How reduced rates for capital gains and qualified dividends affect the FTC.EXECUTIVE SUMMARY * With reduced rates on capital gains and dividends, it is more likely that a taxpayer's foreign taxes win exceed the FTC FTC See Federal Trade Commission (FTC). limit. * Taxpayers with capital gains and/or and/or conj. Used to indicate that either or both of the items connected by it are involved. Usage Note: And/or is widely used in legal and business writing. dividends taxed at a reduced rate are required to adjust the maximum FTC calculation. * Tax advisers should check whether their software is calculating the maximum FTC credit for both regular tax and AMT See vPro. purposes. Reduced rates for capital gains and qualified dividends affect the maximum allowable foreign tax credit (FTC) for many taxpayers. This article explains in detail how such reduced rates influence the FTC computation Computation is a general term for any type of information processing that can be represented mathematically. This includes phenomena ranging from simple calculations to human thinking. . ********** This article is an overview of the effect of reduced tax rates on capital gains and/or qualified dividends on the maximum allowable foreign tax credit (FTC) for individuals. Specifically, it addresses the (1) mechanics mechanics, branch of physics concerned with motion and the forces that tend to cause it; it includes study of the mechanical properties of matter, such as density, elasticity, and viscosity. of the adjustment made to the maximum allowable FTC; (2) reasoning behind the percentages used for the adjustment; (3) adjustment's effect on the alternative minimum tax (AMT); (4) changes in FTC carryback carryback n. in taxation accounting, using a current tax year's deductions, business losses or credits to refigure and amend a previously filed tax return to reduce the tax liability. (See: carryover) and carryforward carryforward 1. A business operating loss that, for tax purposes, may be claimed a certain number of years in the future, often up to 15 years. rules; (5) advantages and disadvantages of claiming a deduction deduction, in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs. versus a credit for foreign taxes paid; (6) de minimis An abbreviated form of the Latin Maxim de minimis non curat lex, "the law cares not for small things." A legal doctrine by which a court refuses to consider trifling matters. exemption exemption n. 1) in income taxation, a credit given for each dependent, blindness or other disability, and age over 65, which result in a downward calculation in tax levels. to the FTC limitation; and (7) status of software programs and the calculation of the maximum allowable FTC. Basic FTC Computation The basic premise behind the FTC is to provide relief from double taxation of income from foreign sources. Under Sec. 904(a), the credit is limited to the taxes that would have been paid to the U.S. on foreign-source income Foreign-source income Income earned from international operations. . The maximum allowable credit is the proportion of an individual taxpayer's foreign-source taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. over the taxpayer's total U.S. taxable income before deducting personal and dependency dependency In international relations, a weak state dominated by or under the jurisdiction of a more powerful state but not formally annexed by it. Examples include American Samoa (U.S.) and Greenland (Denmark). exemptions, multiplied mul·ti·ply 1 v. mul·ti·plied, mul·ti·ply·ing, mul·ti·plies v.tr. 1. To increase the amount, number, or degree of. 2. Mathematics To perform multiplication on. by the taxpayer's U.S. income tax before any tax credits. In other words Adv. 1. in other words - otherwise stated; "in other words, we are broke" put differently , it is the taxpayer's average Federal tax rate multiplied by the taxpayer's foreign-source taxable income. For example, if a taxpayer has $40,000 of foreign-source income, $150,000 of U.S. taxable income before exemptions and $30,000 of U.S. income tax before any tax credits, the maximum allowable credit is $8,000 (($40,000/$150,000) x $30,000). The $150,000 of U.S. taxable income is worldwide income and includes the $40,000 of foreign-source income. The calculation of the maximum allowable FTC is rather simple, until the reduced income tax rates on capital gains and/or qualified dividends are considered. Although a lower tax rate on capital gains has existed for many years, the Years, The the seven decades of Eleanor Pargiter’s life. [Br. Lit.: Benét, 1109] See : Time reduction of the individual income tax rates on qualified dividends