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foreign taxes paid. practical questions about tradeoffs of credit vs deduction

Forum|Forum|1 year ago
October 12, 2024
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Im an everyday US citizen who has a few mutual funds and etfs in a garden variety retirement plan with the popular big box brokers. Im flabbergasted how much effort it is to deal with a few hundred dollars of foreign taxes paid that are reported on my 1099s. it is taking me hours to research how to answer all the Q's that TT is asking me about this.

Practical Question:

taking a credit seems to be better than a deduction...but I notice that TT is telling me im only allowed to take a credit for about 1/3 of the foreign tax paid . this seems to happen every year and I now have accumulated (over 7 years) about 6x more than what im allowed to take as credit in a given year

-if i take a deduction rather than a credit, will that allow me to use up more of the accumulated amt?

-after 10 years, do i start losing some of the accumulated amt?

-what if anything can i do to be able to use more in a given year?

thanks!

Credit

Best answer by pk12_2

@tuxedorose , you appear to have two posts around the same subject. My comments on the situation is as follows :

(a) Generally Foreign Tax Credit ( FTC ) is more efficient in reducing Federal tax liability ( exact facts and circumstances will dictate actual benefit )

(b) Deduction is limited by SALT -- Itemized deduction under State And Local Taxes

(c) Safe harbor amount ( US300 per filer i.e. US$600 for a joint return ) often is more efficient then using form 1116.

(d) Form 1116 while recognizing the foreign taxes paid ( dollar for dollar ) , limits the allowable FTC to lesser of actual amount paid and US tax on the same doubly taxed income. Note that what it is trying to do is to reduce double taxation by giving you zero US tax on the doubly taxed income. A corollary / side-effect of this is often while your accumulated FTC plus current FTC may get higher and higher, your allowable FTC is limited to US tax on the foreign income. It is an asymptotic situation.

(e) A great reading material on un-used FTC or unused deduction is below, especially 1.904.2.(c).3

--> 26 CFR § 1.904-2 - Carryback and carryover of unused foreign tax. | Electronic Code of Federal Regulations (e-CFR) | US Law | LII / Legal Information Institute

Note that this FTC/ Deduction is ONLY available if , and only if , US and that foreign country has a tax treaty in effect and also the double taxation clause in effect.

Is there more i can do for you ?

A

Anonymous_

Employee

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P

pk12_2Answer

Employee

@tuxedorose , you appear to have two posts around the same subject. My comments on the situation is as follows :

(a) Generally Foreign Tax Credit ( FTC ) is more efficient in reducing Federal tax liability ( exact facts and circumstances will dictate actual benefit )

(b) Deduction is limited by SALT -- Itemized deduction under State And Local Taxes

(c) Safe harbor amount ( US300 per filer i.e. US$600 for a joint return ) often is more efficient then using form 1116.

(d) Form 1116 while recognizing the foreign taxes paid ( dollar for dollar ) , limits the allowable FTC to lesser of actual amount paid and US tax on the same doubly taxed income. Note that what it is trying to do is to reduce double taxation by giving you zero US tax on the doubly taxed income. A corollary / side-effect of this is often while your accumulated FTC plus current FTC may get higher and higher, your allowable FTC is limited to US tax on the foreign income. It is an asymptotic situation.

(e) A great reading material on un-used FTC or unused deduction is below, especially 1.904.2.(c).3

--> 26 CFR § 1.904-2 - Carryback and carryover of unused foreign tax. | Electronic Code of Federal Regulations (e-CFR) | US Law | LII / Legal Information Institute

Note that this FTC/ Deduction is ONLY available if , and only if , US and that foreign country has a tax treaty in effect and also the double taxation clause in effect.

Is there more i can do for you ?

tuxedoroseAuthor

@pk12_2 thanks for the excellent explanation! that is very helpful

a couple of followups to clarify my remaining confusion..

1. you mention safeharbor ($300 credit for single filer) if often more efficient than dreaded form 1116

do you mean easier ? for example if I have $800 of foreign tax this year and i take safe harbor. does that mean i forfeit any carry forward of the remaining $500 but at least i don't have to deal with all the byzentine calculations?

2. regarding the accumulated carry fwd. will it eventually 'expire/drop off the 10 year look back' ? is it one of those situations where, in theory i can use it in the future, but the rules are such that, from a practical perspective, I will never get to use.

i will read the article you linked to as well. thx!

P

pk12_2

Employee

@tuxedorose

Response to Q-1 --- in order to be able to use the safe harbor ( and keep 1116 out ) you would have to claim/ recognize ONLY the safe harbor amount. While you must recognize any and all foreign income, there is no such requirement for the foreign taxes paid. The form 1116 is not only complicated but its limitations often will result in less FTC for the year. My personal view is that because this area of statute is driven by treaty requirement of "ameliorating" the effects of double taxation it advertises " we recognize dollar for dollar " foreign taxes paid, the actual effect on the taxpayer is far less. So I always suggest ( especially when FT is not too far above the safe harbor ), try it both ways and see which is more beneficial to you.

Response to Q-2 ---- You are correct in your understanding.

Is there more I can do for you ?