Never-Ending Foreign Tax Credit Problem

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restingonmylaurels
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Never-Ending Foreign Tax Credit Problem

Post by restingonmylaurels » Wed Feb 15, 2017 8:36 am

I imagine any VG investor with some foreign equity exposure may be experiencing the same problem I am. The issue is that VG foreign stock funds pay foreign tax. To avoid double taxation on that foreign income, the IRS allows for a foreign tax credit for US taxpayers. The allowable foreign tax credit is only for the percentage of foreign income to total worldwide income. For example, if I have foreign income from my VG fund of $1000 and $10,000 in total income from my VG funds (the other $9000 from the US), that means only 10% (1000/10,000)of the foreign tax credit can be used against US taxes. The unused foreign tax credit can be carried forward up to 10 years (or back one).

The issue that I am seeing is that, because my foreign investment income in relation to my US investment income is never very high, every year I am having to carryforward part of the foreign tax credit. The carryforward is getting larger and larger and I cannot foresee a case where my foreign income would be high enough to ever use it. This essentially means I am being double taxed (in the US and in the foreign country) on parts of my VG fund income.

Has anyone determined a way to get out of this seeming death spiral, so that they can fully utilize all of the foreign tax credit carryforward before it expires?

kaneohe
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Re: Never-Ending Foreign Tax Credit Problem

Post by kaneohe » Wed Feb 15, 2017 8:56 am

restingonmylaurels wrote:................................ The allowable foreign tax credit is only for the percentage of foreign income to total worldwide income. For example, if I have foreign income from my VG fund of $1000 and $10,000 in total income from my VG funds (the other $9000 from the US), that means only 10% (1000/10,000)of the foreign tax credit can be used against US taxes. The unused foreign tax credit can be carried forward up to 10 years (or back one).

..............................................................
I believe there may be a misunderstanding in how the FTC works. You take the ratio of foreign income/total income and multiply by your US tax.
You then compare that against the foreign tax paid and take the lower of the two for FTC. Your FTC may indeed be lower than the foreign tax paid but it won't be ratio won't be 10% unless you have a very low US tax.......like low income or lots of QDIV/LTCG.

If you are retired w/ low income, the issue may self-correct when RMDs kick in and your income is higher.
Last edited by kaneohe on Wed Feb 15, 2017 8:59 am, edited 1 time in total.

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Re: Never-Ending Foreign Tax Credit Problem

Post by jebmke » Wed Feb 15, 2017 8:58 am

restingonmylaurels wrote: The allowable foreign tax credit is only for the percentage of foreign income to total worldwide income. For example, if I have foreign income from my VG fund of $1000 and $10,000 in total income from my VG funds (the other $9000 from the US), that means only 10% (1000/10,000)of the foreign tax credit can be used against US taxes. The
I don't think your understanding is correct. It has been a while since I worked through the math on 1116 but my recollection is that you can apply the credit against the proportion of your tax that is attributable to your foreign income. Ignoring adjustments for a moment, that means that if your pre-credit tax liability is $1,000 and your foreign income is 10% of your income, then the tax liability associated with the foreign income is $100. You can apply the foreign tax against the full $100.
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livesoft
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Re: Never-Ending Foreign Tax Credit Problem

Post by livesoft » Wed Feb 15, 2017 9:04 am

I agree with the others.

I think one should find an example of how to fill out the Form 1116 and follow the example.

Now it is true that if one has more than $20,000 in foreign qualified dividend income, then it gets trickier. Your post suggests that this is not the case.

If I google "form 1116 example", then I see many examples to follow.
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Re: Never-Ending Foreign Tax Credit Problem

Post by jebmke » Wed Feb 15, 2017 9:14 am

livesoft wrote:Now it is true that if one has more than $20,000 in foreign qualified dividend income, then it gets trickier.
Trickier but not impossible. If one carefully follows the instructions for F1116, one can get to the right answer. It might be a little tedious but if you start at the end of February after all the 1099s are in, you should be able to get an answer by October 15. :beer

F1116 is one of those pesky multi-purpose forms. The key for me is to read the instructions and cross out all the sections that don't apply to me. Remarkably, that leaves a fairly short document to follow.
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Re: Never-Ending Foreign Tax Credit Problem

Post by livesoft » Wed Feb 15, 2017 9:26 am

jebmke wrote:F1116 is one of those pesky multi-purpose forms. The key for me is to read the instructions and cross out all the sections that don't apply to me. Remarkably, that leaves a fairly short document to follow.
I've seen that advice before:
viewtopic.php?p=2843110#p2843110
House Blend wrote:To resolve that, you need to sit down with a pot of coffee, a bottle of Tylenol, and the instructions for Form 1116. Best to use a hard copy so that you can cross out the large swaths of it that don't apply to you.
https://www.irs.gov/pub/irs-pdf/i1116.pdf
and
viewtopic.php?p=2340268#p2340268
jebmke wrote:1116 appears complicated because it covers a range of activities. For most passive investors (especially if only in RICs) it is quite simple actually. The key for forms like this is to read through the IRS instructions and cross out all the sections that don't apply. Usually what is left isn't that onerous.
and
viewtopic.php?p=1938734#p1938734
livesoft wrote:Y[...]
But it doesn't hurt to read the Form 1116 instructions. Use a highlighter and cross off all the fluff that does not apply to you. grabiner has some comments on this, too. search the forum for "grabiner 1116" or something like that (no quotes).
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Re: Never-Ending Foreign Tax Credit Problem

Post by jebmke » Wed Feb 15, 2017 9:39 am

The generalized version of this is
livesoft wrote:But it doesn't hurt to read ..... the instructions
When you discover that you are riding a dead horse, the best strategy is to dismount.

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House Blend
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Re: Never-Ending Foreign Tax Credit Problem

Post by House Blend » Wed Feb 15, 2017 9:57 am

jebmke wrote:The generalized version of this is
livesoft wrote:But it doesn't hurt to read ..... the instructions
IMO it does hurt, in a way somewhat proportional to the number of paragraphs in the instruction booklet that apply to you.

