Interaction of forms 2555 and 1116

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Jyrki21
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Joined: Fri Jun 04, 2010 9:03 am

Interaction of forms 2555 and 1116

Post by Jyrki21 »

First off, let me say that these forums are wonderful and I'm glad I've stumbled across them.

I am a dual citizen -- I have never filed U.S. taxes before (lived in Canada all my life, never had any U.S. income), but have been meaning to file some back taxes to try to catch up.

I have never made more earned income than the threshold in any given year, as such I was going to take the exclusion (form 2555) for each year. However, I understand that this exclusion cannot be used for interest income. So:

1. If filing form 1116 to claim the foreign-tax-paid credit for interest income, do I calculate the amount of foreign taxes paid on the interest by simply multiplying my Canadian tax bracket rate against the amount of interest income?

2. If my interest income is relatively modest, and therefore below the standard deduction on form 1040 (e.g. $5,700 in 2009 for single filers), is there actually anything to be gained in claiming the foreign-tax-paid credit (f1116), or will my balance owing simply work out to zero anyway?

3. In claiming my income for the purposes of the exclusion (f2555), do I put the gross amount, or my net income as determined in Canada (i.e. less all Canadian deductions)?

Thanks for any advice!
nelsona
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Post by nelsona »

Let me first state that if you have children, you should not use 2555 but use several 1116s for all income, including your wages. This will be eligible to get the child tax credit of $1000 per child, which you might not get using 2555.

1. To allocate your Cdn tax on any type of income, you take the TOTAL income (for example, line 150 of your Cdn return)and WHOLE tax you owed (you can look at line 429 on the fed, and equivalent line for the prov tax) This is your EFFECTIVE tax rate), and then divide the tax by the ratio of specific income to toatl income.

So, say you had $100K of income, including $100 of interest, and you owed $25000 of tax. For form 1116 purposes, $25 of the tax would be for interest.

2. If you use 2555, you don't get to calculate the tax the normal way, so every penny above the 2555 exemption would be taxable, so yes, youwould need to use the 1116 on the other typres of income.

3. Gross amount. The deduction that are eligible go on schedule A, or use standard deduction.

It is very rare, regardless of the method used that full-time Cdn resident with no US income pays any tax in US, if they do their taxes correctly. As I mentionned, those with kids should actually get money back .
However, as you now realize, unless you actually have less than the threshold income you are required to report world income on 1040, and apply any of these deductions, credits, exclusions, or you are liable to tax penalties and interest.

You need to go back six years.
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nelsona
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Post by nelsona »

By the way, for wage income, CPP and EI are included as tax for this income only.
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Jyrki21
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Post by Jyrki21 »

Thanks for your reply! Inevitably I have many follow-up questions, and I genuinely appreciate the effort you obviously put into this. It's remarkably generous of you.

[quote="nelsona"]Let me first state that if you have children, you should not use 2555 but use several 1116s for all income, including your wages. This will be eligible to get the child tax credit of $1000 per child, which you might not get using 2555.[/quote]
Thanks for this tip. I do not yet have children, but have a baby on the way, so this will be useful for 2010. Is it worthwhile to ignore 2555 entirely and simply always use 1116, for past years too?

[quote="nelsona"]1. To allocate your Cdn tax on any type of income, you take the TOTAL income (for example, line 150 of your Cdn return)and WHOLE tax you owed (you can look at line 429 on the fed, and equivalent line for the prov tax) This is your EFFECTIVE tax rate), and then divide the tax by the ratio of specific income to toatl income. [/quote]
Ah, so I am using gross income for these purposes too, then, notwithstanding that Canada only taxes me on my smaller net income? Doesn't this risk reducing the amount of credit I receive for Canadian taxes paid (since interest income is a very small proportion of my gross income) to an amount below what I might actually owe in the U.S. for that interest income?

[quote="nelsona"]2. If you use 2555, you don't get to calculate the tax the normal way, so every penny above the 2555 exemption would be taxable, so yes, youwould need to use the 1116 on the other typres of income.[/quote]
I understand that it is tax[i]able[/i], But if I can still claim the standard deduction, and this deduction is considerably greater than my non-excluded income (generally less than $1,000 every year), do I actually need to bother claiming the credit? Won't it just get deducted out anyway?

A similar question -- if my gross income annually (completely ignoring deductions I take in Canada for RRSP contributions) fits underneath the f2555 exclusion threshold, is there any sense in claiming deferment treaty provisions for RRSPs, or should I just treat it all as taxable -- but excluded -- income for U.S. purposes?


[quote="nelsona"]It is very rare, regardless of the method used that full-time Cdn resident with no US income pays any tax in US, if they do their taxes correctly. As I mentionned, those with kids should actually get money back .[/quote]
I figured as much, but then based on your answer to question 2, I am worried that due to the relatively smaller allocation of taxes-paid for interest income in the U.S. than Canada, the credit won't make up for what I could owe in the U.S. Again depending on what happens with the standard deduction, I guess...?

[quote="nelsona"]You need to go back six years.[/quote]
What happens if I submit, say, three years? Particularly as the information available from six years ago will be quite scant and I don't know if I have it all. It seems like a real perverse incentive against filing at all to go after people trying to do the right thing.

