Foreign Tax Credits

[user17714562865]

How is line 1k "Adjustment required for QD/LTCG" calculated on the Foreign Tax Credit Computation Worksheet?

[DaveF1006]

Line 1k on the Foreign Tax Credit Computation Worksheet (often titled "Adjustment required for QD/LTCG") is where the software calculates the "reduction" required by the IRS when you have foreign income taxed at lower U.S. capital gains rates.

This calculation is designed to reduce your foreign income so that you don't get a full-value credit for income that was only taxed at $15\%$ or $20\%$ in the U.S.

The IRS requires this because $1 of dividend income taxed at 15% is not "tax-equivalent" to $1 of ordinary income taxed at 37%. To make them equal for the credit limit calculation, the software applies a rate differential.

[user17714562865]

My other income is taxed at 12%, not 37%.  

[DaveF1006]

The adjustment on Line 1k of the Foreign Tax Credit (Form 1116) Computation Worksheet still applies, even if your income falls in the 12% tax bracket instead of the 37% bracket.

This adjustment helps treat foreign income taxed at lower U.S. rates (0%, 15%, or 20%) the same as ordinary income taxed at higher rates.

My question to you is whether you really need to make this adjustment. The IRS allows you to skip the Line 1k adjustment (meaning you get to keep the full value of your foreign income in the calculation) if you meet both of these criteria:

1. Your total foreign source capital gains and qualified dividends are less than $20,000. 
2. You are below a certain taxable income threshold (for 2025/2026, this is roughly $191,950 for Single filers or $383,900 for Married Filing Jointly)

[user17714562865]

First of all, thank you so much for your help!

My taxable income is less than $383,900 for Married Filing Jointly, however my foreign capital gains and qualified dividends are more than $20,000.

Can you explain how the adjustment is calculated so I can confirm the adjustment is correct?

[DaveF1006]

Yes. If the Capital Gain Rate was taxed at 15%, the multiplier for the adjustment is .4054. At 20%, it is .5405.  

[user17714562865]

My Capital Gain Rate is 15%.  Form 1116 Line 3d Gross foreign source Income is $40,635 and Line 1a is $16,425, so my adjustment factor is .4042.  Why isn’t .4054?

Why is there any adjustment at all if my foreign income is taxed at the higher rate of 15% and my other income is taxed at the lower rate of 12%?

[DaveF1006]

The .4054 factor is the usual adjustment for the 15% rate group in a typical year. This number can change, though, since it’s tied to the highest U.S. ordinary tax rate for each tax year.

For the 2025 tax year, the tax brackets were shifted significantly due to the One Big Beautiful Bill Act (OBBBA) or standard inflation indexing. If the top ordinary tax rate used in the IRS's 2025 calculation is roughly 37.1% (or if a different "maximum rate" is being pulled by the software based on your specific tax data), the math changes. In this case 15%/37.1%=.4042. Normally, if you used the standard 37% this year, the factor is .4054. It increased to 37.1% because it was indexed for inflation, which changed the multiplier.

To answer your second question, the IRS isn't looking at your specific 12% bracket for this adjustment. They are looking at the "Preferential Benefit" you received because your income was classified as Qualified Dividends. 

The IRS lets you pay a lower 15% tax rate on these dividends. If that money were regular income, it could be taxed at rates up to 37%.

Since you’re getting a tax break by paying 15% instead of the higher ordinary rate, the IRS also limits the amount of foreign tax credit you can claim. If you were able to count all of that income on Form 1116 but only paid 15% tax, you could end up with extra credits that'd reduce the tax you owe on your regular salary.

Not all is lost. You don't necessarily lose the difference. The "unused" portion of your 15% payment,the part that exceeded the 12% U.S. limit, is considered excess foreign tax. You can typically: 

• Carry it back to the previous tax year to get a refund if you had a "tax deficit" there.
• Carry it forward for up to 10 years to use in a future year when your foreign taxes might be lower than the U.S. limit.

[user17714562865]

Thank you so much for the help and prompt responses.  I really appreciate your patience explaining this to me.  I'm getting closer to understanding these rules, but I still have a couple of questions.

