Foreign tax credit carryovers - Schedule B, Form 1116
For the 2121 taxable year, IRS now requires that taxpayers determine foreign tax credit (FTC) carryovers and carrybacks in a uniform manner using new Schedule B of Form 1116. For 2021, a taxpayer with either an FTC carryover from 2020 to 2021 or a 2021 carryover to 2022, or both, must establish the amount of any such carryover in Schedule B and attach it to Form 1116 as part of its Form 1040 filing. Prior to 2021, FTC carryovers claimed on Form 1116, Line 10, were required to be established in a "detailed schedule" attached to the tax return. Form 1116 Instructions prior to were not detailed as to exactly what 'detailed' information should be provided. Lack of uniformity is not congruent with efficient tax return processing, which probably led to the birth of Schedule B. In the long run, this is a good thing - for taxpayers, the IRS and tax return processing systems, such as TurboTax. Tax year 2021 has been a frustrating experience, but 2022 will be a better tax year for FTC processing, as long as the 2021 Schedule B is properly completed, filed with any required Form 1116 and saved for future use.
By the way, U.S. tax law dealing with foreign tax credits is most complicated. Programming Form 1116 is most challenging. My focus is on the least complicated aspect: FTC claimed by individuals with respect to foreign-source dividends and interest ("passive category income") and related foreign tax credits reported on official U.S. tax information statements, such as Forms 1099-DIV and 1099-INT.
2021 Observations and Remaining Questions.
(1) Limitations on claiming the full amount of eligible FTC reported by financial services providers.
Not all foreign income tax withheld from foreign dividend and interest income is eligible for FTC. For example, U.S. tax treaties with other countries generally reduce the amount of income tax that U.S. residents pay on dividends paid by companies in treaty partner countries. Assume that the income tax treaty between the U.S. and Country X provides that tax on dividends paid to U.S. residents is limited to 15%. Under Country X law, the statutory rate is 25%. A refund of excess tax withheld can be obtained upon application to the Country X tax authority.
Mary, an unmarried resident of the USA, holds shares of Company B, a resident of Country X, in the form of American Depository Receipts ("ADRs") in her U.S. investment account. In 2021, her account receives a dividend of $1,000 from Company A, from which Country X tax of $250 is withheld; Mary's account receives $750 after such withholding is applied. Mary is entitled to apply for a tax refund of $100 excess tax withheld from Country X based on the U.S. income tax treaty with Country X. The administrative cost of the application exceeds the amount on the refund amount, so Mary opts not to claim a refund of $100 excess tax withheld. Even though Mary received a 2021 Form 1099-DIV reporting foreign tax paid of $250 on Line 7, only $150 is eligible for FTC under U.S. law. Because the eligible amount of FTC under U.S. law is limited to $150 in this example, Mary has no foreign tax credit from 2021 to carry over to 2022. It is unlikely that Mary would be aware of this rule of law, unless she was a CPA or a tax attorney, or carefully read the Form 1116 Instructions. How does TurboTax handle this situation in its step-by-step interview process?
(2) Requirement to File Form 1116 - Eligible FTC greater than $300 (or $600 if married filing jointly).
The FTC of $150 in the above example is subject to further limitation in 2021 to the amount of U.S. tax paid on the foreign dividend of $1000 as determined in Form 1116 (lines 15-23). But, if the total amount of foreign tax paid in 2021 by Mary on 'passive category income' does not exceed $300 ($600 if MFJ) and other conditions are met, the limitation rule described in this paragraph does not apply.
However, assume that the dividend in the above example is $3,000 and foreign tax withheld is $750. In this case, $450 of the foreign tax withheld is eligible for a 2021 foreign tax credit and Mary would be required to File Form 1116 with her 2021 tax return. Her FTC would be limited to the U.S. income tax paid on her foreign passive category income of $3,000 as determined in Lines 15-23 of the Form. In making this calculation, two questions arose:
(2a) Form 1116, Line 3e, Gross income from all sources (see instructions).
How is this line determined by TurboTax? Please provide the current formula. Is a Worksheet or Schedule supporting this calculation provided for users?
(2b) Form 1116, Line 3b, Other deductions (attach statement).
How is this line determined by TurboTax? Please provide the current formula. Is a Worksheet or Schedule supporting this calculation provided for users?