Back on topic, another resource that the OP may find useful is Publication 514.

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Re: Never-Ending Foreign Tax Credit Problem

Post by livesoft » Wed Feb 15, 2017 9:58 am

I wonder if the OP will now have to file amended tax returns. :twisted:
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Re: Never-Ending Foreign Tax Credit Problem

Post by BrandonBogle » Wed Feb 15, 2017 10:12 am

livesoft wrote:Now it is true that if one has more than $20,000 in foreign qualified dividend income, then it gets trickier. Your post suggests that this is not the case.
I just want to call out this part (bolding mine) as I misread it the first time and pulled out my 2016 filing to check. I misread it as holding USD$20k of foreign investments (like Vanguard's Intl Funds), not what livesoft actually of it having actual dividends over USD$20k from intl sources. Turns out I've never filed Form 1116 since my FTC has always been under the "simple reporting" limit. Whew.

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House Blend
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Re: Never-Ending Foreign Tax Credit Problem

Post by House Blend » Wed Feb 15, 2017 11:11 am

BrandonBogle wrote:
livesoft wrote:Now it is true that if one has more than $20,000 in foreign qualified dividend income, then it gets trickier. Your post suggests that this is not the case.
I just want to call out this part (bolding mine) as I misread it the first time and pulled out my 2016 filing to check. I misread it as holding USD$20k of foreign investments (like Vanguard's Intl Funds), not what livesoft actually of it having actual dividends over USD$20k from intl sources. Turns out I've never filed Form 1116 since my FTC has always been under the "simple reporting" limit. Whew.
It's a two part deal: $20K in foreign qualified dividends, *OR* being in the 33% or higher tax bracket. (And being above the $300/$600 foreign tax paid level.) Either one forces you to adjust for the lower tax rates on QDI.

If all of your foreign income was from VG Total International, I think you'd need to have something like to $900K invested in order to have $20K in foreign QDI.

It's one of those horrible problems you hope never to have to deal with, like having too much money.

One other general tip for lurkers: much ink is spilled in the instructions regarding the treatment of foreign capital gains. Things become much simpler when you realize that capital gains realized by a sale of mutual fund shares by a US resident, even when the underlying investment is a foreign stock, do not count as foreign capital gains.

From Pub. 514:
In most cases, if personal property is sold by a U.S. resident, the gain or loss from the sale is treated as U.S. source. If personal property is sold by a nonresident, the gain or loss is treated as foreign source.

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restingonmylaurels
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Re: Never-Ending Foreign Tax Credit Problem

Post by restingonmylaurels » Wed Feb 15, 2017 11:14 am

For those who believe I do not understand the form 1116 (I hate to do this on a general posting), I will explain the form below. I may have wrote too quickly on my way out the door earlier. But what I am really looking for is someone who has been able to get out of the situation of ever-increasing foreign tax credit carryforwards. Please comment on that aspect only.

Form 1116, who first page in essence tries to identify your foreign income and foreign tax paid, then proceeds in the second page to determine how much foreign tax credit you have available, which includes any carryforwards, on Line 14. From this the remainder of the second page is going to limit the application of that foreign tax credit by comparing your non-US income to your global income (US + non-US). Line 19 is a percentage of your foreign income over your adjusted gross income from your 1040 line less your deductions (or your taxable income plus your exemptions, same result). This gives you the percent of your foreign to your global income. Your tax calculated on your return is then multiplied by that percentage from Line 19 to get Line 21. This basically is the amount of the US tax liability that is attributable to foreign income.

You can then take the lower of the foreign tax credit available from line 14 or the US tax attributable to your foreign income on Line 21. It is that simple.

The problem comes when Line 14 is year after year larger than Line 21. That creates additional FTC carryforward, which has a limited lifetime of 10 years. Therein lies my question, has anyone ever determined a way, with a tax advisor or on their own, to use that carryforward despite their foreign to US income ratios being too low?

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HueyLD
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Re: Never-Ending Foreign Tax Credit Problem

Post by HueyLD » Wed Feb 15, 2017 11:25 am

Which Vanguard foreign funds do you own?

Do you own country specific foreign funds or ETFs in high tax countries?

livesoft
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Re: Never-Ending Foreign Tax Credit Problem

Post by livesoft » Wed Feb 15, 2017 11:39 am

restingonmylaurels wrote:The problem comes when Line 14 is year after year larger than Line 21. That creates additional FTC carryforward, which has a limited lifetime of 10 years. Therein lies my question, has anyone ever determined a way, with a tax advisor or on their own, to use that carryforward despite their foreign to US income ratios being too low?
I have not. I will guess that at some time in the past, you paid a lot of foreign taxes and not from your mutual fund or ETF investments.

Or perhaps you are not making use of the exception for folks with less than $20,000 of foreign qualified dividend income. For instance, I pay no taxes on my US qualified dividend income. In theory, I should not get a foreign tax break at all on my foreign qualified dividend income because I pay no US taxes on it. However, because I have made sure that I do not have $20,000 in foreign qualified dividend income, I don't have to fill out Form 1116 the same way that some else does with more than $20,000 of foreign qualified dividend income.
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Re: Never-Ending Foreign Tax Credit Problem

Post by House Blend » Wed Feb 15, 2017 11:41 am

resting,

I think what people were objecting to is that your OP appeared to limit the apportioning to US and foreign sourced dividends. That's correct only if this is the only income you have.

Given that you are filling out the form correctly, and that your ability to claim the credit is limited, then the carryforward/carryback is going to help only if you have other tax years where your FTC is not limited. If your income picture is relatively stable year to year, then there's going to be no relief in sight. You might want to consider lowering your use of international stocks in taxable. (If you can't claim the FTC at all, a fund like VG Total International will cost you another ~20 basis points extra compared to someone who can.) Another option is to claim your foreign tax as a Schedule A deduction.

As a sanity check, I would compare your effective tax rate (Fed tax divided by AGI or AGI minus exemptions) with the percentage of your foreign dividends that were withheld for tax. (That's about 7% for Total International.) If your ability to claim the credit is limited, then your effective tax rate needs to be noticeably smaller than the tax rate you paid on your foreign dividends.

