ABCs of Foreign Tax Credit for individuals - YouTube video text script

I see it is the top of the hour. For those of you just joining us, welcome to today's webinar, ABCs of FTC for Individuals. We're glad you're joining us today. My name is Veronica Tubman, and I am a Senior Stakeholder Liaison with the Internal Revenue Service, and I will be your moderator for today's webinar, which is slated for approximately 100 minutes. This webinar offers up to two IRS Continuing Education or we call them CE credits. Certificates of completion will be emailed to qualifying participants from the email address seen on this slide.

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So just click on the materials dropdown arrow on the left side of your screen and download your browser document. Again, welcome, we're glad you joined us today for today's webinar. But before we move along with our session, let me make sure that you're in the right place. Today's webinar is ABCs of FTC for Individuals. The webinar is scheduled for approximately 120 minutes from the top of the hour. I have the pleasure and please allow me to introduce today's speakers, Patti Marando and Jim Wu, are Senior Revenue Agents in Large Business and International, specifically, in its Withholding, Exchange, International Individual Compliance division in the Foreign Tax Credit practice network.

Patti and Jim joined in 2010. They are technical specialists with extensive experience focusing on the Foreign Tax Credit for Individuals. I'm going to turn it over to Patti to begin the presentation. Patti? Thank you, Veronica. Hello, everyone, and welcome to today's webcast. Our purpose here today is to give a very broad overview of the Foreign Tax Credit or FTC, and discuss the concept and ideas that we need to be thinking about when we're working in this area.

This is not just a matter of calculation. Foreign Tax Credit has complex rules. For example, some questions include, but are not limited to, who is the taxpayer that's entitled to the credit? When does foreign law control in the credit calculation and when does U.S. law control? What taxes are creditable? Are there international tax agreements or treaties that decide when foreign law controls the credit calculation and when does the U.S. law control?

When is the tax payment voluntary versus compulsory? At a basic level, Foreign Tax Credit development raised the question of whether our system should encourage cross-crediting to alleviate the inefficiencies of our Foreign Tax Credit system. So let's look at today's topic. But before we dive in, I always like to start with piece of trivia. So for today's topic, let me ask you two questions. And if you could, please answer in text chat. Does anyone know what year the income tax was enacted? I'm going to give you a few seconds to put that in. Well, it was in 1913. And so when was the Foreign Tax Credit introduced?

And again, put that in text chat. Thank you. It wasn't until 1918, when the first predecessor of IRC 901 was enacted to allow a credit. Prior to that, from 1913 to 1918, a taxpayer can only deduct the foreign income taxes. So that's today's piece of tax and Foreign Tax Credit trivia. Our topic today is our Foreign Tax Credit Concept, Foreign Tax Credit Election, Foreign Tax Credit Eligibility, Foreign Tax Credit Limitation, Categories of Income, Sourcing of Income, Creditability, Adjustments to Income and related taxes, Treaties, Substantiation, Exhaustion of Remedies,

Timing of credit, Carryback and carryover and new Schedule B, and the Foreign Tax Redeterminations and Schedule C. Now, I'm going to share Foreign Tax Credit Concepts. The Foreign Tax Credit is predicated on three basic principles. The first is the same income should not be taxed more than one. The second, the country in which the income is earned has the primary right; sorry alerts happening.

My apologies on this; the country in which the income is earned has the primary right to tax that income. And three, the taxpayer's country or residence has a secondary or residual right to tax the income earned in a foreign country. So let's discuss these concepts. U.S. citizens and U.S. residents are often referred to as U.S. personal or taxed by the U.S. on their worldwide income. It doesn't matter whether the taxpayer lives or where the income is earned. In other words, income can be from foreign sources or U.S. sources. While working abroad, a U.S. person very often pays taxes on the foreign income to foreign governments. But we just said being a U.S. person, we'll take taxes on the worldwide income to the U.S. Now, we have foreign income tax by both the U.S. and the foreign countries, and we request this as double taxation.

The FTC may significantly alleviate the double taxation of the U.S. person. Now, why do I say, significantly alleviate? There are a lot of limitations and requirements to qualify for the FTC. The FTC reduces the U.S. tax liability only on that double taxation of the U.S. foreign source income by all or part of the foreign taxes paid or accrued during a tax year. Why do we say by all or part? It's because the FTC is subject to a limitation. That limitation is the lesser of: a) foreign taxes paid or accrued, or b) the U.S. tax on that foreign income. And more on this in a bit. The U.S. only allows a credit for creditable foreign income taxes paid or accrued. Some items shown here, such as fines, penalties, property taxes, value added taxes, inheritance, wealth taxes are not creditable. Now, let's move on to the FTC Election.

Taxpayers can make an annual election to either claim the FTC or choose to deduct the foreign income tax, but not both. Taxpayers may claim a credit in one year and a deduction in the following year, or vice versa. If the taxpayers choose to deduct, they must file Schedule A and itemize deductions. Generally, a taxpayer must complete a Form 1116 to claim the credit. Attaching the Form 1116 to the return actually constitutes electing the credit. If the taxpayer chooses to take a credit for qualified foreign income taxes, they must take the credit for all the foreign income taxes paid or accrued.

The taxpayer cannot take credit for some foreign income taxes and a deduction for others. If the taxpayer chooses to deduct the foreign income taxes, all the foreign income taxes must be deducted. If the taxpayer deducts their foreign income taxes, the taxpayer must treat any foreign tax credit carryback or carryover as if it was used in that year. We have seen where a taxpayer claimed the foreign income taxes both as a deduction and a credit and derived a double benefit, this obviously is not allowed. Taxpayers have an exception, and they may also elect to report the Foreign Tax Credit without filing a Form 1116.

This is done directly on Schedule 3, Line 1 if all the following conditions. I'm sorry, I did get some feedback here, so I'm just going to try and adjust the volume a little. Thank you. I hope that's a little bit better. Taxpayers have an exception, and they may also elect to report the Foreign Tax Credit without a Form 1116. And like I said, it's done directly on Schedule 3, Line 1 if all of the following conditions are met: all foreign source income is passive; the foreign income tax is withheld at the source; all foreign passive income was reported on a qualified payee statement; and the foreign income tax withheld is not more than $600 for married filing jointly or $300 for all other filing statuses. Veronica, this is a good time for our first polling question.

Patti, yes, it is. Okay, audience, time for our first polling question. U.S. citizens and resident aliens must report and pay applicable U.S. taxes on: A, all of their income, and that's both U.S. and foreign source, if living in the U.S.; is it B, only the U.S. source income? C, all of their income, both U.S. and foreign source regardless of where they live; or is it D, only their foreign source income? So take a moment and click the radio button that answers the question. I'll give you a few more seconds to make your selection. Thank you. Okay. And the correct response is C, all of their income, and that's both U.S. and foreign source regardless of where they live.

All right. I see that, let me check the percentage for those of you who responded correctly. Oh, good job. 82% of you responded correctly. Okay. back to you Patti to talk about eligibility to claim the FTC. Okay. IRC 901(b) defines the category of taxpayers who are eligible to claim the FTC. This event focuses on the individual side of the taxpayer's eligibility. The most common taxpayers you will encounter are U.S. citizens and resident aliens. Both are referred to collectively as U.S. persons. This includes any person who is a member of a partnership or beneficiary of an estate or trust and certain non-resident aliens. Let's explain what each means.

A U.S. citizen, as I'm sure we're all aware, individuals are U.S. citizens simply by being born here. Other individuals may be citizens by complying with certain procedural requirements. If a taxpayer is a U.S. citizen, determination of eligibility is clearly discernible. They're eligible. Now, a U.S. resident or individual who are not U.S. citizens, but may be considered resident aliens for U.S. income tax purposes. Resident aliens are those who possess a green card, also known as lawful permanent residents, or those who meet the substantial presence test, or individuals who make a valid election be treated as resident aliens.

