Form 1116: Allocating State Taxes (TurboTax)

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Chip
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Form 1116: Allocating State Taxes (TurboTax)

Post by Chip » Sun Dec 31, 2017 6:03 am

I'm looking for some clarification on the allocation of state income taxes on Form 1116, particularly in TurboTax. I have read many of the threads here on Form 1116 but haven't seen this question directly answered.

The question is that once I have determined the amount of state taxes that is "definitely related" to my foreign income, is the remainder of my state taxes allocated to US source income, or is it "not definitely related"?

Let's assume I have figured my state tax liability at $5,000. Using the calculation methods shown in Pub 514 and discussed in many threads here, I calculate that $500 of that is definitely related to foreign income. If I enter that $500 on the TurboTax FTC Computation Worksheet, Line 2b, Turbotax assumes the remaining $4,500 is "not definitely related" and puts it on Line 3a(5)a "Remaining itemized dedns". Is this correct?

It would seem to me that if I have calculated an amount that is definitely related to foreign source income the remainder, almost by definition, would have to be definitely related to US source income. In which case I believe it shouldn't even be entered on the worksheet. As in the way charitable contributions are assumed to be definitely related to US source income and don't appear on Form 1116.

Opinions on this? I can certainly override the amount shown on Line 3a(5)a and put in a zero, but it seems that Turbotax should have figured this one out and wouldn't require an override.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by gd » Sun Dec 31, 2017 7:24 am

The state tax thing is beyond what I do with this form, so I can't help other than to note as I do in every thread on 1116 I see-- I do not assume that any of the tax prep software deals with this form correctly. I figure out what needs to be done by working through the IRS instructions sentence by sentence (without expecting to make sense of it as I go), try to get TT to cooperate, override as needed, and at the end maybe it'll allow e-file and maybe I send in paper.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by jebmke » Sun Dec 31, 2017 8:58 am

This has always been a puzzler for me too. I suspect that the tax software can't do the calculation because each state adjusts income in different ways so they would have to figure out how to make the split so robust that the program would become unmanageable.

I always leave the Federal 1116 to the end -- after completing everything on the Federal and the State. Since there are a lot of adjustments to income (plus and minus) on the state return I can't prorate until I get the state return done. Then I go back and plug the values in on 1116.

I have used several retail and professional tax programs over the years and I have never seen one with which you can complete 1116 programmatically. They all seem to require manual intervention.
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by livesoft » Sun Dec 31, 2017 9:02 am

jebmke wrote:
Sun Dec 31, 2017 8:58 am
I have used several retail and professional tax programs over the years and I have never seen one with which you can complete 1116 programmatically. They all seem to require manual intervention.
I've come to the conclusion many years ago that not even the IRS knows how to fill out Form 1116.
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Chip
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by Chip » Sun Dec 31, 2017 9:23 am

Thanks to everyone who responded. Do any of you have an opinion on the basic question: If I have allocated some state tax as "definitely related" to foreign source income is the remainder automatically related to US source income and therefore doesn't even belong on the form?

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by jebmke » Sun Dec 31, 2017 9:28 am

livesoft wrote:
Sun Dec 31, 2017 9:02 am
jebmke wrote:
Sun Dec 31, 2017 8:58 am
I have used several retail and professional tax programs over the years and I have never seen one with which you can complete 1116 programmatically. They all seem to require manual intervention.
I've come to the conclusion many years ago that not even the IRS knows how to fill out Form 1116.
this raises a philosophical question as to whether there is even a right answer to begin with. I do note that you wrote "how to fill out" and not "how to correctly fill out." :wink:
When you discover that you are riding a dead horse, the best strategy is to dismount.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by livesoft » Sun Dec 31, 2017 9:55 am

My opinion is that since the state would tax all of one's income, that ALL the state tax is related to foreign source income.
See my follow-up post below.
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by Chip » Sun Dec 31, 2017 10:14 am

livesoft wrote:
Sun Dec 31, 2017 9:55 am
My opinion is that since the state would tax all of one's income, that ALL the state tax is related to foreign source income.
:shock:

Would your opinion change if making that choice would substantially reduce the allowable FTC?

Which it does.....

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by livesoft » Sun Dec 31, 2017 10:25 am

Uh-oh. Yes, my choice would probably change. :)

At some point I was going to do a Form 1116 thread with screen captures of actual numbers, but not until I got my 1099-DIVs for 2017 later in 2018.

