Form 1116 only allows fraction of canadian taxes as credit?

[twoboats]

1. Spouse A: Citizen of USA, Resident of USA, W2 income in USA e.g. USD 80K
2. Spouse B: Citizen of Canada, Resident of USA, has no US income, visits Canada part of the year and has consulting income from Canadian Source e.g. CAD 80K

So far this is what we have found, please correct any mistakes:

1. Spouse B as a Non Resident of Canada still has to pay and file taxes in Canada (on the CAD80K) as the source of of income is Canadian e.g. pay 30K in taxes to Canada

2. Spouse A+B file joint return in USA and has to show total income (USD 80K W2 + CAD 80K self-employment?)

3. Self-employment taxes on the 80K will also be paid to US?

4. In US Taxes, use Form 1116 to claim credit of the taxes paid to canada on the CAD 80K e.g. CAD 30K in taxes

The issue is that we assumed we can credit all 30K in taxes. But Form 1116 has a weird formula which says you can only credit a fraction i.e. ForeignTaxes * ForiegnIncome/TotalIncome => 30K * 80/160 => 15K

This means we can only credit half of the taxes paid to Canada. There is a formulae to carry over the remaining portion to next 10 years but the issue doesn't get resolved as every year there will be portion of taxes not allowed to be credited.

Does this make any sense?

[fadius]

I'm no expert but it makes sense to me, assuming that the tax liability on the Canadian side on that 80k income is higher than the one on the US side.

[DolphinNose]

I am in the same boat. Paid 11K in Canadian Taxes. But not able to credit it all in my USA taxes. Without Foreign Income, My Fed Taxes are 18,000 USD and with Foreign Income, It increased to 27,000 USD.

[twoboats]

It doesn't make sense because the US Treaty did not let me credit even to the extent that I could remove the US Taxation part on the Canadian income.

Lets assume:

Total US Tax on the USD 80K is 16K
Total US Tax when we add CAD80K to our income is 36K (additional 20K tax)

We already paid a higher 30K tax on Canadian Income to Canada which is not a US concern.
However the Treaty should have taken care of the additional 20K portion of US Tax so my total US Tax burden is reduced to 16K. Instead I am only able to credit 15K so I owe total US tax of 21k.

[DolphinNose]

More or less a similar concern to me as well. I am filing for the first time and claiming the FTC. After researching and talking to 1-3 CPA, I realized there is no option other than to pay the IRS.