It seems I may have been mistaken about the requirement to always use the adjusted version of 1116 when figuring the ODL amount creation even if you elect not to adjust for the FTC limitation.
I went through a long flip flopping conversation with ChatGPT:
It seems that there is no explicit regulation or instruction that states you must adjust when figuring the ODL amount if you elect not to adjust for the FTC limitation.
Here's why:
§ 1.904(b)-1(h)(1)(iii) states that when determining the ODL amount under section 904(f)(5)(D), you “shall make appropriate adjustments.”
- This could imply that adjustments must always be made.
However, Example 3(iv) in § 1.904(b)-1(h)(1)(iii)(2) contradicts that, showing that Y does not adjust when calculating the ODL amount because Y elected not to adjust for the FTC limitation.
- This suggests that the “shall make adjustments” rule only applies if you didn’t elect out of the adjustment.
§ 1.904(g)-1(d)(3) says:
"The amount by which a domestic loss is considered to reduce foreign source income in a taxable year shall equal the section 904(f)(5)(D) amount determined under § 1.904(b)-1(h)(1)(iii), regardless of the amount of domestic loss that was determined before taking any section 904(b)(2) adjustments into account."
- This references § 1.904(b)-1(h)(1)(iii), which, as we saw, allows for no adjustment if the taxpayer elects out.
- Since the ODL amount is based on § 1.904(b)-1(h)(1)(iii), and that section allows for no adjustment in Example 3(iv), the same rule applies here.
Conclusion:
There is no clear rule requiring adjustments when calculating the ODL amount if you elected not to adjust for the FTC limitation. In fact, Example 3(iv) shows the opposite—that you don’t adjust. So while some parts of the regulations seem to imply adjustments are required, the example suggests otherwise, and there is no definitive statement mandating adjustments in all cases.
Now regarding ODL recapture, I had to keep telling ChatGPT that it was hallucinating non-existent sections of the regulation. After about an hour:
§ 1.904(b)-1(h)(1)(i):
- States that adjustments under (a), (c)(1), (d), and (e) apply when determining separate limitation income/loss, overall foreign loss (OFL), separate limitation loss (SLL), and additions/recapture of those losses.
- (e) contains the election not to adjust (my comment: only about dividends though, not about capital gains)—meaning that if you elect not to adjust, then the figures used for these calculations should reflect that election.
§ 1.904(b)-1(h)(1)(iii):
- Defines the section 904(f)(5)(D) amount, which is used to determine the portion of a domestic loss that reduces foreign source income.
- Also references (e), which contains the election—again suggesting that if you elected not to adjust for FTC limitation, that same election should apply when calculating the ODL creation.
§ 1.904(g)-2(b):
- Covers ODL recapture and states that U.S. source taxable income is determined "by taking into account adjustments for capital gains and losses and qualified dividend income in a similar manner to the adjustments made to foreign source taxable income under section 904(b)(2) and § 1.904(b)-1, following the principles of § 1.904(b)-1(h)(1)(i)."
- Since (i) references (e), and (e) contains the election, this means that if you elected not to adjust when calculating FTC limitation, that election should carry through to ODL recapture as well.
Final Answer
- If you elect not to adjust capital gains and qualified dividends for FTC limitation under § 1.904(b)-1(d)(2), then that election also applies when:
- Calculating ODL creation under § 1.904(b)-1(h)(1)(iii).
- Calculating ODL recapture under § 1.904(g)-2(b), because it references § 1.904(b)-1(h)(1)(i), which also incorporates (e), where the election is made.
This means that if you do not adjust when calculating FTC limitation, you should also not adjust for ODL recapture.
I then noticed some ambiguity about the election for not adjusting capital gains:
1. Elections for Capital Gains and Qualified Dividends
Capital Gains Election: Under 26 CFR § 1.904(b)-1(b)(3), taxpayers with a capital gain rate differential can elect not to apply the rate differential adjustments to their capital gains when calculating the FTC limitation.
Qualified Dividends Election: Per 26 CFR § 1.904(b)-1(e)(2), if a taxpayer elects not to apply the rate differential adjustments to capital gains under § 1.904(b)-1(b)(3), they are also not required to adjust their qualified dividend income.
Key Point: The election regarding qualified dividends is contingent upon the election made for capital gains.
2. Application to ODL Creation and Recapture
ODL Creation: Both § 1.904(b)-1(h)(1)(i) and § 1.904(b)-1(h)(1)(iii) reference § 1.904(b)-1(e)(2), which pertains to the election for qualified dividends. However, they do not explicitly reference § 1.904(b)-1(b)(3), the election for capital gains.
ODL Recapture: § 1.904(g)-2(b) states that U.S. source taxable income for ODL recapture should be determined by making adjustments for capital gains and qualified dividends, following the principles of § 1.904(b)-1(h)(1)(i).
Implication: The explicit reference to § 1.904(b)-1(e)(2) in the context of ODL calculations suggests that the election not to adjust qualified dividends applies to both ODL creation and recapture. The absence of a direct reference to § 1.904(b)-1(b)(3) raises ambiguity regarding the application of the capital gains election in these contexts.
Now the issue for me is:
ODL only exists when adjustments are made (in my case)
→ The ODL account was built under an adjusted 1116 calculation.
If you later elect not to adjust during recapture (because sometimes it results in a higher FTC limitation for me)
→ The recapture amount is larger because the FTC limitation is higher.
→ This results in a disproportionate depletion of the ODL for a relatively small FTC benefit.
Key Problem:
If ODL was only created due to adjustments, but you later recapture it without adjustments, the system forces you to use up more ODL than necessary.
This could all be wrong though.