But I always read what grabiner has to say on the subject, so I hope he contributes to this discussion.
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by livesoft » Sun Dec 31, 2017 11:26 am

I am using HRBlock to look at Form 1116 now. The tax software has a mini-worksheet for Line 3a "Other deductions, not definitely related to income on Line 1a or United States Income". Note that Line 3a is
Pro rata share of other deductions not definitely
related:
a Certain itemized deductions or standard deduction
(see instructions) . . . . .
FWIW, HRBlock fills in the mini-worksheet with 100% of my real estate taxes and 100% of my General sales taxes and the sum of those two go into Line 3a. And this is exactly what the instructions for Form 1116 state.

My state does not have state income taxes, so that is why I deduct General sales taxes.
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by jebmke » Sun Dec 31, 2017 11:30 am

livesoft wrote:
Sun Dec 31, 2017 11:26 am
I am using HRBlock to look at Form 1116 now. The tax software has a mini-worksheet for Line 3a "Other deductions, not definitely related to income on Line 1a or United States Income". Note that Line 3a is
Pro rata share of other deductions not definitely
related:
a Certain itemized deductions or standard deduction
(see instructions) . . . . .
FWIW, HRBlock fills in the mini-worksheet with 100% of my real estate taxes and 100% of my General sales taxes and the sum of those two go into Line 3a. And this is exactly what the instructions for Form 1116 state.

My state does not have state income taxes, so that is why I deduct General sales taxes.
The major issue for state income taxes is all the adjustments that states make to income that should be reflected in the split. I'm not surprised that it does OK without state income taxes.
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by Chip » Sun Dec 31, 2017 11:53 am

livesoft wrote:
Sun Dec 31, 2017 11:26 am
FWIW, HRBlock fills in the mini-worksheet with 100% of my real estate taxes and 100% of my General sales taxes and the sum of those two go into Line 3a. And this is exactly what the instructions for Form 1116 state.

My state does not have state income taxes, so that is why I deduct General sales taxes.
TurboTax starts out the same way, defaulting to putting all itemized deductions (except charitable) on Line 3a. But the instructions for F1116 require that some of the state income tax be allocated to Line 2 based on the amount of state tax definitely related to the foreign income. In my example above, that's $500 on Line 2. TurboTax then does the math and defaults the remaining $4500 to Line 3a.

Because of the way the calculations work you would rather have dollars on Line 3a vs. Line 2. But it's even better if the $4500 doesn't belong on the form at all due to it being definitely related to US source income. Which I think is the case here but I would really like some confirmation.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by livesoft » Sun Dec 31, 2017 12:03 pm

So why don't charitable contributions from Schedule A get placed on Line 3b (Other dedns) ?

Or do they and tax software doesn't do it?
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by HueyLD » Sun Dec 31, 2017 12:21 pm

Chip,

The form instructions say:
You must reduce your foreign gross income on line 1a by entering on lines 2 through 5:

Any of your deductions that definitely relate to that foreign income; and

A ratable share of your other deductions that don't definitely relate to that foreign income, any other foreign income, or U.S. source income.
I understand that the instructions and logic may not go together, but the IRS instructions are clear. The gross income from foreign source must be reduced by both deductions definitely related to foreign income and a pro rata portion of deductions not definitely related to foreign income.

So, IMO Turbo Tax does it correctly.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by Chip » Sun Dec 31, 2017 12:34 pm

HueyLD wrote:
Sun Dec 31, 2017 12:21 pm
Chip,

The form instructions say:
You must reduce your foreign gross income on line 1a by entering on lines 2 through 5:

Any of your deductions that definitely relate to that foreign income; and

A ratable share of your other deductions that don't definitely relate to that foreign income, any other foreign income, or U.S. source income.
I understand that the instructions and logic may not go together, but the IRS instructions are clear. The gross income from foreign source must be reduced by both deductions definitely related to foreign income and a pro rata portion of deductions not definitely related to foreign income.

So, IMO Turbo Tax does it correctly.
Thanks. But if I have determined that X amount of my state income tax definitely relates to the foreign income, doesn't that mean that the balance of the state tax definitely relates to US source income? Which, according to the last line of your quote, would exclude it from deduction proration. Right?

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by Chip » Sun Dec 31, 2017 12:56 pm

In the immortal words of Emily Litella, NEVER MIND.

Here's a quote from the help screen for the TurboTax FTC Computation Worksheet:
NOTE: There are special rules for state income taxes deducted as an itemized deduction and how they are to be allocated. These rules are based on how foreign income is taxed in your state and are explained in IRS Publication 514. Depending on how your state treats foreign income, enter any state income tax deductions allocable to foreign income on line 2b-e, enter an 'I' in the I/J column, and A, B or C to indicate the country the state taxes apply to. Also enter any state income tax deductions allocable to U.S. income on line 2b-e, enter an 'I' in the I/J column, and U in the code column.
The bolded part is how you tell TT that the remainder of the state income tax is definitely related to US source income. That's what the "U" in the code column is for. Once that is done there is no state income tax on Line 3a.

