Author Topic: Form 1116, what a nightmare. Any tips on how to handle this?  (Read 3416 times)

LAGuy

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Form 1116, what a nightmare. Any tips on how to handle this?
« on: February 14, 2018, 04:38:16 PM »
So, apparently my tax preparation software is telling me that since my foreign taxes paid has gone over $300, I now need to fill out form 1116. Woah boy is that a HUGE headache! It wants me to breakdown every source of foreign income and taxes paid. But I don't have any of that information...all of my foreign income comes from dividends on my worldwide stock ETF. Before I went over $300 I just plugged in the amount of foreign tax paid from Line 6 of my form 1099-DIV right onto the 1040A line 48. Anybody have any tips on how to navigate the form 1116 so that the same amount from Line 6 1099 pops up over on Line 48 1040A?

LAGuy

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #1 on: February 14, 2018, 05:05:46 PM »
To answer my own question, it's looking like you just screwed out of the credit if you go over $300. My tax preparation software is telling me I'm only going to get $166 in credit on the $335 paid. Is it legal to say I paid LESS in foreign taxes than I actually did? If I had $299 in foreign taxes paid I'd be looking at a larger credit right now. Gotta love the IRS.

Edit: well, looks like you're not so much "screwed" out of it. If you go through the fine print of the generated tax return the credit flows through to the next year. The question is...how to use it? Increase my income (increase 401k rollover amounts)? Probably not worth it I'm guessing?
« Last Edit: February 14, 2018, 05:18:29 PM by LAGuy »

seattlecyclone

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #2 on: February 14, 2018, 08:35:48 PM »
Oh man, I'm just running into this same headache. Until this year my foreign dividend taxes have always been lower than the limit for simply reporting them on Form 1040. Now I'm wading through some terribly-written instructions for Form 1116 and hoping I filled the thing out right.

Our income is low enough to qualify for the "adjustment exception" allowing me to not do a bunch of unfavorable-looking math related to qualified dividends, and the result when I fill out the form seems to be that I get a credit for the full amount paid.

LAGuy

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #3 on: February 14, 2018, 10:34:04 PM »
Search the instructions for “RIC” and see if that helps.

Thanks. That's actually what I managed to sort out on my own as far as reporting. Had to scroll all the way to the very bottom of my 1099-DIV to find where they broke it out for me. Still only managed about half the credit I was expecting, however.

Oh man, I'm just running into this same headache. Until this year my foreign dividend taxes have always been lower than the limit for simply reporting them on Form 1040. Now I'm wading through some terribly-written instructions for Form 1116 and hoping I filled the thing out right.

Our income is low enough to qualify for the "adjustment exception" allowing me to not do a bunch of unfavorable-looking math related to qualified dividends, and the result when I fill out the form seems to be that I get a credit for the full amount paid.

What's this adjustment exception you speak of? I couldn't find any exception to the thing once you go over $300 (for a single). You're stuck with form 1116 and it basically kneecaps you on the amount you can claim. I guess I need to rebalance like 30% of my foreign owned ETF's away from my taxable account to my tax exempt accounts, but that creates more headaches of it's own since I don't rebalance my taxable every year (I still work some and in California at that so I don't want to realize any taxable capital gains yet).

Goldielocks

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #4 on: February 14, 2018, 10:45:24 PM »
In Canada, foriegn dividends in tax exempt accounts get ZERO foreign tax credits.
US dividend/ tax credit is allowed in one type of tax exempt account (similar to a IRA /401k) but not the other (similar to a Roth IRA)


Be careful that the US doesn't do the same thing with excluding foreign tax credits in tax exempt accounts.

seattlecyclone

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #5 on: February 15, 2018, 12:19:20 AM »
Oh man, I'm just running into this same headache. Until this year my foreign dividend taxes have always been lower than the limit for simply reporting them on Form 1040. Now I'm wading through some terribly-written instructions for Form 1116 and hoping I filled the thing out right.

Our income is low enough to qualify for the "adjustment exception" allowing me to not do a bunch of unfavorable-looking math related to qualified dividends, and the result when I fill out the form seems to be that I get a credit for the full amount paid.

What's this adjustment exception you speak of? I couldn't find any exception to the thing once you go over $300 (for a single). You're stuck with form 1116 and it basically kneecaps you on the amount you can claim.

Search for "adjustment exception" in the instructions for Form 1116. You're ordinarily supposed to adjust your foreign-sourced income downward a bit on that form to account for qualified dividends, but if you meet certain income qualifications you may opt out of doing this.

It looks like opting out is beneficial if you can, because adjusting your foreign income downward would reduce the fraction you calculate on Line 19, which would in turn reduce the maximum credit you report on Line 21.

terran

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #6 on: February 15, 2018, 11:23:07 AM »
In Canada, foriegn dividends in tax exempt accounts get ZERO foreign tax credits.
US dividend/ tax credit is allowed in one type of tax exempt account (similar to a IRA /401k) but not the other (similar to a Roth IRA)


Be careful that the US doesn't do the same thing with excluding foreign tax credits in tax exempt accounts.

