After I went through the questionnaire for foreign tax credit, I saw that I got a credit of $4089. This is from taxes paid on qualified dividends for a stock from a foreign country.
But then in this review step
I believe the amount should be $16335.
But then upon entering that value, my credit dropped by about $2000.
Why would that happen? What's the calculations going on behind the scene?
the calculations are complicated, so you need to review the 1116 and the 1116 comp worksheet.
a quick summary of the FTC computation. the foreign dividends are reduced by an allocation of your itemized or standard deduction based on the ratio of it to your gross income. this reduction is on line 6 of the form. (see 1116 instructions for what's included on in gross income). this is your net foreign income. this net is divided by line 15 of your 1040 to come up with another %. this % is applied to line 16 of 1040 + schedule 2 line 2 to come up with the current year allowable FTC.
another way to put it is if your effective federal tax rate before the FTC is less that the effective rate of foreign taxes (foreign taxes divided by net foreign income). you won't be allowed all the foreign taxes you paid. you may be able to carryback the unused to 2021 any unuse may be carried forward 10 years.
the calculations are complicated, so you need to review the 1116 and the 1116 comp worksheet.
a quick summary of the FTC computation. the foreign dividends are reduced by an allocation of your itemized or standard deduction based on the ratio of it to your gross income. this reduction is on line 6 of the form. (see 1116 instructions for what's included on in gross income). this is your net foreign income. this net is divided by line 15 of your 1040 to come up with another %. this % is applied to line 16 of 1040 + schedule 2 line 2 to come up with the current year allowable FTC.
another way to put it is if your effective federal tax rate before the FTC is less that the effective rate of foreign taxes (foreign taxes divided by net foreign income). you won't be allowed all the foreign taxes you paid. you may be able to carryback the unused to 2021 any unuse may be carried forward 10 years.
Ok I think what happened is that I hit a limit for the credit, it says the rest can be carried forward to next year.
Still not sure what limit I hit though.
@taxhero1 , while agreeing with the general comments by my colleague @Mike9241 , a very simple way to look at the limitation of allowable foreign tax credit is that the recognized amount of foreign tax credit ( generally the amount you have paid or accrued ) is multiplied by a factor which takes into account the ratio of foreign sourced income to world income ( income from all sources ). The non-allowed portion of the credit is available for carry back ( 1 year ) and forward but available ONLY when there foreign income available and again limited by the same rule. It is not quite as simple as related here but gets you in the ball park.
Does this help or ??
pk