Form 1116 HTKO?
Moderator: Mark T Serbinski CA CPA
Form 1116 HTKO?
When claiming a foreign tax credit for capital gains on form 1116, should I compare the effective tax rate that I pay on these gains in Canada against the maximum tax rate in the U.S. for short-term capital gains or long-term capital gains to determine if a "High Tax Kick Out" applies?
Re: Form 1116 HTKO?
It is the 39.6 tax rate. There is no way in canad, given that gains are only 50% included that you will meet HTKO
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Re: Form 1116 HTKO?
Do you have a source that states this?
I have found different opinions on the internet. For long-term cap gains some say it should be 20% not 39.6%.
I have found different opinions on the internet. For long-term cap gains some say it should be 20% not 39.6%.
Re: Form 1116 HTKO?
What does your software say? HTKO is programmed into the software, no?
Are you paying 40% EFFECTIVE taxrate (not marginal) in Canada?
Are you paying 40% EFFECTIVE taxrate (not marginal) in Canada?
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Re: Form 1116 HTKO?
I am trying to determine my U.S. tax liability for 2020 if I sell shares of an ETF and incur a large long-term capital gain this year. I'm doing this on a spreadsheet since I don't have any software.
My effective Canadian tax rate might be over 20% which is the maximum tax rate on long-term capital gains in the U.S. Hence, I need to know if for the purposes of the HTKO the highest U.S. tax on these gains is considered to be 20% or 39.6% - the highest tax on general income.
What are the implications of having income "kicked-out" and moved to general income category? Is the income then taxed at a higher rate on the U.S. return?
My effective Canadian tax rate might be over 20% which is the maximum tax rate on long-term capital gains in the U.S. Hence, I need to know if for the purposes of the HTKO the highest U.S. tax on these gains is considered to be 20% or 39.6% - the highest tax on general income.
What are the implications of having income "kicked-out" and moved to general income category? Is the income then taxed at a higher rate on the U.S. return?
Re: Form 1116 HTKO?
I think you meant your effective taxrate in Canada would be 40% ? (since cap gains are taxed at 1/2 your effective rate.
As with all FTC, you are ALWAYS limited to the taxrate you would owe in US, whether by HTKO (which I've never seen applied) or 1116 limits themselves, software does this nicely, especially for cap gains.
You will not pay US tax on this income, regardless of how it is classified on your 1116's.
As with all FTC, you are ALWAYS limited to the taxrate you would owe in US, whether by HTKO (which I've never seen applied) or 1116 limits themselves, software does this nicely, especially for cap gains.
You will not pay US tax on this income, regardless of how it is classified on your 1116's.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing
Re: Form 1116 HTKO?
As far as I can tell even if the HTKO moves a “passive category income” item to “general category income” it doesn't change the tax calculation on the U.S. return. It just means that the foreign tax credits associated with that income are moved from the passive category to the general category. Correct?
It seems to me that the concept behind the HTKO is simply to prevent a large foreign tax credit associated with a specific item of highly taxed passive income from potentially offsetting U.S. taxes on other items of passive income that have a lower foreign tax rate.
So it doesn’t seem like such a big deal to me. The U.S. tax calculation remains the same and the foreign tax credits are still available for use, it’s just that they can only be applied against general instead of passive category income.
It seems to me that the concept behind the HTKO is simply to prevent a large foreign tax credit associated with a specific item of highly taxed passive income from potentially offsetting U.S. taxes on other items of passive income that have a lower foreign tax rate.
So it doesn’t seem like such a big deal to me. The U.S. tax calculation remains the same and the foreign tax credits are still available for use, it’s just that they can only be applied against general instead of passive category income.
Re: Form 1116 HTKO?
Yup.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing
Re: Form 1116 HTKO?
I dug into this deeper.
About the applicable tax rate to determine if a HTKO applies, I think I know why it is 39.6%, and not something else such as 20% for long-term capital gains.
Section 1.904-4(c)(1) of the U.S. tax regulations states:
“Income is considered to be high-taxed income if, after allocating expenses, losses, and other deductions … the sum of the foreign income taxes paid or accrued … by the United States person with respect to such income … exceeds the highest rate of tax specified in section 1 or 11, whichever applies (and with reference to section 15 if applicable), multiplied by the amount of such income …”
https://www.law.cornell.edu/cfr/text/26/1.904-4
Section 1, “Tax on Individuals” is the applicable section. (Section 11 is for “Tax on Corporations” and section 15 is for “Changes in rates during a taxable year.”)
https://www.law.cornell.edu/uscode/text/26/1
The wording from regulations quoted above simply states “… exceeds the highest rate of tax specified in section 1 …” Interpreting this statement literally, we just need to find the highest rate of tax in section 1 of the code, which is 39.6% (as far as I could find).
For 2018 to 2025 the highest rate is 37%, but this is only a temporary change and “the highest rate of tax specified in section 1” is still 39.6%.
About the applicable tax rate to determine if a HTKO applies, I think I know why it is 39.6%, and not something else such as 20% for long-term capital gains.
Section 1.904-4(c)(1) of the U.S. tax regulations states:
“Income is considered to be high-taxed income if, after allocating expenses, losses, and other deductions … the sum of the foreign income taxes paid or accrued … by the United States person with respect to such income … exceeds the highest rate of tax specified in section 1 or 11, whichever applies (and with reference to section 15 if applicable), multiplied by the amount of such income …”
https://www.law.cornell.edu/cfr/text/26/1.904-4
Section 1, “Tax on Individuals” is the applicable section. (Section 11 is for “Tax on Corporations” and section 15 is for “Changes in rates during a taxable year.”)
https://www.law.cornell.edu/uscode/text/26/1
The wording from regulations quoted above simply states “… exceeds the highest rate of tax specified in section 1 …” Interpreting this statement literally, we just need to find the highest rate of tax in section 1 of the code, which is 39.6% (as far as I could find).
For 2018 to 2025 the highest rate is 37%, but this is only a temporary change and “the highest rate of tax specified in section 1” is still 39.6%.
Re: Form 1116 HTKO?
As I said earlier, there are other factors that limit your FTC for below HTKO, since FTC is limited to what your effective US tax obligation is in all cases.
Since your US tax rate cannot exceed the highest rate (duh!), then your FTC can never reach HTKO. The only thing HTKO does is remove that income from the passive basket to the general.
Since your US tax rate cannot exceed the highest rate (duh!), then your FTC can never reach HTKO. The only thing HTKO does is remove that income from the passive basket to the general.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing
Re: Form 1116 HTKO?
I'm just saying that I agree with you that 39.6% is the tax rate that determines whether HTKO applies. That's what the tax code says, as far as I can tell.