Foreign Tax Form 1116 questions

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Foreign Tax Form 1116 questions

Postby ShortStop » Thu Jan 27, 2011 11:33 pm

Okay, since this is the first year I'm over the $300 limit, I need to fill out Form 1116 for the foreign tax credit. I have been reading the form instructions (2010) and Publication 514 (2009), and have been playing with TurboTax (the free download, thank you Vanguard), and by now I have figured out almost everything. Almost. (Be advised, when I do get this figured out my taxes will be done with pen and paper as always. I'm just using TT as a learning tool.)

Question 1:
For Part 1, line 1a, TurboTax gives the option of using the 1099-DIV Box 1a (Total Ordinary Dividends) amount or another number of my choosing. I just received a 2010 Foreign Tax Paid Reporting Information form with the amount in Box 2 (Foreign Income) being a little less than the 1099-DIV amount. Which is correct for Form 1116 line 1a? From what I have read, the Box 2 makes more sense. If it is Box 2, do I have to provide supporting proof (e.g. a copy of the form) so that the IRS won't come back later saying "Where did you get this number? You owe us money!"? There is no notice on the Reporting Information form about it "being furnished to the Internal Revenue Service." I would rather pay a couple of bucks more than necessary to keep the IRS off my back.

Question 2:
For Part 1, lines 3a and 3b, I am really having a problem. I have only three items on my 1040 Schedule A - state income taxes, real estate taxes, and gifts to charity. TurboTax wants to put all three of them on line 3a. (Since I won't be filing with TT that's not really a problem, but I want to know WHY?) From what I have read 3a should only contain medical expenses, real estate taxes, new motor vehicle taxes, and possibly general sales taxes. So there is a problem. In my reading I found that gifts to charity usually should not even be considered for Form 1116 and I finally figured out the way the remove them (using the "Forms" version and putting them on line 2b and putting a 0 on line 3a4). The real estate taxes get put on line 3a2. That is fine. But TT still wants to put my state income taxes on line 3a5a. Is TT correct? Also, since my state does not exempt foreign income from taxes should the amount be somehow prorated? For example let's say I had $100,000 in income in 2010 of which $10,000 was foreign dividends. My state income tax deduction was $5000. Does that make the prorated amount for Form 1116 $500 or something else? And on which line does it go? And do I need to provide a written explanation? Oh, I'm so confused.

No matter which way things go it's not going to make much difference dollar-wise. I just want to get it right. If someone has the answers to these questions or can point me in the right direction I would be grateful.
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Postby kaneohe » Fri Jan 28, 2011 1:25 am

I don't know anything about TT..........just the other stuff you're using....Pub 514 and F1116 instructions.

Q1. You should use the Foreign Income number. Some funds make it convenient as an item on the 1099DIV. Some provide it indirectly in supplemental info....perhaps as a % of Box 1 on the 1099DIV. Sounds like they're making it easy for you. If you have a pure foreign fund, total dividends and foreign income will probably be close as yours sounds to be.
If it's a global fund w/ US component, there might be a significant difference. I don't think you need to furnish any info to IRS. They get your 1099DIV info and perhaps the fund provides other info.

Q2. F1116 instructions tell you about the deductions for lines 3a and 3b.
3a contains medical, RE taxes and new car taxes. 3b are other deductions not specifically related to the foreign income.....that would include charitable contributions and others not included in 3a....I would think state income taxes also tho strange why it wouldn't be in 3a.......answer comes out the same either way.

Just fyi........don't be surprised (but double check anyway) if the FTC comes out less than the foreign tax paid.........e.g. if your foreign tax had been 300, you would be allowed to use the simple method and claim 300 as the FTC. Yet if your foreign tax was 1 dollar more at 301, it is possible that your FTC might be less than that...say e.g. 200 which may at first seem unfair. It might come out that way if your US "tax rate" is lower than the foreign tax rate or it could be that you are allowed the full amount if the US tax rate is higher.

If your foreign tax is just a bit over 300, I wouldn't think it would be worth IRS time to hassle you so I wouldn't be too nervous.....just do your best to follow the instructions. Oh, if your tax credited is limited and you can't use all of it this yr, you are allowed to carry the unused part back 1 yr and forward 10 yrs so you don't necessarily lose it........but you need to keep track of it.
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Postby ShortStop » Fri Jan 28, 2011 9:28 pm

kaneohe wrote:Q1. You should use the Foreign Income number.

