Foreign tax credit on Federal/State returns

[atlasthere]

I am a US person for tax purposes and generate some passive income (interest, capital gains) from India.

US-India has DTAA agreement and it clarifies which country holds first right to tax different types of income etc. To clarify, this isn’t my focus for this post.

Coming to my question. India follows a different tax calendar than US which runs from April to March of the following year. And taxes are due by July in general.

While claiming foreign tax credit in US (federal/ NC state) tax returns, which date ranges to consider to calculate foreign tax credit?

1. Same as US tax calendar (Jan-Dec)? If so, how to calculate foreign tax credit since income from Apr-Dec isn’t due for taxes in India and I can’t calculate taxes paid for these months yet. Plus taxes paid in India are for Indian tax calendar, so how to calculate the Jan-Mar portion out of the paid taxes?

2. Indian tax calendar(Apr-Mar)? If so, do I leave out Indian income from Apr-Dec for US return and claim them once Indian tax is paid next year and show them on US return next year?

Is there any other approach which works better than above options?

Thanks in advance. 🙂

[DaveF1006]

According to the IRS, you cannot take a credit for some foreign taxes when paid and take a credit for others when accrued. Here is an example how the tax is determined.

1.  Foreign Taxes paid between April 2022-March 2023 is $2000.
2.  Number of days between Jan-March2023 is 89.
3. The tax would be calculated by the following formula.  ($2000) (89/365) = $488. If you decide to use the cash basis, this is the amount of credit you are entitled to receive.
4. To receive a bigger credit, you may wish to choose the accrual method rather than the cash method, which you have the right to do so.
5. If you decide to use the accrual  method for taxes accrued between April-Dec 2023,  your foreign tax credit would be $2000-488= $1512. If you choose the accrual method though, it is binding for all future tax years.

 Here are some sources you may wish to look at for future reference.

The Tax Advisor 

IRS Publication 514  Look in the section that mentions Credit for Taxes Paid or Accrued.

I hope this helps.

[atlasthere]

@DaveF1006 thanks for your reply. Coming back to the same question again this year as I didn't need to dig deeper last year.

Based on the examples you gave for cash and accrual method, I feel like I am leaving some portion of foreign taxes on table without claiming any credit for it. Am I right? Or is there a way to claim credit for this left out taxes in previous or next US tax return?

For simplicity, let's say I am going to stick with cash basis method forever. My foreign tax year runs from April to March of next year.

For April 2022 - March 2023 period I have $5000 foreign taxable income, and pay $1000 in foreign taxes for this period in June 2023.

For April 2023 - March 2024 period I have $10000 foreign taxable income and pay $2000 in foreign taxes for this period in June 2024.

For cash basis, could you please explain what will go on my US 2022, 2023 and 2024 tax returns?

[guywong]

My understanding is that each Indian bank files a quarterly Form No. 16A with the Indian Income Tax Department.  The form reports the gross interest income and the amount of withholding.

The bank statements and/or the passbooks also clearly each time the interest amount was posted and the Indian Income tax withheld.

So if you have either the Form 16A or the history for the calendar year, you will have the amount of interest earned and the amount of Indian Income tax withheld for the calendar year.  You just have to add them up and convert/translate the amounts into U.S. dollar.

[DaveF1006]

It depends. Since you are now a cash basis, payer, you may now only claim a Foreign Tax Credit in the year they were paid. This means:

1.  There is no credit that can be claimed in 2022 so you would not report taxes paid for that year.  
2. In 2023, you may report $1000 foreign taxes paid to claim the credit.
3. For 2024, $2000 can be reported to claim the credit.

@atlasthere 

[atlasthere]

Thanks for your guidance @DaveF1006

Let me add scenarios with tax withholding as well to the previous example I took.

For April 2023 - March 2024 period I have $10000 foreign taxable income and $500 were withheld in taxes each quarter bringing total tax withholding to $2000.

1. If I do not file tax return in India for this period, can I claim tax withholding amount as taxes paid for cash basis  as foreign tax credit on US 2024 return? If yes, how much of total tax withholding can be claimed?

2. If I file tax return in India for this period and receive a refund of $900, can I claim $2000 as foreign tax credit on cash basis? Or will it be $1100?

[DaveF1006]

 Yes, you may claim a foreign tax credit (FTC) paid in that country even though you did not file a return in the country. There is no requirement for you to file a return in a country to claim the Foreign Tax Credit.

If you receive a refund, your Foreign Tax Credit must reflect the amount paid minus the refund. This is briefly mentioned in IRS Topic 856 where the example given mentions that if you received a refund and claimed the FTC, to amend your return to reflect the difference in the credit after the refund. The scenario may be slightly difference but illustrates the principle that the the IRS will not allow the full amount of the foreign tax to be claimed without the refund. 

[atlasthere]

Thank you @DaveF1006 that helps.

One final question for the cash basis FTC.

Consider below timeline for foreign income withholding and tax return:

June 30, 2023 - $500 withheld in taxes

Sept 30, 2023 - $500 withheld in taxes

Dec 31, 2023 - $500 withheld in taxes

Mar 31, 2024 - $500 withheld in taxes

1. If foreign tax return isn’t filed, how much can be claimed as FTC on US 2024 return? Is it full $2000 or $500 which was withheld during 2024?

2. If Indian tax return was filed and processed with refund of $900 in June 2024, how much can be claimed in FTC

a.2000-900 =$1100 or

b. 500-900 =-400 (foreign income of 400) in addition of 500 withheld during 2024?

[DaveF1006]

It depends. If you paid estimated taxes in 2023 to apply toward your 2024 return, you may report $2000. I assume this is what it is. $1100 can be reported for 2024.