Foreign tax issue, ? FTC

[skaufmann]

Hello,

I realize FTC is credit for foreign taxes paid for which you are subjected to US tax on the same income.
How would one deal with this scenario (see below), I am sure many have come dealt with before.

Hypothetical Scenario: A US resident in Year 2012 purchases 100$ worth shares of Mutual bond fund A (@ 1$ per share). The person later relocates to Germany and is a German tax resident starting 2022. In July 2022, that person sells the share lot when the price is down for 90$ (@9 $ a share). For US tax purposes he would register a loss of 10$ (90-100= -10).

If Germany insists on converting both these transactions to Euro using rates at purchase and sale (lets assume at purchase rate was 1 US$ = 0.75 Euro in 2012, and 1 US$ = 1 Euro in 2022), then this transaction results in a 90-75=15 Euro gain.

In above scenario, by US dollar there is a loss of 10$ registered, whereas Euro conversion leads to a Gain.
My question is can anything be done with the taxes paid in Germany for this gain? Is there any other recourse, or ideas how one would handle it. Has anyone experienced this before? I would think one would come across this scenario if one held US federal tax exempt Mutual funds also. I would appreciate any feedback, Thanks.

[pk]

@skaufmann ,  assuming that you are a US parson ( citizen/ GreenCard ) from 2012  till date    i.e. US laws were and are applicable to you for the duration:

(a) Germany  , while you were/are a resident, can indeed tax ypou on the disposal of such assets  and execute such based on its laws, irrespective of US tax laws. ( if I remeber correctly Germany taxes you on world income while being a resident of Germany ).  Thus Germany will indeed  com pute the gain based on Euro of the day ( both for acquisition and disposal)

(b) For US tax purposes, US$ being operative currency all transactions are ij US$ of the day ( or average of the year  ).

(c) Since both jurisdictions are taxing the same income you are eligible for foreign tax credit ( and thereby ameliorating the double taxation bite )  using form 1116. Note however that  while the US will recognize the total  foreign taxes paid, the amount allowable  in the current year is based on a ratio of  Foreign income to world income  ( and thus is never 100% ).  You can also take the foreign tax as a deduction ( but here you have to contend with the SALT limitations ).

Does this make sense ?  Is there more I can do for you ?

pk

[skaufmann]

@pk 

Thanks for your reply. 

Yes I am a US person since 2012.

So you are saying that even if in US 1099-B, it is a loss, I can claim a FTC?

Also what is included in Foreign income? (the FTC I am claiming is all for US sourced mutual fund dividends and Capital gains). I don't have earned income in DE.

Thanks

[pk]

@skaufmann ,  yes  if your tax home is foreign , you are paying foreign taxes  on income that US is also taxing and the actual source of income is US, you can  ( only for purposes of form 1116 ), resource  the US sourced income "by treaty" -- you use the correct category on form 1116  for this purpose .

Does that help ?

pk

[skaufmann]

@pk 

Thanks pk, that does help.

A small clarification, I always thought that US source dividends, interests and capital gains go in the "passive category" for form 1116 (and not the re-source by treaty). Is that not true.

The confusion arises when one read this statement on the IRS publication 514, section "certain income re-source by treaty", This rule does not apply to income that is re-sourced by reason of the relief from double taxation rules in any U.S. income tax treaty that is solely applicable to U.S. citizens who are residents of the foreign treaty country.

[pk]

@skaufmann , i was wrong ( and slightly right ).  The confusion is this that  if you ignore the  tax treaty assertions/conditions, then you  let US tax you at the rate it  does and then mitigate double taxation by claiming  foreign tax credit / deduction as usual  ( the former using form 1116 and "passive category" , the latter using itemized deduction and with current SALT limitations ). 

What the treaty does is  also puts in an additional constraint on the US to not  tax this income at a rate  higher than dictated by the treaty -- mostly at 15%.  This gets complicated  and may or may not be  of sufficient benefit  for the additional work involved  ( note that  form 1116 allowable credit limitation still applies ).  What I have been searching for  is if this additional benefit is mandatory  ---  sections 865 and 904  are the pertinent sections of code .  Pub 514 uses the word "should" and "may" and the above code sections also do not indicate  any mandatory nature .  Therefore my conclusion is that you are free not to use / assert  treaty  benefits.

Does this help ?  or am I additing to the confusion ?

pk

[skaufmann]

@pk 

@pk, you input (as always!) helps. I appreciate it. 

I now understand what you are saying, i.e pay full US tax and take FTC using 'passive category' for the tax portion paid in resident country OR assert the treaty using "treaty resourcing rules" and limit US tax to treaty agreed 15%. I see that most CPAs want to avoid the treaty regulations and extra forms (e.g. 8833) advocate just paying US tax and taking FTC credit in passive category.

Thanks again for your expertise.