Foreign Tax Credit - Glitch in Program Calculation of Amount of Foreign Tax Credit?

[11486]

I have foreign taxes paid of $610.47 on line 7 of form 1099-DIV. All of the foreign taxes paid were on passive ordinary dividend income from line 1a of form 1099-DIV. The TurboTax program assumes I must file form 1116 because the foreign taxes paid exceeded $600, which could be a limiting factor as I am married filing jointly. However, if you log into TurboTax.intuit.com and read Claiming the Foreign Tax Credit with Form 1116, you will discover when you scroll down to the heading Foreign Tax Credit Without Form 1116, that there are three conditions where you do not need to file Form 1116. The first of these, which is applicable to me, is “if all your foreign taxed income was 1099 reported passive income, such as interest and dividends, you don’t need to file form 1116, provided that any dividends came from stock you owned for at least 16 days.” That is the situation with my $610.47 foreign taxes paid. Apparently the TurboTax program will not allow you to take the full $610 credit on passive foreign income because it thinks you are subject to the second condition, which says that you must file form 1116 if you paid more than $600, but by implication must conclude that some or all of the income was not passive income. This becomes apparent because the program prompts you to tell the program what entity or country paid the. foreign dividend on which the foreign taxes were paid. In my case, using form 1116, TurboTax only allowed me a $309 foreign tax credit, instead of the $610 credit I should be entitled to without having to file form1116. They applied the excess $301 as a carryover to my 2025 taxes.

I believe this is a program oversight that needs to be addressed by TurboTax.  If anyone can explain to me where my thinking is incorrect, I would appreciate hearing from them in this forum. Also, if I am correct in my analysis, does someone know how to report this oversight to TurboTax?

Thank you.

[pk]

@11486 , sometimes it is better to claim only the safe harbor amount of  US$600  for  MFJ filer.  You will get the full amount.  If you choose the form 1116 , it is always  going to be limited to LESSER of actual Paid  and  Allocated US tax on the same  foreign source income.  The allocation is based on multiplying the total US tax on world income by the ratio of Foreign Source income to World Income.   That is  what  the tax treaty calls out.

Is there more I can do for  you ?

[11486]

I am not sure if you addressed my issue with the program. As I stated above, one of the exceptions to filing form 1116 according to turbotax.intuit.com is if all the foreign tax income was passive income. That is the case with me. I did not choose to file form 1116, the program demanded it, which I think is wrong. I found the first sentence of your answer interesting because I thought I would be misreporting to the IRS the amount of foreign taxes paid. If there is indeed a "safe harbor" of $600 to avoid filing form 1116, that is news to me and the program did not give me that option. I certainly would have just claimed a $600 foreign tax credit if I knew such a maneuver was above board. In any event, I appreciate your input.

[pk]

@11486 , just to be sure,

(a)    I created a dummy return with Social Security income, single tax payer,  Dividend income of $20,000 and Foreign Taxes paid of US$ 300  ( the safe harbor amount for a single filer ).  TurboTax automatically showed  my tax amount ( the little  Fed Tax box on top ribbon area).

(b) Then just for kicks I went to  Deductions and Credits tab, chose  " I will choose what I work on ", and selected   " Foreign Tax Credit" and went through the screens to  select  "various" as foreign source income, Foreign  income  US$10,000  ( i.e.  10,000 out of the 20,000 dividend income ).   Went to forms mode to see what Turbo has done -- it had filled out a  Form 1116 ( copy-1 ) worksheet.   Now I see that it has recognized the $300 as the foreign Taxes paid. and as credit / exception for line 18.  Form 1040 worksheet shows  the  computed taxes and the credit of $300.  Thus proving that TurboTax recognized the Foreign Tax Credit "Safe Harbor " amount.

