Foreign Tax Credit Compliance Tips

The foreign tax credit laws are complex.  Below are some quick summaries of the more complex areas of the law along with links to web pages on IRS.GOV with additional helpful resources.

Foreign Sourced Qualified Dividends and Gains

If a taxpayer receives foreign sourced qualified dividends and/or capital gains (including long-term capital gains, unrecaptured section 1250 gain, and/or section 1231 gains) that are taxed in the U.S. at a reduced tax rate, the taxpayer must adjust the foreign source income that is reported on Form 1116, line 1a.  Otherwise, the allowable foreign tax credit may be significantly overstated which can trigger a substantial underpayment penalty.

Interest Expense

Interest expense must be apportioned between U.S. and foreign source income using an asset method.  See Publication 514 for more information on the asset methods.

Other Compliance Issues

• Charitable contributions are not apportioned against foreign source income.
• The amount of foreign tax that qualifies is not necessarily the amount of tax withheld by the foreign country. If you are entitled to a reduced rate of foreign tax based on an income tax treaty between the U.S. and a foreign country, only that reduced tax qualifies for the credit. 
• If a foreign tax redetermination occurs, a redetermination of your US tax liability is required in most situations. You must file a Form 1040X or Form 1120X. Failure to notify the IRS of a foreign tax redetermination can result in a failure to notify penalty.

For more details about the topics above, go to Foreign Tax Credit Compliance Tips.

Other References

Foreign Tax Credit

What Foreign Taxes Qualify For The Foreign Tax Credit?

Foreign Tax Credit - How to Figure the Credit

Foreign Tax Credit – Special Issues

Foreign Tax Credit - Choosing To Take Credit or Deduction