to 15% (5% if the taxpayer is in the 10% or 15% income tax bracket Noun 1. income tax bracket - a category of taxpayers based on the amount of their income income bracket, tax bracket bracket - a category falling within certain defined limits ) by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA JGTRRA Jobs and Growth Tax Relief Reconciliation Act of 2003 ) has substantially increased the probability probability, in mathematics, assignment of a number as a measure of the "chance" that a given event will occur. There are certain important restrictions on such a probability measure. that tax practitioners will be confronted with this calculation. (1) Adjustment to Maximum Allowable FTC If taxpayers' capital gains and/or qualified dividends are taxed at a reduced rate, they are required to adjust the numerator numerator the upper part of a fraction. numerator relationship see additive genetic relationship. numerator Epidemiology The upper part of a fraction (foreign-source taxable income) and/or denominator denominator the bottom line of a fraction; the base population on which population rates such as birth and death rates are calculated. denominator (U.S. taxable income before exemptions) for purposes of the maximum allowable credit calculation, under Sec. 904(b) (2)(B). They have to adjust only the denominator if their foreign-source income was not taxed at a reduced rate. They have to adjust both the numerator and the denominator if all or a portion of their foreign-source income was taxed at a reduced rate. Some type of adjustment is made regardless of the origin of the reduced tax rates for capital gains and/or qualified dividends. For example, a taxpayer with no foreign-source income that qualifies for reduced tax rates is still required to adjust the denominator if the taxpayer's domestic capital gains and/or qualified dividends were taxed at a lower rate. Although the FTC adjustment calculation is fairly complex, the reason for the adjustment is to ensure that taxpayers do not receive an FTC greater than the Federal income taxes paid on the foreign-source income. Thus, if the foreign-source income is from capital gains and/or qualified dividends taxed at the reduced U.S. income tax rates, the adjustment ensures that the maximum allowable credit does not exceed the reduced income tax as a result of those rates. In contrast, if the foreign-source income is ordinary income taxed at regular income tax rates, the adjustment ensures the maximum allowable credit is based on the taxpayer's regular income tax rates, rather than the reduced tax rates on capital gains and/or qualified dividends. Adjustment Calculation Exhibit 1 on p. 416 illustrates the calculation and how an adjustment to the numerator and/or denominator ensures the taxpayer does not receive an FTC greater than the Federal income taxes paid on the foreign-source income. An adjustment calculation worksheet See spreadsheet. worksheet - spreadsheet is provided by the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. in the 2005 Instructions to Form 1116, Foreign Tax Credit; see p. 17 (worksheet for line 17). Exhibit 1: A comparison of columns 1, 2 and 3 of Exhibit 1 illustrates the effect of the adjustment on the numerator and/or denominator. Column 2 adjusts only the denominator to negate ne·gate tr.v. ne·gat·ed, ne·gat·ing, ne·gates 1. To make ineffective or invalid; nullify. 2. To rule out; deny. See Synonyms at deny. 3. the effect of the reduced tax rate on the qualified domestic dividend income. Column 3 adjusts both the numerator and denominator to provide a substantially lower allowable FTC, to ensure the taxpayer receives an FTC for the U.S. taxes paid on the foreign-source income at 15%. Thus, these adjustments are made solely to ensure that the maximum allowable FTC is limited to the taxes that would have been paid to the U.S. on the foreign-source income. In Exhibit 1, the taxpayer has total foreign taxes paid of $12,000 on $30,000 of foreign-source income, qualified domestic dividend income of $5,000 taxed at 15%, and other domestic income of $45,000 taxed at an ordinary income tax rate of 35%. Column 1 of Exhibit 1 makes no adjustment to either the numerator (line 2) or denominator (line 5), as required by law. Column 1 is presented solely as a baseline The horizontal line to which the bottoms of lowercase characters (without descenders) are aligned. See typeface. baseline - released version measure to illustrate the adjustment's effect on the numerator and/or denominator. Column 2 of Exhibit 1 assumes the foreign-source income is ordinary income taxed at an income tax rate of 35%. Because the foreign-source