# Form 1116 for unearned income (plus 2555 for earned income)



## pumpkinpie (May 10, 2016)

Hello, new user here. I have a question about Form 1116 (foreign tax credit). I am resident in Italy and use Form 2555 to exclude my earned income. I usually don't bother with 1116 for my unearned income because I have no tax to pay anyway, except for self-employment tax.

This year I wound up with quite a bit of tax (other than self-employment) because of my mutual funds, which I declared as PFICs. So I am trying to recoup some money by filing 1116 for the Italian tax I paid on dividends and interest from other investments (this is unearned income which I can't claim on Form 2555). 

Using TaxAct, I get a credit of zero, because on line 18 of Form 1116 I am asked for the amount from 1040, line 41, which is negative because of the 2555 exclusion and my personal deduction. On line 19 of 1116 I'm supposed to divide line 17 (which is positive) by line 18. The line itself says "if line 17 is more than line 18, enter 1." By entering 1, I would get the full tax credit I expect.

The problem is that TaxAct stops the form at line 18 and does not do the division required for line 19. I asked why and was told that no tax credit is given if 1040 line 41 (and therefore 1116 line 18) is negative. But the instruction says "if line 17 is more than line 18, enter 1" and of course the positive number on line 17 is more than the negative number on line 18. There is no mention of negative numbers on line 18 in the instructions.

Can anyone tell me whether this is correct, and I am not entitled to a credit for foreign tax paid on unearned income because I have "negative taxable income"? Again, I do have tax to pay on 1040 line 44. If I fill in 1116 manually, putting a 1 on line 19, I get a "useful" credit in that it goes on line 48 of my 1040 and is therefore subtracted from 1040 line 44 (tax payable). 

Thanks in advance for any insight.


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## Bevdeforges (Nov 16, 2007)

If line 41 is 0 (or negative), it means that your adjusted gross income is completely covered by your standard deduction. Did you include the income from your mutual funds on one of the lines for Income on the first page of your 1040?

Or, how did you wind up having to pay US tax on your mutual funds? That income (or capital gains) needs to be somewhere on the first page of the 1040 (lines 7 to 22) to generate something as "taxable income " (line 43).
Cheers,
Bev


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## pumpkinpie (May 10, 2016)

Bevdeforges said:


> If line 41 is 0 (or negative), it means that your adjusted gross income is completely covered by your standard deduction. Did you include the income from your mutual funds on one of the lines for Income on the first page of your 1040?
> 
> Or, how did you wind up having to pay US tax on your mutual funds? That income (or capital gains) needs to be somewhere on the first page of the 1040 (lines 7 to 22) to generate something as "taxable income " (line 43).
> Cheers,
> Bev


Hi Bev,

Thanks for your reply. The mutual funds are considered passive foreign investment companies (PFICs) and therefore get reported on form 8621, which funnels the tax due under the punishing PFIC rules onto line 44 of my 1040 (where I check box c and write "1291 tax," 1291 being the code section under which my PFICs are taxed). I also have a small amount of tax on line 44 from form 8814 (parent's election to report child's interest and dividends). 

In other words, tax under section 1291 for PFICs can't be wiped out by exclusions, personal deductions or exemptions. But it CAN be reduced by credits, which are below line 44.

Hope this clarifies things.


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