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How to determine how much foreign tax qualified for foreign tax credit?

My situation is complex.  I file tax form with my wife together.  We live in a foreign country, I have incomes from different sources, A, B, and C, my wife have sole incomes from D.  I paid foreign tax for A and B at different tax rate, but no tax for C, my wife paid foreign tax for D.  Part of my total incomes is excluded as the foreign earned income and foreign housing exclusions, and all my wife's incomes is excluded.  I know I can only take foreign tax credit for the foreign tax paid for those incomes not excluded.  

How to determine how much tax is for those not excluded incomes?  How do I know the excluded incomes are for A, B, or C? Can I choose A or C as excluded incomes since their tax rate is lower, and B as not excluded income?  Or the total tax I paid divided by all my incomes then multiplied by the incomes not excluded? or  the total tax my wife and I paid divided by all our incomes then multiplied by the incomes not excluded? 

Thanks a lot!

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Accepted Solutions
pk
Level 15
Level 15

How to determine how much foreign tax qualified for foreign tax credit?

Foreign income is usually treated as a "lump" with no distinction between  source, assuming that they are all  the same type of income ( say wages, self-employment etc. ).  Of the unexcluded income, eligible for foreign tax credit,  the most correct accounting method would be to allocate the tax  based on some criteria such as amount or  effort spent etc.  But nothing stops a taxpayer from choosing to allocate the tax in a manner that is best for the tax payer -- just do it consistently year after year. for example  if you had 140k in income  and 30k total foreign tax, foreign exclusion ( say ) for the year being 90K, the easiest way to allocate would be to apply the 30K to the total 140K and therefore the  foreign tax eligible for  credit would be 0.2143  ( over all foreign tax rate ) times 50K ( unexcluded income ) = 10K, the other 20 K having been allocated to the excluded income.  Suggest you work out some similar methodology and stick to it. If IRS challanges it, they will question the method and that it unfairly benefited you-- it is not so easy to prove that and may not be worth the turmoil

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6 Replies
pk
Level 15
Level 15

How to determine how much foreign tax qualified for foreign tax credit?

Foreign income is usually treated as a "lump" with no distinction between  source, assuming that they are all  the same type of income ( say wages, self-employment etc. ).  Of the unexcluded income, eligible for foreign tax credit,  the most correct accounting method would be to allocate the tax  based on some criteria such as amount or  effort spent etc.  But nothing stops a taxpayer from choosing to allocate the tax in a manner that is best for the tax payer -- just do it consistently year after year. for example  if you had 140k in income  and 30k total foreign tax, foreign exclusion ( say ) for the year being 90K, the easiest way to allocate would be to apply the 30K to the total 140K and therefore the  foreign tax eligible for  credit would be 0.2143  ( over all foreign tax rate ) times 50K ( unexcluded income ) = 10K, the other 20 K having been allocated to the excluded income.  Suggest you work out some similar methodology and stick to it. If IRS challanges it, they will question the method and that it unfairly benefited you-- it is not so easy to prove that and may not be worth the turmoil

How to determine how much foreign tax qualified for foreign tax credit?

Thanks a lot!  So I do can allocate the excluded incomes to C (no tax paid) and B (lower tax rate) , and the unexcluded  income to A (higher tax rate), right?  This is the ways that always benefits taxpayers, so of course I can stick to it if it's allowed.  Thank you!
pk
Level 15
Level 15

How to determine how much foreign tax qualified for foreign tax credit?

As I said, the blended rate ( all taxes  for the total foreign income ) is the most correct method ( in IRS' view but then there is other doctorine of allocating the way that is best for  unless there is a regulation forbidding  it.  I don't know of such reg or case law , so I think you are safe --- but make sure you stay on the same path all the time Good Luck

How to determine how much foreign tax qualified for foreign tax credit?

Thank you very much!
ttnllwang
New Member

How to determine how much foreign tax qualified for foreign tax credit?

Just to clarify, if I have foreign income of $140K from one foreign employer only (and filing jointly with my spouse in US with US income only), with $90K exclusion, and foreign tax of $30K, I can file for the exclusion AND the foreign tax credit simultaneously, right?

How to determine how much foreign tax qualified for foreign tax credit?

Yes, I think so.  But you can only take the foreign tax credit for the income not excluded
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