# Foreign Tax Paid



## FFMralph

The actual amount of paid foreign tax isn't really known until my foreign tax statement has been processed. This usually isn't until late in the year. Long after the US tax deadline. Also on my US tax I file "Married, filing seperately" on my foreign tax I file "Married, filing jointly" 

My questions are:
--Do I have to amend my US tax (1040 und 1116) each year or can should I just use the estimated amount that I determined when preparing my foreign return?

--Do I just prorate my spouses taxable income (percent from total income) from the total paid foreign taxes?


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## Bevdeforges

FFMralph said:


> My questions are:
> --Do I have to amend my US tax (1040 und 1116) each year or can should I just use the estimated amount that I determined when preparing my foreign return?


Actually, you are supposed to only credit the amounts paid in the tax year. So, if you're doing your US return for 2012, your foreign tax credit is those amount paid in 2012 (i.e. the actual amount withheld from your pay during 2012). When you file for 2013, if you had to pay anything over and above for 2012, you add that to what was withheld from your salary in 2013 as your tax credit amount. (This is one reason it is often easier to just use the Foreign Earned Income Exclusion - as long as your salary is under the limit, you just exclude the whole thing and you're done.)



> --Do I just prorate my spouses taxable income (percent from total income) from the total paid foreign taxes?


Take a look at the instructions for the form 1116, but as noted, taking the FEIE is a simpler way to go. 
Cheers,
Bev


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## BBCWatcher

The poster is in Germany, though -- a comparatively high tax jurisdiction -- so the U.S. Foreign Tax Credit may be more U.S. tax favorable. We also don't know his income which could be above FEIE limits.


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## Bevdeforges

BBCWatcher said:


> The poster is in Germany, though -- a comparatively high tax jurisdiction -- so the U.S. Foreign Tax Credit may be more U.S. tax favorable. We also don't know his income which could be above FEIE limits.


The issue here, however, is that in the first year that one is in Germany you are subject to German taxes. The German tax system does withhold income tax from your salary - and thus for the Foreign Tax Credit, you can only take the tax you actually paid during the year (i.e. your withholdings). If you have other sources of income, on which you will be assessed tax after submitting your tax declaration, you have to wait until the year in which those taxes were paid to credit them against your US taxes due.

Not sure if other countries do it like in France, but in France you pay no income taxes at all during your first year in France. You file your declaration after the end of the year, and receive your assessment a couple of months later, at which time you pay. So, in that first year in France, you have no French taxes paid to take as a credit against your US income taxes. 



> The actual amount of paid foreign tax isn't really known until my foreign tax statement has been processed. This usually isn't until late in the year. Long after the US tax deadline.


This is the statement I was reacting to. For the first tax year, it may be a simpler solution simply to take the FEIE if it drops you into the "no taxes due" category - and then you can use the actual tax paid the next year (i.e. cash basis) as your credit on your US form in the second year. I don't believe they allow you to use an estimate to keep the tax years in synch. (It also eliminates the need to apportion the tax paid between the two spouses if you want to continue to file as married, filing separately.)
Cheers,
Bev


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## BBCWatcher

Maybe, but if the problem is cash flow the FEIE might be an expensive way to address that narrow problem (if it exists). The FEIE also has its partial year oddities at startup. The Foreign Tax Credit does allow applying excess credits to the previous tax year and/or to the next 10 tax years. This'd be the time to decide on the best tax strategy, and the FTC (alone) could very well be the right choice for a resident of Germany.

Anyway, I think the better way to phrase this is to decide on the best tax strategy first, then if there's a cash flow problem tackle that as a separate matter. I'd hate to see anybody take out the IRS equivalent of a payday loan by choosing the wrong tax strategy in their circumstances.


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## Bevdeforges

I'll only caution that, for people living in "high tax countries" they work out their situation carefully (particularly in their first year overseas). In some cases "high tax countries" are judged to be that way based on the accumulated total of all taxes paid at a particular income level. Only income taxes as such are creditable against US income tax (on form 1116), so if there are other taxes in that "high tax" total (or even just assessed along with your income tax forms or declarations), you may find that "your mileage varies."

