Correct way to complete both foreign tax credit forms?

[RobC]

Hi,

Thanks for the forum! I think I have a straightforward situation, but I'm confused on a few details. I'm a US citizen and moved to Canada in late 2018. My income was as follows:
- Jan-Oct: Resident of US, wages from US company and US bank interest
- Nov-Dec: Resident of Canada, wages from Canadian company, Canadian bank interest, and US bank interest
If my understanding is correct, and if we disregard any min/max reporting thresholds for now, I can file both a t2209 and 1116 for foreign tax credits (please correct me if I'm wrong).

1. For Canada form t2209, the instructions make it clear that for line 431 (income tax paid to a foreign country), I should not include US taxes related Canadian-sourced income given that I'm a US citizen. So, for that entry, I'll enter the proportion of my US tax paid that corresponds only to my US bank interest earned in Nov-Dec. Is that correct?

2. For US forms 1116, Part II (foreign taxes paid), I understand how to split the income categories among general and passive categories, but I'm unclear on what income sources should be included in my calculations: Should I enter one of the following, and if so, which one?
(a) Canadian taxes that I paid that correspond to Canadian wages, Canadian bank interest, and US bank interest, for Nov-Dec.
(b) Canadian taxes that I paid that correspond only to Canadian wages and Canadian bank interest for Nov-Dec.
I'm guessing (b) makes sense, but I'm confused because the instructions for this part mention "foreign tax base", and since Canada also taxes me on some of my US income, I'm not sure if that US income is included in this "foreign tax base".

3. If 2(b) above is correct, perhaps this next question isn't relevant, but I couldn't find a definitive answer elsewhere so any clarification would be appreciated: Will I need to perform circular calculations between my US and Canadian forms until things converge, given that a tax credit on my US taxes would reduce the amount of taxes I report on my Canadian forms, and vice-versa?

Perhaps another way to ask question 3 is with this example: Suppose half my income was from the US and the other half was from Canada. If, before computing any foreign tax credits, my US taxes were $1k, then half of that ($500) would correspond to US income, and that's what I'd put on the t2209 as foreign taxes paid (assuming question 1 above is correct). However, supposed after filling out US form 1116 I'm entitled to a $200 foreign tax credit on my US return. That will reduce my final US taxes to $800. Should I then go back to my t2209 and change the $500 foreign tax paid to $400, or do I leave t2209 alone because the foreign credit taken on my US return only reduces the portion of taxes that applies to the Canadian-source income on my US return? Apologies for the long question!

Thanks in advance for any help!

[nelsona]

1. You will have no foreign tax credits on your Cdn return, because US bank interest is not taxable in US if you are not a US citizen, thus Canada does not give you credit. You will need a 're-sourced by treaty' 1116 to reduce the US tax on that portion of US interest earned once you left US.

2. Your other 1116's will be passive for Cdn bank interest, and "general" for Cdn wages. Just a tip, usually USC's use 2555 on foreign wages (you would need to wait until next November 2019 to use 2555, but it generally works out better. Try it both ways.

[nelsona]

foreign tax credits (FTC) are calculated ONCE, after both tax returns are completed without FTC. The taxes are then apportioned to each type of income that appears on the other tax return, and the credits are calculated. Thus there are no iterations, and the order doesn't matter.

[RobC]

Thank you very much for your quick reply! Sorry if I wasn't clear, but I am a US citizen. Does that change your answers to questions 1 & 2? Thanks also for your answer to questions 3 -- that's quite a relief :-)

Thank you!

[nelsona]

Reread what I said.

My answer was BASED on you being a USC. USC's cannot claim credit on their Cdn returns for income tax paid in US on US-sourced that would not be paid if they were not USC's. If you were not a USC, you would not be reporting US bank interest once you left US.

[RobC]

Thank you for the clarification, I didn't know about the re-sourced concept. If my understanding is correct, then while residing in Canada, in order to avoid double-taxation on my US bank interest, I should fill out the worksheet "Additional Foreign Tax Credit on U.S. Income" on page 26 of IRS publication 514 (2017 version, as the 2018 version isn't available yet), and then attach it to a third Form 1116 for the "re-sourced" category, and limit that credit to be no more than 15% of that US interest?

Thank you again!

[nelsona]

The form is right, but the limit will be whatever your US effective tax rate, not an arbitrary 15%. You will re-source all the US bank interest earned after you left, and reduce the US tax to 0%, or reduce it by the Cdn tax you paid on that amount, whichever is less.

The 15% limit that Canada limits foreign tax credit is a separate issue, which I won't go into here.

Please use software to do your taxes. They will handle all these 1116's.

[RobC]

Thanks again, that's clear now. I see from your reply in a different post that for a simple case of re-sourcing bank interest, it isn't necessary to also file form 8833, as the "re-sourced by treaty" on form 1116 is sufficient, so I assume that would apply to my case as well.

Thanks again for your help!

[RobC]

Hi,

Thanks again for informing me about how US interest income can be re-sourced. I was able to fill out the form 1116, both with software and manually, although I think the software I was using wasn't aware of anything related to citizenship or treaties. So, here's a final result (with well-rounded numbers for discussion purposes) for my re-sourced form 1116, with all figures in US dollars:

- re-source $1000 of US bank interest to Canada (Line 1a)
After calculations:
- Total foreign taxes paid = $155 (Line 8)
- Maximum amount of credit = $200 (Line 21)

If I just use those numbers, that would make the final credit $155 on Line 22, so basically Canada would be taxing me 15.5% and the US would be taxing me 20% and then applying a credit equal to the Canadian tax. However, both those tax rates are above 15%, and given that I'm a US citizen residing in Canada, I'm unclear on whether I need to reduce my credit to 15%, or if the US rate can be reduced to 15% so the credit makes the US tax zero, or something else. Do you know if I need to make any adjustments, or if I'm all set?

Thanks again for your help!

[nelsona]

Foreign tax credits never really give you full credit when you have income in both countries, but remember that the way things are set up, IRS won’t give you more than the tax CANADA charged.
The treaty doesn’t say that IRS can’t tax you as a US citizen on interest — quite the opposite. It simply states that Canada won’t give you credit, and that US will give you some, based on their rules.
But in your case, things are correct. You pay $155 to Canada and $45 to US.That’s 20% overall — your US tax rate.

Not sure what your reference to 15% means. Canada does limit some FTC’s to 15%, but in this case the limit is 0%, ie you are not entitled to any in Canada, so that doesn’t apply

[RobC]

Thanks for the clarification, and for all your help! My reference to 15% was related to some tax limits mentioned in Article XI of the treaty. One of my certificate of deposits is contingent, but I'm guessing that a CD is considered to be portfolio income, so perhaps paragraph XI 6(a) doesn't apply to me.

[nelsona]

CD's are interest.

[nelsona]

Investment income in US (cap gains)) would again not get any tax credit in Canada, since it is considered Cdn sourced. You would need to use 1116 to get tax back (simple passive income, not re-sourced income) to US.

You will see when living in Canada, that CRA gives very little tax credit; you usually have to get the credit from IRS.