Thanks. That's what I'll do.
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Postby HueyLD » Fri Jan 28, 2011 10:26 pm

Re: state income taxes paid

Per IRS Pub 514:
State income taxes. State income taxes (and certain taxes measured by taxable income) are definitely related and allocable to the gross income on which the taxes are imposed. If state income tax is imposed in part on foreign source income, the part of your state tax imposed on the foreign source income is definitely related and allocable to foreign source income.

Foreign income not exempt from state tax. If the state does not specifically exempt foreign income from tax, the following rules apply.
If the total income taxed by the state is greater than the amount of U.S. source income for federal tax purposes, then the state tax is allocable to both U.S. source and foreign source income.

If the total income taxed by the state is less than or equal to the U.S. source income for federal tax purposes, none of the state tax is allocable to foreign source income.

Foreign income exempt from state tax. If state law specifically exempts foreign income from tax, the state taxes are allocable to the U.S. source income.

Example. Your total income for federal tax purposes, before deducting state tax, is $100,000. Of this amount, $25,000 is foreign source income and $75,000 is U.S. source income. Your total income for state tax purposes is $90,000, on which you pay state income tax of $6,000. The state does not specifically exempt foreign source income from tax. The total state income of $90,000 is greater than the U.S. source income for federal tax purposes. Therefore, the $6,000 is definitely related and allocable to both U.S. and foreign source income.

Assuming that $15,000 ($90,000 − $75,000) is the foreign source income taxed by the state, $1,000 of state income tax is apportioned to foreign source income, figured as follows:
$15,000 / $90,000 × $6,000 = $1,000


Since your state does not exempt foreign source income from taxation, a portion of your state tax liability may be definitely related to your foreign source income. You need to perform calculations per the instructions above and put the resulting amount on line 2 of Form 1116.
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Postby ShortStop » Fri Jan 28, 2011 11:15 pm

HueyLD wrote:Re: state income taxes paid

Since your state does not exempt foreign source income from taxation, a portion of your state tax liability may be definitely related to your foreign source income. You need to perform calculations per the instructions above and put the resulting amount on line 2 of Form 1116.


Thank you. I hadn't even been looking at line 2 because TurboTax was insistent on putting it on line 3. Once you mentioned it, I dug down into the TT help section and found exactly what you said. It's my own fault. I should have read the entire thing instead of skimming. I appreciate your assistance.

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Re: Foreign Tax Form 1116 questions

Postby grabiner » Fri Jan 28, 2011 11:22 pm

ShortStop wrote:For Part 1, line 1a, TurboTax gives the option of using the 1099-DIV Box 1a (Total Ordinary Dividends) amount or another number of my choosing. I just received a 2010 Foreign Tax Paid Reporting Information form with the amount in Box 2 (Foreign Income) being a little less than the 1099-DIV amount. Which is correct for Form 1116 line 1a?


Use the foreign income amount. Your fund may have some US income in its dividends, such as from Treasury bills that it holds for liquidity, US stocks that are somehow in the fund, or short-term gains that have been distributed along with the dividends

From what I have read, the Box 2 makes more sense. If it is Box 2, do I have to provide supporting proof (e.g. a copy of the form) so that the IRS won't come back later saying "Where did you get this number? You owe us money!"?


Hold onto the form in case you are audited. However, using the Box 2 number rather than the Box 1 number results in a lower tax credit, so the IRS is unlikely to complain.

For Part 1, lines 3a and 3b, I am really having a problem. I have only three items on my 1040 Schedule A - state income taxes, real estate taxes, and gifts to charity. TurboTax wants to put all three of them on line 3a. (Since I won't be filing with TT that's not really a problem, but I want to know WHY?) From what I have read 3a should only contain medical expenses, real estate taxes, new motor vehicle taxes, and possibly general sales taxes.


TurboTax gets this wrong; following the Form 1116 instructions is correct. (I think the logic is that gifts to charity must be made in the US, and thus are connected with your US income.)

But TT still wants to put my state income taxes on line 3a5a. Is TT correct? Also, since my state does not exempt foreign income from taxes should the amount be somehow prorated?


