Another reason why your Foreign Tax Credit may be calculated as zero (Form 1116): Foreign Tax Carryover but no current year foreign income

[HardRightEdge99]

This is an FYI-only about a circumstance I recently discovered, a pretty simple one.

I have no foreign source income (and thereby no foreign tax paid) for the current year's return, the 2023 return at this writing.  However, I have a meaningful amount of foreign tax credit carryovers, all from stock dividends and reported on 1099s, accumulated in dribs and drabs over the last 10 years.  Yet I'm getting a calculation of zero foreign tax credit on my 2023 Fed return despite having a meaningful amount of tax due to offset.  I discovered this is not a mistake or miscalculation by TurboTax.

What I discovered in manually working through the Form 1116 calculations is that if there is no foreign source income for the current tax year certain factors in the calculations get set to zero which end up resulting in a zero bottom line for the credit.  There is no way around it.  I did not look at anything related to income other than dividends--whether that's different I can't say.

It would be too exhausting to explain, but there is an internal logic to these calculations.  But one can't help but think there could be a better way.  Maybe this is one reason why the IRS offers the deduction vs. credit option as a way to derive some benefit in circumstances like this but that ain't no help if you don't itemize.  As it stands, without anticipating buying foreign dividend paying stocks in the future, my carryovers will continue to expire bit by bit.  I'm beginning to think "good riddance".

[ThomasM125]

You can only deduct foreign taxes to the extent that you paid US tax on foreign income. For instance, if you earned $10,000 in foreign income and your US tax on the income is $1,500, you can't deduct $2,000 of foreign taxes paid on your tax return. The purpose of the credit is to allow you to avoid being double taxed on the same income. So, your foreign tax credits represent taxes paid on foreign income that has not yet been taxed domestically. Consequently, you are not losing a tax credit or deduction when you have foreign tax credit carryovers, you are just not able to use it yet to avoid double taxation.  

[HardRightEdge99]

@ThomasM I'm not sure how what you posted clarifies the situation I described:  foreign tax carryover never translates to a credit in a year where there happens to be no foreign source income.  It's just something I discovered that I thought was interesting (and disappointing).

It should seem odd that how a prior year's foreign tax carried over translates to a credit (or not) in the current year is a function of whether you happen to have current year foreign income.  The double taxation (or lack thereof) as relates to carried over tax has nothing to do with the foreign income (or lack thereof) in the current year.

But I'm just repeating myself, my federal taxes are done, so I'll leave it at that.

[ThomasM125]

The foreign tax is carried over because you didn't have enough domestic tax on foreign income in the year it arose to allow all of it to be used. It can only be used in a year that you have foreign income because the foreign tax can only be used to offset US tax on foreign income. So, if you have no foreign income in a given year, you will have no US tax on foreign income that year. So, there would be no US tax on foreign income available to offset the foreign taxes carried over.

The double taxation issue comes in to play because you have foreign tax. The foreign income was taxed in the foreign country and then the same income is taxed again on your US tax return. So, you get a credit against your US tax equal to the foreign tax paid on the same income, otherwise you would be double taxed.

[HardRightEdge99]

@ThomasM125  There's more to it than that.  I'll take one more shot with some examples:

1)  If you have no foreign source income in the current tax year, Form 1116 formulas dictate that no foreign tax carryover can be converted to a credit.  On this we agree.  But it's not about double taxation per se--it's about the fact that Form 1116, line 3f is set to zero when 2023 foreign income is zero. 

2)  As a second example, I added a test entry to my completed 2023 Fed return which happens to have about $2,600 in available foreign tax carryover for 2023 and about a $5,600 Fed tax liability available for foreign tax credit offset.  The entry is a simple $100 foreign stock divided with a $15 foreign tax from box 7 on the 1099 with no other variables.  What then happens is Form 1116, line 3f is now calculated by TurboTax as a very small factor that ends up resulting in a $6 foreign tax credit with the remaining $9 of the 2023 foreign tax added to carryover to 2024.

So far so good, I guess.  It matches what a manual calculation of line 3f would yield.