Check the website for your local US consulate, where they sometimes have information at tax time about which taxes are or aren't considered "income tax" - or check the website of the IRS office that covers your particular country (in Europe, normally either London or Paris).
Cheers,
Bev


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## BBCWatcher

We can be a little more specific since we know it's Germany. According to what I can see online, Germany's top marginal income tax rate is 47.475% (including "solidarity surcharge"), and the top capital gains tax rate is 26.375% (including surcharge again). Both are higher than the top U.S. marginal rates. Moreover, the 44.31% bracket kicks in rather low on the income scale, so one doesn't have to be too comfortably well off to get into that bracket which is still higher than the top U.S. rate. All of these taxes are unquestionably income taxes for purposes of the U.S. Foreign Tax Credit from the looks of it, so on a "headline" basis one would expect the FTC to be favorable across the board.

Yes, please do check things carefully, but the FTC path looks pretty good for residents of Germany.


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## BBCWatcher

To be even more precise, here are what seem to be the 2012 German income tax brackets:

0 to 8004 euro: 0%
8005 to 52881 euro: 14.77%
52882 to 250730 euro: 44.31%
250731 euro and above: 47.475%

These are the figures for a single taxpayer, including surcharges but excluding church tax (which looks highly avoidable). Here are the capital gains brackets:

0 to 801 euro: 0%
802 euro and above: 26.375%

Keep in mind capital gains cannot be shielded with the Foreign Earned Income Exclusion. However, those with capital gains are going to benefit from the Foreign Tax Credit and accumulate excess credits it would appear since that 26.375% is clearly higher than the U.S. rate. (And assuming no treaty protection.)

For earned income it's a bit more complicated but only a bit. For low and middle income earners the FEIE looks like it might work, though you should still run the numbers both ways. Once you dig deeper into that 44.31% bracket (which starts at only 52,882 euro), the Foreign Tax Credit looks like the clear winner. There's a crossover point which (I would guess) is somewhere around 60K+ euro (single filer) where the FTC will "always" make better sense.

Interesting!

Keep in mind you might be able to optimize things a bit below that "rule of thumb" 60K euro level. For example, you could make a pre-tax Traditional IRA contribution in the U.S. to lower your U.S. taxable income, claim the Additional Child Tax Credit (if you have qualifying children), and take the Foreign Tax Credit -- and that recipe might be a better deal than taking the Foreign Earned Income Exclusion, even at lower earned income levels. As another example, if you have low-to-moderate earned income and more significant capital gains, I think your Foreign Tax Credit on the capital gains can shield your earned income and still let you do things like make IRA contributions and take refundable tax credits like the Additional Child Tax Credit. And you might even pick up some excess FTCs to use in the future.

So...do the math! Run the numbers both ways and see what you get.


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## Bevdeforges

As the old saying goes, "your mileage may vary." I've lived (and paid taxes) in Germany and they determine "taxable income" a little differently from how such is determined for the US. It also depends on the goals of the taxpayer - find the easiest way to discharge their reporting duty, or take the optimum tax position with the possibility of later reclaiming of all possible benefits.

For someone looking to renounce and be done with it all in the next few years, it could be worthwhile to go "fast and dirty." I'm not advocating one over the other - just advising someone to take a look at both their long and short term goals and intentions.
Cheers,
Bev


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## FFMralph

Thanks for the info.


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## RandallSamaritan

To answer the question about what to do if your statement is not available, with the foreign tax credit you have the option of using the amount paid or accrued. With both options (including amount paid), you can only deduct up to the amount legally obligated to. Thus, if you have income tax withholdings from your pay that exceed your tax liability, you can only claim only those payments up to the tax liability for the foreign tax credit. If your foreign tax changes (i.e. by having a final statement) after your U.S. tax filing, the U.S. requires a corresponding amendment on the U.S. return to revise the FTC (this is required but the reality is that this isn't always done).

Randall


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## BBCWatcher

Or (as I understand it) you can apply the foreign refund to that new year's foreign taxes, then file for the FTC on that new year's net foreign taxes. Which is how most people do it, I think -- they just go with the pure cash flow. And that's fine (and simpler).

This is only an issue if the foreign tax refund occurs at the end of a stint outside the U.S., and you have to back out a prior year's FTC to some degree. If you're continuing to pay nontrivial foreign taxes, no problem.


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## RandallSamaritan

If you have $20,000 in withholdings from your paycheck, $15,000 in tax liability in 2013 of which $5,000 you apply as a payment on your 2014 tax liability. On your US return, you can claim $15,000 in foreign taxes paid on your 2013 US return, the $5,000 can be used on the 2014 U.S. return as foreign taxes paid assuming there is $5,000 in foreign tax liability in 2014 on the foreign return.


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## BBCWatcher

Yes, I agree with that, but the tricky part sometimes is calculating that actual foreign tax liability in the tax year it occurs. Here's what the IRS says: "You cannot take a foreign tax credit for income taxes paid to a foreign country if it is reasonably certain the amount would be refunded, credited, rebated, abated, or forgiven if you made a claim."