It should be, but this is a calculation which is impossible for tax software to do correctly, because the number is not yet known, and not all the data that is available has been entered. Prorating the state taxes according to your federal income is a good estimate. Only after you fill out your state tax form for 2010 will you know how much of your state income taxes relate to your foreign income. And if you paid 2009 state tax in April 2010, that state tax is not related to your 2010 foreign income at all, but it could be related to your 2009 foreign income.

(My own situation for this form will be even more complicated, because I moved mid-year. None of the 2010 tax I paid to Maryland is related to foreign income, because all my foreign income was earned in December after I moved to New Jersey. Meanwhile, a much larger share of the 2010 tax paid to New Jersey is related to foreign income, since I earned only a small part of my salary but all my foreign income in New Jersey.)

It is likely that any mistakes you make on the form will not matter. I discovered these errors last year, after comparing the 2008 form from TurboTax with the 2009 form from TaxAct (TaxAct got everything except state tax right), but either way, the maximum credit allowed was double the foreign tax I paid.
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Re: Foreign Tax Form 1116 questions

Postby ShortStop » Fri Jan 28, 2011 11:44 pm

grabiner wrote:Only after you fill out your state tax form for 2010 will you know how much of your state income taxes relate to your foreign income. And if you paid 2009 state tax in April 2010, that state tax is not related to your 2010 foreign income at all, but it could be related to your 2009 foreign income.

I thought I had this figured out, but now I'm confused again. Are you saying that the state income tax deduction on Schedule A (before prorating) is not the number I should using? Because if so, why does TurboTax want to willy-nilly put the number on Form 1116? Is it the deduction minus the April 2009 payment? And what if I'll be getting a refund this year? Is it the deduction minus the payment minus the refund? Could they make this any more confusing?????
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Re: Foreign Tax Form 1116 questions

Postby grabiner » Sat Jan 29, 2011 12:05 am

ShortStop wrote:
grabiner wrote:Only after you fill out your state tax form for 2010 will you know how much of your state income taxes relate to your foreign income. And if you paid 2009 state tax in April 2010, that state tax is not related to your 2010 foreign income at all, but it could be related to your 2009 foreign income.

I thought I had this figured out, but now I'm confused again. Are you saying that the state income tax deduction on Schedule A (before prorating) is not the number I should using? Because if so, why does TurboTax want to willy-nilly put the number on Form 1116? Is it the deduction minus the April 2009 payment? And what if I'll be getting a refund this year? Is it the deduction minus the payment minus the refund? Could they make this any more confusing?????


The correct amount to deduct depends on how much of the state tax was based on foreign income. The payment you made in April 2010 is not related to any income you earned in 2010; it is related to income you earned in 2009. However, Publication 514 is not helpful here about which year you should adjust for, and it doesn't say what to do about refunds of state taxes; I would check with a tax advisor if the numbers actually matter.

What TurboTax is doing is definitely wrong, as it violates the instructions in Publication 514. If you have $75,000 of US source income and $25,000 of foreign source income on your US tax return, and $90,000 of total income on your state tax return, then Publication 514 says that the state tax is based on $75,000 of US source income and $15,000 of foreign source income, regardless of the reason for the discrepancy. Turbo Tax would deduct 1/4, not 1/6, of the tax.

It would make more sense to determine how much US and foreign source income is taxed by the state, but the IRS says not to do that. For example, if the reason that $10,000 of your income was not taxed by your state is that the income was from Treasury bonds, then the state is taxing $65,000 of US income and $25,000 of foreign income.

And given that you are told not to follow common sense there, you might reasonably do the same for the year of the taxes, and apportion your tax payments in 2010 according to your 2010 state income taxes, even if some of them were payments made for other years.
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Re: Foreign Tax Form 1116 questions

Postby ShortStop » Sat Jan 29, 2011 12:40 am

grabiner wrote:And given that you are told not to follow common sense there, you might reasonably do the same for the year of the taxes, and apportion your tax payments in 2010 according to your 2010 state income taxes, even if some of them were payments made for other years.

Okay, given all that, it looks like I'll be using the Schedule A number and ignoring everything else. It won't make much of a difference this year and in the future it will probably all even out. Thank you for the explanation.

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Postby House Blend » Sat Feb 05, 2011 6:39 pm

I'm slogging my way through Form 1116 :evil: and encountering similar questions.

