Foreign Tax Deduction in US Dual-Status Return

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i407
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Joined: Sun Dec 25, 2022 4:00 am

Foreign Tax Deduction in US Dual-Status Return

Post by i407 »

If I file Form 1040 as a full-year resident, I can claim a foreign tax deduction on Schedule A line 6 as other taxes paid.

If I file a dual-status tax return in the year that I give up my residence, the IRS wants Form 1040-NR to be filed with Form 1040 as a dual-status statement for the resident part of the year.

Can I claim an itemized deduction for foreign taxes paid during the part of the tax year that I am resident?

If so, I assume I would include my worldwide income in the 1040 dual-status statement along with the foreign tax deduction on Schedule A line 6 for the resident part of the year.

For Form 1040-NR, I would sum the worldwide income during the resident part of the year and the US source income during the non-resident part of the year. However, the non-resident version of Schedule A does not have a corresponding line for other taxes paid. Would it be appropriate to enter the foreign taxes paid from the 1040 dual-status statement as Other Itemized Deductions in line 7?
nelsona
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Re: Foreign Tax Deduction in US Dual-Status Return

Post by nelsona »

1040NR is very limited in its deductions.
In a departure year, your 1040 portion is only used to determine your INCOME, nothing else. That INCOME is then added to your 1040NR, so any 1040 deductions you have are meaningless.

I prefer simply filing 1040 for the full year (yes you are allowed). This gives you full credits, and you can use 1116 and/or 2555 on the income you earn after departure.

Can I ask why you use the foreign tax deduction rather than FTC (1116). Since you live in US, what foreign income are you making that would not be best using the credit instead?
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
i407
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Joined: Sun Dec 25, 2022 4:00 am

Re: Foreign Tax Deduction in US Dual-Status Return

Post by i407 »

Merry Christmas nelsona!

Publication 519 says for dual-status residents: "You cannot use the standard deduction allowed on Form 1040 or 1040-SR. However, you can itemize any allowable deductions." But it does not clarify if deductions allowed for resident aliens are considered allowable deductions during the period of residence. Your interpretation is that only deductions allowed for non-resident aliens can be taken for the entire dual-status year?

The main reason I am considering a dual-status return is to avoid the additional 3.8% net investment income tax on US source capital gains during the non-resident part of the year.

The foreign tax deduction would be for estimated foreign income taxes in the following year, when the income is not considered taxable income in the US so foreign tax credits would not be helpful. The US allows estimated state and local taxes paid for the next year to be deducted in the current year. Since foreign taxes are enumerated with state and local taxes in the same IRC § 164, I would assume the IRS would apply the same treatment to foreign taxes.
nelsona
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Re: Foreign Tax Deduction in US Dual-Status Return

Post by nelsona »

As I said, the 1040NR will be your tax retirn, the 1040 will only be to enumerate your income prior to departure.

The instruction state you " Can claim deductions and losses properly allocated and apportioned to income effectively connected with
a U.S. trade or business. Do not include deductions and/or losses that relate to exempt income or to income that is not effectively connected with a U.S. trade or business."

So, since you will be reporting estimated tax on income from a future year, I don't see it as allowable.

However, if you choose to file 1040, like I suggest, you will be allowed to claim any estimated taxes you pay in the calendar year (as long as these are not later refunded of course).
It'll be upto you to decide, after running the numbers both ways.

Can you hold off on triggering your cap gains until Jan 1 the year after you leave?
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
i407
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Joined: Sun Dec 25, 2022 4:00 am

Re: Foreign Tax Deduction in US Dual-Status Return

Post by i407 »

Thank you for that explanation! Yes, I will prepare the return both ways to see which yields the lowest taxes.

I am looking into an installment sale to defer enough of the capital gains to be under the NIIT threshold in the departure year and get some "free" capital gains at the 0% tax bracket in the following non-resident year.

Do you know how Canada would treat such an installment sale, considering the step-up in cost basis on emigration to Canada? Would the capital gain for Canadian purposes be crystallized on the date of the sale? Would subsequent payments on the installment sale trigger any tax consequences in Canada?
nelsona
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Re: Foreign Tax Deduction in US Dual-Status Return

Post by nelsona »

Just t be clear, you would be tax-free in US, not because of low income, but because you would be Cdn resident. the treaty does not allow US to tax Cdns who are non-residents on cap gains, unless it is US real estate or resource related.
So, why noy just wait.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
i407
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Joined: Sun Dec 25, 2022 4:00 am

Re: Foreign Tax Deduction in US Dual-Status Return

Post by i407 »

Sorry, should have mentioned that I was referring to US real property which would be US sourced income even after moving to Canada.

Does Canada treat any of the installment sale payments after the disposition as taxable events?
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