The IRS just recently announced the final regulations that can aid taxpayers in determining their eligibility and calculations for foreign tax credits. The changes have come in response to the Tax Cuts and Jobs Act as well as the need to develop regulations for foreign tax credit issues that have arisen, such as the apportionment of R&D costs and foreign tax redeterminations determined under Section 905 of the tax code.
Tax code sections affected by the changes
There are different sections of the tax code dealing with foreign taxes that have been affected either by the Tax Cuts and Jobs Act or the new regulations created in response to it. With the passing of the TCJA, the rules were changed that dealt with the apportioning and allocating of expenses that were used to determine the foreign tax credit limitation.
- Section 864(e)(2) was altered so that the fair market value form of asset valuation could no longer be used for allocating interest expenses.
- Section 904(b)(4) now includes alternative adjustments.
- Section 904(d) saw the addition of two new foreign tax credit limitation categories.
- Section 902, which dealt with paid credit for taxes paid by a foreign corporation, has been repealed.
- Section 951A was added, requiring U.S. shareholders of a foreign-controlled corporation to include certain amounts of their income.
Other regulations passed provided taxpayers with additional guidance involving:
- The apportionment and allocations of deductions and creditable foreign taxes.
- The defining of financial services income.
- The availability of foreign tax credits under Section 95.
- Foreign tax redeterminations.
- The application of foreign tax credit limitations on consolidated groups.
How do you know if your qualify for the Foreign Tax Credit?
Just because you have paid taxes to a foreign government does not mean you are automatically eligible for a foreign tax credit. To be eligible, the following four situations must be true.
- The tax was one that was imposed on you.
- You paid or accrued the tax.
- The tax qualifies as an actual legal foreign liability.
- The tax was imposed in lieu of income tax or as an actual income tax.
How to file for a foreign tax credit
If you qualify for the foreign tax credit, you will need to complete Form 1116 from the IRS. In this form, the limitations will be calculated on the amount of the tax you are eligible for. When calculating the credit, the credit allowed will be the smaller of the amount of foreign tax accrued or paid, or the amount of the U.S. tax that would be attributed to your foreign income. In some instances, filing Form 1116 will not be a requirement to claim the credit. You can directly claim the paid foreign taxes on your 1040 without calculating the limitations if the following statements are true.
- The source of your foreign income was from dividend or interest.
- The foreign tax you paid was reported to you on a Schedule K-1, a 1099-DIV, or a 1099-INT.
- Your foreign taxes paid totaled less than $300 for filing single and less than $600 for filing married.
- The stock and bonds that the dividends or interest was paid was held for at least 16 days without the obligation to pay them to someone else.
- You are not also filing a Form 4563.
- The foreign taxes were not eligible for a reduced tax rate or refund under a tax treaty.
It is also important to note when filing for the foreign tax credit that those working in a foreign country cannot claim a double benefit. If you earn wages in a foreign country and pay taxes to a foreign government, you can exclude some of it on your U.S. federal return, but will not be able to claim both the foreign tax credit and earned income exclusion on the same wages.
Trouble determining if you qualify for a foreign tax credit? Kundra & Associates, P.C. can help. Contact one of our experienced tax professionals today to help determine what credits you may qualify for on your foreign paid taxes.