income is taxed at ordinary income tax rates in column 2, the numerator (foreign-source income) is not adjusted on line 2, but the denominator (taxable income before exemptions) is adjusted on line 5. The adjustment factor for line 5 is from p. 17 (worksheet for line 17) of the instructions to Form 1116. The maximum allowable FTC in column 2 (line 9) is $10,500. It is no coincidence Coincidence is the noteworthy alignment of two or more events or circumstances without obvious causal connection. The word is derived from the Latin co- ("in", "with", "together") and incidere ("to fall on"). that the foreign-source taxable income of $30,000 times the ordinary income tax rate of 35% also equals $10,500. Thus, column 2 of Exhibit 1 illustrates the basic premise that the maximum allowable FTC is the amount of taxes that would have been paid in the U.S. on the foreign-source income. Importantly, the maximum allowable credit in column 2 ($10,500) is greater than the credit in column 1 ($10,125), because the adjustment to the denominator in column 2 (line 5) negates the effect of the reduced taxes rates on the qualified domestic dividend income. Column 3 of Exhibit 1 assumes that the foreign-source income is qualified dividend income taxed at 15%. Because the foreign-source income is taxed at a reduced rate in column 3, the numerator (foreign-source taxable income) is adjusted on line 2 and the denominator (taxable income before exemptions) is also adjusted on line 5. The factors for these adjustments also come from the instructions to Form 1116. Importantly, the maximum allowable FTC in column 3 (line 9) is $4,500, which equals the foreign-source taxable income of $30,000 times the reduced tax rate on dividends of 15%.The maximum allowable credit in column 3 ($4,500) is significantly less than the credit in column 1 ($10,125), because the credit in column 1 considers the $45,000 of other domestic income taxed at an ordinary income tax rate of 35%. The maximum allowable credit does not consider this other domestic income; the credit is limited to the amount of taxes that would have been paid to the U.S. on the foreign-source qualified dividend income. The adjustment to the numerator in column 3 (line 2) of Exhibit 1 for the qualified dividend income taxed at 15% is required only for certain taxpayers. An adjustment to the numerator is not required if taxpayers have less than $20,000 of foreign-source net capital gains and foreign-source qualified dividends taxed at a reduced tax rate and if their taxable income less net capital gain income and qualified dividends (line 7 of the qualified dividends and capital gains worksheet) does not exceed certain amounts ($182,800 if married filing jointly Married Filing Jointly A filing status for married couples that have wed before the end of the tax year. They can record their respective incomes, exemptions and deductions on the same tax return. Married filing jointly is best if only one spouse has a significant income. (MFJ MFJ Married Filing Jointly MFJ Modified Final Judgment MFJ Martin F. Jue (founder of MFJ Enterprises, Inc.) MFJ Modified of Final Judgment MFJ Meta Font Job ) or qualified widow widow n. a woman whose husband died while she was married to him and has not since remarried. A divorced woman whose ex-husband dies is not a widow, except for the purpose of certain Social Security benefits traceable to the ex-husband. WIDOW. (er), $91,400 if married filing separately Married Filing Separately A filing status for married couples who choose to record their respective incomes, exemptions and deductions on separate tax returns. This method is opposite to "married filing jointly" and has few benefits. , $150,150 if single or $166,450 if head of household for 2005). Thus, for Exhibit 1, the adjustment to foreign-source taxable income on line 2 of column 3 is not required if the foreign-source qualified dividend income is less than $20,000. This adjustment exemption can provide a tremendous benefit to taxpayers. As noted in Exhibit 1, the maximum allowable FTC with the numerator adjustment is $4,500 (column 3, line 9). If the numerator is not adjusted, the maximum allowable FTC for column 3 is $10,500 (calculation not presented). Thus, if the exemption for the numerator adjustment increases to $30,000 to cover the example, the maximum allowable credit would increase by $6,000. Reasoning Behind Adjustment Percentages As noted in the instructions to Form 1116, the percentage adjustment for 28%, 25% and 15% gains for individual taxpayers is 0.2000, 0.2857 and 0.5714, respectively. These percentages are calculated under Sec. 904(b)(3)(E) by taking the difference