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.