Yeah, the US does not allow any foreign tax credits for funds held in tax exempt accounts. Taxable only.

Undecided

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #7 on: February 15, 2018, 02:11:09 PM »
Search the instructions for “RIC” and see if that helps.

Thanks. That's actually what I managed to sort out on my own as far as reporting. Had to scroll all the way to the very bottom of my 1099-DIV to find where they broke it out for me. Still only managed about half the credit I was expecting, however.

Oh man, I'm just running into this same headache. Until this year my foreign dividend taxes have always been lower than the limit for simply reporting them on Form 1040. Now I'm wading through some terribly-written instructions for Form 1116 and hoping I filled the thing out right.

Our income is low enough to qualify for the "adjustment exception" allowing me to not do a bunch of unfavorable-looking math related to qualified dividends, and the result when I fill out the form seems to be that I get a credit for the full amount paid.

What's this adjustment exception you speak of? I couldn't find any exception to the thing once you go over $300 (for a single). You're stuck with form 1116 and it basically kneecaps you on the amount you can claim. I guess I need to rebalance like 30% of my foreign owned ETF's away from my taxable account to my tax exempt accounts, but that creates more headaches of it's own since I don't rebalance my taxable every year (I still work some and in California at that so I don't want to realize any taxable capital gains yet).

It's been a while since I got into the weeds with this, but isn't the net effect that once you're in Form 1116 land, you can't take a current deduction for the excess of the foreign tax paid over your US tax attributable to the foreign income (although you can carry it forward)? So it's a deferral for foreign withholding that averages out to exceed the applicable blended ordinary income/QDI rate?
« Last Edit: February 15, 2018, 02:15:37 PM by Undecided »

seattlecyclone

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #8 on: February 15, 2018, 02:18:48 PM »
Based on my experience reading through the instructions and filling out the forms yesterday, that does seem to be the gist of it. You're supposed to figure out what percentage of your total income is from foreign countries and multiply that by your total US tax. The lesser of this number or your actual foreign tax is what you can claim a credit for.

Wile E. Coyote

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #9 on: February 16, 2018, 11:18:05 AM »
It's been a while since I got into the weeds with this, but isn't the net effect that once you're in Form 1116 land, you can't take a current deduction for the excess of the foreign tax paid over your US tax attributable to the foreign income (although you can carry it forward)? So it's a deferral for foreign withholding that averages out to exceed the applicable blended ordinary income/QDI rate?

You are correct.  The foreign tax credit is designed to prevent double taxation of foreign income.  If you pay more than the US tax rate on that foreign income, your credit will be limited to the US tax on that foreign income, so that the US isn't taxing that income.  The fact that the foreign country imposed more taxes on the income than the US would does not mean that US will credit you back the full amount of taxes paid to the foreign country.  However, to the extent that you have other similar foreign income that is taxed at a lower rate in either the current year or a later year, you should be able to claim this excess foreign tax credit.

Undecided

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #10 on: February 16, 2018, 12:43:13 PM »
Based on the most recent posts, while the OP may have unusual circumstances, in general this doesn’t seem like a dire (or even unreasonable) situation, although it’s certainly worth being aware of it and considering the potential effect. Personally, unless my average foreign tax rate exceeds 23.8%, there shouldn’t even be a current limitation.

LAGuy

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #11 on: February 18, 2018, 09:14:49 AM »
Based on the most recent posts, while the OP may have unusual circumstances, in general this doesn’t seem like a dire (or even unreasonable) situation, although it’s certainly worth being aware of it and considering the potential effect. Personally, unless my average foreign tax rate exceeds 23.8%, there shouldn’t even be a current limitation.

My circumstances are only unusual in the sense that I don't work full time anymore. Essentially, my budget looks a lot like what people here are striving to achieve in FIRE. That is low spend, low draw, low to zero taxes. I would imagine this situation would hit every single person in FIRE that has around $100,000 ($200,000 couple) or more in foreign ETFs/mutual funds in their taxable brokerage account and plans to keep their taxable income in the 12% bracket.

Undecided

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #12 on: February 18, 2018, 03:56:48 PM »
Based on the most recent posts, while the OP may have unusual circumstances, in general this doesn’t seem like a dire (or even unreasonable) situation, although it’s certainly worth being aware of it and considering the potential effect. Personally, unless my average foreign tax rate exceeds 23.8%, there shouldn’t even be a current limitation.

My circumstances are only unusual in the sense that I don't work full time anymore. Essentially, my budget looks a lot like what people here are striving to achieve in FIRE. That is low spend, low draw, low to zero taxes. I would imagine this situation would hit every single person in FIRE that has around $100,000 ($200,000 couple) or more in foreign ETFs/mutual funds in their taxable brokerage account and plans to keep their taxable income in the 12% bracket.

