Sorry, I was going in a roundabout way of thinking. I thought about it again and found a simpler way to describe the problem. Please let me reword it.
For the adjustment to foreign long term capital gain on line 1a of 1116, the full portion taxed at 0% and 59.46% of the portion taxed at 15% rates are to be removed. How would you pro rate these amounts between foreign and U.S. long term capital gain, if worldwide long term capital gain is greater than the taxable income?
The numerator of the pro rata fraction would be the total foreign long term capital gain.
For the denominator, would you use the worldwide long term capital gain, or the taxable income?
Example:
- $30,000 total worldwide long term capital gain, of which $20,000 is foreign sourced
- $12,000 standard deduction
- $18,000 taxable income
- $30,000 foreign earned income exclusion reduces the $40,000 threshold for 0% rate to $10,000
- $10,000 worldwide L-cap-gain taxed at 0% rate
- $8,000 worldwide L-cap-gain taxed at 15% rate
For line 1a of 1116, the foreign L-cap-gain to be entered must be reduced by:
- the amount that was taxed at 0% rate
- and 59.46% of the amount that was taxed at 15%
How would you pro rate these amounts to foreign L-cap-gain?
- Option 1: $20,000 foreign L-cap-gain / $30,000 worldwide L-cap-gain (result = 67% ratio, line 19 of 1116 would be greater than "1" and all foreign tax is available to reduce US tax to zero)
- Option 2: $20,000 foreign L-cap-gain / $18,000 taxable income (result = $937 in line 1a, $4000 in line 3g, negative number in line 7, no foreign tax credit, full US tax of $1,200) This is what I've seen some software do
I don't know if the software was purposefully using the taxable income as the denominator, or if this was because it was taking the number from line 4 of the QDCGTW, which was reduced by the capital gain excess as instructed by the FEIETW, but the reduction is supposed to be only for the purpose of calculating tax on FEIETW. Reducing line 4 of QDCGTW by capital gain excess essentially results in the same number as the taxable income. But the taxable income already has the standard deduction subtracted from it, and line 3g and 7 of 1116 are again subtracting the pro rated amount of standard deduction. So essentially, Option 2 is double subtracting the standard deduction from line 1a and greatly reducing the available foreign tax credit.