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Re: Never-Ending Foreign Tax Credit Problem

Post by Wagnerjb » Wed Feb 15, 2017 2:47 pm

House Blend wrote: As a sanity check, I would compare your effective tax rate (Fed tax divided by AGI or AGI minus exemptions) with the percentage of your foreign dividends that were withheld for tax. (That's about 7% for Total International.) If your ability to claim the credit is limited, then your effective tax rate needs to be noticeably smaller than the tax rate you paid on your foreign dividends.
Resting - this is good advice. Let us know what your effective tax rate is, and maybe why it is below 7%. That might help others give you some constructive advice on how to manage the FTC's going forward.

Best wishes.
Andy

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Re: Never-Ending Foreign Tax Credit Problem

Post by kaneohe » Wed Feb 15, 2017 4:14 pm

restingonmylaurels wrote:............................. But what I am really looking for is someone who has been able to get out of the situation of ever-increasing foreign tax credit carryforwards. Please comment on that aspect only.

......................................
When I first retired, I had relatively low income and a significant portion from QDIV/LTCG , thus relatively low tax rates and FTC credit was limited with the disallowed part building yr after yr as you describe. Once RMDs occurred, income increased from ordinary income which raised the tax rates and allowed absorption of the disallowed part of the FT over a few yrs.

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Re: Never-Ending Foreign Tax Credit Problem

Post by Epsilon Delta » Wed Feb 15, 2017 4:30 pm

jebmke wrote:The generalized version of this is
livesoft wrote:But it doesn't hurt to read ..... the instructions
I have read the instructions, and it did hurt. :twisted:

Houseblend suggested Tylenol. I think somebody should investigate if form 1116 is responsible for the opioid epidemic.

At least they've relaxed the rules since the 80's, back then you had to fill the whole thing out for $10 of tax credit.

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Re: Never-Ending Foreign Tax Credit Problem

Post by Dirghatamas » Wed Feb 15, 2017 5:34 pm

OP
There is either something seriously wrong in your understanding of foreign tax credit OR you have some unusual case (very large foreign income in the past not coming from mutual funds).

I get WAY more than 20K in foreign income (all passive total market index dividends) each year. I invest globally by market cap so this is a feature not a bug. It is also because international stocks (curse them) pay more of the earnings back through dividends rather than tax friendly buybacks. Obviously, if I had to pay double taxes, I would worry a lot about investing globally and would NOT invest globally by market cap (I would overweigh US).

Every year, I file the form and get back the double taxation. I have personally NOT had a case ever where my taxes were higher than they would have been if the equivalent qualified dividends (income) were US based. So, I find your situation highly unusual if you are investing in mutual funds/ETF. I have no idea about any other type of foreign income (salaries, properties whatever else).

The key is to print out the form once, get a good cup of coffee, read the entire thing and black out with a marker everything that doesn't apply to you. If you are a Boglehead, very little will apply. The part that does is actually simple (ok not really but it is not THAT complicated). In most cases, your taxes will be the same as if the income was from US.

PS: One case I have not considered is retirement. I am still in accumulation and have a healthy normal income from my job so the foreign income doesn't become a very large fraction of my total income. I can potentially see a case if there is no other income, your taxes may be higher/not fully avoid double taxation. However, in "normal" cases, the foreign credit should work just fine.

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Re: Never-Ending Foreign Tax Credit Problem

Post by Geologist » Wed Feb 15, 2017 6:21 pm

restingonmylaurels wrote:I imagine any VG investor with some foreign equity exposure may be experiencing the same problem I am.
I also am having trouble understanding your problem especially when you express it as you do in this first sentence. I have "some foreign equity exposure" and I never even have to file Form 1116. You seem to be making too broad a generalization.

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Re: Never-Ending Foreign Tax Credit Problem

Post by grabiner » Wed Feb 15, 2017 9:56 pm

How do you do your taxes? Tax software should get a reasonable Form 1116, even if it isn't completely right. (With TurboTax, you need to go to the form to get the best treatment of charitable deductions, and no tax software can get the state tax right because you have to fill out your state tax form before you find out how much was imposed on the foreign income). I usually wind up with an allowed credit which is about twice what I actually paid. Even if I had to adjust my qualified dividends (I don't in the 28% bracket), I would still get to deduct everything.
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Re: Never-Ending Foreign Tax Credit Problem

Post by *3!4!/5! » Thu Feb 16, 2017 1:49 am

OP, the problem you describe is very real. It is quite common for people to be double taxed on foreign income. And you can definitely be stuck with ever increasing carryforwards, which can not get used, and will expire unused. The way FTC is set up is not fair in any way shape or form. That's the reality about FTC, as you have unfortunately discovered.

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Re: Never-Ending Foreign Tax Credit Problem

Post by kramer » Thu Feb 16, 2017 3:44 am

My foreign tax credit carryover increases every year and I do NOT have $20,000 in foreign source dividend income (all from Vanguard ETFs).

The answer lies with the fact that my US tax rate is lower than the taxes paid on my foreign dividends AND that I exceed the $300/$600 threshold in foreign taxes paid for getting the full credit back. This is one of those places in the tax code where exceeding a threshold by even one dollar can create a step function in taxes paid.

The reason my US tax rate is low is that virtually all of my income is qualified dividends and capital gains, and my interest and unqualified dividends fall into the 0% bracket.

A few years ago I started doing T-IRA to ROTH IRA conversions and my marginal rate of conversion is lower because as I am paying more US taxes I capture more of the foreign tax credit for that year. So, in the 10% bracket, I really only pay about 8% marginal, and in the 15% bracket, I really only pay about 12% marginal. However, I can never use all of my foreign tax credit in any one year (unless I convert at higher tax rates), so I will just lose it forever at some point as the carryovers expire.