between the maximum tax rate on ordinary income (35%) and the income tax rate on that particular class of income and dividing this difference by the maximum tax rate on ordinary income. The ratio for each type of gain is calculated as follows: 28% gain: (0.35 - 0.28)/0.35 = 0.2000 25% gain: (0.35 - 0.25)/0.35 = 0.2857 15% gain: (0.35 - 0.15)/0.35 = 0.5714 These different ratios ensure that the maximum allowable FTC is based on the appropriate tax rate. Exhibit 2 on p. 418 illustrates how the maximum allowable FTC should remain the same, regardless of the reduced tax rate on the qualified domestic income (i.e., 28% in column 1 and 25% in column 2). The only difference between columns 1 and 2 of Exhibit 2 is that the qualified domestic income is taxed at 28% and 20% in columns 1 and 2, respectively. The use of different adjustment factors in step 5 of Exhibit 2 allows the maximum allowable FTC to remain the same. As noted in step 9 of Exhibit 2, the maximum allowable FTC is $10,500 in both columns 1 and 2. Once again, it is no coincidence that the foreign-source income of $30,000 multiplied by the ordinary income tax rate of 35% also equals $10,500. Thus, the different ratios (i.e., 0.2000 for the 28% tax rate and 0.2857 for the 25% tax rate) for the qualified domestic income ensure that the maximum allowable credit remains the same. Effect on AMT Because the reduced tax rates on capital gains and qualified dividends are the same for regular tax and the AMT, the adjustment calculation is the same for the AMT, under Sec. 904(b) (3)(E)(iii). As with the calculation for regular income tax, if a taxpayer's foreign-source income was not taxed at a reduced rate, the taxpayer is required to adjust only the denominator (alternative minimum taxable income (AMTI AMTI Applied Marine Technology Inc AMTI Advanced Mechanical Technology Inc (Watertown, MA) AMTI Applied Marine Technology, Inc. AMTI Advanced Medical Technology Institute AMTI Automatic Moving Target Indicator )) for the AMT under Sec. 904(b)(2)(B)(ii). Likewise, if all or a portion of the taxpayer's foreign-source income was taxed at a reduced rate, the taxpayer is required to adjust both the numerator (taxpayer's foreign-source AMTI) and the denominator (AMTI) for the AMT; see Sec. 904(b)(2)(B). The factors used are the same for regular tax and AMT. Changes in Carryback and Carryforward Rules With the reduced tax rates on capital gains and qualified dividends, a taxpayer has a higher probability that the amount of foreign taxes paid will exceed the overall limit for the year under Sec. 904(a). Although FTCs can still be carried over, the carryover carryover n. in taxation accounting, using a tax year's deductions, business losses or credits to apply to the following year's tax return to reduce the tax liability. (See: carryback) rules for FTCs have changed the carryback and carryforward periods. Prior to Oct. 23, 2004, the excess could be carried back to the two preceding tax years and then forward to the five succeeding tax years. The American American, river, 30 mi (48 km) long, rising in N central Calif. in the Sierra Nevada and flowing SW into the Sacramento River at Sacramento. The discovery of gold at Sutter's Mill (see Sutter, John Augustus) along the river in 1848 led to the California gold rush of Jobs Creation Act of 2004 modified mod·i·fy v. mod·i·fied, mod·i·fy·ing, mod·i·fies v.tr. 1. To change in form or character; alter. 2. the carryback and carryforward periods for foreign taxes. After Oct. 22, 2004, the carryback period is reduced to one year, while the carryforward period has been extended to 10 years for both existing and future carryforwards Carryforwards Tax losses allowed to be applied to offset future income in some specified number of future years. under Sec. 904(c). Deduction Versus Credit Most tax practitioners recognize that a taxpayer may claim a deduction or a credit for foreign income taxes paid on foreign-source income under Sec. 275(a)(4)(A). In most instances, the FTC is more advantageous, because it provides a direct offset against the Federal tax liability, and a deduction is available only to taxpayers who itemize To individually state each item or article. Frequently used in tax accounting, an itemized account or claim separately lists amounts that add up to the final sum of the total account on claim. . However, with the reduced tax rates on capital gains and/or qualified dividends, an itemized deduction Itemized Deduction A deduction from a taxpayer's taxable adjusted gross income that is made up of deductions for money spent on certain goods and services throughout the year. for foreign taxes paid on foreign-source income might be more advantageous. For example, if a taxpayer's foreign-source dividends are taxed at 40% in the foreign country and these dividends are taxed at 15% for Federal tax purposes, it is likely that the taxpayer will have a large amount of foreign income taxes that will be unallowed as an FTC for Federal tax purposes (i.e., the unallowed portion being the difference between the 40% foreign tax rate and the 15% Federal tax rate). If the reduced tax rates stay in effect for over 10 years, the unallowed foreign taxes may go unused and expire expire /ex·pire/ (ek-spi´er) 1. to exhale. 