# Form 1116 and Treaty for Czech Republic



## laotzu (Mar 20, 2016)

I am trying to determine if I have this right:

Separated, but still married couple. Both are US citizens. One lives in the US, the other in CR. They amenable to filing together or separately.

Details below

Questions:

1 - The CR resident uses the FEIE to remove W2 and W2-like income from US tax return. Can the RSU's that were issued by the CR company be eliminated this way? I think they are considered earned income as they are part of employment.

1 - When claiming FTC on 1116 for the other items that CR also taxes, is this the right thought process:

a) Tax liability is the lower of
1) accrued taxes associated with the income in question. CR return will be completed before US return, so the exact amount is known - excess tax after withholding is paid in 2016. I do not have to calculate a blended rate when the return contains multiple tax rates for different income types.
2) maximum rates allowed to be charged under the treaty by resident country (CR)
b) Form 1116 is used to claim the credit in the appropriate category
a) Passive category income (Bank Interest, Dividends, Capital Gains/Losses)
b) General category income (salary and self-employment) - unused in this situation
c) Section 901(j) income - unused in this scenario
d) Certain income re-sourced by treaty - see below
e) Lump-sum distributions - unused in this scneario

3) The savings clause of the tax treaty seems to mean that the treaty can never be used to reduce US tax liability below that of a US resident citizen. This seems to indicate that I will never be re-sourcing US income as foreign. This is bothersome because the treaty seems to indicate that:
a) Interest is only taxable in the Resident country. Normally I would think this means to re-source it as foreign income, but the savings clause seems to mean report it and take a tax credit
b) Dividends - taxable at a maximum of 15% by the non-resident country (where the dividend payer is resident)
c) Gas Well Royalty - The well is in the US which the treaty seems to say means it is chargeable to the US. However, there is a paragraph that says that seems to say that a resident of the other state (CR) can treat the income as arising in the CR and tax it that way (with presumably a credit on the US return). However the savings clause seems to invalidate this for US residents. See below for what is happening now .. but yeesh!

4) Does anyone know how 403b, 401K, IRA and ROTH IRA are treated by the CR?

Details:

US Resident (and US citizen)
W2 - Line 7 of 1040
1099-INT - line 8 of 1040
1098-E Student Loan Interest - 1040 line 33 or not if MFS
1098 Mortgage Interest - Schedule A (loan is in both names, this person does the paying and so gets the deduction)
1098G - State Tax Refund - 1040 line 10

CR Resident (and US Citizen)
Note: All items taxed by CR at 15% (unless otherwise noted)
W2 from US company for work done remotely - Tax paid in CR (less than 15%)
W2 style income from CR company for work done in CR - Tax paid in CR (not 15% with supra-salary)
Restricted Stock Units from CR company (US parent company) - vested and treated as income in CR
1099-INT from US Bank
1099 - Self Employment Income from US company for work done remotely
1099 DIV from US investment firm (Div and Qual Div)
US Stock Transactions for gains/losses
K1 for Natural Gas royalties (well is in USA) (ignored by CR accountant as he doesn't want to deal with the treaty that makes it US only income - this is painful to do in the CR and this is for so little money it is pointless)
K1 for some weird commodity investment in USA 

US taxes are done with TaxAct. CR taxes done by accountant.

Thank you in advance!


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## BBCWatcher (Dec 28, 2012)

laotzu said:


> Can the RSU's that were issued by the CR company be eliminated this way?


Maybe. One factor is that the FEIE has a time limit (a next tax year limit), so income cannot be _too_ deferred. And RSUs are a form of deferred income, in part anyway.

Let's suppose for example the date of the RSU award was August 14, 2013, and all the shares vested on August 14, 2014 (12 months later). If that RSU income stretched across a period when there was exclusively foreign work, and the recipient otherwise qualified for the FEIE, then I think all of that income can be treated as FEIE-eligible income. It's not _too_ deferred (all the services performed for that income were in the prior or current tax year), so that looks fine in this example. But I'd have to dig into the rules on this a bit more -- that's a bit of a guess.