3) I ran another test replacing the dividend entry in 2) above with a simple foreign stock dividend of $100,000 with a box 7 foreign tax paid of only $1.  This large amount of foreign source income relative to total income results in a much, much larger factor in line 3f than in example 2).

The end result is all of the $2600 in foreign tax carryover to 2023 plus the $1 in foreign tax from the test entry were calculated as a foreign tax credit flowing through to 1040, Line 20 and thereby reducing the 2023 tax liability by the self-same $2601.

So riddle me this:  How does adding $1 in foreign tax payments reported in the current return, and by extension $1 in the aggregate across the previous 11 years including the carryover foreign tax, suddenly result in a $2,601 recognition of "double taxation"?   The answer is that it doesn't.  The maximum change to  double taxation is $1.  The results of this example are a peculiar artifact of the internal logic of Form 1116.  The rationale behind this logic could be articulated perhaps in English but we'd have to ask whoever drafted the relevant tax code.

While example 3) is an extreme case, less extreme examples yield less extreme results demonstrating the same point.  Again, this is not a TurboTax problem.  It's a peculiarity of the tax code that is not entirely explainable with boilerplate language about double taxation.

[MVP5]

I’ve been studying the FTC, and I don’t think it is at all as benign and helpful as some here make it out to be. The way I see the calculations work, you only get credit for a portion of the foreign tax paid, but deviously, that percentage is dependent on the ratio of foreign to total gross income. So you never receive a 1:1 benefit for your foreign tax, and you are indeed effectively double-taxed. I could understand the cut off being related to not enough US tax to offset or if it were compensating for a higher US tax rate by charging the difference- but the current way it is structured seems patently unfair. 

[girigiri]

Hi:

Dear All:

• I have paid taxes in India for Dividend income, interest income and capital gains. (The total tax liability from the India Tax return is apportioned to each of these buckets). 
• An Example Data is per below:
• Say if I have paid an overall $30 as part of the total India tax return and the total tax paid of $30 can be apportioned as below (Dividend tax = $10, Interest income tax =$15 and Capital gains tax = $5)
  

• Where do I need to enter this apportioned tax amount in Turbo Tax that has been already paid to India? 

• Is it in each of the interest income, Dividend income and capital gain entry screens per below? 

For Example:

Say $160.90 interest income was earned and total tax paid to India (for all income as part of the tax return) = $30 (as shown in the above table), and out of $30 tax paid,  $15 of tax can be apportioned to Interest income of $160.90, then can we enter the information per below?

If not, how do we get credit for the taxes paid for each of the income categories to India?

Regards,

[pk]

@girigiri , generally agreeing with the idea of ratiometric apportionment of foreign taxes  paid  to different categories  ( interest, dividend, capital gain  etc. ) for purposes of form 1116.  This done   on line 1(a)   Gross Foreign income by country and the details of taxes paid by category  on  line 7 of the same form.

Should I assume that the amounts you have put up are only as an exercise to demonstrate the  method  POR are these real figures?   I ask because  the amounts you quote are under the safe harbor amounts  i.e. you do not need  a form 1116   ( and its limitations ).

Is there more I can do for you ?

[girigiri]

Hi pk:

• The amount I have shown above is just to demonstrate the methodology and logic.  
• Is the approach to enter the taxes paid to India in Turbo tax  (Per above screen shot as "Adjustment" & as part of "Other Reason") is the correct approach?
• Also, If I am making adjustment for taxes paid on interest, dividends, capital gains...etc. to foreign country as "Adjustment" via Turbo tax screen entries shown above for various income buckets such as Interest income, Dividend...etc.,, do I need to still file Form 1116?
• Further, what is defined as "Safe harbor amount (Ex: Does this amount relate to income from foreign country or taxes paid  to foreign country)" and "what is the limit on this amount" and "the implication of being above or below this limit  (Ex: Amount above a certain limit mean we need to file Form 1116 and below the limit no need....etc.,,)

Again, Thank you for your input. 

