What is the correct method of applying the recapture of US overall domestic loss account when electing not to adjust qualified dividends and long term capital gains on form 1116?
I have not found any specific instructions about this when electing not to make the adjustment.
The problem is that line 15 (foreign income) and 18 (worldwide income) can be several times larger between the adjusted vs unadjusted form 1116, especially if most of the Q-DIV & LTCG are in the 0% tax bracket. And the recapture amount is based on 50% of the US sourced income, which is the difference between line 15 and 18.
Which way is correct?
- Option 1: Applying the Recapture Amount Without Scaling
- Method: Use the recapture amount calculated from the adjusted Form 1116 directly on the non-adjusted Form 1116 without any scaling.
- Rationale: This approach follows the IRS instructions, which do not specify any scaling based on the election regarding qualified dividends and capital gains.
- Option 2: Scaling the Recapture Amount Based on U.S. Source Income
- Method: Calculate the recapture amount using the adjusted Form 1116. Then, scale this amount by the ratio of U.S. source income between the non-adjusted and adjusted versions of Form 1116.
- Rationale: This method aims to maintain consistency in the proportion of U.S. source income being recharacterized as foreign source income across both versions of the form, since the recapture amount is based on 50% of the US source income.
- Option 3: Scaling the Recapture Amount to Maintain the Same Effective Increase in FTC Limitation
- Method: Calculate the recapture amount using the adjusted Form 1116. Then, scale this amount by the ratio of line 18 (taxable income) between the non-adjusted and adjusted versions of Form 1116.
- Rationale: This approach seeks to ensure that the effective increase in the Foreign Tax Credit (FTC) limitation due to the recapture is consistent between the adjusted and non-adjusted forms.