I don't think there's much argument _against_ RSUs being earned income. In general they are subject to FICA (U.S. payroll taxes) after all.

I'll ponder the rest of your questions.  Or perhaps somebody else would like to jump in.


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## BBCWatcher (Dec 28, 2012)

OK, I did some more checking. IRS Publication 54 has a brief discussion of "stock options," generically, in relation to the Foreign Earned Income Exclusion. (RSUs are a particular form of "stock options.") Yes, it appears I was correct.

As another example, let's suppose you were granted RSUs on January 23, 2012, and they vested (and you sold them -- let's keep it relatively simple here) on January 23, 2015. Let's further suppose your "foreign period" began on January 23, 2014, and continues to this day. The RSUs have a cost basis of zero, and you received $9,000 of RSU income (after any broker commission). In this example the RSUs cover a three year period of employment, but only one of those years (one third) was within your "foreign period." So you can count one third of that income as foreign, for services you performed while overseas. Since the income was received in the next tax year, after the services performed, that's fine -- it meets the FEIE's time limit. So in this example you could exclude up to $3,000 of your RSU income in tax year 2015 as foreign earned income. For the other $6,000 you'd pay ordinary U.S. income tax first, but presumably you could take a foreign tax credit on your Czech tax return.

Note that just because $3,000 in this example is excludable doesn't mean the CR can't tax that income. The CR might say, "Well, that's fine your U.S. tax rate is zero on that $3,000, but we'll collect our full rate, thank you very much." It just depends on the CR's tax rules.

Double check all that please, but that's my understanding of how this works.

As an aside: why is there a time limit in the FEIE? Well, hopefully it should be pretty obvious. If there weren't, it'd be a gigantic loophole. Basically your employer could send you to Dubai for a year, then keep paying you "deferred" (ahem) income when you return to the United States, in ~$100K increments per year "forever," tax free. The IRS (Congress, really) doesn't allow that.

As a general answer to the rest of your questions, if you have Czech bank interest (for example) you pay the Czech Republic first, then take a Foreign Tax Credit on your U.S. tax return and pay any balance (or get an excess Foreign Tax Credit). Think of it as two major "buckets" of income: a Czech "bucket" and a U.S. "bucket." For Czech income pay the CR first, then settle up with the U.S. For U.S. income, pay the U.S. first then settle up with the CR. Keep that basic principle in mind and you'll probably be OK.

And yes, you can pretty much ignore the tax treaty. The savings clause eliminates most of the tax treaty for U.S. persons. Social security retirement benefits (from either/both countries) are probably the most common exception. Then the treaty can have something to say.


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## laotzu (Mar 20, 2016)

BBCWatcher said:


> OK, I did some more checking. IRS Publication 54 has a brief discussion of "stock options," generically, in relation to the Foreign Earned Income Exclusion. (RSUs are a particular form of "stock options.") Yes, it appears I was correct.
> 
> As another example, let's suppose you were granted RSUs on January 23, 2012, and they vested (and you sold them -- let's keep it relatively simple here) on January 23, 2015. Let's further suppose your "foreign period" began on January 23, 2014, and continues to this day. The RSUs have a cost basis of zero, and you received $9,000 of RSU income (after any broker commission). In this example the RSUs cover a three year period of employment, but only one of those years (one third) was within your "foreign period." So you can count one third of that income as foreign, for services you performed while overseas. Since the income was received in the next tax year, after the services performed, that's fine -- it meets the FEIE's time limit. So in this example you could exclude up to $3,000 of your RSU income in tax year 2015 as foreign earned income. For the other $6,000 you'd pay ordinary U.S. income tax first, but presumably you could take a foreign tax credit on your Czech tax return.
> 
> ...


The idea of RSUs as deferred compensation jives with how I think about them. I hadn't found the line in pub54 that said it as clearly. I reviewed it in light of your comments. It appears that stock options also vary a bit and it seems that RSUs are an even more special case. That said, it is all deferred comp. That makes me wonder when it is considered earned. From your description, it sounds like an RSU granted in year X is considered earned in that year and just delivered later. Therefore, in general, a portion delivered in Year X+1 is exemptible under FEIE and Years X+2 and further would require the use of an FTC.

