John R. Bullis: Foreign tax credit can be a great source of savings
The Individual Income Tax Return provides for a tax credit (like withholding) that reduces your tax if you paid some foreign income tax. (Form 1040, Page 2, Line 47.)
Most folks will have paid some foreign taxes if they have foreign stocks that pay dividends. There are other kinds of foreign income that might have foreign taxes withheld.
You can choose to claim the tax credit or claim an additional deduction for foreign taxes paid on Schedule A, but the credit almost always saves the most tax.
You can elect to use foreign taxes paid or elect to use foreign taxes accrued, but most folks will choose the taxes paid to simplify their preparation.
There is a simplified method of claiming foreign taxes paid if the total for the year is not too much. Single individuals having foreign taxes paid of not more than $300 (married folks joint return not more than $600) can claim the tax credit without filling out or filing form 1116. They just directly enter the amount of foreign taxes paid on the return. But that method does not allow for any carryover for unused foreign taxes.
Form 1116 can be complicated and the instructions are detailed and cover many situations. If your foreign taxes paid are more than the “small amounts” above, then the two page form 1116 needs to be prepared and an Alternative Minimum Tax form 1116 also should be done.
Because of the various limitations and special computations, if you paid a lot of foreign taxes, you may not get a full deduction this year for all the foreign taxes you paid. But there is a special carryover computation for the past 10 years that may help you save tax.
If you have to prepare and file form 1116, one of the complications that will reduce your current tax credit is if you have home mortgage interest deduction on Schedule A-Itemized Deductions. You are required to apportion interest expense you pay for home mortgage interest, business interest, investment interest expense, passive activity interest and partnership interest. (Form 1116, page 1, line 4a.)
You will need to have your entire tax return details, 1040 instructions and the form 1116 instructions handy to go through all the computations of carryover amounts.
IRS publication 514 — Foreign Tax Credit for Individuals and Instructions for Form 1116 can be printed off the irs.gov website. Those are great bedtime reading! (Joke.)
Did you hear? “There are three ways to get something done: do it yourself, hire someone, or forbid your kids to do it.” — Monta Crane
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Co. CPAs.