My 2024 Form 1116 Line 1a and 3d both reported foreign income of $20,379, which is over the $20,000 threshold.  Why was there no adjustment in 2024?

Why does irs.gov indicate a maximum tax bracket rate of 37%, not 37.1%?

[DaveF1006]

 It depends. If your income levels and dividend amounts are nearly identical between 2024 and 2025, but you saw an adjustment in 2025 that wasn't there in 2024, it could be because of:

• If in 2024 you had capital losses (from selling stocks at a loss) that offset your dividends, your "net" amount might have dropped below the $20,000 threshold.
• If in 2025 you don't have those same losses to offset the gains, the full $20,379 becomes "exposed" to the adjustment rule.
• You may have crossed an income threshold barrier in 2025. f your income increased even slightly (e.g., a small raise, more interest income, or a capital gain), you might have landed in a higher tax bracket. Even if your foreign dividends stayed at $20,379, crossing that income threshold (e.g., moving from the 24% bracket into the 32% bracket) forces the IRS to "weight" your foreign income differently to account for the tax savings you get on those dividends. I
• Because of the changes in the One Big Beautiful Bill Act, your income may have been taxed in a different tax bracket in 2024. 
• Your total qualified dividends (Foreign + U.S. combined) were $20,000 or less, you were exempt from the adjustment regardless of your income.
• In 2024: If your total qualified dividends were $19,999, you did not adjust. If this is the case, did you have other foreign income that brought the income level to $20,379? 

These are some possible reasons why this may have occurred.  As for the IRS difference, the IRS uses 37.1% instead of the standard 37% top marginal bracket because of inflation indexing and the specific formula for the "rate differential." The income brackets were established in the One Big Beautiful Bill Act as base rates, but mentioned they were indexed for inflation. The IRS has not caught up to revising the change.

[user17714562865]

Following is a detail of my 2024 and 2025 foreign income and AGI.  Does this explain why there was no adjustment in 2024?

2024

$3,688.68 - Non-Qualified Dividends

$9,958.25 - Qualified Dividends

$6,732.22 - Long Term Capital Gain Distribution

$20,379.15 - Total Foreign Income

$254,576 - Form 1040 Line 11 AGI

2025

$4,981.73 - Non-Qualified Dividends

$12,011.09 - Qualified Dividends

$23,642.63 - Long Term Capital Gain Distribution

$40,635.45 - Total Foreign Income

$327,589 - Form 1040 Line 11 AGI

[DaveF1006]

Yes, based on the data provided, the reason there was likely no (or minimal) adjustment in 2024, but a likely requirement for one in 2025, is the significant increase in foreign Qualified Dividends/Long Term Capital Gains relative to your total Adjusted Gross Income (AGI). Here is the breakdown of why this occurred:

1.     2024: No Adjustment (Low Ratio of Passive Foreign Income)

• Total Foreign Income (2024): $20,379.15
• AGI (2024): $254,576
• Analysis: Your foreign income was a relatively small percentage (approx. 8%) of your total AGI. The "adjustment" to the Foreign Tax Credit (Form 1116) usually triggers when foreign-sourced qualified dividends or capital gains (which are taxed at lower U.S. rates) are high enough to cause a mismatch, meaning the foreign tax credit is higher than the U.S. tax actually owed on that income.
• In 2024, because the foreign passive income ($20k) was low compared to the total income ($254k), it likely did not trigger the "rate differential adjustment" needed to reduce the foreign source income on Form 1116, line 1a. 

2.     2025 Adjustment Likely Required (High Ratio of Passive Foreign Income)

• Total Foreign Income (2025): $40,635.45 (nearly double 2024)
• AGI (2025): $327,589
• Analysis: Not only did your total foreign income double, but the amount of foreign qualified dividends and capital gains (taxed at 0%, 15%, or 20%) also increased significantly compared to 2024. I notice especially the sharp rise in the long-term capital gains distribution.
• The 2025 Shift: Starting in 2024/2025, tax software (and IRS rules) became more stringent regarding Form 1116, line 18, to prevent over-crediting. The 2025 rules call for a required multi-step adjustment that treats all income as if it’s taxed at regular rates. This can sharply lower your foreign tax credit, especially if you have a lot of foreign qualified dividends or capital gains.