(c)  To your question about legality of recognizing incomes and expenses/ taxes paid --- While it is mandatory you recognize each and every income, there is no such requirement  for  taxes paid  ( Foreign ) and/or expenses.  This is generally expressed as  " All income  is taxable unless  excluded by statute and all  deductions  are disallowed unless specifically allowed by statute".

So to answer your situation,  try   recognizing  safe harbor amount for your filing status and see what TurboTax does.

pk

[11486]

Thank you for this, PK. I appreciate the time you put into my problem.

Since my original post last night (April 10), I’ve done some further research regarding the TurboTax.intuit.com article > Claiming the Foreign Tax Credit with Form 1116 > Foreign Tax Credit Without Form 1116. I was interpreting their three bullet point exceptions as each being an independent exception for the need to file form 1116. However, after consulting the IRS.gov instructions for filling out form 1116, the instructions make it clear that all of the three bullet point exceptions are required in order to qualify for being exempt from filing form 1116. 

I think that the TurboTax article is somewhat ambiguous and confusing, the way it presents filing for the foreign tax credit without form 1116. The article talks about a qualifying definition in the first sentence, but then goes down to say “for example,” followed by the three bullet points, making me think that each bullet point was a qualifying definition. Perhaps I am the outlier to how most people would interpret the way TurboTax presented the section Foreign Tax Credit Without Form 1116. 

My misunderstanding of the actual qualifications needed to claim the foreign tax credit without filing form 1116 made me think that TurboTax’s refusal to grant me a foreign tax credit in excess of $600 (in my case $610) was a glitch in the program. I was wrong and TurboTax will properly file with or without form 1116 based on the inputted foreign tax paid. 

PK, to your tax simulation, I have no doubt that TurboTax performed as it should. What I would be interested in, were you to do another simulation (for married filing jointly), where the foreign tax credit is, let us say $700, whether Turbo Tax would grant the full $600 foreign tax credit or some lower amount based on the criteria you used for foreign dividends.

I have concluded that it is just one of the perversities of the tax code that you can get a full $600 foreign tax credit, no questions asked, if this is the amount you enter on line 7 of form 1099-DIV TurboTax worksheet. However, if you were to enter on line 7 an amount greater than $600 (let’s say $650), it is my belief that TurboTax will calculate a substantially smaller foreign tax credit than the “safe harbor” amount of $600 (based on the criteria for foreign dividend amount and country or entity paid entered), creating a carryover of the difference to the following year. This seems fundamentally unfair to foreign taxpayers such as myself.

PK, you seem very knowledgeable about taxes and tax laws, and I am not questioning your assertion that a $600 safe harbor provision exists. The only way that you could utilize this maneuver in TurboTax would be to enter $600 on line 7 of the TurboTax worksheet instead of the actual greater amount. I find it odd that TurboTax does not give filers who have a de minimis amount of foreign taxes paid over $600 the suggestion to not enter the actual amount but only the $600 amount to avoid filing form 1116. I would certainly have done so had TurboTax suggested that as a viable option to avoid the rigamarole of filing form 1116. 

Any further thoughts?

Many thanks.

[pk]

@11486 , 

(a) I went back and tried  with  301  ( 300 resulted in  safe harbor credit of 300 ), -- and Turbo cleared out the 1116  data and  deleted the safe harbor credit.. It therefore isa acting as it should.  

(b)  Turbo does not warn you about the safe harbor, because   it assumes that the tax-payer knows   and needs to choose the  amount of  Credit/Deduction .  It cannot legally suggest to the Tax Payer  that instead of  say $800 ( as shown on the 1099-DIV as foreign tax paid ), the taxpayer may be better off by claiming only $600.  Because  it is your return and it is your choice.  Besides  officially it does not  have all the facts  at this point ( while filling out form 1116 ), even though it can guess .   It is just playing by the rules and   leaving all the decision s to the  User/Client/Taxpayer.

(c) Also note that this safe harbor  availability is  kind of limited to only  US based  earnings i.e. where a 1099-DIV/INT is  issued.  I don't remember the exact statute language on this though.

