Foreign tax credit (Form 1116) and California state income tax.

[Anonymous]

I recently moved from Canada to the US and am currently a resident of California; as a result, I have to pay Canadian taxes for part of my 2022 income due to multi-year compensation.

Trying to file Form 1116 with the IRS but found the instructions around "Non-exempt state income taxes" to be very confusing, specifically, the IRS Publication #514 states the following:

- You must allocate and apportion your interest expense and state income taxes under the special rules...

- If state income tax is imposed in part on foreign source income, the part of your state tax imposed on the foreign source income is definitely related and allocable to foreign source income.... If the total income taxed by the state is greater than the amount of U.S. source income for federal tax purposes, then the state tax is allocable to both U.S. source and foreign source income.

The document then went on to give an example:

- Your total income for federal tax purposes, before deducting state tax, is $100,000. Of this amount, $25,000 is foreign source income and $75,000 is U.S. source income. Your total income for state tax purposes is $90,000, on which you pay state income tax of $6,000. The state does not specifically exempt foreign source income from tax. The total state income of $90,000 is greater than the U.S. source income for federal tax purposes. Therefore, the $6,000 is definitely related and allocable to both U.S. and foreign source income. 

Assuming that $15,000 ($90,000 − $75,000) is the foreign source income taxed by the state, $1,000 of state income tax is apportioned to foreign source income.

Since California taxes foreign income, I figured this rule applies to my case; but it's unclear where the amount of the state income tax apportioned to foreign sourced income should go on Form 1116; my best guess is it should be added to Line 1a to be part of the foreign-source gross income, but it's counterintuitive.

Does anyone know how this case should be handled?

[ThomasM125]

Line 1(a) of Form 1116 is where you report your foreign income. You qualify to treat the California tax on your foreign income as foreign tax paid, but the foreign income is the income from Canada, so that goes on line 1(a). The California tax paid on your Canadain income, along with your tax paid to Canada on that income, is reported in Part II of Form 1116. 

[Jim Aitken]

I live in California and recently sold a farm (rental) property in Canada.  Looking ahead to my 2023 tax filings, I know that I will have to pay Canadian capital gains tax, and I know that I will be able to claim a foreign tax credit for this  (form 1116) on my Federal return.  But I have no idea on how California will want to treat this.  Here are the options that I see so far:

!.  Claim the CDN tax as a Credit on my federal return and assume it is not allowed on my CA return.  Results in low Federal tax but very high CA tax.

2. Claim the CDN tax as an Expense on my federal return, and assume it will be allowed on my CA return.  Result is much higher federal tax and lower state tax.

3. Claim the CDN tax as a Credit on my federal return and claim it as an Expense on my CA return.  This results in the lowest tax in both cases, but requires that I manually add the expense to my CA return as a "selling expense".  Not sure that I'm allowed to do this.

4.  In searching this forum I found this item (below) from ThomasM125 which seems to offer a fourth approach of paying the full CA tax, but then adding it to Form 1116 as an additional foreign tax paid.  This sounds strange and I would like to further verify if its allowed.

I would really appreciate some advice on this.  It has been my experience that local tax preparers are woefully lacking when it comes to foreign tax issues.

Jim A.

 ThomasM125

Expert Alumni

Line 1(a) of Form 1116 is where you report your foreign income. You qualify to treat the California tax on your foreign income as foreign tax paid, but the foreign income is the income from Canada, so that goes on line 1(a). The California tax paid on your Canadain income, along with your tax paid to Canada on that income, is reported in Part II of Form 1116. 

[sabasu]

I have a similar situation for tax year 2024, but for India.

I am an US citizen and resident of California. I sold a piece of land in India in July 2024. The Indian tax authorities deducted a hefty tax at source (a.k.a TDS, Tax Deducted at Source), from my sale proceeds @~24%. This is kinda a witholding tax to be adjusted against my Indian Tax Return (a.k.a ITR) . India's fiscal year runs from April 1 to Mar 31, so I will file my ITR on or after April 1, 2025 and expect to get a refund out of my TDS.

In a post (https://ttlc.intuit.com/community/taxes/discussion/re-reporting-capital-gains-on-sale-of-land-in-ind...), I have been advised..."You will have to prepare your federal return, then your California return to determine that tax paid.  Then you will return to the federal portion to include that additional tax." and was pointed to this thread. 

I lived the whole year in California as an US citizen, but I sold a property in India and made some Capital Gains income. Therefore, I have both US income from salary, dividends, interest, investments etc. PLUS India Capital Gains, on which I have paid Indian taxes. I understand that I can claim credit on my India taxes, but I can't understand how to separate out the California taxes for my Indian Capital Gains, since my California income will include both US income and Indian income. 

@ThomasM125 says 

• "Line 1(a) of Form 1116 is where you report your foreign income." Ok, so I report the Indian Capital Gains in Line 1(a) of Form 1116
• "The California tax paid on your Canadain income..." How do I get that because my State tax will include BOTH US income and Indian Income (capital gain). How do I know how much is my California tax ONLY on my Indian income, which I will reported in Part II of Form 1116.

@Jim Aitken, @ThomasM125 can you pls help?

Thanks in advance.

[RobertB4444]

When filling out your California tax return the easiest way to get the amount paid for taxes on the Indian amounts is to do the complete return and then go back through and delete the Indian amount from form 1116.  Note the difference in the taxes and then re-enter the Indian amount.  That difference in taxes due is what is deductible on your Indian return.

@sabasu