This includes bona fide residents of Puerto Rico. This training does not address the residency requirements, but we did want to mention bona fide Puerto Rico residents because we do get questions on residency. Normally, non-resident aliens or NRAs and foreign corporations do not qualify for foreign tax credits. However, certain non-resident aliens and foreign corporations in certain circumstances may be allowed the credit under IRC 906. May be allowed a credit if are engaged in a U.S. trade or business and have effectively connected income on which are taxed. In this case, NRAs, non-resident aliens, may claim a foreign tax credit for foreign income taxes paid with respect to that income.

Veronica, this is a good time for our next polling question. Patty, it sure is. Okay, audience, our second polling question is, which statement below is false? Now, remember, which statement below is false? So, please take a minute and click on the radio button that you believe most closely answers this question. Do you think the correct answer is, A, the purpose of the credit is to eliminate double taxation of income; B, property taxes may be creditable under some circumstances; or is it, C, some foreign countries do not have an income tax; or is it, D, married filing jointly taxpayers can claim FTC directly on Form 1040 when not more than $600 is subject to other requirements.

Okay. Take a minute and review the question again, then click on the radio button you believe most closely answers the question. So, go ahead and make your selection and I'll give you a few more seconds. Okay, we're going to stop the polling question and we'll share the correct answer on the next slide. And the correct response is, B, property taxes may be creditable under some circumstances. So let's see how well you all did with this question. Oh my goodness, I see 61% of you responded correctly. So maybe we need a little clarification, Patti. Can you provide a little more detail? Sure, can. This was basically asking which is not the correct answer.

And basically an income tax, for Foreign Tax Credit to be allowed the predominant character of the tax must be an income tax by definition. Now, property tax is not an income tax and, therefore, it would never be creditable, basically. So it was just process of elimination on those questions. Thank you, Patti, for the explanation. That helps our audience out a lot. I will turn it over to Jim now to talk about FTC Limitations. All right. Thank you very much, Veronica. So far we talked about FTC Concepts and, Patti briefly mentioned FTC Limitations. I'm going to give you an example here.

The first Code Section 904 limitation amount is the pre-credit U.S. tax on foreign source income. It is a smaller of, A, foreign income taxes paid or accrued; or B, the U.S. tax on the foreign income. So let's say, for example, a taxpayer works abroad and paid the foreign government, $4,000 of foreign taxes on $10,000 of foreign income. If this income was earned in the U.S., the taxpayer would have paid a U.S. tax of $2,900. Therefore, the U.S. would only consider a credit of $2,900. And this is the limitation. It is the smaller of the $4,000, foreign taxes paid by the taxpayer and the $2,900 of U.S. tax on the same income. Let's put it another way. The Foreign Tax Credit does not reduce U.S. tax on U.S. income.

It is strictly limited to U.S. tax on foreign source income. The maximum amount or the maximum allowable FTC is often expressed with this formula you see on the screen. It takes the total foreign source taxable income and divides it by the total worldwide taxable income, and then multiplies that fraction by the U.S. tax before any credit. And the result is the FTC Limitation. And that limitation applies to each separate category of income which we will talk about next. All right. On this slide, we see Page 1 of the Form 1116. The upper part of the page of the form shows seven categories of income, sometimes referred to as baskets.

I'm going to spend a few minutes to discuss each one of these categories. If you want to delve more into this, you can refer to the Form instructions or Publication 514. We also have what we call Practice Units on IRS.gov. So there's a Practice Unit on this topic in its titled, FTC Categorization of Income and Taxes into Proper Basket. So let's start with category A. And Category A is Section 951A category income. And what is that? Beginning in 2018, a U.S. shareholder who directly or indirectly owns 10% of the voting power or value of the stock of a Controlled Foreign Corporation, or CFC, must include Global Intangible Low-Taxed Income, or GILTI, in their taxable income.

So, generally, individual U.S. shareholders are not eligible for the GILTI deduction under Section 250 for FTC purposes. The taxes being paid for GILTI under Section 960. However, there is an option to allow an individual taxpayer to make a Section 962 election, and that allows the individual taxpayer to pay the GILTI tax as if the individual was a U.S. corporation. And of course, the corporation tax rate is lower than the individual tax rate at this point. Now, Category B is foreign branch category income.

Also beginning in 2018, we have foreign branch category income, and that is defined by reference to the definition of a qualified business unit or QBU. It includes the income of a U.S. person that is attributable to the foreign branch, a distributed share of partnership income attributable to a foreign branch and income of other pass-through entities, such as s-corporation or trust that is attributable to a foreign branch. Pass-through entities cannot have foreign branch category income, but their non-pass-through U.S. owners can. Category C is passive income. Interest, dividends, rent, royalty, gains from the sale of real or personal property and income of inclusions relating to passive foreign investment companies or PFIC.

Additionally, limited partners who own less than 10% of the value in a partnership will generally treat their distributive share of the partnership income as passive income. Category D is general category. Section 904 defines general category income as income other than what we've already mentioned, and that is Section 951A foreign branch passive category income.

So it also includes income that does not fall into one of the other six separate categories. So in effect, the general category is a catch all category. Category E is Section 901(j) income. This Code section states, no credit is allowed for foreign income taxes imposed by and paid or accrued to certain sanctioned countries. In order to assume that FTCs for these taxes are not claimed, income derived from each such country is subject to a separate FTC limitation.

Therefore, the taxpayer must use a separate Form 1116 for income derived or earned in such sanctioned country. Because no credit is allowed for taxes paid to sanctioned countries, the taxpayer would generally complete the Form 1116, only through line 17, and that's the 2022 version of the Form 1116. Keep in mind that even though taxes paid to sanctioned countries are not allowed for the FTC, the taxpayer can claim an itemized deduction and deduct these taxes. For a detailed list of sanctioned countries, refer to the most current Publication 514. Category F is certain income re-sourced by treaty.

If a sourcing rule in an income tax treaty treats U.S. sourced income as foreign source, and the taxpayer elects to apply this treaty provision, the income would be treated as foreign source. Taxpayer must compute a separate foreign tax credit limitation for such income using a separate Form 1116 for each item of re-sourced income from U.S. to the foreign country. The taxpayer should complete a Form 8833, and that form is for treaty-based return position disclosure and applies in this instance of re-sourced income. Category G is lump-sum distribution, Foreign Tax Credit is available for taxes you paid, you paid or accrued on a lump-sum distribution from a foreign pension plan. You might need to use a special formula to calculate a separate tax on a qualified lump-sum distribution. And Publication 575 is very helpful in this respect.

The applicable IRC for lump-sum distribution is 409A. Continuing to the next slide. What's the relationship between these income categories that we just talked about and the FTC computation? Form 1116 is laid out sort of like a 1040 in many aspects. First, you have the gross income, then expenses either directly related or not directly related to the gross income. And these expenses are deducted from the gross income and then finally you have taxable income on which the tax liability is computed.

So the Form 1116 is sort of like the foreign subset of the worldwide Form 1040. Now, let's talk about sourcing rules. The sourcing rules are stipulated in Code Sections 861 through 865. Sourcing of income is important in computing the FTC. Remember when we said that FTC is a credit to reduce U.S. tax on foreign source income. Therefore, we need to look to these code sections when determining whether the income generated or earned is from the U.S. or from a foreign source. When used in a geographical sense, the United States includes the 50 states and the District of Columbia.

It also includes the territorial waters of the U.S. and the seabed and subsoil of those submarine areas that are adjacent to the territorial waters of the U.S. and over which the U.S. has exclusive rights based on international law, especially with respect to the exploration and exploitation of natural resources. However, it does not include the possessions and territories of the U.S. or the airspace over the United States. Conversely, foreign source income is generally income determined by tax law to be earned outside the U.S. or in a foreign country. A foreign country when used in a geographical sense includes any territory under the sovereignty of the United Nations or government other than that of the United States. So it's important to note that tax treaties should always be considered when you're determining the sourcing of income and later on we will have affection on tax treaties. Now, we'll review the most common income categories.

