Foreign Tax Credit: "Category" vs "Source" vs "Item"

[paulinus49]

I have two Schwab brokerage accounts.  In both I have dividends on which foreign taxes were paid.  Thus, the dividends are in the category of "passive." 

In Account "A," the 1099 shows 8 securities producing dividends on which foreign taxes of $267.14 were paid.  Two of the securities (One is Pembina Pipeline)  earned dividends of  $1137.07 and paid taxes to Canada of $170.56.   Four mutual funds earned $441.36 in dividends and paid foreign taxes of $51.04 to RIC; and two securities earned $287.09 in dividends and paid foreign taxes of $45.48 to Switzerland.

In Account "B," the two securities earned $1226.28 in dividends and paid $183.95 in foreign taxes to Canada.  (One of these securities is also Pembina Pipeline.)

I have been reviewing TT's "Special instructions when multiple categories of foreign income is present" which provides in pertinent part  as follows:

How TurboTax Works Currently....

(Form 1116 is what is used to calculate the amount of your foreign tax credit). When different categories of income are present, or there are more than 3 different sources in the same category, multiple Forms 1116 must be generated. We generate those forms in a specific order....

When multiple copies of Form 1116 are required, this method will generate multiple copies of Form 1116 in the correct order required by the IRS for the vast majority of taxpayers. You simply report income from forms in the order they're presented in the interview. However, in a small number of cases, this will result in forms that are not in the order required by the IRS, and special instructions must be followed instead of the standard procedure.

When Special Procedures Must Be Followed

The IRS requires the copy of Form 1116 reporting the largest Foreign Tax Credit to be listed first in the return, and on this copy is a summary of the foreign tax credits claimed on additional copies. Since TurboTax generates the forms in the order in which they're linked, this sometimes results in the first copy NOT being the copy with the largest foreign tax credit. This can result in a return that can't be e-filed. This will usually happen if the foreign income on which you paid the most foreign tax is not the first copy of Form 1116 that you create in TurboTax.

How To Create Copies Of Form 1116 In The Right Order

In order to make sure TurboTax generates multiple copies of Form 1116 in the correct order, you should first identify which source of foreign income incurred the most taxes. This item will generally result in the largest credit and should be listed first. Once you know which income item to list first, make sure the first copy of Form 1116 includes this item. In the interview, you do this by NOT "reporting" income from any K-1's or 1099's the first time you visit the Foreign Tax Credit interview, except for the income item that generates the largest credit. ("Reporting" income in the Foreign Tax Credit interview creates a copy of a Form 1116 and links the income to the Form 1116). The first time through the interview, only report income from the item with the largest tax paid. After completing the interview the first time for the largest item, then you can revisit the interview and report any other items you have. (Note: "completing the interview" involves answering Yes to question about being done with "all Foreign Tax Credit Computation Worksheets.") This will generate the additional copies of Form 1116 that you need, and they should be in the correct order.

My questions:  I have figured out that all of my dividends are categorized as "passive."  However, (1) what is the source of the income.  The  brokerage account?  The security?  The country?

For example, I earned the most dividends from Canada, but those dividends came from three different securities, one of which is in both accounts (Pembina Pipeline).

(2) Then in midstream, TT switched to the term "item."  It says the during the first interview NOT to report income..."except for the income item that generates the largest credit.... only report income from the item with the largest tax paid." 

What is that "item" in my scenario?  Is that different from the "source"?

(3) Further confusion arises from the instruction on what constitutes "completing the interview."  Apparently, that involves only the largest "item."  Then you supposedly revisit the interview and report other "items."  Apparently, even though you have further "items," you are supposed to say "yes" about being done with all foreign tax credit computations worksheets.

I've gone through the step-by-step multiple times and so far have been unable to apply the "special instructions" correctly.

Has anyone else run into similar problems with the foreign tax credit and how to correctly complete the step-by-step interview?  Is this process easier than I have described it?  Thanks in advance.

[rogge1722]

You have 3 countries, Canada, RIC and Switzerland.  You have only one category of income: Passive.

You will need only one form 1116.  In preparation, open a spreadsheet and use column A for Canada, column B for RIC and column C for Switzerland.  In cell A1 insert the total foreign ordinary income from Canada from all 1099’s.  In cell A2 insert the total foreign qualified dividends for Canada from all 1099’s.  In cell A3 insert the foreign tax paid to Canada from all 1099’s.  Do the same for the other two countries.

Since you have more countries than 1099’s here is a suggested technique to incorporate all this into f1116 via the interview.

TT can support only one country per 1099.  Here is a suggested workaround.

This is an example of the preparation to fill out a form 1116 for taxes paid by 3 countries within a 1099-DIV.

They are:

 a: RIC which includes all mutual funds/ETF”s

b: Canada

c: United Kingdom

Three fictitious 1099-DIV’s will be created.  The original 1099-DIV will be used for domestic income only.

Bring up a new blank 1099-DIV.  For convenience name the payer the same as the country it represents. In this case the payer is RIC.  From the broker’s supplemental info, insert into box 1a the ordinary dividends from any and all mutual funds/ETF’s.  In box 1b, insert all qualified dividends form all mutual funds/ETF’s.  In box 7, insert the foreign tax paid from all mutual funds/ETF’s.  That completes the 1st fictitious 1099-DIV.

Bring up a 2nd blank 1099-DIV.  Name the payer Canada.  In box 1a, insert all the ordinary dividends from Canada; in box 1b all the qualified dividends from Canada and in box 7 the tax paid to Canada. That completes the 2nd fictitious 1099-DIV.

Bring up a 3rd blank 1099-DIV.  Name the payer U.K. In box 1a, insert all the ordinary dividends from the U.K.; in box 1b all the qualified dividends from the U.K.  The U.K. does not withhold taxes, but TT must see an amount in box 7 during the interview.  Insert $1.00 into box 7 and subtract $1.00 from box 7 of either of the previous fictitious 1099’s.  That completes the 3rd fictitious 1099-DIV.

On the original 1099-DIV, subtract all the foreign amounts from box 1a so that only the domestic ordinary dividends remain. Subtract all foreign amounts from box 1b so that only the domestic qualified dividends remain. Delete the amount in box 7, the foreign tax paid.  The foregoing applies to both 1099's.

[paulinus49]

Wow, Rogg!  I'm blown away by your answer.  I truly appreciate your efforts but my hope is that the TT folks will tweak their instructions and the step-by-step process so that we don't need to do what you recommend.  The whole point of TT is to avoid entering data on the forms directly.  

You obviously know what you are doing, but we simple-minded taxpayers are paying TT to hold our hands a little tighter.

Thanks again for replying so quickly.

[C-Starr]

I face similar challenges.  Like previous seasons, the 2023 Foreign Tax Credit interview and Forms take more time and efforts to decipher and fill than the entire 2023 Tax Return.   Still, TT's instructions and suggestions make accuracy of entries questionable.  I strongly urge TT to revamp this entire section and ideally provide auto-entry of downloaded Investment data like that of numerous other forms.