On Form 1116 are both 403b plan distributions and income from a US rental classified as "Passive category income"?

[carlos3]

My wife and I are retired and living in the Netherlands, which is our tax home now. Our income is from 403b and 408 plan distributions, US Social Security, plus income from renting our home in the US. My questions have (mostly) to do with the "category of income" that I should list on Form 1116 for each of these types of income:

1) I believe that the 403b and 408 plan distributions and the income from renting our home in the US should both be listed on the same Form 1116 as "Passive category income." Is this correct?

2) Is it correct that the US always taxes US Social Security, and that it should NOT be listed on Form 1116? (If a credit is needed here, am I correct in assuming that I need to consult a tax specialist in the Netherlands about having their taxes on US Social Security reduced?)

3) When I list the income amount from the rental, should I merely list "rental income" from Schedule E? Or do I need to specify rental expenses in the section of Form 1116's Part I related to "Deductions and losses"?

Many thanks for any help you can provide.

[DianeC958]

1)  Yes, it is correct that these types of income are passive.

2) No the US does not always tax Social Security.  At the most Social Security 85% of you Social Security may be taxable depending on your other income.  If you are Married Filing Joint and your combined income is more than $44,000 then 85% of your Social Security is taxable.

If you combined income is less than $32,000 then none of your Social Security is taxable.  Between $32,000 and $44,000 50% of your Social Security is taxable.

Link to Benefits Planner from the Social Security Web Site

3) For you rental income/loss you just report the loss or income after the deductions are taken for the rental.

[carlos3]

Thanks for responding, DianeC958. With respect, you are not responding to my questions within the context of Form 1116. At issue with this form is whether various types of a US citizen's income are first taxed by another country before the US has (according to its anti-double-taxation treaty with that country) the right to tax the income to the extent that the foreign taxes are less than what the IRS would levy. For example, if country A's taxes on the amount in the income category are more than the IRS's taxes would have been, the citizen would pay the IRS zero taxes on that income. But if the IRS's taxes were greater than country A's taxes, then the citizen would owe the IRS the difference. So in filling in Form 1116 it is critical that one knows which country is the one to tax a US citizen first. To avoid double-taxation, the US taxpayer needs to notify "the country that taxes second" that s/he is eligible for a "Foreign Income Tax Credit" for the taxes they are paying to "the country that taxes first". When completing a 1040, Form 1116 is where one communicates to the IRS that you have already paid part (or all) of the taxes that you would have paid the IRS if the US were "the country that taxes first." The hitch in all this is that these taxes are specific to income types (e.g., passive, general, re-sourced).

Deciding on a category generally depends on the income source. That is, if your income was from wages earned in country A while you were a resident in country A, then country A is (as I said, generally) "the country that taxes first." This income would be classified as "General category income" on Form 1116. Hitch number 2 is that some types of income are "Re-sourced by treaty." This means that a deal has been made between the US and country A that a specific type (passive, general, or some other sort) of income is taxed first in your country of residence even though its source is in the US. My questions have thus foremost to do with whether or not distributions from 403b & 408 plans, income from a US rental property, and Social Security payments should be reported on Form 1116 at all. The form is only for reporting income that the US "taxes second," right? If the US is "the country that taxes first" on a type of income, than that income would not be reported on the form.

So getting back to your answers: Of course, distributions from 403b & 408 plans, rental income, and Social Security benefits are all passive income. But since each has its source in the US, knowing whether or not these are classified as such on Form 1116 involves knowing whether any or all of them are re-sourced to the US citizen's country of residence. Maybe TurboTax does not have the resources to research every anti-double-taxation treaty that the US has negotiated with foreign countries. If so, this too would be useful to know.

I realize that TurboTax experts like you are flooded with questions at this time of year. However, might you please revisit this question?

[DianeC958]

The United States taxes world wide income.   So you report all of your income from the United States and foreign countries on your United States Income Tax.  Any foreign income you have earned and paid tax to a foreign country on that income is then reported on form 1116 and you receive a credit for the tax paid to the foreign country for any income tax you would owe to the United States.

Since your 403, 408, rental income and Social Security income are from the United States none of this income belongs on form 1116 since it is all United States Income.

If you are considered a resident of the Netherlands they also tax worldwide income and may have a similar form to give you a credit for income tax you pay to the United States on the income.

For the United States it does not matter who taxes the income first or second it is a matter of you receive a credit for taxes you pay to another country against what you owe to the United States for that same income.

[carlos3]

I have been slow in responding to your 2nd post, DianeC958, because I wanted to be absolutely sure of what I am about to say:
1. It is NOT true that residents of the Netherlands (and of many other countries worldwide) should not list income from their IRAs (including 401k, 403b, 408, and other “qualified” retirement plans) on Form 1116. In the vast majority of tax treaties, these types of income are re-sourced to the country of residence and are taxed in the foreign country as regular income. Moreover, the values of Roth IRAs, stocks, bonds as well as holdings in US mutual fund companies (including all non-qualified retirement plans) are taxed here (i.e., in the Netherlands) as wealth, and in your US tax return these values should be listed on a separate Form 1116 for passive category income.
2. On the other hand, it IS true that social security benefits and rental income from US property are only taxed in the US, and should not be listed on a Form 1116. (As an aside: Even though the Netherlands does not tax rental income on property outside its borders, it does require its residents to list the [non-taxed] value of these properties on their Dutch tax returns.)
3. My references to the country that “taxes your income first” (typically, your country of residence) was my shorthand way of referring to the country that can claim that it is the income’s source. (The “sourcing” terminology gets tricky with types of income that are re-sourced by treaty.) The country that “taxes your income second” (again my shorthand) refers to the one that you need to request a tax credit from for taxes paid in the country that taxed it first. Once you are a Dutch resident, the Netherlands taxes your (re-sourced) IRA-type income and your worldwide wealth (excluding non-domestic real estate) first. You must then use Form 1116 to obtain tax credits (to prevent double-taxation of this income) on your US income tax return, since for these types of income the US gets second “crack” at taxing them. The tax treaties ensure that there is no income type that requires you to seek credits from both countries. The country that has second crack, is the country to which you apply for tax credits.
Some other useful facts about residing in the Netherlands:
a) As soon as you have lived in the Netherlands for 4 months, you are a Dutch resident (for both US and Netherlands) and are required to pay taxes retroactively to the day you arrived. (You are also required to buy health insurance from a Dutch health insurance company. Moreover, if you had not previously done so, you are also delinquent in registering your address and arrival date with your local city hall.)
b) Dutch income taxes are of four types: income (wages, re-sourced IRAs, etc.), business (about which I know nothing), wealth (market value of stocks, mutual fund holdings, non-qualified US retirement plans, etc.), and social health contribution. All these taxes are progressive, so it is not easy to convey precisely how they might apply in any specific case. However, anyone contemplating retirement in the Netherlands should be aware that as soon as your income (e.g., from IRAs) exceeds about 35,000 Euros, almost 40% of every penny over this amount goes to taxes (and it reaches over 50% for income over about 70,000 Euros). The only way for most retired folks to avoid this, is to have enough wealth to cover your expenses above this amount. Hint: Instead of renting your Stateside house, it might be wisest to sell it in case your other wealth won’t provide you with sufficient cash-flow.
I hope this information proves useful to others. It certainly would have been useful to me when we moved to the Netherlands back in 2016.