There's a chart here on this slide for your easy reference in dealing with sourcing rules for the most common categories, which are passive and general categories. Of course, U.S. citizens and resident aliens are taxed on the worldwide income, no matter where the income originates. So why is it important to determine the source? Well, the sourcing of income is important not only for the Foreign Tax Credit, but also for taxpayers who qualify for the exclusion of foreign income earned under Section 911. The most common general category, of course, is salaries and other compensation.

The sourcing of labor or personal services depends on where the labor or service is performed. So if the service is performed in the U.S., its U.S. source. And conversely, if the personal service is performed outside the U.S., it's foreign source. So that's pretty straightforward. If compensation for labor or personal services is earned both inside and outside the U.S., an allocation must be made between the U.S. and the foreign country, and that regulation is 1.861-(4)(b). When it comes to interest income, it is the residence of the payer that generally determines the source.

As far as dividend income, Code Section 861(a)(2) provides that dividends from domestic corporations are U.S. source income, dividends from foreign corporations are foreign source. But there are always some exceptions, so you may have to dig a little bit deeper. Rent, real property and natural resources royalties are sourced where the property is located. Royalties are intangibles such as patents, copyrights, et cetera. are sourced where the property is actually used. Okay, moving on to the next slide, we have sale and exchange of real property. This is sourced where the property is located, and that's pretty straightforward. What about sale or exchange of personal property? Well, that is sourced where the seller's tax residence is located. Of course, there's always an exception, and that exception for personal property sale is under Code Section 865(g).

Then, we have Social Security benefits, which are U.S. source, and then finally we have income items, like fellowship, fellowships' grants, prizes, and award-type items, which are generally sourced by the residents of the payer. With that, I'm going to turn it back over to Patti. Generally, for a foreign tax, levy, to qualify for a foreign tax credit, all four of the following tests must be met. First, the foreign tax must be imposed on the taxpayer, a credit can be claimed only for foreign income taxes that are imposed on a taxpayer. For example, a tax deducted from wages is considered imposed on a taxpayer by a foreign country or U.S. possession.

Next, the foreign tax must be paid or accrued by the taxpayer. Generally, taxpayers can only claim the credit if paid or accrued by foreign taxes to a foreign country or U.S. possession. There are some instances in which taxpayers can claim the credit even if they did not directly pay or accrue the tax, such as if a joint return is filed, the spouses can claim the credit based on the total foreign income taxes paid or accrued by both spouses, a partner or S corporation shareholder, a beneficiary of an estate or trust, for an extensive list, look at Publication 514, which is a good resource.

Third, the foreign tax must be the legal and actual tax liability. I'm going to repeat that. The foreign tax must be the legal and actual tax liability. This means that the amount of foreign tax that qualifies for the credit is not necessarily the amount of tax withheld by the foreign country. This is an extremely important concept that is often missed. What this means that if the U.S. has a treaty in place with the treaty country, then the actual and legal tax liability is the tax rate specified on the treaty, not necessarily the amount of tax that is withheld. Therefore, we need to be aware of whether a tax treaty exists in these situations and ensure that the amount of tax used for the foreign tax credit computation is the treaty rate and not the statutory rate.

We're going to be talking more about this issue in a few minutes. Also, the foreign tax credit cannot be taken for income taxes paid to a foreign country if it is reasonably certain the amount would be refunded, credited, abated, rebated, or forgiven if a claim was made. It is not reasonably certain that the amount will be refunded, credited, rebated, abated, or forgiven if the amount is not greater than a reasonable approximation of the final tax liability to the foreign country.

Finally, the foreign tax must be an income tax or a tax in lieu of an income tax. Now, whether a foreign levy is an income tax is determined independently for each separate foreign levy. A foreign levy is considered an income tax if it meets both the following requirements. It is a tax, that is, must be paid and there is no specific economic benefits from paying it and the predominant character of a foreign tax is that of an income tax in the U.S. sense.

A foreign levy is considered a tax, which means that it will generally be eligible for the Foreign Tax Credit if it is a compulsory payment. This means that the tax is not voluntary and that there is not a specific economic benefit. And an economic benefit is where the taxpayer received or will receive in exchange for that payment, such as goods, properties or services. This is not a tax. For tax years 2021 and prior, a foreign levy is an income tax in the U.S. sense. The Treasury amended the regulation in January of 2022. The new regs replaced "the predominant character of a tax is that of an income tax in the U.S. sense" with "the foreign tax as a net income tax". This clarified the vague concept of "income tax in the U.S. sense".

The foreign tax generally has to be on a net basis. What does that mean? Under the new reg, requires that the foreign tax must meet the four net gain requirements. The tax meets the net gain requirements if it satisfies the realization, gross receipts, cost recovery, and attribution requirements. Also, not creditable are taxes paid in sanctioned countries. Other non-creditable items include but are not limited to fines, penalties, interest, custom duties, and other similar obligations are not creditable for the Foreign Tax Credit.

On the other hand, the taxpayer may be able to take a business deduction for some of those items, such as custom duties under IRC 162 as a business deduction, but never for fines or penalties. Furthermore, excise, inheritance taxes are not creditable taxes for the Foreign Tax Credit. Publication 514, and I'm going to repeat that Publication 514, shows you a list the foreign income taxes that are qualified and not qualified for the Foreign Tax Credit. Let's look at the Form 1116 Part II. Taxes must be paid or accrued. Look at where the creditable foreign income taxes are shown.

Taxpayers can only claim the credit if paid or accrued the foreign tax to a foreign country or U.S. possession and as you guessed we give you the exceptions of this general rule. Having said that, next, the taxpayer needs to make an election in Part II for either taxes paid on Box (j) or Accrued on Box (k). For purposes of this lesson, we're just going to give you the two key concepts here. Individual taxpayers on a cash basis method of accounting for foreign income taxes paid will deduct the taxes in the year that paid those taxes. But a cash basis taxpayer may elect to claim the Foreign Tax Credit on the accrued basis by checking the "Accrued" Box (k) in Part II of the Form 1116.

The taxpayer must use the same method for all subsequent years, and that's in the Internal Revenue Code, Section 905(a). For the accrued method, taxes accrue when all the events occur that fix the amount of the tax. Basically, if the taxpayer uses the accrued method, he can only claim the Foreign Tax Credit in the year in which accrue the tax. Foreign income taxes accrue when all the events have taken place that fix the amount of taxes and the liability to pay them. This occurs on the last day of the tax year for which the foreign return is filed. For accrued basis taxpayers, IRC Section 986 generally calls for the conversion of foreign income taxes into U.S. dollars based on the average exchange rate for the year of the actual payment. For Partner or S corporation shareholder.

If the taxpayer is a member of a partnership or a shareholder in an S corporation, the taxpayer can claim the credit based on their proportionate share of the foreign income taxes paid or accrued by the partnership or the S corporation. These amounts starting in 2021 will be shown on the Schedule K-3 received from the partnership or S corporation. Prior to that year that information should have been shown on Schedule K-1. Another thing about the accrued method is that you can generally cannot switch to electing it on an amended return.

There is a very narrow exception and I'm going to try and simplify this. There's a new regulation effective for tax years after December 28, 2021, that allows for a one-time change to the accrued method on an amended return. But this is allowed only once and in the very first year the Form 1116 is filed by the taxpayer. And that's Treasury Reg 1.905-1(f)(1). And moving on to the Foreign Tax Credit and Treaty versus Statutory Rate. The U.S. has tax treaties with many countries. Under the terms of these tax treaties, residents or citizens of the U.S. taxed at a reduced rate, or sometimes even exempt from foreign taxes altogether on certain types of income they receive. And portfolio income is very common.

