Form 1116 (Foreign Tax Credit) and capital gains & losses

[tangofan]

Due to owning dividend paying stocks from multiple countries in several of my brokerage accounts, I have to fill out form 1116 this year for seven countries. For some of the countries I am having (long-term) capital gains and capital losses due to stock sales (no foreign taxes were withheld on the sales).

The dividends were entered in Turbo Tax (Deluxe) as 1099-DIVs and the sales as 1099-Bs. On the 1116 forms I am using income category "passive income".

Here's a reduced scenario of what I'm facing:

• Brokerage account A: Dividend on Spanisch stock ABC of ca. $85 with foreign tax withheld of about $13.
  
  
• Brokerage account B: Capital loss on sale of (different) Spanish stock DEF (several thousand dollars). No foreign tax withheld on sale.
  
  
• Brokerage account C: Dividend on a Danish stock with foreign tax withheld. Capital gain on sale of part of this stock with no foreign tax withheld on sale.

Now my questions:

1. I am currently reporting the (long-term) capital loss from account B in Part I, field 5a ("Foreign losses for this category") of the "Foreign Tax Credit Computation Worksheet" in the column for country "Spain" (which then flows down to the corresponding column Form 1116, Part I, field 5).
   
   Is that correct? If not, how should I report this capital loss on Form 1116 or the worksheet (if at all)?
   
   
2. I am currently reporting the (long-term) capital gain from account C in Part I, field 1a (under the title "Long-Term Capital Gains") of the same worksheet in the column for country "Denmark" (which then flows down to the corresponding column in Form 1116, Part I, field 1a).
   
   Is that correct? If not, how should I report this capital gain on Form 1116 (or the worksheet) (if at all)?
   
   
3. The overall foreign tax withheld for "Spain" is only about $13 on dividends of about $85, but the capital loss is several thousand dollars, which currently reduces my foreign tax credit by several hundred dollars.
   Is is permissible to not claim the foreign tax credit for certain countries (in my case "Spain"), because it would actually increase my foreign tax credit (because the capital loss for "Spain" would no longer need to be reported)?
   Or must I report all countries on that form for which taxes were withheld?

[Spino]

I'm going to take a stab at answering your question, even though it's complex and I'm not looking at all the details.

1) You can submit your overall foreign tax liability balanced against profits and losses for all foreign investments. Usually this means that you will be able to claim most or all of your foreign taxes even when you need to file 1116, but not always.

2) No, you do not need to claim a credit for foreign taxes paid just because you can--but you shouldn't pick and choose, as that could get dicey as far as your intent if the IRS reviewed it.

3) You don't need to do it account by account, just collect and summarize the information from all the accounts on Form 1116, etc. Taxes are paid by taxpayer, not by account. All accounts you report should have your tax ID number on the forms you receive, or if a joint return one of both of you.

[tangofan]

Spino, thank you so much for your response. 

2) No, you do not need to claim a credit for foreign taxes paid just because you can--but you shouldn't pick and choose, as that could get dicey as far as your intent if the IRS reviewed it.

Thank you, that answers question #3.

3) You don't need to do it account by account, just collect and summarize the information from all the accounts on Form 1116, etc. Taxes are paid by taxpayer, not by account.

Ok, thanks. I'm not filling out Form 1116 manually, but I let Turbo Tax populate it from the 1099-DIVs and it aggregates the accounts per country already from the 1099-DIVs.

At this point the open questions are still #1 and 2:

- Do I enter a net positive capital gain from stock sales of a foreign based company  (1099-B) on Part 1, field 1a in that country's column of Form 1116?

- Do I enter a net negative capital gain (aka a capital loss) from stock sales of a foreign based company (1099-B) as a positive number on Part 1, field 5 ("Foreign loss") in that country's column of Form 1116?

[Spino]

For me, that sounds like time to reference the IRS instructions, which you will find here:

https://www.irs.gov/pub/irs-pdf/i1116.pdf 

That's about all I know 🙂

[tangofan]

Well, the IRS instructions do not help, because they use terms such as "Foreign losses", but the do NOT define them.

