Foreign Tax Credit

[JorgeB1972]

We cashed out RRSP's from Canada in 2020 and again in 2021 (an RRSP is the Canadian version of 401K / IRA).  I always thought there was a tax treaty between the 2 nations, so that you would not have to pay double taxation for income earned in the other country.

The taxes paid in Canada on the RRSP default to 25%.  In 2020, the US tax credit allowed us to only apply less than a 1/3 of the taxes paid in Canada, so the balance of the RRSP was subject to US taxation.  This year, the IRS has allowed about 1/2 of the taxes paid to count as a credit, so I'm confused by the tax treaty and double taxation; it seems (to me at least) this is a myth and I am subject to a lot of double taxation.

I'm wondering if my situation sounds correct - even though I've paid taxes in Canada, does the IRS only allow a share of those foreign taxes to count as a credit towards our US return?  If I can't use all my foreign taxes credits when the income is subject to US taxes, is there ever any situation where I can use those left over tax credits, or will they just expire after 10 years?

When preparing my taxes, Turbo Tax asked if I want to apply any left over credits from prior years.  If I can't apply all of the current year credits, is it of any benefit to try to apply prior year credits?  And if I do include them, is that when the clock starts towards the 10 year window or will they expire in 2030 regardless?

Any feedback is appreciated.

[jtax]

The FTC makes my head hurt. It is so complicated and not very intuitive.

One thing to understand is that your FTC is limited by the proportion of foreign income to worldwide income times US tax.

This effectively means that if you have modest foreign income compared to your total income, you can't claim all the credit.  As you say the carryforward is worthless if you won't have more foreign income and a higher proportion of foreign income to US income in the future before the credits expire.

(One alternative is to get an itemized deduction not credit for the whole amount. But you can't switch back and forth (I think) and with the large standard deduction it might not make any sense.)

So for example if you have $25k in foreign income and $75k in US income, with $10k if foreign tax and $20k in US tax, the FTC limitation looks like this:

15k us tax times (25 / 100k) = 20k x .25 = 5k max credit for the foreign tax of $10k.

Now that is only about the US FTC. Treaties can change which country gets to tax what. That is very complicated. You might look at the actual treaty. It is here:

https://www.irs.gov/businesses/international-businesses/canada-tax-treaty-documents

It could well override US tax law or Canadian tax law and only allow one country to tax it. If so there may be a special procedure to stop Canada from taxing the pension or claiming an additional US tax credit.

You also might find IRS Pub 514 helpful

https://www.irs.gov/forms-pubs/about-publication-514

You might want to hire a CPA, enrolled agent, or tax attorney who specializes in US/international personal taxation to review your situation. There are probably many who special in Canada/US tax issues. I suggest that you do not use a regular professional. Specialization here is very important. Someone who regularly works in this area will just know the answer and will be worth buying an hour of their time.