To pay only the legal amount of tax, an eligible taxpayer must invoke the tax treaty and provide a statement to the withholding agent requesting the lower rate. If the taxpayers don't invoke the lower treaty rate, a foreign statutory withholding rate, and it's almost always higher, is applied by the withholding agent. That excess amount is not deemed compulsory enforced and fails the previously listed fourth requirement. If a lower treaty rate exists, the taxpayers are only allowed to claim the lower treaty rate.

If the taxpayer wants the excess back, they're going to have to invoke the treaty and file an amended return with the foreign country. So, firstly, if a tax treaty exists between the United States and the foreign country. If it does, determine if a lower rate is applicable to the type of income. The IRS.gov website houses the latest tax treaties. One can access by going to IRS.gov and typing in the search box, tax treaties. There's also a publication on treaties, which is Publication 901 Tax Treaties. Veronica, I think this is a good time for our third polling question.

Patti, yes it is. Thanks for that good information. Okay, audience, our third polling question is, Taxpayer A earned $1,000 passive income in Country X and had $150 withheld. Country X, tax treaty stipulates a 10% withholding rate on passive income. What is the maximum amount of Country X tax Taxpayer A can claim for FTC purposes? Is it, A, $100; is it, B, $200; is it, C, $300; or is it, D, the actual amount withheld by Country X? Okay. So audience take a minute and review the question again then click in the radio button you believe most closely answers the question.

So go ahead and make your selection, and I'll give you a few more seconds to answer the question. Okay, we're going to stop the polling now and we'll share the correct answer on the next screen. And the correct response is A, $100. So let's take a look and see how you did audience. Okay, audience, I see that there's a 70% of you responded correctly. So let's ask, Patti, if she can clarify that for us. Patti?

Sure, can, Veronica. Well, basically, here it is an example of a tax treaty. There's $1,000 of passive income, and even though $150 was withheld, there's a tax treaty that said the withholding rate on passive income is 10%. So the maximum amount on that $1,000 would be 10% allowed. So it would be the 1,000 times the 10% which is equal to $100. Okay, Patti, we appreciate that. Audience, we're going to let, Patti, carry on with Adjustments to Income-General Category. Thank you, Veronica. Now, let's focus on line 1 of the Form 1116. And this is the line for gross income from foreign sources.

We've been discussing how the Foreign Tax Credit is a mechanism available to relieve double taxation. Another is the Foreign Earned Income Exclusion, also known as the FEIE, and also known as the IRC 911 exclusion. We're not going to go into detail on the Foreign Earned Income Exclusion except to say that it is available to U.S. citizens and residents who live and work in a foreign country and meet some various tests. It is claimed by filing Form 2555 and attaching it to the Form 1040. As Jim mentioned in the categorization topic, foreign earned income falls into the general category. Line 1 gross income must be adjusted to remove any earned income that is excluded under the Foreign Earned Income Exclusion. Now, remember, Form 1116 is the foreign portion of the total worldwide Form 1040 income.

Since the taxpayer has excluded a portion of their worldwide income from taxation on the Form 1040, then the foreign subset of that total should also be reduced in line 1a. Let's look at an example. A taxpayer files the 2022 return and includes the Form 1116 general category form. The taxpayer was employed in Country X; the total gross foreign wages was $245,000. The taxpayer qualifies for the foreign earned income exclusion of $112,000 as reported on the Form 2555. The taxpayer will enter country X in column A and $133,000 on Form 1116 Part I line 1a. This is the net number resulting from the difference between the foreign employment income of the $245,000 less than $112,000 of the Foreign Earned Income Exclusion.

Some tax software may show the gross and reduction for the Foreign Earned Income Exclusion to the left, but some software just shows the net. So just see if we have some adjustment is required. Now, we're going to discuss taxes allocable to the excluded income. Another corollary aspect to the adjustment we discussed is that the taxpayers not only have to reduce foreign earned income by any Foreign Earned Income Exclusion taken, but also reduce foreign income taxes allocable to that excluded income on Form 2555. Also another corollary adjustment must be made for the taxes related to that excludable income. That's the question was not doubled tax.

A taxpayer with foreign earned income is completely excluded, cannot take the credit for any foreign income taxes allocable to that excluded income. On the other hand, if only a part of the foreign earned income is excluded, then the part that is not excluded under IRC Section 911 can be used to compute the Foreign Tax Credit. This reduction of foreign tax is reported on line 12 of the Form 1116. The computation for line 12 is an off the form computation, meaning it's not shown in the body of the Form 1116. A schedule showing this computation should be attached to the return. To compute the amount on line 12 taxpayer must apply a formula to arrive at the amount of this adjustment.

So let's look at the formula. Here is the formula used to compute taxes that are allocable for the excluded income. The numerator of our fraction is excluded earned income minus deductible expenses allocable to the excluded income. And the denominator is the foreign earned income minus unreimbursed deductible expenses.

Then, as we mentioned earlier, we take that fraction, multiply it by the income tax paid or accrued to the foreign country and get the amount of foreign income tax paid that cannot be used as a credit. Now, I know you all want to look at an example. Here, we have an example. A U.S. citizen works for Company B and lives in Country Z. And here are the facts. A U.S. citizen works for Company B and lives in Country Z and has records that show the following. The foreign earned income received is $175,000.

The income tax is paid to Country Z is $45,000. The foreign earned income exclusion, and housing allowance is $112,000. So we have a numerator of $112,000, which is the foreign earned income and housing deduction. And we're going to divide the numerator by the total foreign earned income of $175,000, which is your denominator. That percentage comes to 64% is then multiplied by the foreign income tax is paid of $45,000. Since 64% of the income was excluded, we now have to exclude the 64% of the foreign taxes paid.

So the Form 1116, line 12, will show a reduction of $28,800. Now, I'm going to explain another common adjustment to another category. We're going to talk about the adjustments to passive category income, and these are going to be your capital gains and qualified dividends. Because of the preferential tax treatment of capital gains and qualify dividends under U.S. tax law, even though the taxpayer may otherwise be in a higher tax bracket, an adjustment is required to reduce the amount of foreign source capital gains and qualified dividends by a rate differential when computing Foreign Tax Credit.

The effect of this adjustment is to only include a portion of the capital gains in the IRC 904 fractional limitation since the U.S. tax rate that applies to capital gains is less than the tax rate that applies to ordinary income. Or stated another way, because taxing capital gains at a low rate is the same as taxing just part of the gain at the full rate, only the part that is theoretically taxed at the full rate should enter the IRC 904 limitation calculation.

Under IRC 904(b)(2), a gain from the sale or exchange of capital assets is included in foreign source taxable income only to the extent of foreign source capital gain net income. Because qualified dividend income also receives that preferential tax treatment, the rate differential adjustment is required for the qualified dividend income as well. The adjustment is made by multiplying the total gain divided by the qualified dividends within each capital gain rate category by a decimal amount specific to each rate. The rates and the amounts by which are multiplied are found in the instructions on Form 1116.

There's also a worksheet for that adjustment. Publication 514 is also a good resource. And don't forget, a separate adjustment is also made for Alternative Minimum Tax. Let's look at the effects of tax treaties on the Foreign Tax Credit. Earlier we discussed the four required tests of creditability. One of those was the tax must be the legal and actual foreign tax liability. Tax treaties can affect this determination. The U.S. has income tax treaties with over 60 foreign countries. An income tax treaty is an agreement between the U.S. and a foreign country on the tax treatment of certain items of income.

