As the economy continues to grow, more taxpayers will leverage investment accounts to fuel their financial growth strategy. When such accounts are held in the US there are very few tax concerns. However, when the accounts are held in foreign financial institutions there can be significant tax concerns. The issue arises from how tax on interest and dividends is collected and by which government. Remember, the IRS requires taxpayers to claim income earned on global revenue. So there is an obligation to pay the U.S. government, but often times the foreign government will withhold tax as well. This creates a double taxation situation. The good news is the IRS offers relief in the form of the Foreign Tax Credit or through itemized deductions to offset the foreign withholding. To help clients, prospects, and others understand how this tax credit can benefit them, JLK Rosenberger has provided a summary of the important details below.
Qualifying for the Benefits
Remember there are two benefits which can be utilized. First is the foreign tax credit, which not all taxpayers with a foreign investment account qualify to claim the credit. The following criteria must be satisfied before qualification can be established. First, a foreign tax liability must have been paid or accrued to a foreign county or a U.S. territory. The tax must be imposed on the individual taxpayer and must be an income tax or tax imposed in lieu of an income tax. Second, if taxpayers don’t meet these qualifications they may then be qualified to deduct the withholding on their income taxes.
Claiming the Benefit
To choose the deduction, you must itemize on Form 1040, Schedule A. To choose the foreign tax credit, you generally must complete Form 1116 and attach it to your Form 1040 or 1040-NR. Taxpayers can claim the foreign tax credit without filing Form 1116 if you meet all of the following requirements:
- All foreign source income is passive income, such as interest and dividends
- All foreign income and the taxes are reported to you on a qualified payee statement, such as Form 1099-INT, Form 1099-DIV, or Schedule K-1 from a partnership, S corporation, estate, or trust
- The total of the qualified foreign taxes is not more than the limit for the filing status you are using,
Choosing Credit or Deduction
Generally speaking, it’s better to take a credit for qualified foreign taxes than to deduct them as an itemized deduction because a credit reduces income tax on a dollar-for-dollar basis, while a deduction only reduces the income subject to tax. In addition, you can choose to take the foreign tax credit even if you do not itemize your deductions, which means you can take the standard deduction in addition to the credit. If you choose to take the foreign tax credit and cannot claim a credit for the full amount of qualified foreign income taxes you paid or accrued in the year, a carry back (for one year) or carry forward (for 10 years) is permitted.
Reviewing opportunities such as the Foreign Tax Credit is an essential part of tax planning. As the end of the year approaches it’s important to review all tax saving opportunities available. If you have tax planning questions or would like more details about the Foreign Tax Credit, JLK Rosenberger wants to help! For additional information please call us at 949-860-9902 or click here to contact us. We look forward to speaking with you soon.