It's the exact equivalent of overriding the 3a entry for the balance to zero.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by Chip » Sun Dec 31, 2017 1:00 pm

livesoft wrote:
Sun Dec 31, 2017 12:03 pm
So why don't charitable contributions from Schedule A get placed on Line 3b (Other dedns) ?

Or do they and tax software doesn't do it?
From TurboTax help:
TurboTax Help wrote: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 proposed Regulation 1.861-8T and temporary rules T.D. 9143, taxpayers are allowed to allocate charitable deductions 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.
If a deduction is allocated solely to US source income it doesn't have to appear on F1116.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by livesoft » Sun Dec 31, 2017 1:03 pm

Thanks for that. I wish the IRS had a such a statement in an obvious place like Form 1116 instructions or Pub 514.
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by livesoft » Sun Dec 31, 2017 1:09 pm

Chip wrote:
Sun Dec 31, 2017 12:56 pm
Also enter any state income tax deductions allocable to U.S. income on line 2b-e, enter an 'I' in the I/J column, and U in the code column.
Sorry, but I don't see any lines 2b-e on Form 1116.

So those are some lines on some separate TT-provided worksheet?
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by tnjj » Sun Dec 31, 2017 1:27 pm

1.861-8T (e)(1)(12) talks about being able to allocate charitable deductions to U.S. source income even if the charity was used overseas. The allocation rules are listed earlier in the statutory groupings listed earlier in the regulation.

Not a tax pro, but I’m inclined to take the literal plain text of the regulations at face value. It seems the charitable contributions (without regard for where they benefited) as long as they were deductible under section 170, must be allocated between the statutory groupings as listed in 1.861-8T. Just my 2 cents.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by HueyLD » Sun Dec 31, 2017 1:28 pm

Chip wrote:
Sun Dec 31, 2017 12:56 pm
In the immortal words of Emily Litella, NEVER MIND.

Here's a quote from the help screen for the TurboTax FTC Computation Worksheet:
NOTE: There are special rules for state income taxes deducted as an itemized deduction and how they are to be allocated. These rules are based on how foreign income is taxed in your state and are explained in IRS Publication 514. Depending on how your state treats foreign income, enter any state income tax deductions allocable to foreign income on line 2b-e, enter an 'I' in the I/J column, and A, B or C to indicate the country the state taxes apply to. Also enter any state income tax deductions allocable to U.S. income on line 2b-e, enter an 'I' in the I/J column, and U in the code column.
The bolded part is how you tell TT that the remainder of the state income tax is definitely related to US source income. That's what the "U" in the code column is for. Once that is done there is no state income tax on Line 3a.

It's the exact equivalent of overriding the 3a entry for the balance to zero.
Good. So, TT is correct if the user enters data correctly.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by Chip » Sun Dec 31, 2017 2:13 pm

livesoft wrote:
Sun Dec 31, 2017 1:09 pm
Sorry, but I don't see any lines 2b-e on Form 1116.

So those are some lines on some separate TT-provided worksheet?
Yes, they are on the TurboTax FTC Computation Worksheet.

2b-e are simply itemizations that feed back into Line 2 of F1116. But it's awkward the way they do it -- the code "U" I tagged the remaining $4500 of state tax with caused it NOT to be added to the $500 that was coded "A" (related to foreign income in Column A). Therefore it didn't appear on Line 2 or anywhere else on F1116.

Does HRBlock have a similar worksheet?

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by livesoft » Sun Dec 31, 2017 2:29 pm

Chip wrote:
Sun Dec 31, 2017 2:13 pm
Does HRBlock have a similar worksheet?
If it does, then I can't find it. It does have "mini-worksheets" that are not part of the form. For Line 2, it has a simple worksheet to enter "Expenses definitely related to income shown on line 1" that are "Not from K-1." It seems to populate the "From K-1" category by itself, but I do not have K-1's this year.

There is no such mini-worksheet for line 3b, so one enters a number manually there.

