Schedule J (Form 1118) - Adjustments to Separate Limitations Income (Loss)

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Instructions for Schedule J (Form 1118)

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Instructions for Schedule J
(Form 1118)

Department of the Treasury
Internal Revenue Service

(Rev. January 2009)
Section references are to the Internal
Revenue Code unless otherwise noted.

General Instructions
Purpose of Schedule

• Use Part I to show adjustments to

separate limitation income or (losses) in
determining the numerator of the
limitation fraction for each separate
category.
• Use Part II to show the year-end
balances of future separate limitation
income that must be recharacterized as
income in other separate categories (as
the result of current year or prior year
separate limitation losses that were
allocated to reduce income in those other
separate categories).
• Use Part III to show: (a) the balances in
the corporation’s overall foreign loss
accounts at the beginning of the tax year,
(b) any current year adjustments, and (c)
the balances in the overall foreign loss
accounts at the end of the tax year.
• Use Part IV to show: (a) the balances
in the corporation’s overall domestic loss
accounts at the beginning of the tax year,
(b) any current year adjustments, and (c)
the balances in the overall domestic loss
accounts at the end of the tax year.
Important. Complete Schedule J only
once. Include adjustments for each
applicable separate category.

Computer-Generated Schedule
A computer-generated Schedule J can be
filed if it conforms to the IRS version of
the schedule. Expand Schedule J to
properly complete Parts I, II, III, and IV of
the schedule if the corporation has more
than one separate category of “other
income.” Income from each sanctioned
country to which section 901(j) applies
and each item of income resourced under
a tax treaty are treated as a separate
category of “other income.”

Specific Instructions
Part I
Note. See Temporary Regulations
section 1.904(g)-3T for detailed
information on the ordering of
adjustments in Part I.
Line 1. For columns (i), (ii), and (iii),
enter in each applicable column, the
income or (loss) from column 13 of the
corresponding Schedule A for that
separate category. In column (iv), enter
an amount equal to the income or (loss)

from Schedule B, Part II, line 8c, minus
the aggregate income or (loss) entered in
the other columns of this line 1.
Line 2. This allocation grid must be
completed to show the pro rata share of
each separate limitation loss to allocate
among other applicable separate
categories.
To determine each pro rata share:
1. Add all of the separate limitation
loss amounts entered across line 1. Then
add all of the separate limitation income
amounts entered across line 1.
2. If the combined separate limitation
losses for the tax year do not exceed the
combined separate limitation income for
the tax year, the pro rata share of each
separate limitation loss to allocate to each
category with positive income is as
follows:
(Separate limitation income /
Combined separate limitation income
from all categories with positive income) x
Separate limitation loss being allocated
3. If the combined separate limitation
losses for the tax year exceed the
combined separate limitation income for
the tax year, the pro rata share of each
separate limitation loss to allocate to each
category with positive income is as
follows:
(Separate limitation loss being
allocated / Combined separate limitation
losses from all categories with losses) x
Separate limitation income in a given
category
If separate limitation losses can be
allocated, enter the total amounts
allocated in the bold-outlined boxes as
positive numbers. Enter each separate
amount allocated to a given category
across the same line under the
appropriate column heading to which it
was allocated.
Note. The numbers entered across any
given line should “zero out.”
If a separate limitation loss in one
category offsets income in a second
category and the second category has a
separate limitation loss account balance
that has not been recaptured with respect
to the first category, then the two
offsetting separate limitation loss account
balances are netted for purposes of
determining the amount of income in the
second category that is subject to
recharacterization on line 9, Part I, if any,
and for purposes of determining the
year-end balances in both categories
reported in Part II.
The combined separate limitation
losses for the tax year that are more than
Cat. No. 50277F

