Claiming Foreign Tax Credit Correctly

[RicN]

Hello Everyone,

I am a US expat residing in the UK, and this applies to any country with a similar tax treaty. I have a bank account and a brokerage account in the US, which typically generate interest, dividends, and capital gains. I report on my UK tax declaration and pay taxes on it in the UK. I can use Form 1116 to get a foreign tax credit on my US tax return. My question is whether in Form 1116 I should choose “c) Passive category income” or “f) Certain income re-sourced by treaty”.  Again, note that these are US bank accounts and US brokerages.

My understanding is the following:

1. US bank Interest: file 1116 "f) certain income re-sourced by tax treaty"
2. Dividends reported on US brokerage: file 1116 "f) certain income re-sourced by tax treaty" – a bit complicated how much to claim back, but that is not my question.
3. Capital Gains in stocks held on US brokerage: file 1116, less clear to me which option is correct.

Also, let’s now consider that the bank and brokerage are not in the US but in the foreign country of residence (UK in my case):

     4. If these were bank accounts and brokerage in the foreign residence country (I know PFIC problems, I hold none), then for all cases (interest, dividends, capital gains): file 1116 “c) Passive category income”

Are these the correct elections in Form 1116? What should be done in case 3?

Thank you!

[pk]

@RicN ,  the general issue here is that when a US taxpayer and for US tax purposes incurs FT on US sourced income, there is no way to  claim FTC -- since the source is US.  This occurs ONLY on passive income.  Some treaties  recognize this and allow a way out. To wit , from  --> Foreign Tax Credit – Special issues | Internal Revenue Service 

The United States is a party to tax treaties designed to prevent double taxation of the same income by the United States and the treaty country. Certain treaties allow a U.S. citizen an additional credit for part of the tax imposed by the treaty partner on U.S. source income. It is separate from, and in addition to, your foreign tax credit for foreign taxes paid or accrued on foreign source income.

The treaties that provide for this additional credit include those with Australia, Austria, Bangladesh, Belgium, Bulgaria, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland, Ireland, Israel, Italy, Japan, Luxembourg, Malta, Mexico, the Netherlands, New Zealand, Portugal, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Switzerland, and the United Kingdom.

If a sourcing rule in an applicable income tax treaty treats U.S. source income as foreign source, and you elect to apply the treaty, you can include that income under the category Certain Income Re-sourced By Treaty. Treat the income as foreign source to the extent required in the treaty. You must compute a separate foreign tax credit limitation for any such income for which you claim benefits under a treaty, using a separate Form 1116, Foreign Tax Credit, for each amount of resourced income from a treaty country. See Internal Revenue Code sections 865(h), 904(d)(6), and 904(h)(10) and the regulations under those sections (including Regulation section 1.904-5(m)(7)) for any grouping rules and exceptions.

What this all boils down to is -- in the presence of a treaty allowing "resourced by treaty ", if the taxpayer wishes to assert  this treaty  benefit, then to the extent the Foreign country treats US sourced income as domestic and taxes as such, then for US purposes  the US sourced income can be  treated as foreign source income for purposes of  Foreign Tax Credit.

Hope this helps