There are reduced rates and exemptions which vary amongst countries and specific items of income. If there is no tax treaty between a foreign country and the U.S., the taxpayer must pay the tax on the income in the same way and at the same rates as shown in the instructions of Form 1040-NR. Tax treaties reduce the U.S. taxes of residents of foreign countries. With certain exceptions tax treaties do not reduce U.S. taxes of U.S. citizens or residents. Under these treaties, the rates of foreign withholding tax may be reduced. Normally, a flat statutory rate is withheld, often at 30%.

Typically, there is a reduced withholding rate under the tax treaties for investment income such as dividends and interest. The legal tax liability is not necessarily what was withheld by the foreign country. The legal tax liability is limited to the lowest treaty rate. Where a lower treaty rate is available, it is the taxpayer's responsibility to provide a withholding statement invoking the treaty to the payer. Otherwise, the tax is not due or legally owed. The Foreign Tax Credit should not be allowed if the taxpayer did not take all the necessary steps and exhaust all available remedies to minimize the final tax bill with the foreign country.

Tax treaties may not follow the general U.S. sourcing rules and certain incomes can also be re-sourced by treaties. And this was mentioned earlier during discussion of the separate categories of income. Veronica, I think this is time for our fourth polling question. Patti, yes, it is. Okay, audience, it's our fourth polling question. And here you go. U.S. taxpayer works in Country X and qualifies for the Foreign Earned Income Exclusion of $112,000. Taxpayer's total wages on Form 1040 were $500,000, of which $400,000 were foreign. What amount should be shown on Form 1116, line 1? Is it, A, $500,000; is it, B, $400,000; is it, C, $388,000; or is it, D, $288,000?

So take a moment and click the radio button that best answers the question. I'll give you a few more seconds to make your selection. So let's think about the things that Patti talked about. Look at the question and look at the answers and pick the best answer to the question. Give you just a few more seconds to think about that one. Okay, make sure that you've selected the correct answer and we're going to stop the polling and we'll share the correct answer on the next slide. And the correct response is, D, $288,000. $400,000 foreign source income, less than $112,000 of the foreign earned income exclusion.

Oh, my goodness. And I see that 92% of you responded correctly. You audience, you rock. That's a great response rate. Now, I'm going to turn it over to Jim to cover substantiation. All right. Thank you, Veronica. I'm going to briefly discuss the Foreign Tax Credit Election before going to Substantiation. I know that Patti had alluded to this previously, but the taxpayer can make an annual election to either deduct the foreign tax or claim a credit for it. And as she mentioned earlier, the election to claim the Foreign Tax Credit is made simply by attaching a Form 1116 to an individual 1040. We said earlier, that if the Foreign Tax Credit amount is less than $300 for a single filer and less than $600 for married filing joint, and if other certain requirements are met, Form 1116 is not required to be filed in that instance.

So now with that out of the way onto Substantiation. If the taxpayer's Foreign Tax Credit is under exam, the taxpayer must be able to substantiate with supporting evidence, all the information provided or reported on the Form 1116. In a perfect world, the taxpayer is able to provide a receipt for each foreign tax payment. If the tax has been paid. And if the taxpayer claims the FTC using the accrued method, the foreign tax return on which the accrual is based should be provided as substantiation. And this is what's considered direct evidence, and the preferred substantiation under Treasury Reg 1.905-2(a). The receipt for tax payments and/or the foreign tax return can be the original, a duplicate copy of the original, or a duly certified, or authenticated copy. If the receipt or return is in the foreign language, a certified translation must be provided by the taxpayer.

Next, I'm going to talk about secondary evidence. Always remember the burden of proof is on the taxpayer. In an imperfect world in which we operate, if the taxpayer has established that it's impossible to provide direct evidence, then Treasury Reg 1.905-2(b) provides some acceptable secondary evidence. For example, in lieu of the receipt for payment of foreign income taxes, the taxpayer can submit a photocopy of a check, a draft, or other form of payment showing the amount and date of payment together with certification identifying it with the tax paid and confirming that the tax was paid from the taxpayer's account. In case the credit is claimed based on the accrued method, and the receipt of payment is not available, the taxpayer must show that the tax accrued in the tax year in question.

And if the foreign tax return is not available and the accrued foreign tax has not been paid, the taxpayer must provide the following. The certified statement of the amount accrued, excerpts from the taxpayers' book and records showing the amount of foreign income and related tax. Documentation substantiating the computation of the foreign tax established by foreign legal authorities, such as foreign law, assessment notices, or other evidence. If at any time the foreign tax receipts of foreign tax returns become available, the taxpayer must promptly submit them to the IRS.

In a case of taxes withheld at source from dividends, interest, royalties, compensation, or other forms of income, where evidence of withholding and of the amount withheld cannot be secured from those who have made the payments, the IRS may accept secondary evidence of such withholding and of the amount of tax so withheld, having due regard to the taxpayer's books of account and to the rates of taxation prevailing in a particular foreign country during the period or periods involved. In case of withholding taxes, the taxpayer must be able to document not only the tax withheld, but also that it has been paid. An official tax receipt issued by the foreign government is entitled to the presumption of regularity. Now, let's review Exhaustion of Administrative Remedies. For a foreign tax to be creditable under Section 901, it must be compulsory.

So the question to ask is, is the taxpayer legally required to pay the tax? Does the amount of foreign tax paid exceed the taxpayer's legal liability to pay that tax? Did the taxpayer in good faith pay only the foreign income tax required of them? This goes back to one of the criteria of credibility. That is the tax must be the legal and actual foreign tax liability. The focus here is on the word legal. For example, if a tax treaty exists which reduces the normal tax rate on a particular type of income, did the taxpayer do everything he could or she could to apply the lower treaty rate?

Another example, if there is a controversy regarding the application of a foreign tax law, did the taxpayer do everything he could to mitigate the tax, including seeking legal advice, going to appeals, competent authority, litigation in court, et cetera. There is a caveat. That is a taxpayer's exhaustion of remedies should be practical and cost-efficient in relation to the amounts at issue and the likelihood of success. Reasonable cost for individuals can be an issue because the amount in controversy may not justify spending a lot of resources to contest an item.

Therefore, taxpayers may ordinarily take a reasonable business approach, weighing costs and benefits, in settling foreign income tax issues. For the applicable law refer to Treasury Reg 1.901-2(e), in particular, -2(e)(5). Remember polling question 3, a while ago where the taxpayer was limited to the treaty rate, even though what was withheld exceeded the lower treaty rate? While the remedy to the taxpayer here or there is to file an amended return with that foreign country to claim a refund on the taxes that were over withheld. I will cover next how to analyze whether a taxpayer has exhausted all administrative remedies.

When determining whether the taxpayer has exhausted all administrative remedies, several factors should be considered. We've already mentioned some. Again, the burden of proof is on a taxpayer to show that all effective and practical remedies have been exhausted to contest their foreign tax liability using a reasonable business approach, again, weighing the cost and benefits, in settling their foreign tax issues.

So, some questions to ask, what available channels were there with the foreign tax authority? Did the taxpayer avail themselves of appeals, competent authority, an amnesty program, or the court system? Is the taxpayer eligible for refund from the foreign government? So now let's look at an example. Let's look at the example on the next slide here. Okay, so in this example, James, a U.S. taxpayer, earned dividend income of $100 in country X, and 20% of income or $20 of foreign income taxes was withheld, and this is based on that country's statutory rate, and that was paid over to country X. However, there is a tax treaty between country X and the U.S., and that provides that the maximum rate of withholding on dividend earned in country X is 15%, not 20%. Therefore, there is an overpayment or over withholding to country X of $5, $20 minus $15.

So when James files a claim for FTC with the U.S., only $15 or 15% the treaty rate of the $100 dividend qualify as foreign income taxes paid for FTC purposes, because this represents the compulsory amount of foreign taxes James was legally liable to pay. James should file a claim with country X as a remedy for the $5 that was over withheld. All right. Next slide, we have a continuation of this example. And so James in Example 1 claims the benefit of the treaty.

