Foreign Tax Credit - Canadian vs. US Recognition of Income

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Stevecanada
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Foreign Tax Credit - Canadian vs. US Recognition of Income

Post by Stevecanada »

My elderly father is a US citizen and a long term resident of Canada. He has a number of Canadian non-registered GICs, on which interest is recognized by the CRA on their anniversary date. For his US taxes, he has always used the cash method of recognizing interest income. For 2019, he has Canadian T5 slips totaling over $4,000, but he actually received only about $1,000 in interest during 2019 (the rest was accrued). My question - can he claim on form 1116 the taxes he paid to Canada on $4,000 of interest income, or only the taxes he paid on $1,000? Any help would be greatly appreciated.
nelsona
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Re: Foreign Tax Credit - Canadian vs. US Recognition of Income

Post by nelsona »

You can claim the taxes on the $4000, unfortunately you can only use it against the $1000 of CDn passive income. This would be a case to use the accrual method in US. It is very complicated to change methods, which needs to be approved by IRS.

Looking at his past taxes, has he REALLY used the cash method, or can the case be made that accrual method was nearly the same.
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nelsona
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Re: Foreign Tax Credit - Canadian vs. US Recognition of Income

Post by nelsona »

Another thing to realize is that unused foreign taxes can be carried forward, so in years when he nay have rried forward, so he should have some reserves already that he can use up
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testone
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Re: Foreign Tax Credit - Canadian vs. US Recognition of Income

Post by testone »

nelsona wrote:
> It is very complicated to change methods, which needs to be approved by IRS.

If you use the cash method to account for foreign tax credits, you can change to the accrual method by simply checking the accrual box on Form 1116. Once you choose to use the accrual method, you cannot change back to the cash method. From IRS Publication 514:

"Even if you use the cash method of accounting, you can choose to take a credit for foreign taxes in the year they accrue. You make the choice by checking the box in Part II of Form 1116. Once you make that choice, you must follow it in all later years and take a credit for foreign taxes in the year they accrue."
nelsona
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Re: Foreign Tax Credit - Canadian vs. US Recognition of Income

Post by nelsona »

I don't believe we were talking about the accrued vs paid method of FTC.

What we are discussing is the cash vs accrual method of accounting for income. As you may realize, for US tax purposes, you can account for interest income as it accrues, or when it is actually paid out (cash method). CRA does not give one the choice, and one must account for interest yearly as it accrues. That is why is best to use accrual accounting if one reports interst income ion US and Cdn tax returns.
For FTC one can choose tax accrued or tax paid on a yearly basis, alternating as often as one wishes. Not so for cash vs accrual accounting.
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Stevecanada
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Re: Foreign Tax Credit - Canadian vs. US Recognition of Income

Post by Stevecanada »

Nelsona and testone, thank you for your help - very much appreciated.

If I understand CRA rules correctly, interest income is not accounted for on a true accrual basis in Canada. For example, if I purchased a two-year non-cashable Canadian G.I.C on Feb 1, 2017, then interest income would be recognized by the CRA as having been earned on Feb 1, 2018 and Feb 1, 2019 (so no interest recognized by the CRA in 2017, and about half the interest income recognized in 2018 and the other half in 2019).

If I understand the IRS accrual income rules correctly, interest on this GIC would be recognized in 2017 (11 months), 2018, and a little bit in 2019 (1 month), whereas on a cash basis, 100% of the interest would be recognized in 2019. So no matter how I recognize income in the US, it is unlikely that the amount of interest income would match on US and Canadian tax returns for Canadian GICs. Is my understanding correct?
nelsona
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Re: Foreign Tax Credit - Canadian vs. US Recognition of Income

Post by nelsona »

Correct, but even if the situation, accrual method would still be the correct method, as IRS allows carryBACK for one year, covering this situation nicely.
But one really would not need to get into such detail. Reporting the same income in US and Canada the year Canada taxes one for it would be good enough for IRS.

Bottom line, Cdn resident with US tax obligations should report interest income on accrual method, since that is the way one must report it in Canada.

But, even if your father doesn't change methods, another solution, since your father is been paying Cdn tax on $1000 income that he has not yet reported in US, would be to have included the CDn tax (say $300) each year on a 1116, with no CDn income, thus accumulating FTC carryFORWARD, which he would have $1200 of Cdn tax when eventually reports $4000 with on his 1040.
In this way, at some point, the Cdn tax catches up with the income reported on his 1040.

So, make sure your father has been reporting the CDn tax accurately in the past few years, and he should already have some reserves, and certainly will when the GIC matures.

Be advised of course that in matters of FTC between US and Canada, Cdn tax is almost never completely used up on 1116, no matter how long one carries it forward, since the taxrate in US is always lower than Canada for a Cdn resident.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
Stevecanada
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Re: Foreign Tax Credit - Canadian vs. US Recognition of Income

Post by Stevecanada »

Thank you Nelsona, this is very helpful.
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