Form 1116 Box 3d when there are capital gains and losses

[PV24]

This question is about form 1116 for Passive income when there are capital gains and losses (net gain). For instance, $30,000 in stock gain and $5,000 in stock losses (net gain of $25,000).

The instructions for form 1116 say that boxes 3d (gross foreign source income) and 3e (gross income from all sources) include the capital gains before subtracting any losses. Box 3e is automatically calculated by Turbotax based on the information entered about the sale of stock and it correctly takes into account the capital gains but not the losses. However I don't know how to enter the information about the foreign capital gain/loss so that it can calculate box 3d. I can enter the net gain, but I cannot tell what part was gain and what loss.

How can I indicate the foreign capital losses so that box 3d is calculated without taking those losses into account as required by the form instructions? 

[pk]

@PV24 , you have to tell a little bit more on this .

( a) are you a US person  ( citizen/GreenCard/ Resident for tax purposes )?  Or NRA ?

(b) which country or countries are we talking about?  Are you a citizen of that country ?

While I await your answers and making a few assumptions:

1. Generally instructions for  ( at least for this form 1116)  forms , often miss the nuances because of trying to cover all ;possible situations.

2.  Note what you are trying to achieve with form 1116 -----  mitigate /extinguish double taxation on the same income ( by US and the other contracting country ). 

(3) Thus what the form asks for  are  "gross" foreign source incomes from each of the countries involved.  The term "gross " here is  subject to interpretation . but keeping in mind what you are trying to achieve would  mean that this is  Gross { implying net of gains and losses from the same country and of the same type of income source )  income before considering foreign taxes paid for this  income stream.

(4) These  "gross" incomes from each country is then divided by the world income I.e. income from all sources  ( US  Gross income plus incomes from each of the foreign countries -- note that the US income is also before  taxes imposed/withheld ) to create a ratio so the  total US taxes can be allocated to each of the foreign income streams.

(5) As you are surely aware , per the  "double taxation  clause" requires  US to give  credit for the taxes   paid to a foreign taxation & contracting country.  US does this by recognizing dollar for dollar  foreign taxes paid, but the allowable  credit for the  year is the LESSER of  Foreign Taxes paid  and  US tax on the same income.

Does this make sense  or am I muddying the water ?

Is there more I can do for you ?

[DaveF1006]

It depends. Allow me to give you a brief primer on the concept of foreign taxes and then how the FTC is determined by the US.

1. First of all, most foreign income taxes are determined from gross income, without regard of any loss. 
2. Now when this capital gain income is reported in your US tax return, you are taxed on the net capital gain if there is a capital gain.

Now the Foreign tax credit is based on a formula that takes the Foreign Taxes paid and multiplies it by a fraction. The numerator of the fraction is your taxable income from sources outside the United States. The denominator is your total taxable income from U.S. and foreign sources.  

The foreign losses you refer to are used on your US tax return to determine your net capital gain. It is accounted for in the the denominator since the denominator includes the net capital gain (not gross amount) as total income. What this does is reduce the ratio (numerator/denominator) and gives you a bigger Foreign Tax Credit. This total income amount is also reflected in 3e of the Form 1116.

I realize this may sound confusing but if you follow the logic, it does make sense. This follows the path on what PK mentioned but expressed differently. PK did well explaining this also.

@PV24 

[PV24]

Thank you PK and Dave for your answers. Let me elaborate more for further clarity.

My question is more a technical one about how Turbotax calculates box 3d of form 1116 rather than a fundamental one. This box participates in the calculation of the portion of the deductions that must be subtracted from the foreign source income declared in box 1a of form 1116. This portion should be the ratio between the “Gross Foreign Source Income” (box 3d) and the “Gross Income from all sources” (box 3e), where “gross” in the case of capital gains means “excluding losses” based on form 1116 instructions. My problem is that Turbotax does not seem to subtract the losses from the numerator (box 3d) but it does it correctly for the denominator (box 3e), so I wonder where I can let the tool know that the losses must be subtracted from the numerator (gross foreign source income).

Let’s assume the following scenario for better clarity: 

- US citizen living in Spain, married filing jointly. 

- Job related income: $400,000 (entirely sourced to Spain). 

- Standard deduction ($29,200)

- Passive income just coming from two foreign stock sale events (both short-term in Spain) with a combined net capital gain of $25,000:

               Sale 1: Proceeds=$80,000, Cost=$50,000 (net gain of $30,000)

               Sale 2: Proceeds=$15,000, Cost=$20,000 (net loss of $5,000)

- Passive income is also sourced to Spain

Line 9 in form 1040 (total income) would therefore be $425,000, which is the $400,000 from job related income plus the $25,000 of net short-term capital gains.

There would be two forms 1116, one for General and one for Passive. My question is about the Passive form:

- Form 1116 (passive) box 1a would be $25,000 as the entire passive income will be considered as foreign sourced. It is a short-term capital gain, so no adjustment factor is needed.

- Form 1116 box 3e (gross income from all sources) is $430,000, which differs from line 9 in form 1040 because it excludes the $5,000 loss from “Sale 2”. Turbotax does this right. It reads from Schedule D that there was a loss in one of the sale events and does not take it into account for box 3e calculation.

- Now here is where the problem is. Form 1116 box 3d (gross foreign source income) should be $30,000, which is the foreign short-term capital gains excluding the $5,000 losses from “Sale 2”. However Turbotax calculates $25,000 for this box leading to the wrong number in line 3g. The correct amount in 3g should be $29,200x$30,000/$430,000=$2,037, but it incorrectly calculates $29,200x$25,000/$430,000=$1,697 (the error is that is uses $25,000 in the numerator instead of $30,000) because of the incorrect number in box 3d.

The problem is that I don’t know where to tell Turbotax that the loss in one of the stock sales is foreign sourced. I have not found a way to manually edit box 3d of form 1116 to correct for this. 

Thanks

[DaveF1006]

It depends.  in calculating the Foreign Tax Credit, the numerator is reported as a gross amount without regard to gains or losses. Besides if it did, this would reduce the numerator and give you less of a credit. This would not be to your advantage. Reducing the denominator, which is what it is designed to do, will increase your foreign tax credit. 

Line 3D is reported correctly because this is Gross income irrespective of gains and losses. Line 3E reports total income, which has foreign gains or losses built into it, which is correct. 

i think you are confused with the concept of net and gross amounts. Just remember, Line 3D is a gross amount that is listed and not a net amount as you suggest that it should be. Gains and losses area accounted for in Line 3E, like it should be.

Rest assured, TurboTax is reporting this correctly