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Re: Never-Ending Foreign Tax Credit Problem

Post by restingonmylaurels » Thu Feb 16, 2017 4:06 am

House Blend and Wagnerjb/Andy, what you say seems correct, that it is an issue of my global effective tax rate being less than my foreign effective tax rate from the passive income on VG international funds. Kaneohe, that may happen to me as well, with rising ordinary income given the rising interest rate environment and hopefully may have some affect on my FTC carryforward. *3!4!/5!, if that does not happen, then I will be in essence in the thralls of double taxation forever as my FTC carryforwards will eventually expire year by year.

Kramer, you have echoed my situation completely. And as fortune would have it, I have also been considering doing the T-IRA to Roth IRA conversion in these low effective tax rate years. So your suggestion may take care of two birds, the FTC carryforward and the eventual tax liability of the T-IRA. Very insightful and just the kind of strategy I was looking for. I am wondering, in your conversion from T-IRA to Roth, what is the limiting factor in the timeframe you are using, the amount of tax you are willing to bear in any one year, any investment implications of the conversion, or a specific date you want to be completed with the conversion by (or something else)?

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Re: Never-Ending Foreign Tax Credit Problem

Post by kramer » Thu Feb 16, 2017 5:52 am

restingonmylaurels wrote:Kramer, you have echoed my situation completely. And as fortune would have it, I have also been considering doing the T-IRA to Roth IRA conversion in these low effective tax rate years. So your suggestion may take care of two birds, the FTC carryforward and the eventual tax liability of the T-IRA. Very insightful and just the kind of strategy I was looking for. I am wondering, in your conversion from T-IRA to Roth, what is the limiting factor in the timeframe you are using, the amount of tax you are willing to bear in any one year, any investment implications of the conversion, or a specific date you want to be completed with the conversion by (or something else)?
Most of my net worth is in taxable and I retired ten years ago. I am 51 so I have a lot of years to do conversions before I turn 70 and start Social Security and before I start taking RMDs at age 71.

Yes, I don't want to get into the 25% bracket for conversions and I am already filling up a lot of the 15% space with dividends (which have a 0% rate). Even going too far into the 15% bracket with conversions makes me hit a 30% marginal rate (minus the tax credit bonus I described) because my dividends and any capital gains start to be taxed at 15% also. So far I have been harvesting a few capital gains each year, also, for rebalancing. I have been considering nixing any 0% capital gains for a few years and converting as much as possible to top of the 15% bracket -- better earlier than later. Although I don't think it makes financial sense in my case for my IRA to be zero dollars at age 71 I certainly hope it is greatly reduced.

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Re: Never-Ending Foreign Tax Credit Problem

Post by Wagnerjb » Thu Feb 16, 2017 9:00 am

restingonmylaurels wrote:House Blend and Wagnerjb/Andy, what you say seems correct, that it is an issue of my global effective tax rate being less than my foreign effective tax rate from the passive income on VG international funds. Kaneohe, that may happen to me as well, with rising ordinary income given the rising interest rate environment and hopefully may have some affect on my FTC carryforward. *3!4!/5!, if that does not happen, then I will be in essence in the thralls of double taxation forever as my FTC carryforwards will eventually expire year by year.
One thought on managing the expiring FTC's would be to invest instead in a foreign ETF or mutual fund that invested in a country that had zero withholdings tax. I believe Australia is one example. By switching your international fund for an Australia fund (for example), you would keep the same percentage of foreign income to US income, but you would have no foreign withholdings. This would allow you to use some of the carried over FTC's.

Another way of explaining that strategy is that you are getting your international effective tax rate (at 0%) down below your US effective tax rate.

I would only suggest undertaking such a strategy if the FTC's were truly significant. By investing in one or more single country ETF's (vs. total international) you are sacrificing diversification.

Best wishes.
Andy

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Re: Never-Ending Foreign Tax Credit Problem

Post by NotWhoYouThink » Thu Feb 16, 2017 9:07 am

So it sounds like your "problem" is that you owe so little in US tax that you can't offset the foreign taxes you pay on your investment. Not really a problem, just a life choice. If paying the foreign taxes but little/no US tax leaves you better off than not investing in the foreign funds, you've made the right choice for you. Kind of like me complaining that I can't use all my half off coupons at the furniture store because I don't buy furniture.

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Re: Never-Ending Foreign Tax Credit Problem

Post by livesoft » Thu Feb 16, 2017 9:28 am

I will tell folks more about my situation which may shed light on OP's. A couple years ago, I had FTC around $1200. From Form 1116 then, I saw that I was limited to take about $1250 in FTC. At that point, I decided to limit my future contributions to foreign mutual funds in my taxable account. At the same time, I saw that VSS/VFSVX (small-cap foreign) had a higher percentage of non-qualified dividend income, so I sold all my shares of it in a taxable account offsetting the gains with previous tax-loss harvested losses. I bought VSS in tax-advantaged. I replaced the taxable VSS with VEA (large-cap foreign) and VTI (tax-efficient US). My overall asset allocation did not change.

But what did change is that I had a more tax-efficient taxable account and foreign taxes dropped to about $800 on about $13,000 of foreign dividend income. That's about a 6% foreign tax rate. Also, my taxable dividends went from about 72% overall qualified to about 82% overall qualified. So my FTC the past two years has been around $800 and there is plenty of room to go up to $1200.

In the past 2 years, we have been in the 15% marginal income tax bracket and have been doing Roth conversions up to the limit of that bracket. Our taxes are quite low because of 401(k) contributions, itemized deductions, qualified dividend income, $3,000 capital loss, the foreign tax credit, a full $2500 American Opportunity Tax Credit. Our Form 1116 Line 3e (gross income from all sources) is about 2.7 times our taxable income.

A point to re-iterate: I chose to put the tax-efficient VTI and to a lesser extent VEA into taxable than a foreign fund that was less tax-efficient. The VTI will be tax-free for me in taxable, but would have been eventually taxed if held in a tax-deferred account, so that was a tax savings to offset paying foreign taxes on VSS in a tax-deferred account. I made other arrangements not discussed in the post to make the overall portfolio more tax-efficient, too.
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Re: Never-Ending Foreign Tax Credit Problem

Post by Tanelorn » Thu Feb 16, 2017 11:19 am

I had some very large foreign withholdings from an individual stock I held a number of years ago, and they still aren't gone. Fr a while I thought I'd be stuck as some have described here, where the average foreign tax rate is higher than my US rate so I keep accruing more withholdings than I can take FTC. I did look into Andy's suggestion about Australia and it is a good one if you actually have this problem. Since then, my investments seem to be withholding less and my taxes are higher, so I've been able to use up the majority of the old FT withholding and at least it seems to be going in the right direction and I haven't changed my AA specifically to address this.