the combined separate limitation income
for the tax year reduce the U.S. source
income (if any) for the tax year. If the
corporation has no U.S. source income
for the tax year, or if the excess of its
combined separate limitation losses for
the tax year over combined separate
limitation income for the tax year exceeds
its U.S. source income for the tax year,
the excess is treated as a net operating
loss. This loss may be carried over or
back to other tax years according to the
rules of section 172.
Example 1. Corporation X has a
separate limitation loss of $2,000 in its
general category (line 1, column (i)) and
separate limitation income of $4,000 in its
passive category (line 1, column (ii)). In
addition, the corporation has separate
limitation income of $1,000 in its
resourced treaty income category (line 1,
column (iii)).
Since the corporation’s combined
separate limitation losses for the tax year
($2,000) do not exceed its combined
separate limitation income for the tax year
($5,000), the entire $2,000 loss may be
allocated to other separate categories.
Therefore, Corporation X enters a positive
$2,000 in the bold-outlined box on line 2a,
column (i).
To compute the portion of the $2,000
separate limitation loss that is allocable to
passive category income, Corporation X
divides the $4,000 of income by $5,000
(the combined separate limitation income
from all separate categories with positive
income). The result of 80% is multiplied
by the separate limitation loss of $2,000.
Corporation X enters the product of
$1,600 on line 2a, column (ii).
To compute the portion of the $2,000
separate limitation loss that is allocable to
resourced treaty income, Corporation X
divides the $1,000 of separate limitation
income by $5,000. The result of 20% is
multiplied by the separate limitation loss
of $2,000. Corporation X enters the
product of $400 on line 2a, column (iii).
Corporation X enters $0 (negative
$2,000 plus positive $2,000) on line 3,
column (i); $2,400 ($4,000 minus $1,600)
on line 3, column (ii); and $600 ($1,000
minus $400) on line 3, column (iii).
Line 4. In columns (i) through (iii), enter
the overall foreign losses for the tax year
(from line 3) as positive numbers if they
have reduced U.S. source income for the
tax year. In column (iv), enter the total
amount of overall foreign losses that have
reduced U.S. source income for the tax
year as a negative number.

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Instructions for Schedule J (Form 1118)

16:25 - 17-FEB-2009

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

Note. The numbers entered across this
line should “zero out.”
Line 5. In columns (i) through (iii), enter
U.S. source losses allocated to separate
categories with income on line 3 for the
current tax year. In column (iv), enter the
total amount of U.S. losses allocated to
the separate categories as a positive
number. Use the following formula:
U.S. source loss x (Line 3 income in a
given category / Combined line 3 income
of all separate categories with income on
line 3)
U.S. source losses in excess of the
combined line 3 income for a tax year is
treated as a net operating loss that may
be carried back or forward to other tax
years using the rules of section 172.
Note. The numbers entered across this
line should “zero out.”
Line 7. Recapture overall foreign losses
that reduced U.S. source income in prior
tax years (section 904(f)(1)). To do this,
treat a portion of the current year
separate limitation income that is of the
same category as the loss that resulted in
the prior year overall foreign loss as U.S.
source income. Recapture continues until
the applicable overall foreign loss account
balance (Part III) is reduced to zero. Enter
the recapture amount for each category of
separate limitation income in the
appropriate column as a negative
number. Enter the total amount of
recapture for all categories of separate
limitation income as a positive number in
column (iv).
Note. The numbers entered across this
line should “zero out.”
The total amount of current year
separate limitation income subject to
recapture is the smaller of the aggregate
amount of maximum potential recapture
in all overall foreign loss accounts, or
50% of all amounts entered on Part I, line
6, columns (i) through (iii). The maximum
potential recapture amount for the overall
foreign loss account in any given category
is the smaller of the current year separate
limitation income in that category (the
applicable amount entered in Part I, line
6), or the balance in the applicable overall
foreign loss account (the applicable line 1
amount in Part III). If the aggregate
amount of maximum potential recapture
in all overall foreign loss accounts
exceeds 50% of all amounts entered on
Part I, line 6, columns (i) through (iii), then
the amount of current year separate
limitation income in each separate
category subject to recapture is computed
using the following formula:
Total recapture amount x (Maximum
potential recapture amount for the overall
foreign loss account in the separate
category / Aggregate amount of maximum
potential recapture in all overall foreign
loss accounts)
The corporation can make an annual,
revocable election to recapture a greater
portion of the balance in an overall foreign