2. to die. ex·pire v. 1. To breathe one's last breath; die. 2. To exhale. ; with the carryback period limited to one year, the FTC carryforward period would expire without the taxpayer getting any benefit from the foreign taxes paid. It is also important to remember that most states allow a deduction, but not a credit, for foreign taxes paid. Thus, when determining whether to claim a deduction or a credit for foreign taxes paid, it is important to consider the effect of a taxpayer's marginal (jargon) marginal - 1. Extremely small. "A marginal increase in core can decrease GC time drastically." In everyday terms, this means that it is a lot easier to clean off your desk if you have a spare place to put some of the junk while you sort through it. 2. state income tax rates. A taxpayer elects to claim a credit for foreign taxes paid on an annual basis by filing Form 1116. Under Sec. 6511(d)(3), the election to claim a credit or deduction can be changed as long as the statute of limitations A type of federal or state law that restricts the time within which legal proceedings may be brought. Statutes of limitations, which date back to early Roman Law, are a fundamental part of European and U.S. law. for the year in question remains open. Thus, tax practitioners should consider reviewing their clients' 2003 and 2004 income tax returns to determine whether the election to claim a credit or deduction produced the most advantageous tax result. Foreign taxes paid are deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). for regular tax, but are not deductible if the taxpayer is subject to the AMT. When determining whether to claim a credit or deduction, tax practitioners should consider whether the taxpayer is likely to be subject to the AMT. De Minimis Exemption Because of these rules, the IRS has offered some relief to taxpayers with minimal foreign taxes. The de minimis exemption under Sec. 904(j) allows taxpayers with $300 or less of foreign taxes ($600 if MFJ) to be exempt from the FTC limit, provided they have no foreign-source income other than qualified passive income. Importantly, the exemption is not automatic. To qualify, a taxpayer must elect to take the exemption by taking the credit directly on Form 1040. This election must be made in each year that the taxpayer qualifies. Under Sec. 904(j)(1)(B) and (C), a taxpayer electing the de minimis exemption may not carry back or carry forward excess foreign taxes to a year in which he or she has elected e·lect v. e·lect·ed, e·lect·ing, e·lects v.tr. 1. To select by vote for an office or for membership. 2. To pick out; select: elect an art course. the de minimis exemption. The carryback and carryforward are not available, because the purpose of the exemption is to provide relief from the complexity of the calculation related to the FTC. Software Programs Tax practitioners should ensure that their software is calculating the maximum allowable FTC correctly for both regular tax and the AMT. Because these calculations are relatively new, certain programs could be calculating these amounts incorrectly in·cor·rect adj. 1. Not correct; erroneous or wrong: an incorrect answer. 2. Defective; faulty: incorrect programming of the computer. 3. . Some manufacturers may have corrected the problem for 2005. Tax practitioners should carefully review Form 1116, especially when foreign-source income is taxed at reduced rates that require an adjustment to the numerator (taxpayer's foreign-source taxable income). Practitioners can manually calculate the maximum allowable credit using the step-by-step calculations in Exhibit 1, and compare these calculations to the output of their software programs. Conclusion If a taxpayer's capital gains and/or qualified dividends are taxed at a reduced rate, the taxpayer is required to adjust the numerator (foreign-source taxable income) and/or denominator (U.S. taxable income before exemptions) for purposes of the maximum allowable FTC calculation. However, even a taxpayer with no foreign-source income that qualifies for