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Re: Never-Ending Foreign Tax Credit Problem

Post by halfnine » Thu Feb 16, 2017 4:18 pm

kramer wrote:..
Yes, I don't want to get into the 25% bracket for conversions and I am already filling up a lot of the 15% space with dividends (which have a 0% rate). Even going too far into the 15% bracket with conversions makes me hit a 30% marginal rate (minus the tax credit bonus I described) because my dividends and any capital gains start to be taxed at 15% also. So far I have been harvesting a few capital gains each year, also, for rebalancing. I have been considering nixing any 0% capital gains for a few years and converting as much as possible to top of the 15% bracket --
OTOH, maxing out conversions might be best saved for down years when you might have little or no capital gains anyway. One could also then lock in larger capital losses to possibly offset against income in future years. I haven't followed through completely on this thought process but its something I have been thinking about as well.

kramer wrote:..
better earlier than later. Although I don't think it makes financial sense in my case for my IRA to be zero dollars at age 71 I certainly hope it is greatly reduced.
There is something to the thought of better earlier than later. Depending on balances it is quite possible for the IRA to grow faster than one can convert it leading to a higher tax bracket when social security kicks in.

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Re: Never-Ending Foreign Tax Credit Problem

Post by rkhusky » Fri Feb 17, 2017 9:18 am

I have a significant chunk of international stock in a tax-deferred account, where one can't claim the FTC and for which we will be double-taxed once we withdraw. I decided I would rather have the higher percent of qualified dividends and lower dividends that US stocks provide in taxable. I also have foreign stocks in a Roth, which won't be double taxed. Just some trade-offs one has to make when investing.

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Re: Never-Ending Foreign Tax Credit Problem

Post by grabiner » Fri Feb 17, 2017 9:54 am

rkhusky wrote:I have a significant chunk of international stock in a tax-deferred account, where one can't claim the FTC and for which we will be double-taxed once we withdraw. I decided I would rather have the higher percent of qualified dividends and lower dividends that US stocks provide in taxable. I also have foreign stocks in a Roth, which won't be double taxed. Just some trade-offs one has to make when investing.
There is no loss to double taxation for traditional versus Roth; the tax deduction makes it a wash. Suppose that you are in a 25% tax bracket, and contribute $3000 to a Roth, which doubles in value; you can spend $6000 in retirement. For the same $3000 out of pocket, you could put $4000 in a traditional account, and would pay $2000 in tax when you withdraw the $8000, also ending up with $6000.
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Simple Solution

Post by Dontridetheindexdown » Fri Feb 17, 2017 10:46 am

We hold all foreign investments in taxable accounts, as direct shareholders.

All foreign investments are in countries that have reciprocal tax agreements with the U.S., e.g. UK, the Netherlands, Switzerland.

Every dollar of foreign tax withheld is used to offset our U.S. tax liability.

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Re: Never-Ending Foreign Tax Credit Problem

Post by rkhusky » Fri Feb 17, 2017 12:03 pm

grabiner wrote:
rkhusky wrote:I have a significant chunk of international stock in a tax-deferred account, where one can't claim the FTC and for which we will be double-taxed once we withdraw. I decided I would rather have the higher percent of qualified dividends and lower dividends that US stocks provide in taxable. I also have foreign stocks in a Roth, which won't be double taxed. Just some trade-offs one has to make when investing.
There is no loss to double taxation for traditional versus Roth; the tax deduction makes it a wash. Suppose that you are in a 25% tax bracket, and contribute $3000 to a Roth, which doubles in value; you can spend $6000 in retirement. For the same $3000 out of pocket, you could put $4000 in a traditional account, and would pay $2000 in tax when you withdraw the $8000, also ending up with $6000.
And how does the FTC affect each of these, compared to a taxable account? I realized after posting this that I hadn't actually done the math to see if there is a difference. I intend to do so at some point, but if you have the calculation at your fingertips ...

edit: okay I see that they're the same. Even if the the doubling was all due to dividends, there would be no difference between Trad and Roth.

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Re: Never-Ending Foreign Tax Credit Problem

Post by Random Poster » Thu Mar 30, 2017 2:37 pm

restingonmylaurels wrote:Form 1116, who first page in essence tries to identify your foreign income and foreign tax paid, then proceeds in the second page to determine how much foreign tax credit you have available, which includes any carryforwards, on Line 14. From this the remainder of the second page is going to limit the application of that foreign tax credit by comparing your non-US income to your global income (US + non-US). Line 19 is a percentage of your foreign income over your adjusted gross income from your 1040 line less your deductions (or your taxable income plus your exemptions, same result). This gives you the percent of your foreign to your global income. Your tax calculated on your return is then multiplied by that percentage from Line 19 to get Line 21. This basically is the amount of the US tax liability that is attributable to foreign income.

You can then take the lower of the foreign tax credit available from line 14 or the US tax attributable to your foreign income on Line 21. It is that simple.
I'm not sure that it is quite "that simple," and I find the whole matter to be quite confusing, at least in my situation.

Vanguard reported that, in 2016, I paid $558 in foreign taxes, thanks to my International Stock Fund holding, which generated a little less than $8,500 in total dividends (and a bit more than $6,000 in qualified dividends).

For some reason that I cannot fully understand, I apparently have around $39,000 in passive income foreign tax carry-forwards available in 2016. I used to be an expat, but how I got that much in passive income carry-forward is beyond me.

In any event, when I do the calculations on Form 1116, Line 14 shows around $40,000, but line 21 shows around $1,100, so the total foreign tax credit becomes $1,100---even though I only paid $558 in 2016 in foreign taxes!?!?!

