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Allocating charitable contributions in computing FTC.

Foreign tax credits (FTCs) are limited to the portion of U.S. tax generated by foreign-source taxable income (FSTI). Expenses that must be deducted in computing FSTI include not only cost of sales but also all other expenses "allocable or apportionable" to foreign source gross income.

On Mar. 12, 1991, the IRS released Prop. Regs. Sec. 1.861-8(e), which deals with allocating charitable contributions in computing FTC limitations. Previously, contributions were apportioned to both U.S. and foreign-source gross income. Thus, a U.S. contribution could have resulted in lost FTC.

Under Prop. Regs. Sec. 1.861-8(e), contributions to foreign charities would be allocated to foreign-source income. Contributions to U.S. charities would be allocated to U.S. -source income--if they are restricted solely for use in the United States. Other contributions would be apportioned based on gross income, in accordance with the old rules.

This proposed change could mean substantial tax savings for taxpayers with excess FTCs. To qualify for allocation to U.S.-source income, contributions would have to be restricted to U.S. use. This could be easily accomplished by endorsing contribution checks to U.S. charities "for use only in the United States."

Example: X Corporation earns half of its gross income in Japan and the other half in the United States. It contributes $200,000 to a U.S. charity in 1992. X's Japanese taxes exceed its U.S. tax on FSTI. Therefore, its FTC is limited under Sec. 904. Without the suggested endorsement, 50% of the contribution would be allocated to foreign-source income and would further reduce X's FTC.

However, if X endorses the U.S. charity's check as suggested, its FTC is increased by $34,000 (50% of the $200,000 contribution x X's 34% U.S. tax rate). There is no change in X's Japanese tax or in X's precredit U.S. tax. The endorsement on the check allows 100% allocation to U.S.-source income. While total taxable income is the same in either case, X's net U.S. tax is reduced by $34,000.

Numerous witnesses (including many charities) opposed this proposed regulation at an IRS public hearing held on Aug. 1, 1991. However, under President Bush's budget proposals (released by the Treasury on Jan. 29, 1992), all charitable contributions would be allocated to U.S.-source gross income (to the extent thereof)--effective for contributions made in calendar years ending on or after Dec. 31, 1992.

From Stephen C. Fox, CPA, New York, N.Y.
COPYRIGHT 1992 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:foreign tax credit
Author:Fox, Stephen C.
Publication:The Tax Adviser
Article Type:Brief Article
Date:May 1, 1992
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