Form 1116 line 4a (mortgage interest) is wrong when line 1a (gross foreign income) is adjusted

[lambell]

There are times when foreign source qualified dividends/capital gains must be adjusted before entering on line 1a (gross foreign income). See fed instructions page 9 for details, if interested. In cases where the adjustment is made, TT uses the UNADJUSTED amount when calculating the mortgage amount for line 4a. That's wrong; it should use the ADJUSTED amount.

Here is the worksheet from page 18 of the instructions for calculating line 4a.

In my case, unadjusted gross foreign income is ~$16,000. Adjusted gross foreign income is ~$7,000. TT correctly calculates and puts $7,000 on line 1a of Form 1116. But it uses $16,000 instead of $7,000 on line 1 of the worksheet above. That results in a larger amount being calculated for line 4a, which ultimately results in a smaller max tax credit being calculated on line 21. As a result, I am not able to take the full FTC that I am entitiled to.

[rogge1722]

The worksheet on p18 uses the phrase "gross foreign source income" and that exact phrase is used in form 1116 line 3d. TT's instructions state that the source for line 3d is the f1116 worksheet line 1f which uses the phrase "unadjusted gross income this category." Apparently TT takes the position that is what the IRS requires.

[lambell]

Interesting, good point. Yet the instructions for line 1a refer to that line as "foreign gross income", which is basically the same as "gross foreign source income", so are we reading too much into specific wording?

When income is adjusted on line 1a, TaxAct uses the adjusted number for line 1 of the Home Mortgage Interest worksheet. That's why I assumed TurboTax was doing it wrong.

The instructions for line 3d explicitly say to use the unadjusted amount. The instructions for line 4a don't specify. So an argument could be made that you should use the adjusted amount, else the instructions would have been explicit as with line 3d. But I suppose you could also argue that since lines 3 and 4 both calculate pro rata shares of expenses/deductions, they both should use the same, unadjusted, number.

I guess this is a gray area open to interpretation, since there doesn't seem to be any specific IRS guidance. Thanks for the reply; it gives me something to think about.

[DaveF1006]

Yes.TurboTax and TaxAct handle the Home Mortgage Interest (HMI) Worksheet differently because the IRS gives clear instructions for Line 3d, but not for Line 4a. That’s why you’re seeing a difference.

As you noted, the IRS is explicit here. Even if you have "Adjusted" your income on Line 1a (reducing it because of the lower tax rate on qualified dividends/capital gains), Line 3d must use the unadjusted, full gross amount. This line is used to create a ratio for general expenses (like the standard deduction). The IRS wants that ratio based on real-dollar flow, not the "adjusted" lower number used to calculate the tax limit.

Line 4a (Mortgage Interest) is calculated via its own separate worksheet. Because the IRS instructions for that specific worksheet don't explicitly say "use the unadjusted amount" (unlike Line 3d), software companies have to interpret the law. TurboTax takes a conservative approach by saying "If the IRS wants gross income for the Line 3 ratio, they want the same consistent denominator for the Line 4 ratio." 

Tax Act may interpret this differently by saying "Line 1a is the official 'Foreign Gross Income' for the form; unless told otherwise, we use the value on the form." 

You could make a case either way, but TurboTax uses the unadjusted gross amount to keep things straightforward and avoid extra attention from the IRS.

@lambell