[pk]

@girigiri , i suspect what you are talking about is using "adjustment" as a means to enter foreign taxes  paid and what I was quoting  how it is actually entered on form 1116.  I realize that you do not have 1099s for the interest   nor for the dividend or capital gain.

You need to enter  the  amounts of foreign earnings  and the foreign taxes paid  just as if you had  1099s.   ( i.e. 1099-div , 1099-Int and 1099-B including all applicable boxes.   Some of these  may give you trouble because there is no EIN of the payor --- you can always  use some dummy ( if forced to use one ) EIN like  12-2345678--- this is obviously a dummy one.  IRS only looks for  a match with information returns  ( 1099s from domestic entities ).

Once you have done this things will flow properly.

The reason I  mentioned the safe harbor tax credit  (  US$ 300 per filer  i.e.  US$ 300 for a single filer and US$ 600 for  MFJ ).  This means  that claims for foreign taxes  paid  up to and including this safe harbor  amount  is  foreign tax credit to you ( no need to use  form 1116 -- which limits the amount of Foreign tax credit ).  Sometimes  , say ,for an MFJ  whom have  paid US$700 as foreign ta, it may be more beneficial to claim US$ 600 as  foreign taxes paid -- because you will get  all US$ 600 in current year  while a form 1116  while recognizing the US$ 700 as credit will allow only US$400 as  allowable for current year, the rest being banked  for use later

Does this make sense ?

Is there more I can do for you ?

Namaste ji

pk

[girigiri]

Namasteji pk:

Thank you for the clarification on "Safe harbor limit". 

My key confusion is with respect to when I can enter the Foreign taxes paid  (Ex: as if I had 1099s for each income category and use "Adjustments"  field to take credit for taxes paid in  Turbo tax  screens)  versus when I should not do that and  need to use Form 1116 to get credit for foreign taxes paid 

Let me know your thoughts.

Regards,

[pk]

@girigiri , generally when you enter  the "foreign taxes  paid " on form 1099-Div , box  7 , country in box 8 of your dummy  1099-Div, TurboTax would recognize  the foreign taxes paid.   The adjustment box/amounts  are only for  form 1116 and is used to adjust the  foreign source income ( a requirement for form 1116 ) to harmonize  with treaty requirements  -- some treaties  require say only 10% tax while US actually say charges  15% on the double taxed income -- so you adjust the source income to bring the tax down to as if the applicable tax was 10%.    Very few times do you have to use these .   I don't remember  ( so have to refresh my memory ) if India  puts up such conditions on the tax treaty.

Is there more I can do for you ?

Namaste ji

pk

[girigiri]

Dear pk ji:

I will enter that way in Turbo Tax and see how it goes. If I have any questions, I will loop back.

Again, Thank you Sir.,

[girigiri]

Dear Sir pk:

• I was unable to find out how to enter Foreign taxes paid on Capital gains, I tried several ways. 
• Below I have provided step-by-step Turbotax screen shots  and no where it gives an option to enter  foreign tax paid on capital gains.
• Hence, request your help.

Regards,

Giri

[pk]

@girigiri ,  it is obvious to a casual observer that I was wrong -- for some stupid reason I  was  thinking that there is a box in 1099-B,   (or form 8949 and schedule- D  ) somewhere there is  Foreign Taxes p[aid  - a la 1099-DIV.    NO there is not one , even though  Schedule-B does require  whether FATCA  reporting is required , implying foreign  assets  and/or foreign financial institution involvement.  Forgive  my mistake.

Since there is  no entry point  for foreign taxes  --- you have to use  --- (a) under  Deductions and Credits tab, choose  " I will choose what I work ... ". Then from drop down  list of credits and deductions, near the end  you will Foreign Tax credit.  Click this  " Edit/ Visit ".   Then in the following screens  you will need to enter the details for form 1116 -- Foreign Source Income ,  Source Country, amount paid etc. etc.   Note that this  form 1116 is for Passive Category.

Is there more I can do for you ?

Again my apologies for the mistake  ( and resultant goose chase ).

pk