The IRS then goes on to give an example: a tax treaty. That is, if there's a tax treaty that guarantees a foreign refund, you have to That's a "reasonably certain" situation. But lots of situations are not "reasonably certain."


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## FFMralph

Ok, I think I got it.

I take the FTC on the foreign tax which was witheld monthly from my wages in 2012. Naturaly, I did not include anything that was excluded with the FEIE. 

If in 2013 a portion of my 2012 tax was refunded, I include this amount on Form 1040, Line 10 as *Taxable-Refunds*. If I owe additional tax for 2012, I add this to my total foreign taxes paid when doing my 2013 US return and take this FTC in 2013.

My wife also has income and our foreign return is filed jointly. My US return does not include her or her income. How do I seperate her taxes from my taxes in our jointly foreign return so that I know what amount I report on?


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## FFMralph

Line 10 is wrong. The amount has already been taxed. There is no way to correctly carry the refunded portion of 2012 paid foreign taxes over to my 2013 US return. An amendment to 2012 return is probably the correct method. 

Subtracting the refunded amount from the new years paid foreign tax is easier, but probably not correct because it could result in a tax bracket Change.


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## BBCWatcher

Check whether taking the FEIE makes sense. "Maybe not," as we've just seen, for a resident of Germany. You are not required to take the FEIE -- that's a common misconception.



> How do I seperate her taxes from my taxes in our jointly foreign return so that I know what amount I report on?


The IRS tells you exactly what to do in Publication 514: pro-rata allocation. That is, you apportion the foreign tax between you and your spouse in the same percentages as the foreign taxable income each of you generated.

For example, if your spouse earned $86,000 of foreign taxable income in tax year 2012 and you earned $63,000 of foreign taxable income in the same tax year, you are responsible for about 42.28% of total household foreign taxable income, so the amount of foreign tax you paid is 42.28% of the total foreign tax, i.e. your pro-rata share. In other words, the IRS assumes that your foreign tax rate and your spouse's are always equal when apportioning the foreign tax.

Things might get a little interesting when determining the IRS's definition of foreign taxable income, and Publication 514 gives you a little clue there might be a complication there, citing a particular IRS rule: IRC 1.901*2(f)(3)(iii). But generally it's pretty straightforward.


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## FFMralph

@BBCWatcher: Thanks. That makes since now.


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## Bevdeforges

One quick little word to the wise: however you decide to allocate income or taxes paid or anything like that on your tax returns, show your work and keep your notes about how you did the calculation.

Chances are, you'll never need the notes. But, if you are ever questioned about it, just explain to them how you calculated the numbers you used. Unless you're hiding millions somewhere, a rational, logical explanation of your assumptions will usually be acceptable, even if it's not exactly the way they might have told you to do it if you had asked.
Cheers,
Bev


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## RandallSamaritan

From the Form 2555 instructions, please keep in mind that:

"Once you choose to claim an exclusion, that choice remains in effect for that year and all future years unless it is revoked. To revoke your choice, you must attach a statement to your return for the first year you do not wish to claim the exclusion(s). If you revoke your choice, you cannot claim the exclusion(s) for your next 5 tax years without the approval of the Internal Revenue Service."

Thus the decision to choose the exclusion vs. FTC is an important one not just for the current year but future years as well.


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## BBCWatcher

Both very good points.

Randall, if you happen to know, can a taxpayer who chose the FEIE say, for a couple tax years, go back and file amended returns without the FEIE and thus wipe out the initial FEIE election, moving to an FTC-only basis? To make it a little more concrete, let's suppose you first claimed the FEIE in tax year 2011, claimed it again in tax year 2012, but now want to file amended tax returns for both tax years (2011 and 2012) to pull that FEIE back out. (You moved to Sweden in early 2013 and your wages trebled, for example.) How does the IRS feel about that?

Incidentally (and looking back), I don't think my accountant should have taken the FEIE when I was living and working in Japan, a relatively high income tax jurisdiction. But that was (probably) solely my employer's problem since I was tax equalized at the time. That was too long ago to be recoverable in my case.


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## RandallSamaritan

Yes, you can go back and amend those returns, but you have to weigh to see if it is worthwhile to do so in time and effort (of course...), keeping in mind there is a three year statute of limitations on claiming a refund. However, there may be benefits to do so, such in carry-forward foreign tax to future years that may be of benefit in later years where there is a higher income/income tax liability for the U.S.


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