Really stuck in the foreign income and foreign tax and foreign tax credit carryover, help

[ZengFreeman]

I have Turbotax home & business. For the past few years, I had accountant doing my taxes because I do not know how to handle foreign income. I thought well this year is simple since I only had pension withdraw from the UK, so I tried to use Turbotax myself. 

First time, I entered everything from scratch, did all my rental income, investment and taxes, the foreign income left in the end since I did not know how to do it. First time I entered under the uncommon income section according to gemini, well, the turbotax could not link the income entered in uncommon section to the foreign tax credit section, and anyway, it ended up the file corrupted, so I lost all the information I entered.  I was so pissed after  three days of hard work. I hired a turbotax tax accountant to do the tax. She is worse. She actually entered my UK tax withheld under the federal tax section. So I decided to try myself again.

The second time, according to gemini, I tried to enter the income under retirement income section, and went to foreign tax and credit section, enter my tax and carryover, still ended up massively wrong, the end showed my foreign tax credit is $239, and I could not find the information entered. 

Anyway, I have $33000 UK income last year, with $13000 UK tax withheld, and I had $54000 UK foreign tax credit carryover, anyone can give me detailed instructions how to do that? Gemini is making things up. I followed step by step of what it said. 

many many thanks. 

[DaveF1006]

It depends. The $239 tax credit may be correct, depending on whether you have other US income you received during the year. This is the part that feels “wrong” but is actually how the law works.

The foreign tax credit is limited to the portion of your U.S. tax that relates to your foreign‑source income. In plain terms: Max Foreign Tax credit= US tax on all income X foreign source income / all income. So even if you:

• Paid $13,000 UK tax this year, and
• Have $54,000 carryover from prior years,
• You cannot claim more credit than the limitation formula allows for this year. The rest stays as carryover (forward or back, depending on the year rules). So if TurboTax shows something like $239 as the allowed foreign tax credit, that usually means:

1. Your U.S. tax on the UK pension portion (after the formula) is only about $239,
2. So that’s the maximum credit you can use this year,
3. The remaining $13,000 + $54,000 − $239 stays as carryover.

That’s why you “can’t find” the full $13,000 and $54,000 as a current‑year credit—they’re mostly stuck as carryover, not allowed this year.

@ZengFreeman 

[ZengFreeman]

I looked at the generated tax form. Because I have not entered other information yet, the only $239 was after the standardized deduction. But I actually do not know why I owe any federal tax to the foreign income at all. 33k Uk income with 13k tax, that is higher than US federal tax rate already, plus I have so much foreign tax credit, should it not my UK tax completely wiped out the tax due to IRS since UK and US have the treaty that avoids the double taxation. 

[DaveF1006]

The foreign tax credit is a non-refundable credit. A non-refundable tax credit is a tax break that can reduce the amount you owe to $0, but it cannot trigger an additional credit for any "leftover" amount.

So if you haven't entered any other information and since only $239 remained after the standard deduction, only $239 could be claimed as a Foreign Tax Credit to "zero out" your tax liability up to this point. 

This may all change once you complete your tax return.

[ZengFreeman]

This is my third try. 

I entered all my US income and tax information, turbotax said I had tax refund of $10595, 

Then I went to retirement section and enter my 36k UK retirement withdraw,

Then I went to foreign tax credit section, and enter my UK tax withhold of $13k,

Now my tax refund is reduced to $4668.

So obviously Turbotax does not allow me to use all my UK tax withhold against UK income. 

How to fix that? I am so **bleep** annoyed

[rogge1722]

Under Article 17 of the U.S./U.K. tax treaty, pensions are taxable only in the "STATE" where the pensioner is a resident. Here "STATE" means the U.S. This raises the question as to how your U.K. sourced pension payments were subject to withholding. If there is some complication or some other provision in the treaty whereby your payments are taxable in the U.K., was this made known to you by the U.K. taxing authority?

[DaveF1006]

While it feels like TurboTax is "disallowing" your credit, what you’re likely seeing is the Foreign Tax Credit (FTC) Limitation in action.

The IRS has a "fairness" rule: they won't let you use foreign taxes to wipe out tax on your US-sourced income. You can only use the UK tax to offset the US tax specifically assigned to that UK income. The remaining Foreign Tax will be an excess amount that you would first carryback to your 2024 return if you had foreign income for that year and then if there is "additional excess" it will carryforward for ten years (starting in 2026)  to be used to offset any future foreign income. 

The reason, why your refund dropped is when you added the $36,000 UK withdrawal, your total taxable income went up, which increased your Total Tax Liability. Then, when you added the $13,000 foreign tax, TurboTax calculated your "Credit Limit" using this formula:

FTC LIMIT = (US TAX) X ( foreign taxable income/Total worldwide income)

For example, If your total income (US + UK) puts you in a 22% effective tax bracket, the US tax on that $36,000 withdrawal is roughly $7,920. Even though you paid $13,000 to the UK, the IRS will generally only let you take a credit for that $7,920 this year. 

The "missing" $5,080 ($13,000 - $7,920) doesn't disappear; it becomes a carryover that you can use in future years, as I mentioned previously. 

@ZengFreeman 

[ZengFreeman]

Thank you. I have a a really big foreign tax credit carryover from the past few years already. Going forward, we will not have any foreign income. Will those credit simply be expired by the end of 10 years period, or can I use in any other way to offset US tax.  

[DaveF1006]

No, you will need to have foreign income to offset the carryovers in the next ten years. If these carryovers are unused, they will expire at the end of that time period.