I hope this now closes your query -- Is there more I can do for you ?

[11486]

PK -

I agree that we have established that Turbo Tax correctly determines the foreign tax credit one is eligible for using form 1116. However, I do not agree with two of the assertions in your responses. 

Assertion #1. You claim in your response to my initial email query that "sometimes it is better to claim only the safe harbor amount of US$600 for MFJ filer." IRS publication 514, Foreign Tax Credit for Individuals, clearly states on page 41 under the heading Form 1116 "you must file form 1116 to claim Foreign Tax Credit unless you meet one of the following exceptions," followed by the exceptions I have discussed with you in a previous post. Nowhere does it suggest, affirm, recommend or allow the taxpayer the option of claiming only US$600 when the amount of foreign tax paid exceeds that amount. This tactic seems to be what you are advising and claiming to be a foreign tax credit safe harbor.

In addition, if you go to google and type in "safe harbor for payment of income taxes", it correctly describes the conditions that would allow you to underpay without penalty, commonly understood to be a safe harbor, to wit, 100% of last year's taxes due or 90% of current taxes due. 

If, however, you google "safe harbor for foreign taxes", you get no such description, to wit, you can enter US$600 as foreign tax paid on your income tax return even if your 1099-DIV line7 shows an amount greater than US$600 in order to avoid filing form 1116. Instead, what google shows is simply the IRS instructions for form 1116.

Therefore, I think there is no such safe harbor provision for foreign taxes paid, as you claim.  If you continue to insist that such a "safe harbor"exists, you are going to have to direct me to the IRS form or publication or other tax authority that supports that. 

Assertion #2. In your last post to me, you say: "(b) Turbo does not warn you about the safe harbor, because it assumes that the taxpayer knows and needs to choose the amount of Credit/Deduction. " This (b) was in response to my comment saying "I find it odd that Turbo Tax does not give filers who have a de minimis amount of foreign taxes paid over $600 the suggestion to not enter the actual amount but only the $600 amount to avoid filing form 1116." 

TurboTax has no basis to assume that the taxpayer knows about the so-called "safe harbor." Also, if my memory serves correctly, Turbo Tax gives the taxpayer options in several different circumstances, for example, as to whether to take the standard deduction or to itemize. If you elect to fill in the Schedule A worksheet, it will calculate your tax based on which is more favorable. Another example is the foreign tax credit worksheet itself, where it gives you the option of whether to claim the credit or take the credit as a deduction.

Therefore, if this foreign tax credit safe harbor exists as you define it, I can think of no reason why that could not be one of your options in the foreign tax credit worksheet regardless of what you say in (b). I thought the whole point of Turbo Tax was to allow the taxpayer to pay the least amount of taxes legally required. 

[pk]

@11486  

Page 18 of  Pub 514   ( on the subject of whether the safe harbor amount exists)

Exemption from foreign tax credit limit.

You will not be subject to this limit and will be able to claim the credit without using Form 1116 if the following requirements are met.

• Your only foreign source gross income for the tax year is passive category income. Passive category income is defined later under Separate Limit Income. However, for purposes of this rule, high-taxed income and export financing interest are also passive category income.

• Your qualified foreign taxes for the tax year are not more than $300 ($600 if married filing a joint return).

• All of your gross foreign income and the foreign taxes are reported to you on a payee statement (such as a Form 1099-DIV or 1099-INT).

• You elect this procedure for the tax year.

If you make this election, you cannot carry back or carry over any unused foreign tax to or from this tax year.

This election exempts you only from the limit figured on Form 1116 and not from the other requirements described in this publication. For example, the election does not exempt you from the requirements discussed earlier under What Foreign Taxes Qualify for the Credit..

[11486]

PK - How you are now defining the “safe harbor” for the foreign tax credit is like saying the standard deduction is the “safe harbor” for deductions. Nobody does that.