How is it possible to have a greater foreign tax credit, simply as a result of completing Form 1116 (solely due to the existence of carry-forwards that I am still not even using because the result shown on Line 14 is larger than the calculated, mathematical result shown on Line 22), than what I actually paid during the year?

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Re: Never-Ending Foreign Tax Credit Problem

Post by House Blend » Thu Mar 30, 2017 3:06 pm

Random Poster wrote:For some reason that I cannot fully understand, I apparently have around $39,000 in passive income foreign tax carry-forwards available in 2016. I used to be an expat, but how I got that much in passive income carry-forward is beyond me.
Beyond me too.
In any event, when I do the calculations on Form 1116, Line 14 shows around $40,000, but line 21 shows around $1,100, so the total foreign tax credit becomes $1,100---even though I only paid $558 in 2016 in foreign taxes!?!?!

How is it possible to have a greater foreign tax credit, simply as a result of completing Form 1116 (solely due to the existence of carry-forwards that I am still not even using because the result shown on Line 14 is larger than the calculated, mathematical result shown on Line 22), than what I actually paid during the year?
While it's certainly possible that a mistake has been made, if you were unable to claim a credit for all of your foreign taxes paid in previous years, and there is headroom between the max credit you are allowed this year and the amount of foreign tax you actually paid this year, then you get to claim some of the previous foreign taxes this year. The rest carries forward to next year.

A sweet deal, and another shining example of the complexity of our tax code.

If I remember correctly, you get to carry forward "excess" foreign taxes up to 10 years. I don't recall if you lose some of it if you are eligible in a given year and forget to claim it. As always, you need to read the instructions for Form 1116. (Edit: looks like Pub. 514 has the details, including examples.)

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Re: Never-Ending Foreign Tax Credit Problem

Post by *3!4!/5! » Thu Mar 30, 2017 5:18 pm

Random Poster wrote:
restingonmylaurels wrote:Form 1116, who first page in essence tries to identify your foreign income and foreign tax paid, then proceeds in the second page to determine how much foreign tax credit you have available, which includes any carryforwards, on Line 14. From this the remainder of the second page is going to limit the application of that foreign tax credit by comparing your non-US income to your global income (US + non-US). Line 19 is a percentage of your foreign income over your adjusted gross income from your 1040 line less your deductions (or your taxable income plus your exemptions, same result). This gives you the percent of your foreign to your global income. Your tax calculated on your return is then multiplied by that percentage from Line 19 to get Line 21. This basically is the amount of the US tax liability that is attributable to foreign income.

You can then take the lower of the foreign tax credit available from line 14 or the US tax attributable to your foreign income on Line 21. It is that simple.
I'm not sure that it is quite "that simple," and I find the whole matter to be quite confusing, at least in my situation.

Vanguard reported that, in 2016, I paid $558 in foreign taxes, thanks to my International Stock Fund holding, which generated a little less than $8,500 in total dividends (and a bit more than $6,000 in qualified dividends).

For some reason that I cannot fully understand, I apparently have around $39,000 in passive income foreign tax carry-forwards available in 2016. I used to be an expat, but how I got that much in passive income carry-forward is beyond me.

In any event, when I do the calculations on Form 1116, Line 14 shows around $40,000, but line 21 shows around $1,100, so the total foreign tax credit becomes $1,100---even though I only paid $558 in 2016 in foreign taxes!?!?!

How is it possible to have a greater foreign tax credit, simply as a result of completing Form 1116 (solely due to the existence of carry-forwards that I am still not even using because the result shown on Line 14 is larger than the calculated, mathematical result shown on Line 22), than what I actually paid during the year?
It's been a while since I did FTC, but it is not impossible that the calculation you got is correct.

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Re: Never-Ending Foreign Tax Credit Problem

Post by in_reality » Fri Mar 31, 2017 7:14 am

restingonmylaurels wrote:Form 1116, who first page in essence tries to identify your foreign income and foreign tax paid, then proceeds in the second page to determine how much foreign tax credit you have available, which includes any carryforwards, on Line 14. From this the remainder of the second page is going to limit the application of that foreign tax credit by comparing your non-US income to your global income (US + non-US). Line 19 is a percentage of your foreign income over your adjusted gross income from your 1040 line less your deductions (or your taxable income plus your exemptions, same result). This gives you the percent of your foreign to your global income. Your tax calculated on your return is then multiplied by that percentage from Line 19 to get Line 21. This basically is the amount of the US tax liability that is attributable to foreign income.

You can then take the lower of the foreign tax credit available from line 14 or the US tax attributable to your foreign income on Line 21. It is that simple.
It's not that simple. You have entirely missed the part where US adjusts your foreign income to account for US deductions which in no way affect how much you payed on foreign taxes but can subject you to US tax liability at a higher rate than a comparable American would pay even if your foreign tax rate is much higher than the US tax rate.
Random Poster wrote: I'm not sure that it is quite "that simple," and I find the whole matter to be quite confusing, at least in my situation.

Vanguard reported that, in 2016, I paid $558 in foreign taxes, thanks to my International Stock Fund holding, which generated a little less than $8,500 in total dividends (and a bit more than $6,000 in qualified dividends).

For some reason that I cannot fully understand, I apparently have around $39,000 in passive income foreign tax carry-forwards available in 2016. I used to be an expat, but how I got that much in passive income carry-forward is beyond me.
If your foreign tax rate is higher, you can accumulate them. Also, part of US deductions can be allocated for foreign earned income. This will reduce the credit you can claim but not the taxes you paid.

For example:
Head of Household
$200,000 foreign income
=roughly $43,000 (US tax liability)
So if you paid 30% (or $60k) in foreign taxes, you have about a 17,000 carry over
Random Poster wrote: In any event, when I do the calculations on Form 1116, Line 14 shows around $40,000, but line 21 shows around $1,100, so the total foreign tax credit becomes $1,100---even though I only paid $558 in 2016 in foreign taxes!?!?!

