# Foreign Tax Credit ?



## cuerna1 (Mar 7, 2015)

We visited the nice lady at our Mexican bank and she gave us a printout showing the interest etc we got for our accounts. 

I understand that Interes Nominal is the total interest without taking inflation into account and Interes Real is the value with inflation. 

Anyone have any idea what (in layman's terms) "Perdida Deducible" is ? 

"Impuesto Sobre La Renta Retenido" translates as Income Tax Withheld. Do we get to file a credit for that on our US taxes - OR - can I simply take that out of the Intres Nominal I report ?


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## Bevdeforges (Nov 16, 2007)

Actually, I believe you have a choice. You can report your interest income net of taxes paid or withheld on the income - or you can report the gross amount of the interest income, and then use the taxes paid on form 1116 to take the foreign tax credit against taxes owed to the US on the interest.

Can't help you with the Spanish translations, but someone should be by soon who can.
Cheers,
Bev


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## BBCWatcher (Dec 28, 2012)

The second path Bev describes is the _only_ correct way to do it: report gross nominal interest on IRS Form 1040 Schedule B, then take credit for the foreign income tax paid using Form 1116 (Foreign Tax Credit). Otherwise you may end up paying more tax than necessary.


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## cuerna1 (Mar 7, 2015)

Thank you both. I took the second option last year - because I thought it made sense.

Different question - my wife and I are co-owners in all our financial things. Am I correct in assuming that we need to file two FBARs (one for each) for all our accounts ?


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## BBCWatcher (Dec 28, 2012)

If you are both U.S. persons, that's correct.

Glad to hear you got the interest reporting right! To illustrate the problem if you didn't, let's suppose you received $10,000 in gross interest and paid $2,500 in Mexican income tax on that interest, for a net of $7,500. If you report $7,500 on your U.S. tax return, you'd then pay U.S. income tax on that amount. Let's suppose your U.S. tax rate is 20% on that income. That'd leave you with $6,000 after tax. You've now paid a total of 40% of income tax. Not good!

If you report the gross interest to the U.S. ($10,000) plus the Mexican income tax paid as a Foreign Tax Credit ($2,500), you'd then owe zero U.S. income tax on that interest and keep all $7,500. Not only that, you'd get an excess Foreign Tax Credit of $500. If you have U.S. passive income -- interest, dividends, capital gains -- that $500 could be used to offset U.S. income tax on that other passive income, either in the same year or in a future year.

Even if the Mexican rate is lower than the U.S. rate, it should be pretty obvious you don't want to pay U.S. income tax on the after-tax Mexican interest. That is double taxation (or partial double taxation), and that's not a good thing. Sure, you _could_ do that, but you can also try crossing the street without looking both ways first -- not a good idea!


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## Bevdeforges (Nov 16, 2007)

BBCWatcher said:


> The second path Bev describes is the _only_ correct way to do it: report gross nominal interest on IRS Form 1040 Schedule B, then take credit for the foreign income tax paid using Form 1116 (Foreign Tax Credit). Otherwise you may end up paying more tax than necessary.


Sorry but I beg to differ. It is also "correct" to net the tax paid out of the interest received before reporting. True, it rarely results in lower taxes, but in business school we did explore a couple of circumstances where it was a "better" outcome for the taxpayer. (And no, I don't remember the details.) It certainly is an acceptable approach. 

Point is that in most areas of US taxation, you have choices. That's one of the big reasons the US doesn't do the "declaration" approach - where you simply give them your figures and let them figure the taxes for you (as they do in many countries). Up to you to make the various elections and choices, but you have to know that the choices exist.
Cheers,
Bev


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## BBCWatcher (Dec 28, 2012)

Bevdeforges said:


> Sorry but I beg to differ. It is also "correct" to net the tax paid out of the interest received before reporting. True, it rarely results in lower taxes....


How about "never"? Legally minimizing one's tax bill is important! I'll allow the quotation marks, because....



> in business school we did explore a couple of circumstances where it was a "better" outcome for the taxpayer. (And no, I don't remember the details.) It certainly is an acceptable approach.


The only circumstance I can _imagine_ is when there's a "hard" income limit of some kind in the U.S. tax code, and you're trying to fall below that limit rather than above it. There aren't many of those circumstances. Congress has generally gotten smarter about that and incorporated income phase-outs for deductions, credits, and exemptions rather than "hard stops." Moreover, the tax code generally uses the term "gross income" (or AGI, or MAGI) in determining whether you qualify for an exemption, deduction, or credit. The word "gross" must be given meaning, so you aren't (generally) actually allowed the approach you suggest to qualify.

But even if you can somehow get past all that, there are _far_ better ways to address that particular problem than double (or partial double) income taxation. Buying a zero coupon bond is one simple way. Perfectly legal, no PFIC complications, and it defers the interest income to the bond's maturity or until you sell the bond before maturity, as you prefer. (May only be a capital gain if you sell the bond.) A traditional Series EE U.S. Savings Bond is an example of a zero coupon bond, but there are many other examples around the world.


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