I am a US resident, filing singly, working with the form 1040 and schedule D. I am very confused by IRS rules for the foreign tax credit (FTC). I have had my taxes done in recent years by a couple of professional preparers, one an EA and the other a CPA, but I am not sure that they understood all of the rules. (I am trying to work out the carryovers based on what they filed, but it is very confusing.)
I have received dividends from foreign energy companies such as BP.
How should these dividends be handled for purposes of obtaining the FTC?
The instructions for Form 1116 (FTC for Individual, Estate, or Trust ) and the information in Publication 514 (FTC for Individuals) refer to oil and gas in several places.
To begin with, Pub 514 states that
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.
Am I correct that this would not be relevant to receiving dividends from a company like RDS or BP?
It seems instead to apply to someone who is directly trading commodities - purchasing or selling oil or gas - rather than to someone who holds shares in a company that produces oil. Is this right?
Moving along, the instructions for Form 1116 line 12 state
Taxes on combined foreign oil and gas income.
Reduce taxes paid or accrued by a portion of taxes imposed on combined foreign oil and gas income. 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 for the year multiplied by a fraction equal to your pre-credit U.S. tax liability (for example, Form 1040, line 44) divided by your worldwide taxable income. You may be entitled to carry over to other years taxes reduced under this rule. See section 907(f).
Combined foreign oil and gas income is the sum of foreign oil related income and foreign oil and gas extraction income. Foreign oil and gas taxes are the sum of foreign oil and gas extraction taxes and foreign oil related taxes.
Now, this is the really confusing part.
First, would this reduction rule apply to dividends received from a company like Royal Dutch Shell or BP?
I would think that it would, yet neither of the tax preparers who worked on my taxes in past years made any kind of reduction.
Second, if the rule does apply, what exactly is the formula for the reduction? The way it is worded is confusing to me and the IRS instructions do not include any examples.
Can you tell me specifically what the formula would be if, as an example (not the actual numbers - but using large whole numbers for easy calculations), say that
a = taxes withheld at the time dividends were paid by the energy companies totaled $2,000
b = total dividends received from the energy companies is $10,000
c = pre-credit US tax liability (form 1040, line 44) is $15,000
d = worldwide taxable income is $100,000?