How is it possible to have a greater foreign tax credit, simply as a result of completing Form 1116 (solely due to the existence of carry-forwards that I am still not even using because the result shown on Line 14 is larger than the calculated, mathematical result shown on Line 22), than what I actually paid during the year?
You have a high % of net taxable foreign income or a high US tax liability.
Your foreign tax credit = (net Foreign taxable income / total taxable income) * US tax liability
. Of course your credit can not exceed your available credit (foreign taxes paid this year and accumulated from the past).

It might seem nice to have that foreign credit, but actually I suspect you are coming out behind even with it because of the formula to reduce the net taxable foreign income amount.

REAL NEVER-ENDING FOREIGN TAX CREDIT PROBLEM

For a more typical case with foreign earned income, foreign passive income and passive US income (i.e. foreign and US investments held in the US) the expat ends up getting taxed more.

$80k foreign income (excluded via FEIE)
$25k US dividends
$25k Foreign dividend $5k taxes paid (20% rate)

Form 1116 (done in TurboTax)
line 3c $9,300 (standard deduction)
line 3d $25,000 (foreign earned income)
line 3e $130,000 (total income)
line 3f 0.1923 (unlabeled but it's the ratio of foreign to total income 3d/3e)
line 6 $1,788 (unlabeled but it's the amount of standard deduction attributable to foreign earned income i.e 3f*3c)
line 7 $23,212 net foreign source taxable income (i.e. foreign income - allocated US standard deduction i.e. 3d-6)

[now your foreign taxable income has been reduced from a US perspective so the credit they have to give will be less, but your real foreign taxes will be based on the real foreign taxable income so the real amount you had to pay will be higher than the credit your recieve]

line 8 $5.000 foreign taxes paid
line 14 $5,000 total amount of foreign taxes available for credit (assumed no carryover)
line 17 $23,212 net foreign source taxable income (from line 7 above)
line 19 0.5703 unlabeled but it's your credit ratio ... [line 17/(taxable income- deduction)]
line 20 $5,498 (US tax liability)
line 21 $3,136 foreign tax credit (line 20 US liability * line 19 credit ratio)

This results in a $2362 US tax liability
An expat paid $5,000 in foreign taxes but only received a $3,136 credit
Then the US taxes that expat on the $25,000 the expat paid $5,000 in foreign taxes already.

A US taxpayer would pay only $1748 on $25,000 in US dividends. Why does an expat have to pay $2362? Well, the expat has to pay $1748 on $25,000 in US dividends like any American but also pay US taxes on some of the foreign income they already paid foreign taxes on (even though they paid at a higher than US rate).

At very best you are giving uncle Sam a free loan until you get the money back in the future like Random Poster did above. At worst is that you don't keep good enough records to claim it, you never have a chance to claim it, or possibly even if you have a chance and remember to that you don't get back the amount extra you paid.

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Re: Never-Ending Foreign Tax Credit Problem

Post by Random Poster » Fri Mar 31, 2017 9:17 am

House Blend wrote:
Random Poster wrote:For some reason that I cannot fully understand, I apparently have around $39,000 in passive income foreign tax carry-forwards available in 2016. I used to be an expat, but how I got that much in passive income carry-forward is beyond me.
Beyond me too.
I went through my previous tax returns last night and figured out the probable reason: When I left my host country (Canada), all of my taxable investments were subject to a deemed disposition, which resulted in the payment of around $37K in passive-category income tax to the Canadian government. At that time, I already had around $3,500 in passive income foreign tax carry-forwards, so the deemed disposition tax hit caused the carry-forward amount to significantly increase.
in_reality wrote:
Random Poster wrote: In any event, when I do the calculations on Form 1116, Line 14 shows around $40,000, but line 21 shows around $1,100, so the total foreign tax credit becomes $1,100---even though I only paid $558 in 2016 in foreign taxes!?!?!

How is it possible to have a greater foreign tax credit, simply as a result of completing Form 1116 (solely due to the existence of carry-forwards that I am still not even using because the result shown on Line 14 is larger than the calculated, mathematical result shown on Line 22), than what I actually paid during the year?
You have a high % of net taxable foreign income or a high US tax liability.
The high US tax liability is probably the reason.
in_reality wrote:Of course your credit can not exceed your available credit (foreign taxes paid this year and accumulated from the past).
Certainly, but something seems a bit "off" to pay $558 in one year, but be able to (apparently) deduct $1100 in that same year. But seeing your explanation does help me understand things.
in_reality wrote:At very best you are giving uncle Sam a free loan until you get the money back in the future like Random Poster did above. At worst is that you don't keep good enough records to claim it, you never have a chance to claim it, or possibly even if you have a chance and remember to that you don't get back the amount extra you paid.
And this brings up another issue I've got:

When I was an expat, my employer prepared my US and Canadian tax returns, paid all of the foreign tax bills and any tax due to the US as a result of my expat assignment. In that respect, it was my employer--and not me--who actually paid the above-noted deemed disposition tax bill (among others), and there is a part of me that thinks that all of the carry-forwards (passive and general income) belong to my employer (although I can't find any written documentation actually saying so). That said, how would my employer ever recover or claim these carry-forwards when they are on my personal tax return? And should I even try to utilize the carry-forwards on a go-forward basis now that I'm back in the US and my employer no longer does my taxes?

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Re: Never-Ending Foreign Tax Credit Problem

Post by in_reality » Fri Mar 31, 2017 9:29 am

Random Poster wrote: When I was an expat, my employer prepared my US and Canadian tax returns, paid all of the foreign tax bills and any tax due to the US as a result of my expat assignment. In that respect, it was my employer--and not me--who actually paid the above-noted deemed disposition tax bill (among others), and there is a part of me that thinks that all of the carry-forwards (passive and general income) belong to my employer (although I can't find any written documentation actually saying so). That said, how would my employer ever recover or claim these carry-forwards when they are on my personal tax return? And should I even try to utilize the carry-forwards on a go-forward basis now that I'm back in the US and my employer no longer does my taxes?
I would suggest that any amounts paid by your employer were your compensation. If they did a match in your 401k and you quit working there, would you never spend that money? Of course not.