Are you going to move some foreign holdings to tax-advantaged accounts, if you’re not getting the tax benefits anyway? I keep most of my foreign holdings in Roth accounts, anyway, but have been assuming I could hold around $300k in the foreign fund I use in taxable accounts (SCHF) in retirement without it being an issue.

seattlecyclone

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #13 on: February 18, 2018, 09:10:29 PM »
The foreign countries withhold the tax just the same whether you own the mutual fund shares in a taxable account or a retirement account. Seems better to get a partial credit by holding in a taxable account with low overall tax than to get nothing by holding the shares in a retirement account. However someone in LAGuy's shoes could probably optimize a bit by making sure to only hold enough foreign mutual funds in taxable to barely get under the $300/$600 threshold where you can claim the entire amount as a credit.

MustacheAndaHalf

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #14 on: February 19, 2018, 09:53:34 PM »
There's another factor to consider when deciding to favor U.S. or international in your taxable accounts: dividend yield.  Dividends require you pay taxes on them.

Total U.S. Stock Market ("VTI") has 1.67% dividends
Total International ("VXUS") has 2.68% dividends

When you put VXUS (international) in taxable, you volunteer for 1% higher dividends and probably 0.15% higher tax.  In the past, the benefit of the international tax credits was lower than the additional tax caused by higher yields.  And even if the foreign tax credit pulls ahead slightly, you have to ask if it's worth the tax paperwork.

LAGuy

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #15 on: February 20, 2018, 06:08:05 PM »
Based on the most recent posts, while the OP may have unusual circumstances, in general this doesn’t seem like a dire (or even unreasonable) situation, although it’s certainly worth being aware of it and considering the potential effect. Personally, unless my average foreign tax rate exceeds 23.8%, there shouldn’t even be a current limitation.

My circumstances are only unusual in the sense that I don't work full time anymore. Essentially, my budget looks a lot like what people here are striving to achieve in FIRE. That is low spend, low draw, low to zero taxes. I would imagine this situation would hit every single person in FIRE that has around $100,000 ($200,000 couple) or more in foreign ETFs/mutual funds in their taxable brokerage account and plans to keep their taxable income in the 12% bracket.

Are you going to move some foreign holdings to tax-advantaged accounts, if you’re not getting the tax benefits anyway? I keep most of my foreign holdings in Roth accounts, anyway, but have been assuming I could hold around $300k in the foreign fund I use in taxable accounts (SCHF) in retirement without it being an issue.

If by move, you mean change around my taxable vs tax exempt allocations via buying and selling, then yes I'd like to do that. Problem is I'd have to realize more capital gains in the taxable account than I want to right now. Since I still work part time, in California, they're going to tax those capital gains as ordinary income. I was hoping to avoid that until I retired for good and moved my permanent address to a no income tax state.

The foreign countries withhold the tax just the same whether you own the mutual fund shares in a taxable account or a retirement account. Seems better to get a partial credit by holding in a taxable account with low overall tax than to get nothing by holding the shares in a retirement account. However someone in LAGuy's shoes could probably optimize a bit by making sure to only hold enough foreign mutual funds in taxable to barely get under the $300/$600 threshold where you can claim the entire amount as a credit.

Exactly, optimizing such that I stay under that threshold would be ideal. As noted above, however, I don't want to realize the capital gains at this time. Of course, having a great year for stock returns like we just had makes it even harder to keep your funds under that threshold.

There's another factor to consider when deciding to favor U.S. or international in your taxable accounts: dividend yield.  Dividends require you pay taxes on them.

Total U.S. Stock Market ("VTI") has 1.67% dividends
Total International ("VXUS") has 2.68% dividends

When you put VXUS (international) in taxable, you volunteer for 1% higher dividends and probably 0.15% higher tax.  In the past, the benefit of the international tax credits was lower than the additional tax caused by higher yields.  And even if the foreign tax credit pulls ahead slightly, you have to ask if it's worth the tax paperwork.

Yeah, but that's only true if you don't plan to stay in the 12% bracket, but you do have a point that it slightly reduces the amount that you could otherwise realize in capital gains taxes.

At the end of the day, I guess it's not that big of a deal. I ended up losing out on about $150 in tax credit, only receiving about half of what I expected. The unused credit does carry forward, but I can't really imagine a situation where I can take advantage of it unless I felt like going back to work full time in order to increase my income.

gerardc

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Re: Form 1116, what a nightmare. Any tips on how to handle this?
« Reply #16 on: April 12, 2018, 09:21:10 PM »
I filed my return with TaxAct and they produced form 1116 with RIC for me.

I just had to enter data from the "Foreign Tax Paid" page of the consolidated 1099 Vanguard form, that details foreign income from which the foreign tax (1099-DIV box 6) was withheld, and the qualified dividend eligible portion of that income.

I see the foreign withholding rate was roughly 6.5% and 75% of the foreign dividends were qualified.
Assuming 3% annual dividend yield and 20% of your stash in taxable international stocks, you'd get something like:
3% * 20% * 6.5% = 0.04% of your stash paid in non-refundable (?) foreign taxes for the year.
So, nothing to break the bank, but still a few days worth of expenses.