If your investment portfolio includes holdings outside of the U.S., it is not uncommon to see foreign taxes withheld on the foreign sourced income it generates. Generally, you may claim a credit for foreign taxes if the following four tests have been met:
1. The tax must be imposed on you
2. You must have paid or accrued the tax
3. The tax must be the legal and actual foreign tax liability
4. The tax must be an income tax (or a tax in lieu of an income tax)
How do I claim the foreign tax credit?
You should file Form 1116 to claim a credit for the foreign taxes paid and/or withheld from income sources that generally include wages, dividends, interest and royalties.
Foreign sourced income and foreign taxes paid are generally reported on are Forms 1099-DIV, Form 1099-INT, Schedule K-1s (Forms 1041, 1065, 1120S) or similar substitute statements. However, there are occasions in which your foreign source income will not be included on U.S. tax reporting forms.
You may be able to claim the foreign tax credit without filing Form 1116 if the total amount of foreign taxes paid that could potentially be credited back to you is no more than $300 Single Filers ($600 Married Filing Joint Filers).
This election is not available to estates or trusts.
TAX TIPS – Things to watch for
The amount of foreign tax that qualifies for the foreign tax credit is not necessarily the amount of tax withheld by the foreign country.
In preparing your Form 1116, you must report the net foreign source income in calculating your foreign tax credit.
If you have foreign sourced income that is taxed at a reduced U.S. tax rate (i.e. 0%, 15%), then you must exclude a portion of foreign income taxed at the reduced rate from the amount you are reporting on Form 1116. This limitation is imposed to prevent a credit in excess of the U.S. tax assessed on the foreign income.
If you elect the accrual method, the election will be irrevocable for 10 years.
The information above is only general in nature. If you have questions regarding the tax treatment of your foreign sourced income or would like to speak to one of our tax advisors, please give us a call.
Livonia Winkles, EA