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Re: Never-Ending Foreign Tax Credit Problem

Post by bsteiner » Fri Mar 31, 2017 9:33 am

kramer wrote:... my US tax rate is lower than the taxes paid on my foreign dividends ....
The purpose of the foreign tax credit is to avoid double tax on foreign source income. It's is limited to the pro rata portion of the U.S. tax so that you can't use foreign taxes to offset the tax on U.S. source income.

If your foreign tax rates are higher than your U.S. tax rate, you'll have unused foreign tax credits. The carryback and carryover will often give you a chance to use the credits in other years. However, if your foreign tax rates are consistently higher than your U.S. tax rates, some of the credits may expire.

One possible solution is to get some lower taxed foreign source income.

A partial solution (though not of much help to low bracket taxpayers) is to elect to use the foreign taxes as a deduction rather than as a credit.

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Re: Never-Ending Foreign Tax Credit Problem

Post by *3!4!/5! » Fri Mar 31, 2017 10:22 am

bsteiner wrote:The purpose of the foreign tax credit is to avoid double tax on foreign source income.
The way it is designed, you will be effectively double taxed in a lot of scenarios.

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Re: Never-Ending Foreign Tax Credit Problem

Post by max71 » Tue Apr 18, 2017 4:47 pm

A question -

I am in the same boat. I have interest income from foreign bank accounts in Asia. I am not getting full tax credits.
To avoid double tax - Is it possible to take Foreign Tax as an expense or report only net interest after Foreign Taxes paid?


Thanks

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Re: Never-Ending Foreign Tax Credit Problem

Post by RubyTuesday » Tue Dec 24, 2019 10:30 am

jebmke wrote:
Wed Feb 15, 2017 9:14 am
livesoft wrote:Now it is true that if one has more than $20,000 in foreign qualified dividend income, then it gets trickier.
Trickier but not impossible. If one carefully follows the instructions for F1116, one can get to the right answer. It might be a little tedious but if you start at the end of February after all the 1099s are in, you should be able to get an answer by October 15. :beer

F1116 is one of those pesky multi-purpose forms. The key for me is to read the instructions and cross out all the sections that don't apply to me. Remarkably, that leaves a fairly short document to follow.
I know this is an old post, but wanted to give a shout out :beer to jebmke for this post. Form 1116 instructions are about the most difficult tax form instructions I’ve read, and the idea of crossing out sections is, IMO, brilliant.
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Re: Never-Ending Foreign Tax Credit Problem

Post by Alan S. » Tue Dec 24, 2019 3:44 pm

Or, if your FTC is 300 or less for single filers or 600 or less for joint filers, you avoid the 1116 and simply enter the foreign tax paid shown on the 1099 DIV forms on line 1 of Sch 3.

Very roughly, around 150k in a broad international fund plus 50k in an emerging markets fund has a good chance of coming in under 600 in foreign taxes paid. Note I said roughly.

Brokerages do not make it easy to predict the foreign tax on a given fund or even to look up the history if you did not own the fund the prior year.

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Re: Never-Ending Foreign Tax Credit Problem

Post by livesoft » Tue Dec 24, 2019 3:48 pm

I think for 2019 HRBlock Deluxe (download) tax prep software has improved its treatment of Form 1116.
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Re: Never-Ending Foreign Tax Credit Problem

Post by RubyTuesday » Tue Dec 24, 2019 5:38 pm

livesoft wrote:
Tue Dec 24, 2019 3:48 pm
I think for 2019 HRBlock Deluxe (download) tax prep software has improved its treatment of Form 1116.
Perhaps...

I’m trying to figure out whether HRBlock or FreeTaxUSA is in error in determining the FTC from Form 1116. They provide different answers. I think it’s related to the exception to making adjustments related to qualified dividends, but still sorting through it, hence reading old BH FTC threads, lol.

One complication seems to be that the underlying programming for HRBlock doesn’t seem to provide access to the exact “Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 instructions” but rather incorporates it into a “Schedule D Dividends and Capital Gains Worksheet”, and while the 2018 FreeTaxUSA shows the worksheet, the 2019 FreeTaxUSA doesn’t show It yet, probably not until everything is locked down and ready to allow filing. Was this last sentence as confusing as the 1116 instructions? :confused

So I’m reading form 1116 and instructions carefully trying to understand the potential sources of discrepancy.

RT
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Re: Never-Ending Foreign Tax Credit Problem

Post by livesoft » Tue Dec 24, 2019 5:47 pm

Well, please post here when you get it sorted out. I make sure that I don't have more than $20,000 of qualified dividends from international funds in a taxable account.
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Re: Never-Ending Foreign Tax Credit Problem

Post by RubyTuesday » Tue Dec 24, 2019 6:04 pm

livesoft wrote:
Tue Dec 24, 2019 5:47 pm
Well, please post here when you get it sorted out. I make sure that I don't have more than $20,000 of qualified dividends from international funds in a taxable account.
I will for sure...

Am I reading this seemingly straight forward instruction correctly? For Schedule D Filers:
You qualify for the adjustment exception if the amount of your foreign source net capital gain, plus the amount of your foreign source qualified dividends, is less than $20,000 and one of the following applies to you.

Line 7 of the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 instructions or line 18 of the Schedule D Tax Worksheet in the Schedule D (Form 1040) instructions is less than or equal to:
$315,000 if married filing jointly or qualifying widow(er),
If I’m understanding this correctly, then for 2018 I qualify for the adjustment exception. And I’m using initial estimates from 2018 w.r.t. foreign source income and foreign tax paid, so I should qualify for the exception in 2019 as well.

What I’m trying to chase down is that the HRBlock FTC seems to vary based on other inputs that I think should be independent relative to the adjustment exception (e.g. I’m modeling traditional to Roth conversions and capital gains harvesting).
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Re: Never-Ending Foreign Tax Credit Problem

Post by livesoft » Tue Dec 24, 2019 6:38 pm

All I know is that I can always take credit for 100% of the foreign taxes paid by my mutual funds. So if I estimate for 2019 that I paid $1200 in foreign taxes, then in my "What if?" returns I make sure I get $1200 in FTC.
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