However just for future reference, by sheer luck I was able to find definitions in "26 U.S. Code § 865 - Source rules for personal property sales" that (to my layman's understanding) appear to apply here: https://www.law.cornell.edu/uscode/text/26/865

According to this the gain from the sale of personal property (which I assume a stock sale to be) is generally sourced in the United States. One exception might potentially be, if one sells stocks of a foreign company on a foreign stock exchange and the tax treaty between the U.S. and that foreign country (where the exchange is based) calls for different treatment (subsection (h), (2), (A)).

But in general such a gain or loss would appear to be U.S. sourced, which would mean that it should not be reported on Form 1116 at all.

Disclaimer: I'm not a tax pro, so use this at your own personal risk.

[Spino]

Generally it's the dividends that get taxed by foreign governments, not the stock sales. I just filled this out this morning.

Interestingly, TT does not include the entry "various" for the country in the interview, but it is there in the forms view if you have the desktop software.

I did not have success following the interview questions. I tried, but I had to go back and make corrections in the form view. Perhaps this will get better in future years, or I will. Form 1116 is used for many different kinds of tax situations, the least of which may be taxes on dividends of foreign companies, hence the application of the form to this particular situation is more obscure. Maybe the IRS will design another form some day?! (I'm not holding my breath.)

The limit on the credit is the tax rate for your overall return, but the foreign tax rate on dividends might be as high as 20-25% for some countries. (Here's looking at you, Ireland!) 

[tangofan]

Generally it's the dividends that get taxed by foreign governments, not the stock sales. I just filled this out this morning.

This is correct, however that in itself doesn't necessarily answer the question whether a stock sale is foreign sourced income or domestic sourced income.

Interestingly, TT does not include the entry "various" for the country in the interview, but it is there in the forms view if you have the desktop software.

It is indeed there in the desktop software however it appears that "Various" as a country designation is frowned upon. While I have used "Various" in the past, I am now breaking the 1009-DIVs apart, using separate country designations (if I have taxes withheld from more than one foreign country in that account). This "breaking apart" is actually what the TT desktop software suggests to do in their UI.

I did not have success following the interview questions. I tried, but I had to go back and make corrections in the form view. Perhaps this will get better in future years, or I will. Form 1116 is used for many different kinds of tax situations, the least of which may be taxes on dividends of foreign companies, hence the application of the form to this particular situation is more obscure. Maybe the IRS will design another form some day?! (I'm not holding my breath.)

During the many years I have filled out this form it has never gotten any better. That is largely TT's fault doing a crappy job with the interview mode for this form. E.g. the manual breaking up of 1099-DIVs should not be necessary and could be handled by some worksheet within TT. I remember in the past that I always had to go to forms mode to check the box, whether taxes were paid or accrued (I used "paid") and to pick a date for the taxes (I just use Dec 31 of the tax year). That seems to be fixed now.

I do not expect the IRS to design another form, why should they? They're busy enough with other things.

The limit on the credit is the tax rate for your overall return, but the foreign tax rate on dividends might be as high as 20-25% for some countries. (Here's looking at you, Ireland!) 

Another limit appears to be that - according to the instructions - you're actually only allowed to claim taxes that you're legally obligated to pay and cannot claw back from that foreign country.  IIRC in case of Ireland the tax rate in the tax treaty between Ireland and the U.S. is 15%, and Ireland presumably has some mechanism to reclaim the over-withheld taxes (which is probably cumbersome, so most private investors don't do it). I myself have tax withholdings from Ireland on dividends, but I don't claim the full 25% of Irish taxes withheld, only the 15% of the dividends that are within the treaty rate.

[richardR1]

Hi what if the country does not have  tax treaty with the US? Can the foreign capital gain taxes paid still be claimed?

[Mike9241]

to claim the FTC no tax treaty is required. However, you should read form 1116 instructions - 2 sections - foreign taxes eligible for credit and foreign taxes not eligible for credit - starts on page 2

https://www.irs.gov/pub/irs-pdf/i1116.pdf 

[richardR1]

Thank you for addressing