In my specific case, I was granted the RSUs by a foreign employer during a period when I was FEIE eligible and claiming. They vest over 4 years based solely on time employed, not performance. The grant was made in 2014 and first receipt was in 2015. It seems it is reasonable to include the 2015 income in the FEIE as they are connected and reasonably timely.

As for 2016, 2017, and 2018, one interpretation is as listed above, that they are deferred from 2014 and not timely for FEIE. However, another thought is that I since they are vested solely based on time employed, they are effectively earned through continued employment. If this is the case, then a vest in Year X is effectively earned in Year X-1, or in this case I earn the 2016 grant by being employed in 2015, 2017 via employment in 2016 and so forth. I don't know if this can actually be supported by anymore than my wishful thinking however 

Any opinions? Specifically if my wishful thinking is just that, do you think FTC still applies, a minimum because I will be taxed in the CR on the income.

Regardless, I believe the income will always be considered Earned under the code, and therefore if I do have to take FTC I become potentially eligible for things like IRA contributions that require Earned Income.



BBCWatcher said:


> As a general answer to the rest of your questions, if you have Czech bank interest (for example) you pay the Czech Republic first, then take a Foreign Tax Credit on your U.S. tax return and pay any balance (or get an excess Foreign Tax Credit). Think of it as two major "buckets" of income: a Czech "bucket" and a U.S. "bucket." For Czech income pay the CR first, then settle up with the U.S. For U.S. income, pay the U.S. first then settle up with the CR. Keep that basic principle in mind and you'll probably be OK.


I understand what you mean by two buckets of income by source, however I don't think the CR will agree. My understanding is that they read the tax treaty and say, "We have a tax system that taxes our tax residents on their world wide income. Nothing in this treaty prevents us from doing that for the types of income in question. Some income types, such as Interest are in the treaty as sourced in the resident's location regardless of payer location. Therefore we get the tax and the other country has to give the credit."

There is also this in Article 24, Paragraph 3:

Article 24, Paragraph 3:



> In the case of an individual who is a citizen of the United States and a resident of the Czech Republic, income which may be taxed by the United States solely by reason of citizenship in accordance with paragraph 3 of Article 1 (General Scope) shall be deemed to arise in the Czech Republic to the extent necessary to avoid double taxation, provided that in no event will the tax paid to the United States be less than the tax that would be paid if the individual were not a citizen of the United States.


With this technical note:



> This provision overrides U.S. law source rules only in those cases where U.S. law would operate to deny a foreign tax credit for taxes imposed by the Czech Republic under the provisions of the Convention on U.S. citizens resident in the Czech Republic. In no case, however, is this provision to reduce the taxes paid to the United States below the amount that would be paid if the individual were not a citizen of the United States, i.e., the U.S. tax imposed on a nonresident, non-citizen with respect to income arising in the United States.


This seems to leave the following two situations:

Some income, such as Interest, is defined in the treaty as having a source based on the recipients residency. So with US paid interest income that would normally not be eligible for FTC, I believe I should file an 1116 and re-source that income to the CR then take a FTC for the actual CR tax paid (or accrued), limited by actual tax paid in US. In this case the US is "second fiddle."

Other income, such as Dividends, are defined in the treaty as sourced by payer location (simplification). So for US source dividends, I should take an FTC for CR tax paid, but in no way can my US tax liability fall below 15% (the defined rate for non-residents). In this case, the CR is "second fiddle"

Does that sound right?



BBCWatcher said:


> And yes, you can pretty much ignore the tax treaty. The savings clause eliminates most of the tax treaty for U.S. persons. Social security retirement benefits (from either/both countries) are probably the most common exception. Then the treaty can have something to say.


Would another way to phrase this be, that citizenship taxation eliminates most treaty benefits directly, but some items are still allowed explicitly and tax credits are allowed for most other items subject to provisions as mentioned above about minimum payable tax.

Lastly, a bit more reading indicates that some tax treaties directly address US retirement programs (401K, 403B, IRA, etc.) and some don't. CR is one that doesn't, so interpretation will be per CR law.


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