign taxes disallowed under section 965(g) and Regulations section 1.965-5 are not creditable.
• Interest and penalties: You cannot claim a credit for any interest or penalties you must pay.

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Disclaimer: Always verify details with current Federal or State Department of Revenue Forms and Instructions. For complex situations, consult a CPA or tax attorney.