Thank you for the links. @pk is usually right about these kind of things. But, for whatever it is worth, I'm not sure here. I understand the point. I just cannot find any authority for that position. Authority here is the tax code, regulations, or cases. Instructions or other guidance can be helpful but are not the law. Please feel free to point me at some. Or consult with a professional (CPA, enrolled agent, or tax attorney) who deals with the FTC all the time (not a couple times a year.)
I'm not sure because the point is to NOT compute the foreign income as as shown on a foreign return. That's not how I think it works. Rather the income in question is US income that comes from a foreign source. That is based on US rules not foreign rules. The source rules are described in I.R.C. 862. (compare to 861). https://www.law.cornell.edu/uscode/text/26/862
Three Points:
1. The law does not say foreign income. It deals with US income from foreign sources
The computation of the limit in I.R.C. 904(a) is your US tax times "taxable income from sources [outside the US]" divided by your "entire taxable income" ... https://www.law.cornell.edu/uscode/text/26/904
This does not say "foreign income." It says "taxable income" from foreign sources (per I.R.C. 862). "Taxable income" is defined in I.R.C. 62 to be "gross income minus the deductions allowed by this chapter." This chapter means the US tax code, not the foreign tax code. https://www.law.cornell.edu/uscode/text/26/63
Gross income is "all income from whatever source derived." I.R.C. 61(a). https://www.law.cornell.edu/uscode/text/26/61
If someone can point me at the code section or regulation dealing with the FTC that says "foreign income" or "foreign deductions" or redefines "taxable income" for sections 901 et. seq. I would reconsider.
2. Form 1116 does subtracts other deductions that are US only deductions
If that were wrong why does Form 1116 Part I line 3 require that you deduct the US standard/itemized deduction? It the deductions were about the foreign tax code this would be the foreign standard/itemized (or other) deductions.
3. Foreign deductions are taken into account when allocating foreign income among classes of income
Instead of subtracting foreign deductions from US taxed foreign-sourced income, foreign deductions are taken care of when allocating for taxes among different categories of foreign income. This does not matter to you if your only foreign income is in one category, as is probably the case for you. It would apply if you had, say, foreign salary income and also foreign sourced rental or other passive income.
See page 21 of Pub 514. https://www.irs.gov/pub/irs-pdf/p514.pdf
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