Foreign Tax Credit

[DABU]

Good morning,

We are originally from India and now settled here. We have fixed deposits or cumulative deposits in Indian banks and received interest in 2020 in the local currency (rupees). The banks automatically deduct taxes for the interest paid.

The Indian Income tax levies tax on individual taxpayers based on a slab system. Slab system means different tax rates are prescribed for different ranges of income. It means that the tax rates keep increasing with an increase in the income of the taxpayer.

Based on the slab system, there is no tax on income up to $3,500/year irrespective of the source. Our interest income is less than $3,500. Our CPA files taxes in India. So, we receive a full tax refund.

There is Double Tax Avoidance Agreement (DTAA) between India and the USA. My questions are as follows:

• If we are not paying any taxes in India, do we need to report interest received in India on our 2020 US federal tax return?
• The other option is, not to file taxes in India but file ‘Form 1116” and receive foreign tax credit with federal taxes. But the issue is, the “State of Ohio” does not allow foreign tax credit.
• How do we know which one is the best option?

I have been using TurboTax Premier and this is the first year that we are having this issue. But we will face the same issue (capital gains; double taxation) in the coming years when we sell real estate in India. Please provide your comments and suggestions. Thanks, Dabu.

[JeffreyR77]

You are required to report your total worldwide income.  You are required to report interest income received in India.

You would not be able to claim the foreign tax credit for the tax on interest income if you did not file your India taxes. 

To claim foreign taxes on Form 1116, the tax has to be paid and owed. 

As your tax would be refunded if you filed taxed in India, the foreign tax would not be allowed on Form 1116. 

Frequently Asked Questions (FAQs) About International Individual Tax Matters (see FAQ 1 - worldwide ...

[DABU]

Thank you JeffreyR77 for your reply. I appreciate it. 

1. If we don't file taxes in India, we could take a credit on Form 1116. Am I right? Taxes are already taken out at the source by the bank in India. 

2.  I don't understand this statement: "You would not be able to claim the foreign tax credit for the tax on interest income if you did not file your India taxes."

3. Since our income is less than $3,500/year, no need to file taxes in India. If we need to receive a refund, need to file taxes. 

My question is, which scenario is better-filing taxes in India and receive a full refund or don't file taxes in India and receive a foreign tax credit here for the taxes paid in India. Regards, Dabu. 

[DaveF1006]

It depends. Please read this Turbo Tax link, for instructions on how to properly report this. Here are the instructions onn how to do this for an interest form.

1. Log into or open Turbo Tax.
2. Once you are in your tax return, click on the “Federal Taxes” tab ("Personal" tab in TurboTax Home & Business)
3. Next click on “Wages & Income” ("Personal Income" in TurboTax Home & Business)
4. Next click on “I’ll choose what I work on” (jump to full list)
5. Scroll down the screen until to come to the section “Interest and Dividends”
6. Choose “ Interest on 1099-INT” and select “start’
7. Select "I'll type it in myself"
8. Enter the name of the foreign bank, the amount (in USD) in box 1
9. Check the box "My form has info in more than just box 1 (this is uncommon)".
10. Enter any foreign taxes paid in box 6 

[DABU]

Thank you DaveF1006 for your reply and for the links. I thought more about the issue. It is better we file taxes in India and receive a full refund. With US taxes, mention the amount of dividends received and pay taxes. By taking this approach both tax departments (US and India) will have records. In addition, as I mentioned before, State of Ohio doesn't allow foreign tax credit.  Please provide your comments and suggestions. Regards, Dabu. 

[JeffreyR77]

You are not eligible for a foreign tax credit on taxes that would be refunded if a tax return is filed in India.

They are not really taxes owed on that income as the taxes are refundable. 

You would only be able to claim a tax credit if the taxes were not refundable. 

[RG2K]

DABU:

          Thanks for this question. Considering that you will/have filed taxes in INDIA to reclaim your TDS, I have few followup for you:

Say you earned Rs. 1000 as interest in your INDIA account, and TDS of Rs.300 (30% plus education cess) got deducted at source in 2020. Usually INDIA tax refunds will be in following year i.e 2021.  Will you show the full amount of Rs. 1000 on your US 2020 taxes OR will you show Rs. 700 for 2020 and Rs. 300 (refunded by INDIA) in your US 2021 taxes?  In short, the refunded TDS is taxed in US in which year? 

In the past, I have used the approach of showing the full amounts (e.g Rents I have received) as income on my US taxes in the same year, as if the TDS never happened. Then when I file my INDIA taxes, usually I get my entire TDS back. 

I am trying to see what others usually do and if the had any experience checking with tax experts on this? Please share your experience.  

[tax052020]

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@JeffreyR77 wrote:

You would not be able to claim the foreign tax credit for the tax on interest income if you did not file your India taxes. 

Can you please clarify on that. If I did not file taxes in india I wouldn't able to claim foreign tax credit ? My bank in india deducted tax automatically on interest income. But it is minimal and I am not required to file taxes in india.

[DaveF1006]

Yes, you should be able to claim a foreign tax credit if the foreign tax collected was imposed by the foreign government. To claim it, you will need to report the interest income and then declare how much foreign tax paid in Box 6.  Here is how to report.

1. federal>income and expenses
2. Interest and Dividends>1099 INT
3. Even though you don't have this form, you can pretend like you do.
4. You can list the name of the Bank under received from and report the interest income in Box 1 and the tax that was withheld in Box 6.

@tax052020 

[tax052020]

@JeffreyR77 

Jeffrey seems to imply that I can claim ONLY IF I filed taxes in India.

@DaveF1006 

My research shows that if I file taxes in India the TDS would be refunded because my overall income from India is less than a certain value. But I do not have any intentions to file taxes in India. So may I ask again, can I claim this in Box 6 even though I am choosing not to file taxes in India?

[DaveF1006]

It depends.  In reading this IRS publication, 

1. You can claim a credit only for foreign taxes that are imposed on you by a foreign country or U.S. possession. Generally, only income, war profits and excess profits taxes qualify for the credit. If you examine this, the bank withheld tax from the interest paid and paid this to the foreign government for safekeeping.
2. It also mentions in the publication that The amount of foreign tax that qualifies as a foreign tax credit is not necessarily the amount of tax withheld by the foreign country. If you are entitled to a reduced rate of foreign tax based on an income tax treaty between the United States and a foreign country, only that reduced tax qualifies for the credit.  It is up to you whether you want to file  with the foreign country  for a refund of the difference (excess) for which a foreign tax credit is not allowed.
3. The second point seems to suggest that you could file a US tax return but you may only be given credit for a reduced amount of the tax whereas if you file with the foreign country, you may receive a full refund. 

@tax052020