I also did the following experiment: I told HRBlock that I paid state income taxes in an amount that ended up on Schedule A. The program did not change any of the Form 1116 interview steps nor mini-worksheets shown to me, so I was on my own for Line 2 and Line 3b.
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by grabiner » Sun Dec 31, 2017 9:14 pm

jebmke wrote:
Sun Dec 31, 2017 8:58 am
I have used several retail and professional tax programs over the years and I have never seen one with which you can complete 1116 programmatically. They all seem to require manual intervention.
It isn't possible for software to get this right, because of the order in which computations are done. First you fill out your federal tax form, so that you have information to transfer to the state tax form. Then you fill out your state tax form. And only after both can you determine how much of your state tax was connected to the federal income, so you have to go back and fill out Form 1116 manually.

Most tax software will treat state taxes as not definitely related with either US or foreign income. This is approximately right, and usually doesn't make much difference. If the state taxes the same income as the IRS, the final number will be right, although it should be split between deductions definitely related to the foreign income and definitely not related.

The IRS's actual formula, from Publication 514, doesn't even make sense. The state is assumed to tax the same amount of US source income as the federal tax does, and the remainder of the tax applies to the foreign income. It would make more sense to use the income the state actually taxed; most states will tax the same amount of foreign income as the federal tax, but will have differences in US income (state tax refunds, Treasury bonds, out-of-state munis, HSAs in the states that don't recognize them).
livesoft wrote:
Sun Dec 31, 2017 12:03 pm
So why don't charitable contributions from Schedule A get placed on Line 3b (Other dedns) ?

Or do they and tax software doesn't do it?
The Form 1116 instructions say that charitable contributions are directly connected with US income, and do not need to be prorated. The logic may be that you may only deduct contributions to US charities. (There are many US charities which spend money in foreign countries.)

TurboTax used to put them on "Other Deductions", with a note which says that there is an alternative treatment which is that they are connected to US income; I don't know what its current default behavior is. (It's somewhat surprising to put them on Line 3b by default, as that may result in a lower credit.) TaxAct does not list charitable contributions.
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by HueyLD » Sun Dec 31, 2017 10:34 pm

It isn't possible for software to get this right, because of the order in which computations are done. First you fill out your federal tax form, so that you have information to transfer to the state tax form. Then you fill out your state tax form. And only after both can you determine how much of your state tax was connected to the federal income, so you have to go back and fill out Form 1116 manually.
Not always. The state I used to be a resident of requires us to do the state return from scratch. In other word, we start from wages, etc., not the federal AGI. And there is not a requirement to do a federal return in order to do a state return.

I do agree with you that F1116 is a real mess and it will get worse with the new TCJA.

Sometimes I wonder if the IRS auditors even understand the complex rules governing form 1116.

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by livesoft » Sun Dec 31, 2017 10:37 pm

grabiner wrote:
Sun Dec 31, 2017 9:14 pm
The Form 1116 instructions say that charitable contributions are directly connected with US income, and do not need to be prorated.
I searched for the string "chari" in the PDF of the Form 1116 instructions and found nothing. What string should I use to find this statement about charitable contributions in the Form 1116 instructions please? Thanks!
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by HueyLD » Sun Dec 31, 2017 10:49 pm

Charitable contributions are usually not apportioned against foreign source income; however, contributions to charities organized in Mexico, Canada, and Israel must be apportioned against foreign source income.
https://www.irs.gov/individuals/interna ... tax-credit

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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by grabiner » Sun Dec 31, 2017 11:40 pm

livesoft wrote:
Sun Dec 31, 2017 10:37 pm
grabiner wrote:
Sun Dec 31, 2017 9:14 pm
The Form 1116 instructions say that charitable contributions are directly connected with US income, and do not need to be prorated.
I searched for the string "chari" in the PDF of the Form 1116 instructions and found nothing. What string should I use to find this statement about charitable contributions in the Form 1116 instructions please? Thanks!
Form 1116 doesn't quite say it; it says what should be entered on Line 3a, and doesn't say anything about charity, which would need to be mentioned on Line 3a or 3b since it is such an important deduction. (The example for Line 3b is alimony paid.)

It is clearer but still implicit in Publication 514:

"Deductions not definitely related. You must apportion to your foreign income in each separate limit category a fraction of your other deductions that are not definitely related to a specific class of gross income. If you itemize, these deductions are medical expenses, general sales taxes, and real estate taxes for your home. If you do not itemize, this is your standard deduction. You should also apportion any other deductions that are not definitely related to a specific class of income, including deductions shown on Form 1040, lines 23–35; or Form 1040NR, lines 24–34."

If charity had to be apportioned, it would have been listed here as medical expenses are.
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Re: Form 1116: Allocating State Taxes (TurboTax)

Post by LadyGeek » Sun Oct 14, 2018 7:33 pm

New member Kiyomikote has a question which I've moved into a stand-alone thread. See: [Do I need to file IRS Form 1116?]
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