loss account by attaching a statement to
Form 1118 indicating:
1. The percentage and dollar amount
of the separate limitation income that is
treated as U.S. source income and
2. The percentage and dollar amount
of the balance (both before and after
recapture) in the overall foreign loss
account that is recaptured.
If the corporation disposes of property
that was used predominantly in a foreign
trade or business and that generated
foreign source income in the same
separate category as the applicable
overall foreign loss account, the
corporation generally must recognize gain
on the disposition to the extent of the
balance in the account (after amounts are
recaptured under section 904(f)(1)),
whether or not gain would otherwise be
recognized on the disposition. See
section 904(f)(3) and Regulations section
1.904(f)-2(d). Such gain is treated as
foreign source taxable income in the
same separate category as the applicable
overall foreign loss account and is subject
to recapture to the extent of the
corporation’s foreign source taxable
income in that separate category or, if
less, 100% of the corporation’s foreign
source taxable income.
Note. For dispositions after October 22,
2004, the previous paragraph applies to
certain dispositions of stock in a CFC.
See section 904(f)(3)(D) for details.
Example 2. Corporation Y has
$1,400 of current year separate limitation
income, $1,000 in its general category
(Part I, line 6, column (i)) and $400 in its
passive category (Part I, line 6, column
(ii)). The corporation has overall foreign
loss accounts of $600 in its general
category and $800 in its passive category
(Part III, line 1, columns (i) and (ii)). The
maximum potential recapture for the
overall foreign loss account in the general
category is $600 (the smaller of current
year income of $1,000 in that category or
the overall foreign loss account balance
of $600). The maximum potential
recapture for the overall foreign loss
account in the passive category is $400
(the smaller of current year income of
$400 in that category or the overall
foreign loss account balance of $800).
The aggregate amount of maximum
potential recapture in all overall foreign
loss accounts is therefore $1,000 ($600 +
$400).
The total amount of current year
income subject to recharacterization is
$700 (the smaller of the aggregate
amount of maximum potential recapture,
$1,000, or 50% of total current year
separate limitation income entered on line
6, Part I (50% x $1,400, or $700)). To
compute the amount of current year
separate limitation income in the general
category that is treated as U.S. source
income, Corporation Y multiplies the total
recapture amount of $700 by the
maximum recapture amount for the
general category of $600, divided by the

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aggregate amount of maximum potential
recapture of $1,000. Corporation Y enters
the result of $420 on line 7, column (i). To
compute the amount of current year
separate limitation income in the passive
category that is treated as U.S. source
income, Corporation Y multiplies the total
recapture amount of $700 by the
maximum recapture amount for the
passive category of $400, divided by the
aggregate amount of maximum potential
recapture of $1,000. Corporation Y enters
the result of $280 on line 7, column (ii).
Corporation Y enters the total recapture
amount of $700 as a positive number on
line 7, column (iv). Note that the total
amounts entered across line 7 equal zero.
Line 9. If a separate limitation loss was
allocated in a prior tax year and the
corporation has income during the current
tax year in the separate category from
which the loss was allocated, that current
year income (if it was not previously
recharacterized) must be recharacterized
as income of the separate category(ies)
to which the loss was allocated in the
prior year(s) (section 904(f)(5)).
Note. The amount of current year
income in a category subject to
recharacterization is limited to the
year-end balance in Part II for that
category as reported on the prior tax year
Schedule J, reduced by any netting of
offsetting separate limitation loss
accounts as provided for in the
instructions for Part I, line 2.
If a prior year separate limitation loss
was allocated to more than one separate
category and there is not enough current
year income in the separate category
from which the loss was allocated to
recharacterize all remaining balances,
then the current year income must be
recharacterized as income of the other
separate categories on a pro rata basis in
the following manner:
Current year income in separate
category from which losses were
previously allocated x (Amount remaining
to be recharacterized as income of a
given separate category / Amounts
remaining to be recharacterized as
income of all separate categories)
Any amount that is not recharacterized
during the tax year (i.e, the excess of
separate limitation losses previously
allocated over current year income in that
same separate category) must be entered
into the grid at Part II.
Note. Recharacterization of separate
limitation income does not result in
recharacterizing any tax. The rules of
Regulations section 1.904-6 apply on an
annual basis for allocating taxes to
separate categories before any income is
recharacterized.
If prior year separate limitation losses
can be recaptured, the total amounts
recharacterized should be entered into
the bold-outlined boxes as negative
numbers. Each prior-year separate
limitation loss recaptured should be
entered as a positive number on the

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Instructions for Schedule J (Form 1118)