So James did assert the treaty benefit of the lower 15% rate with the foreign country and asked for a refund of $5. However, the claim was rejected by country X for whatever reason. James then invoked the competent authority procedures of the treaty and the cost of going to or going through competent authority is reasonable in view of the amount at issue and the likelihood of success is good. But the competent authority, through that channel, the refund was rejected again. Now, the cost of pursuing any judicial remedy in country X, in James's case, is unreasonable in light of the amount at issue and the likelihood of success.

So in James's case, he decided not to pursue any judicial remedy. Now, the $5 over withheld is now considered a compulsory payment and may be eligible for the U.S. FTC. Just be aware that seeking assistance from competent authority is only available by treaty, it is not an option in all situations, so check each specific tax treaty between the U.S. and the foreign country in question. Next, let's talk about the timing of the credit.

The taxpayer can elect to claim an FTC on either the cash basis known as the paid method or the accrual method by checking either box (j) or box (k) in Part II of the Form 1116. Most individual taxpayers are cash basis, so they're most likely going to be using the paid method. Now, cash basis taxpayers can elect the accrued method under Code Section 905, but once that election is made, it is binding on all future years. Now, I want to talk a little bit about the amended returns.

The general rule is that the taxpayer cannot change from the paid method to the accrual method on an amended return. However, in a new treasury reg that was published recently, and I believe Patti alluded to this earlier, there's a very limited exception, and that is Treasury Reg 1.905-1(e)(2). In illustrates, if a taxpayer claims an FTC for the very first time an election to claim the Foreign Tax Credit using accrued method can be made on the amended return. So let me give you an example. Let's say in year one, we have a taxpayer who is a U.S. resident or U.S. taxpayer with foreign source income, and the taxpayer paid foreign income taxes. But for whatever reason, the taxpayer did not claim the FTC on the original year one return.

Further, the taxpayer never ever claimed the FTC prior to year one. In year two, the taxpayer learned that claiming the FTC on the accrued method would be very beneficial for him. So the taxpayer amended his year one tax return and claimed the FTC on the accrued method, electing the accrued method. But under the new regulation, the taxpayer's election is now permitted because the taxpayer did not claim the FTC in any prior year, nor on the timely filed year one return, the taxpayer never made an election for the accrued method. So in this very limited circumstance, the taxpayer is allowed to change or to elect the accrued method on an amended return. What is foreign tax redetermination?

The foreign tax redetermination occurs when there's a change in a taxpayer's foreign tax liability, which affects the FTC the taxpayer previously claimed. For example, a taxpayer claims an FTC in year one based on the certain amount of foreign taxes paid or accrued in that year. Subsequently, let's say in year three, the taxpayer is audited by the foreign country, and the original tax liability from year one either increases or decreases. This redetermination impacts the FTC that was claimed in year one.

We will talk a little bit more about redetermination in a later slide. But first, let's go over FTC Carryback and Carryover. When a taxpayer cannot claim all the taxes as a credit because of the FTC limitation, the unused credit can be carried back one year and forward 10 years. Taxpayers must first carryback one year with no exception. Any unused credit is then carried forward 10 years. The unused or excess foreign income taxes eligible to be carried back and forward are reported on Form 1116. Carrybacks and carryovers are computed separately for each separate category using a separate Form 1116.

A taxpayer can only carryover excess credits if the taxpayer chooses to claim the credit. Carryback or carryover does not apply if the taxpayer chooses to deduct the foreign taxes instead of claiming a credit. Nonetheless, if the taxpayer elects to deduct the foreign taxes, he still has to reduce any carryback or carryover as if they were used in that tax year. Note that in the case of the GILTI income category, carryback and carryover are not allowed. And that's just the statute. And we don't have time to really get into the reason why carrybacks and carryovers are not allowed for a GILTI.

So I'm just going to stop here. The amount of Foreign Tax Credit carryback and carryover is reported on line 10 of the Form 1116 and that's the current version of the form. Prior to tax year 2021, a statement or detailed schedule was required to be attached to a tax return showing the amount of carrybacks and carryover the year or years they originate from and how they are used. Starting in tax year 2021, a new schedule, Schedule B, named the foreign tax carryover or carryback reconciliation schedule is made part of the Form 1116.

So if you have a carryover or a carryback, you will now need to attach a Schedule B to the Form 1116 for each separate category of income, again, starting in 2021. Now, let's go back to talk about the foreign tax redetermination. So what is foreign tax redetermination, otherwise known as FTR? Code Section 905(c)(1) specifies three types of foreign tax changes that result in foreign tax redetermination. First one is if taxes when paid or later adjusted differ from amounts accrued by the taxpayer and claimed as a credit. Remember that example where foreign government audited the taxpayer a few years later? So that's the first case. Second one, accrued taxes that are not paid within two years after the close of the taxable year to which the taxes relate. Or there was a refund of foreign income taxes.

Okay, continuing with the FTR. Taxpayers must file an amended return to notify the IRS when there's a foreign tax redetermination. And a revised Form 1116 must be attached to a 1040X. If a redetermination results in additional U.S. tax due, but the tax due is eliminated by a carryback or carryover, in this case a Form 1040X does not generally need to be filed. Finally, just like the new Schedule B that was made part of the Form 1116, starting in 2021, there's another new schedule, the Schedule C, which is a schedule called Foreign Tax Redetermination. And this is made to be part of the Form 1116. We don't really have time to get really into the schedule in any depth, but only to say that this new schedule must now be completed and attached to the tax return starting in 2021. It's used to identify and track FTRs that occur in the current year in each separate categories of income, the years to which the FTRs relate, and other information required to be informative to the IRS. The new Schedule C standardizes the way the FTRs are to be reported. Now, let's take a pause for our fifth and final polling question. Yes, Jim, let's do this.

Okay, audience, drum roll please. Our fifth and final polling question is, In 2019 a taxpayer is required to pay additional foreign income taxes for tax year 2014. The taxpayer must file an amended return to report a foreign tax redetermination. By what date is the amended return due? Is it A, October 15, 2025; B, April 15, 2021; C, April 15, 2022; or D, April 15, 2025? So take a moment, read the question, and click the radio button that best answers it. I'll give you a few more seconds to make your selection. So let's take a look at that. Think about what was talked about, and put your best answer. Click that radio button. Okay, audience, we're going to stop the polling now, and we'll share the correct answer on the next screen. D,

So let's take a look and see how everybody did. Based upon the information that we had, how did everybody do? I see that 81% of you responded correctly. Good job. Much appreciated. You've been listening to our presenters. Well, Jim, back to you to discuss resources. Jim, can you give me a hand with resources, please? Yes, I was on mute. Yeah, we do want to share with you some helpful resources from this slide. If this slide comes up for me, let's see.

Okay. All right. So the first one, as you can see, is Pub 54, that's a Tax Guide for U.S. Citizens and Resident Aliens Abroad, and in that, you'll find some definitions for what the U.S. citizen, what is a U.S. taxpayer, including green car holders or resident aliens. Pub 514, of course, is sort of like the Bible for Foreign Tax Credit for Individuals. And then there's Publication 901. It gets into the U.S. Tax Treaties and treaties with other foreign countries. Of course, a Form 1116 instructions to the form. And then we have on the slide listed some phone numbers for taxpayers assistance, the 1800 numbers, that's the domestic line, and then the final bullet point for taxpayers needing assistance calling from outside the U.S. Back to you. Thank you, Jim. Audience will make sure that we take those resources and save those as favorites for the future.