reduced income tax rates is required to make an adjustment if his or her domestic capital gains and/or qualified dividends were taxed at a reduced rate. These adjustments ensure that the maximum allowable FTC is limited to the taxes that would have been paid to the U.S. on the foreign-source income. At face value, the calculation of the maximum allowable FTC is fairly simple. However, the issues discussed in this article illustrate just how complex the calculation of the limit on the FTC can be. (1) See Secs. 904(b)(1), 1(h)(11)(A), 1(h)(11)(B) and 1(h)(11)(C)(iv). Thomas (language) Thomas - A language compatible with the language Dylan(TM). Thomas is NOT Dylan(TM). The first public release of a translator to Scheme by Matt Birkholz, Jim Miller, and Ron Weiss, written at Digital Equipment Corporation's Cambridge Research Laboratory runs E. Vermeer Vermeer successful fakes of his paintings went undetected for many years. [Dutch Hist.: Brewer Dictionary, 371] See : Forgery , Ph.D., CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. Associate Professor of Accounting University of Baltimore The University of Baltimore (UB), located in downtown Baltimore, Maryland in the Mt. Vernon neighborhood, is part of the University System of Maryland. UB recently opened a brand new student center as well as changing the colors to blue and green, and the "UB" logo. Baltimore Baltimore, city (1990 pop. 736,014), N central Md., surrounded by but politically independent of Baltimore co., on the Patapsco River estuary, an arm of Chesapeake Bay; inc. 1745. , MD Phillip Phillip is a variant of the name Philip. It may refer to: Given name:
Associate Professor of Accounting University of Baltimore Baltimore, MD John N. Sigler, J.D., CPA Associate Professor of Accounting University of Baltimore Baltimore, MD
Exhibit 1: Effect of reduced tax rates on capital gains and/or
qualified dividends on the maximum allowable FTC
Facts:
1. Total foreign taxes paid of $12,000 on $30,000 of foreign-source
income.
2. Qualified domestic dividend income of $5,000 taxed at 15%.
3. Other domestic income of $45,000 taxed at an ordinary income tax
rate of 35%.
(Column 1)
Maximum credit
allowed with neither
the numerator nor
denominator adjusted
for qualified
dividends (a)
1. Taxable income from foreign source $30,000
2. Adjustment to numerator for foreign-source 0
income taxed at reduced rates
3. Adjusted foreign-source taxable income $30,000
4. Taxable income before exemptions $80,000
(line 41, Form 1040)
($30,000 + $5,000 + $45,000)
5. Less: adjustment for reduced dividends $0
6. Adjusted taxable income after adjustment $80,000
(line 4 - line 5)
7. Percentage of total income from foreign 0.375
source (line 3 / line 6)
8. Total tax before credits (line 44, $27,000 (b)
Form 1040)
9. Maximum allowable credit $10,125
(line 7 x line 8)
10. Foreign taxes paid $12,000
11. Allowed FTC $10,125
(lesser of line 9 or line 10)
(Column 2)
Maximum credit
allowed foreign-
source income is
taxed at ordinary
income tax rate
of 35%
1. Taxable income from foreign source $30,000
2. Adjustment to numerator for foreign-source 0 (c)
income taxed at reduced rates
3. Adjusted foreign-source taxable income $30,000
4. Taxable income before exemptions $80,000
(line 41, Form 1040)
($30,000 + $5,000 + $45,000)
5. Less: adjustment for reduced dividends (2,857) (d)
6. Adjusted taxable income after adjustment $77,143
(line 4 - line 5)
7. Percentage of total income from foreign 0.3889
source (line 3 / line 6)
8. Total tax before credits (line 44, $27,000 (b)
Form 1040)
9. Maximum allowable credit $10,500
(line 7 x line 8)
10. Foreign taxes paid $12,000
11. Allowed FTC $10,500
(lesser of line 9 or line 10)
(Column 3)
Maximum credit
allowed foreign-
source income is
qualified dividends
taxed at 15%
1. Taxable income from foreign source $30,000
2. Adjustment to numerator for foreign-source (17,142) (e)
income taxed at reduced rates
3. Adjusted foreign-source taxable income $12,858
4. Taxable income before exemptions $80,000
(line 41, Form 1040)
($30,000 + $5,000 + $45,000)
5. Less: adjustment for reduced dividends (19,999) (f)
6. Adjusted taxable income after adjustment $60,001
(line 4 - line 5)
7. Percentage of total income from foreign 0.2143
source (line 3 / line 6)
8. Total tax before credits (line 44, $21,000 (g)
Form 1040)
9. Maximum allowable credit $4,500
(line 7 x line 8)
10. Foreign taxes paid $12,000
11. Allowed FTC $4,500
(lesser of line 9 or line 10)
(a) This calculation assumes that the foreign-source income is ordinary
income taxed at ordinary income tax rates. It also makes no adjustment
to either the numerator or denominator, as is required under the law.