16:25 - 17-FEB-2009

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

same line under the appropriate column
heading to which income was
recharacterized.
Note. The numbers entered across any
given line should “zero out.”
Example 3. Assume the same facts
as in Example 1 on page 1. Also assume
that, in a subsequent tax year,
Corporation X has $1,500 of income in its
general category (on line 8, column (i), of
its Schedule J).
Since there is not enough general
category income to recapture the entire
$2,000 prior-year balance remaining to be
recaptured, Corporation X will prorate the
$1,500 of general category income in that
subsequent year as follows.
• To compute the portion to be
recharacterized as passive category
income, Corporation X should:
1. Divide the $1,600 remaining to be
recharacterized from general category
income to passive category income by the
$2,000 remaining to be recharacterized
from general category income to all
separate categories.
2. Multiply the result (80%) by the
$1,500 of general category income.
3. Enter $1,200 as a positive number
on line 9a, column (ii).
• To compute the portion to be
recharacterized as resourced treaty
income, Corporation X should:
1. Divide the $400 remaining to be
recharacterized from general category
income to resourced treaty income by
$2,000.
2. Multiply the result (20%) by the
$1,500 of general category income.
3. Enter $300 as a positive number on
line 9a, column (iii).
Corporation X enters the $1,500 of
general category income that was
recharacterized in the bold-outlined box at
line 9a, column (i). Note that the total
amounts entered across line 9a equal
zero.
Finally, Corporation X completes the
Part II recharacterization balances grid by
entering $400 ($1,600 minus $1,200) on
line a, column (ii), and $100 ($400 minus
$300) on line a, column (iii).
Line 10. Recapture overall domestic
losses that reduced separate limitation
income in prior tax years (section
904(g)(1)). To do this, treat a portion of
the current year U.S. source income as
separate limitation income in the same
category(ies) as the separate limitation
income that was reduced by the prior year
overall domestic loss. Recapture

continues until the applicable overall
domestic loss account balance (Part IV) is
reduced to zero. Enter the total overall
domestic loss recapture amount as a
negative number in column (iv). Enter the
amount recharacterized as separate
limitation income in each category, as
appropriate, as positive numbers in
columns (i) through (iii).
Note. The numbers entered across this
line should “zero out.”
The total amount of any current year
U.S. income subject to recapture is the
smaller of the total balance in the
applicable overall domestic loss accounts
(the applicable column(s) in Part IV, line
1) or 50% of the amount entered on Part
I, line 6.
If a prior year overall domestic loss or
losses were allocated to more than one
separate category and there is not
enough income in the current year subject
to recharacterization to recapture all
remaining overall domestic loss account
balances, then the current year U.S.
source income subject to
recharacterization must be
recharacterized as income of the
separate categories on a pro rata basis in
the following manner:
Current year U.S. source income
subject to recharacterization x (Amount
remaining to be recharacterized as
income of a given separate category /
Amounts remaining to be recharacterized
as income of all separate categories)

Part II
If a separate limitation loss was allocated
in a prior tax year and the corporation has
income during the current tax year in the
separate category from which the loss
was allocated, that current year income (if
it was not previously recharacterized)
must be recharacterized as income of the
category to which the loss was allocated
in the prior year(s) (section 904(f)(5)).
To determine the amounts to enter into
the grid:
1. Add the current year separate
limitation loss allocations (adjusted as
required by Regulations section
1.904(b)-1(h)(1) relating to capital gains)
to last year’s year-end balances.
2. Net any offsetting separate
limitation loss accounts as described in
the instructions for Part I, line 2.
3. Subtract the amounts
recharacterized during the current tax
year.

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4. Enter the result on the line (line a,
b, or c) for the separate category from
which losses were previously allocated,
under the appropriate column (column (i),
(ii), or (iii)) to which the losses were
previously allocated.
Example 4. Assume the same facts
as in Example 1 on page 1. Also assume
that Corporation X does not have any
remaining balances from any prior
allocations of losses from its general
category to its passive category or its
resourced treaty income category. The
corporation should enter $1,600 on line a,
column (ii), and $400 on line a, column
(iii).

Part III
Line 1. Enter the ending balances from
last year’s schedule.
Lines 2, 3, and 4. Show any
adjustments made to the overall foreign
loss accounts for each separate category
during the tax year. See Regulations
section 1.904(f)-1(d) for a list of possible
additions to the accounts. See
Regulations section 1.904(f)-1(e) for a list
of possible reductions (including
recapture).
Line 6. Enter the year-end balances of
the overall foreign loss accounts for each
separate category.

Part IV
Line 1. Enter the ending balances from
last year’s schedule.
Lines 2, 3, and 5. Show any
adjustments made to the overall domestic
loss account with respect to each
separate category during the tax year.
See Temporary Regulations section
1.904(g)-1T(d) for a list of possible
additions to the accounts. See Temporary
Regulations section 1.904(g)-1T(e) for a
list of possible reductions (including
recapture).
Note. A U.S. source loss that is carried
back as part of a net operating loss to
offset foreign income in a prior qualified
tax year will result in an increase to the
overall domestic loss account in the year
in which the loss arose, not the earlier
year to which the loss was carried back to
offset the foreign income.
Line 6. Enter the year-end balances of
the overall domestic loss account with
respect to each separate category.