Okay. Hello again, it's me, Veronica Tubman, and I'll be moderating the Q&A session. Before we start the Q&A session, I want to thank everyone for attending today's presentation, ABCs of FTC for individuals. Earlier I mentioned we want to know what questions you have for our presenters. So here is your opportunity. If you haven't input your question well, there's still time. Go ahead and click on the dropdown arrow next to the Ask Question field, type in your question and simply click Send. Patti and Jim, they're going to stay on to answer your questions, and we really appreciate that. One thing before we get started, though, we may not have time to answer all the questions submitted, but we'll answer as many questions as time allows.

So let's get started so we can answer as many questions as possible audience. So we do appreciate it. And let's take a look. There are some really, really good questions. Okay. All right, Jim. How do you report income that is not taxable in foreign countries? Is it taxable in the U.S.? That's our first question, Jim. Okay. So it depends on the taxpayer, the status of the taxpayer, of course, U.S. taxpayers, U.S. citizens, and green card holders. or legal resident aliens. Of course, they are taxed on worldwide income.

So income, no matter where earned, generally speaking, is taxable to the taxpayer, even if it's not taxable in a foreign country. Okay, appreciate that. Okay, Patti, you're up. Can a taxpayer claim a Foreign Tax Credit based on foreign withholding prior to filing a return to the foreign country and determining their foreign tax liability? Well, we prefer that they don't do that, because basically there's a couple of issues. The withholding may not be their real and actual tax liability. They may be subject to the Foreign Tax Credit, the treaty rate as defined on the type of income, which may be less than that withholding rate. So withholding rate we equate to something like we're filing our Form 1040, and we have our W-2 withholding, that's not necessarily a tax rate.

So they should file an extension, pay the taxes that they believe they owe with their estimated tax, and then file the foreign return at that time. Okay. Thanks, Patti. I've got another one for you. These are good questions. Are foreign wages earned and paid in a foreign country by foreign entities subject to Social Security and Medicare tax? Well, remember, U.S. taxpayers pay tax on their worldwide income, but when it comes to Social Security, there may be a totalization agreement between that foreign country and the U.S. And those totalization agreements, I believe, are on the Social Security SSA.gov website, and they could look it up in regard to that.

Okay. Much appreciated, Patti. Okay, Jim, can you include foreign source income even if no withholding tax has been taken by the foreign government? I would say, not knowing all the facts of this case, but just say that there's foreign source income, let's say, it's passive dividend income that's taxed to a U.S. taxpayer on the 1040, and then, but there were no foreign taxes paid.

So in that case, if that's all there is, there is no FTC implications, because there was no foreign tax paid. However, if there were other foreign taxes paid related to, let's say, interest income earned in the foreign country, then this dividend income, let's say, which there was no withholding will come into play. So that would need to be combined with the foreign interest income on the Form 1116, because now we have foreign taxes paid. Got you.

Okay. Well, here's another goodie. Is the foreign tax includable in the $10,000 and that's married filing joint tax limit on Schedule A is claiming a deduction, Jim? Can you help us out with that one? Yes, that's a good question, because I think there is some confusion around that. And luckily, the $10,000 does not apply to any foreign taxes that the taxpayer wants to deduct rather than claim as a foreign tax credit. So that $10,000 threshold or limitation on Schedule A does not apply to foreign income tax.

Okay. Good to know. good to know. Okay, Patti, when making the decision to use the cash basis and that's versus the accrual basis, can they make this election for each item of foreign tax or is it the same election made for all foreign taxes from that point forward? Basically, it's the same election for the foreign taxes going forward and it's for all the foreign taxes. So if they pick the accrual method, it would be for the Foreign Tax Credit, they would have to pick the accrual method for all the foreign taxes going forward. Now, they can choose to deduct the foreign taxes on Schedule A. But in regard to the cash and accrual basis, they have to choose one method and that's it. Okay, I have to stick with that one method, the cash basis or the accrual basis. Thank you for that. Okay, Jim.

Can you claim the disallowed FTC as an itemized deduction? If not, can you carry forward the unused amount? I think the answer to that would depend on why the foreign tax was disallowed for FTC purposes was it because of the FTC limitation or because the inherent nature of the tax, let's say, property taxes are not eligible for the Foreign Tax Credit, therefore, it's not going to be there's no Foreign Tax Credit for that type of tax. In that case, of course, the taxpayer can most likely deduct property taxes on the Schedule A. Yeah, so that's kind of a direct answer to that question. If the other part of the question is, if not, can you carry forward the unused amount?

Now, is that tax, that foreign tax, was eligible for the FTC but was limited because of the FTC limitation, there's an excess amount that the taxpayer cannot use in the current year. That portion, of course, can be carried back one year and then forward 10 years. Okay. All right. Sounds good. Appreciate that. Thanks for the clarity. And here's another one for you. Does a U.S. citizen that is a managing and that's a partner or a member of a foreign partnership with foreign source income and taxes, okay, treats this income as passive or active, and what effect does that have on Form 1116?

I'm going to assume that because the fact that the partner is a managing partner, that partner most likely is going to be a general partner. In that case, the income that's going to be pass through to the general partner or to this managing partner would most likely be in a general category rather than passive. Got it. Okay. Let me look at these. You all have some really good questions, and Patti and Jim really clued us in today, and we really appreciate that. Okay, Patti, you're up. This is a carry forward question.

So get ready. I have a U.S. citizen client that worked in Canada from 2009 to 2019. During that period, he filed both U.S. and Canadian taxes and has accumulated $15,000 in Foreign Tax Credit. Can he continue to file Form 1116 and use the FTC against his U.S. tax liability even though he no longer has any Canadian income? Can you help us out with that one? I could help you on that. The one thing the FTC does not do; it never reduces the U.S. tax liability. So basically, he would lose that Foreign Tax Credit, but he does have 10 years to use it against any other foreign tax income.

So you have to have foreign source income in order to have the foreign tax use that carryover Foreign Tax Credit. So he basically at this point, if he never goes to work again in Canada or have any other income from foreign sources in that category, he basically loses that $15,000 in Foreign Tax Credit. Okay, got it.

Thanks a lot for that. And while I'm with you, let me see, I think, I've got a few more, I've got one more for you too. What do you do if the foreign tax covers both wages and passive income and cannot separate them in the foreign tax calculation process? Well, this is where you pull out Excel spreadsheet, basically they will have to be allocated, because the taxpayer should know what is wages and what is passive income. And so they would actually take an allocation and apply that allocation to the actual taxes that was paid or accrued and allowed.

So it would definitely be an allocation method, but they would be entitled to the foreign tax credit. Okay, sounds good. Okay, Jim, back to you. Let's see, is capital gains from U.S. property, now that's U.S. stock, by a Canadian resident considered to fall in category certain income re-sourced by treaty? Treaty says gain from a U.S. stock earned by a resident of Canada is only taxable in Canada. Can you help me out with that one? Yes. Now, certain income re-sourced by treaty, of course, is a separate category on the Form 1116. Now, the only time you would consider this is if there's a conflict between the treaty of how an income is sourced, a conflict between a treaty provision, and the Internal Revenue Code.

So let's take a look at this situation. Remember we said in terms of sourcing for personal property as in a stock. Stock is a personal property. So for sourcing purposes, it's based on the seller's resident. So this taxpayer sells stock, U.S. stock. And I'm going to assume this taxpayer is a Canadian resident, because that's what the question is saying. So it would be sourced, this income would be sourced to Canada based on Code Section 865. So there is no conflict between the Internal Revenue Code and the treaty, because the treaty also says that the gain from the U.S. stock is to be taxable in Canada.

So in this case, I don't see that there's a need to re-source this income from U.S. to Canada, because both the code and the treaty are hinted to be in agreement. And we will have a separate webinar in February. I think the first week of February that we're going to really get into this income re-source by treaty. So I know we only touched upon this very briefly today only as a separate category, but we didn't really talk about what it is. But if you want to join us in February, we have a separate webinar on this very topic. Okay, that sounds good. I know the audience is looking forward to that separate webinar in February, because it looks like you have some good questions here.