It is presented solely for comparative purposes.
(b) ($75,000 x 0.35) + ($5,000 x 0.15) = $27,000.
(c) No adjustment is made to the numerator, because the foreign-source
income is taxed at ordinary income tax rates.
(d) $5,000 x 0.5714 = $2,857. This adjustment factor comes from p.17
(worksheet for line 17) of the 2005 instructions to form 1116.
(e) $30,000 x 0.5714 = $17,142. An adjustment is made to the numerator
because the foreign-source income was taxed at a reduced rate.
(f) ($5,000 + $30,000) x 0.5714 = $19,999.
(g) ($45,000 x 0.35) + ($35,000 x 0.15) = $21,000.
Exhibit 2: Maximum credit allowed with qualified domestic income taxed
at different tax rates
Facts:
1. Total foreign taxes paid of $12,000 on $30,000 of foreign-source
income taxed at ordinary income tax rate of 35%.
2. Qualified domestic income of $5,000 taxed at a different rate.
3. Other domestic ordinary income of $45,000 taxed at a 35% rate.
(Column 1)
Maximum credit
allowed with
qualified domestic
income taxed
at 28%
1. Taxable income from foreign source $30,000
2. Adjustment to numerator for foreign-source 0
income taxed at reduced rates
3. Adjusted foreign-source taxable income $30,000
4. Taxable income before exemptions $80,000
(line 41, Form 1040)
($30,000 + $5,000 + $45,000)
5. Less: adjustment for reduced tax rate
on domestic income
($5,000 x 0.2000) ($1,000) (a)
($5,000 x 0.2857)
6. Adjusted taxable income after adjustment $79,000
(line 4 - line 5)
7. Percentage of total income from foreign 0.3797
source (line 3 / line 6)
8. Total tax before credits (line 44,
Form 1040)
($75,000 x 0.35) + ($5,000 x 0.28) $27,650
($75,000 x 0.35) + ($5,000 x 0.25)
9. Maximum allowable credit $10,500
(line 7 x line 8, rounded up)
10. Foreign taxes paid $12,000
11. Allowed FTC $10,500
(lesser of line 7 or line 8)
(Column 2)
Maximum credit
allowed with
qualified domestic
income taxed
at 25%
1. Taxable income from foreign source $30,000
2. Adjustment to numerator for foreign-source 0
income taxed at reduced rates
3. Adjusted foreign-source taxable income $30,000
4. Taxable income before exemptions $80,000
(line 41, Form 1040)
($30,000 + $5,000 + $45,000)
5. Less: adjustment for reduced tax rate
on domestic income
($5,000 x 0.2000)
($5,000 x 0.2857) ($1,429)
6. Adjusted taxable income after adjustment $78,000
(line 4 - line 5)
7. Percentage of total income from foreign 0.3818
source (line 3 / line 6)
8. Total tax before credits (line 44,
Form 1040)
($75,000 x 0.35) + ($5,000 x 0.28)
($75,000 x 0.35) + ($5,000 x 0.25) $27,500
9. Maximum allowable credit $10,500
(line 7 x line 8, rounded up)
10. Foreign taxes paid $12,000
11. Allowed FTC $10,500
(lesser of line 7 or line 8)
(a) The adjustment factors come from p. 17 (worksheet for line 17) of
the 2005 instructions to Form 1116.
|
|
||||||||||||||||||
Printer friendly
Cite/link
Email
Feedback
Reader Opinion