My only foreign taxes involve dividends distributed by a Vanguard mutual fund. I also qualify for the "adjustment exception", meaning that I don't have to fuss with the special treatment of qualified dividends.

I also have a small amount of short term capital gains, plus a large amount of long term capital losses (including carryovers), all involving Vanguard mutual funds. Some of these gains and losses involve international mutual funds. Line 13 of 1040 will show a capital loss of $3000.

My guess is that all of these gains and losses are considered to be US-source income, not foreign source. Correct? Pub. 514 and the instructions for Form 1116 seem vague on this point (and a lot of other points :evil:). The one sentence I found that seemed to be on-point is this (from p. 3 of the F1116 instructions):

Foreign source income generally does not include gain realized on the sale or exchange of personal property by a U.S. resident as defined in section 865(g).

If that's the case, then it looks like I can ignore all of the complexity on F1116 related to gains and losses (including Worksheets A and B). So it seems the only way Sched D has any effect on my F1116 is through the fact that my total income (Line 3e) is $3000 less than it otherwise would be.

Hoping that some of the experienced F1116 filers can confirm this.

Also, I find grabiner's interpretation of the treatment of charitable contributions a bit puzzling. One could argue that having foreign income makes it feasible to make contributions, so why shouldn't this deduction be prorated across US and foreign income? In any case, it seems to me be safer to add this on line 3b, especially since it doesn't affect the bottom line on my tax credit. Like grabiner, I seem to have about a factor of 2 gap between my foreign tax paid and the maximum I am allowed to claim.
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Postby grabiner » Sat Feb 05, 2011 8:44 pm

House Blend wrote:I'm slogging my way through Form 1116 :evil: and encountering similar questions.

My only foreign taxes involve dividends distributed by a Vanguard mutual fund. I also qualify for the "adjustment exception", meaning that I don't have to fuss with the special treatment of qualified dividends.

I also have a small amount of short term capital gains, plus a large amount of long term capital losses (including carryovers), all involving Vanguard mutual funds. Some of these gains and losses involve international mutual funds. Line 13 of 1040 will show a capital loss of $3000.

My guess is that all of these gains and losses are considered to be US-source income, not foreign source. Correct? Pub. 514 and the instructions for Form 1116 seem vague on this point (and a lot of other points :evil:).


That's how I read it as well. It certainly fits the spirit of the law; you sold your ETF on a US stock exchange, or sold your mutual fund with a US broker, and no foreign tax was charged on the capital gain.

This also matches the way state taxes are handled. I live in New Jersey, and hold a Vanguard ETF which is registered in Pennsylvania and was sold on the Pacific Stock Exchange (in California). When I sell it, I do not pay taxes to either Pennsylvania or California, and if I do have to file Pennsylvania or California taxes for other reasons, I still treat the ETF sale as New Jersey source income.
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Postby Duckie » Sat Feb 05, 2011 10:07 pm

House Blend wrote:I find grabiner's interpretation of the treatment of charitable contributions a bit puzzling. One could argue that having foreign income makes it feasible to make contributions, so why shouldn't this deduction be prorated across US and foreign income? In any case, it seems to me be safer to add this on line 3b, especially since it doesn't affect the bottom line on my tax credit.


The help section of TurboTax for Form 1116 says this about line 3a (which concerns itemized deductions, not 3b):

"Gifts to Charity: The Internal Revenue Service issued guidance allowing U.S. taxpayers to allocate and apportion all of their deductible charitable contributions to U.S. source income for purposes of calculating the foreign tax credit. Under new proposed (REG-208246-90) and temporary and final rules (T.D. 9143), taxpayers would be able to allocate the deductions for those contributions to U.S. source income regardless of whether the contributions will be put to use abroad, as long as they are deductible under the Internal Revenue Code. The temporary and final regulations are effective for charitable contributions made on or after July 28, 2004 and taxpayers may elect to apply the regulations to all charitable contributions made during a taxable year ending on or after that date."

Since it then goes on to explain how to remove the charitable contributions from the form, I believe that they are not supposed to be counted. For some people it won't make a difference. For others it will. (In my case it raises my credit.)
Last edited by Duckie on Fri Feb 21, 2014 5:01 pm, edited 1 time in total.
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Postby House Blend » Sun Feb 06, 2011 6:16 pm

Duckie and grabiner--thanks for the helpful replies.

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