Okay, Patti, do we need to file a return for a U.S. citizen that has not lived in the U.S.? Well, U.S. citizens have to file a return on their worldwide income if they meet the filing requirements. Assuming they have a certain amount of income and have a filing requirement, they would be required to file a return on their worldwide income. But if they're paying taxes to a foreign country, of course, they could file a Form 1116 for the foreign taxes that they paid in subject to limitations, claim the FTC, or claim a deduction on Schedule A. But they do need to file a return on their worldwide income, assuming that they make enough income to file a return. Okay, thanks for that, Patti. Okay. Jim, where can we find these tax treaties, because we have some questions about treaties in countries. So where is a good resource to find information about tax treaties? There are many ways to look up the tax treaty.

Of course, you can just Google. For example, if you want to look up UK treaty or U.S. tax treaty with the UK, you can just Google it up. But we do have a website, IRS.gov, our very own website. And once you're in IRS.gov, go to the search box and type the name of the country, let's say, UK or France or whatever. And then the next, once you click the Search button, the next page will bring up the treaty documents. Okay, much appreciated. So audience, that's a good one. And all you do is go to the search engine box like Jim shared with us in the upper right hand corner and put in the information about the treaty. And then that'll be a great resource for you to bookmark for the future.

So I think that's a good one. Okay, Jim and Patti, here we go again. You mentioned foreign documents such as tax returns should be translated to English by a certified translator. Or the translation must be certified. What does that mean? Okay, I can answer that question, Veronica. Certified translation means whoever is doing the translation should be a credentialed person, someone who's qualified to do the translation, not just anybody off the street, for example, your friend.

This should only mean a professional translator. Got you. Okay, that's a good resource and that's a good answer to that question. We appreciate you. Okay, here we go. We're going to get these questions, because they're really good. Okay. You said if the taxpayer uses the accrued method to claim the FTC, but does not pay the tax that's owed within 2 years after the closing of the taxable year, there is a foreign tax redetermination.

Does the taxpayer have to amend the original return in this particular case? So who can help me out with that one? I can do that one, too. This will be considered a foreign tax redetermination, because for accrued method taxpayer or taxpayer who elected the accrued method, the taxpayer is only allowed 2 years, let's say they accrue a tax and that tax, based on that tax, the taxpayer claimed the FTC. But the taxpayer has to make that payment, that foreign tax payment as accrued within 2 years from the end of the taxable year in question.

So if that didn't happen, if the taxpayer did not actually make the accrued tax payment, then the taxpayer would have to amend the original return to remove the Foreign Tax Credit. Okay. That's good to know. So Jim, while I'm with you, can you help me out with another question? You said a taxpayer can make an annual election to either to file, claim the credit, or deduct the foreign taxes. What if the taxpayer wants to amend a prior election to change it from credit to deduction or vice versa? Can he or she do that? Yes, the election to either claim a credit for foreign taxes or to deduct the foreign taxes is an annual election, and that's correct. And yes, the taxpayer can change the election from credit to deduction or vice versa within the statute of limitation period of 10 years.

And that 10 years starts to run from the date of the original tax return without regards to any extensions. But be aware that if the taxpayer is changing from credit to deduction, the statute of limitation for refund purposes is generally only 3 years, not the 10 years. Got you. But the taxpayer is allowed to make the change from the credit to deduction within the 10 years statute of limitation on an amended return. And that's Treasury Regulation 1.901-1(d). Okay. Appreciate you, Jim.

Okay, Patti, I heard government employees cannot exclude foreign earned income on the Form 2555, but can they claim the Foreign Tax Credit on the Form 1116, Patti? Well, generally, the foreign earned income exclusion doesn't apply to wages and salaries of the military or civilian employees of the U.S. government. But if the taxpayer accrued taxes to the foreign country on that pay, they may be able to relieve their double taxation with the Foreign Tax Credit. The income tax treaties usually have an article providing relief from that double taxation, and many treaties also have special rules for U.S. citizens that are residents of a treaty country.

So I'm going to refer them to Pub 3 Armed Forces Tax Guide; and Pub 516 U.S. Government civilian employees, along with Pub 54, there's always good resources to use. Okay, sounds good. All right. So Patti, what documents do I need to keep for substantiation regarding this? Well, I have to plug up our Practice Unit. We have a Practice Unit on IRS.gov called Substantiation Requirements. It's in our virtual library. In general, the taxpayer must provide a receipt for each tax payment made if their taxes are already paid.

They'll need to support the items that are on Form 1116, and those items include like almost each line on the form, the foreign source income, the foreign taxes paid. They'll want to include a copy of the foreign tax return translated in English. You'll want to have and keep the receipts and statements from the foreign taxing authority. And the taxpayer would also need to show how the allocations are determined. And if they have any carry back and carry forward, they would also have to substantiate those carry back and carry forward for the amount that was claimed.

All right. Okay, Patti, you and Jim, that's given us some great information. Well, audience, unfortunately, that's all the time we have for questions. I want to thank our presenters for sharing their knowledge and expertise and for answering your questions. But before we close the Q&A session, Patti, we'd like you back to start off with some key points. You want the attendees to remember from today's webinar. Thank you, Veronica.

Some key points that we hope you walk away with is the U.S. generally taxes its citizens and residents on its worldwide income. The Foreign Tax Credit is one mechanism to alleviate the double taxation. There's also the Foreign Earned Income Exclusion is another mechanism. The Foreign Tax Credit is there to prevent the offset of U.S. income taxes on U.S. income, because the purpose of the Foreign Tax Credit is to mitigate the double taxation on that foreign income, not U.S. income.

A continuing on with some key points, the taxpayer can make an annual election to either claim the Foreign Tax Credit on the Form 1116 or they can choose to deduct on Schedule A, the foreign income taxes paid, but they can't do both. There's adjustments to be considered that reduce gross income in certain categories. And the tax related to those reductions must also be considered. And I'm going to share our final key points and that is the Foreign Tax Credit limitation is the lesser of the qualified foreign taxes paid or accrued or the U.S. tax on the foreign income.

The limitation must be calculated for each category. And Veronica, that's all we have and I'll turn it back over to you. Okay. Thank you so much. I really want to extend my sincere thanks to both of you. Audience, we are planning additional webinars throughout the year. To register for an upcoming webinar, well, please visit IRS.gov keyword search, write in the search box upper right hand corner webinars and select the Webinars for Tax Practitioners or Webinars for Small Businesses. When appropriate, we will be offering certificates and CE credits for upcoming webinars.

We invite you to visit our Video Portal at www.irsvideos.gov. There you can view archived versions of our webinars. Again, continuing education credits or certificates of completion are not offered if you view an archived version of any of our webinars on the IRS Video Portal. Another big thank to, Patti and Jim, for a great webinar and for sharing their expertise, staying around, answering our questions and giving us some really good resources to take us forward. And moreover, thankful that you can have another opportunity in February to visit this issue.

I also want to most of all thank you our attendees for attending today's webinar, ABCs of FTC for Individuals. If you attended today's webinar for at least 100 minutes from the official start time, well, you will receive an IRS certificate of completion that you could possibly use with your credentialing organization for two IRS CE credits. But if you stayed on for at least 50 minutes from the official start time of the webinar, you will qualify for one IRS CE credit. Again, the time that we spent chatting kind of getting to know each other at the beginning of the webinar, before it started, that does not count towards the 100 or the 50 minutes. So keep that in mind.

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It has indeed been a pleasure to be here with all of you. And on behalf of the Internal Revenue Service and our speakers, we want to thank you for attending today's webinar. It's really important for the IRS to stay connected with the tax professional community, individual taxpayers, industry associations, and that's along with federal, state, and local government organizations.

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