Related practical question: is there any reason I would need my actual Canadian T-slips from all prior years, or if I have Notices of Assessment for each relevant year (which contain most of the crucial data), will I have enough to fill out U.S. forms?

Also, does the Department of Treasury also have a "six year rule" for FBAR submissions (which I have never made -- I only found out about them two days ago, and information there may likewise be quite difficult to get).

Thanks so much again for your help.
nelsona
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Post by nelsona »

Try to limit your use of quotes, as you can see they don't help.

1. If you use 2555 for wages and then switch to 1116, you cannot switch back for a few years, so best to just use 1116 at this point.

2. Whatever the risk is, that is how it is calculated. It is NOT based on marginal tax rate. besides, using that argument, who is to say that your interst was not the FIRST income, and thus no tax was paid in canada on it. Effective rate is the only accepatable way.

3. As I said, whe you use 2555, the tax is calculated as if your deductions (standard or otherwise) were spread over the entire income you had. when you use 2555, you don't have a tax-free amount. This was changed about 7 years ago, to prevent exactly waht you are proposing. it *might* be just small enough to offset, but it may not. See #1 as to why you shouldn't bother anyways.

If you use 1116 for all income, then you won't have to worry about small percentages, since all your income is from canada. I think you are forgetting how low the US fed tax rate really is.


RRSPs: No personal RRSP contributions you make are deductible in US. Only RRSP contributions you make at work, after 2008 are deductible in US. You have no choice on this. So, the deferral you speak of is on INTERNAL RRSP income generated every year. Whether you elect or not to defer US tax on internal RRSP income, you still have to file 8891 or face penalty. Since this income wouldnot have any tax in canada, you would owe something in US every year (plus interest and penaly at this point). so deferral back six years is advisable.

All Cdns are instructed to keep records for SEVERAL tax years. Any particular reason you haven't? Your tax forms and assessments are aminum. All your RRSP statements should be on hand.

The standard for someone who has neglected to fiel is six years. I would file FBAR for 2009. this month. I'm not a fan of going further back on that, since there is no provision to do so.

Its too late to do the "right thing". What you are trying to do now is avoid tax interst and penalties for NOT having done the right thing in the past. I would seize the opportunity.
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Jyrki21
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Post by Jyrki21 »

Yes, I see quoting is disabled now. :) So is editing of messages, apparently!

So it sounds like using only 1116 is a perfectly acceptable way to go. So one follow-up question on that -- six years ago I was still a student, and as such my credits outweighed my very light liability (from summer earnings), and I ended up paying no tax. Since there will be nothing to claim as a foreign credit there, is it best to use 2555 on my income (only about $20,000 that year), then revoke it on my following return? Is there an alternative?

As to using 1116 for everything, I appreciate that tax rates are generally lower in the U.S., but then if I have quite a number of deductions in Canada (RRSPs, charitable donations or what have you) which lowered my net income substantially, I feel it could be evened out pretty quickly if the U.S. is assessing on the basis of gross income, but Canada on net?

My records are a bit scattered because I had family members doing my taxes up until a few years ago, and I am not entirely sure what they have kept (and there is also an immense physical distance between us). For banking records, most of my online banking only goes back three years or so. Although if you think there is no sense in filing back-FBAR forms, then this is a bit less of a concern.

If I am filing multiple forms all at once, for things like the 2555 election (where they ask if you have claimed/revoked it before), do I just fill out everything chronologically and then claim, e.g., in 2009 that I revoked the election in 2005 (even though I am submitting everything at once)?

Or if I submit the forms out of order (such as reverse chronologically)?
nelsona
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Post by nelsona »

Look. If you want to use 2555 and you have no kids and it yields no US tax, then use it. I'm just pointing out why you might not want to use it. You need the practice of doing 1116.

2555 is really best for people who live where there is no foreign tax.

US is assessing on net income not gross income. 1116 uses the the deductions you claim, divvied up by type of income. If you have so many deductions, they can also be used on 1040 instead of standard deduction.

Make sure you are using software to calculate all forms.


It is best to file all at one time.
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Jyrki21
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Post by Jyrki21 »

I appreciate all your help. I have read that the usual U.S. software (Turbotax, etc.) doesn't really work for non-residents without the requisite forms. Do you know of alternatives?
nelsona
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Post by nelsona »

You are not a non-resident.

You are a US citizen abroad, and the off the shelf software works perfectly.

Ttax has form 8891 while taxcut doesn't, if that's a help making the choice.
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Diskdoctor
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Post by Diskdoctor »

Nelson said "when you use 2555, the tax is calculated as if your deductions (standard or otherwise) were spread over the entire income you had. when you use 2555, you don't have a tax-free amount."

Looking at how the values get entered on the 1040 and the Foreign Earned Income Tax Worksheet this doesn't agree with my interpretation of your statement. Please correct me if I'm wrong...
On the 1040 your earned income goes on line 7, then your unearned income on one or more of the following lines. If you fill out the 2555 then your earned income (assuming it's less than the limit) goes on line 21 as a negative value leaving you with the unearned income as your adjusted gross income. You claim the itemized or standard deduction on line 40a ($4700 for an individual) and other exemptions (you, spouse, children * $3650) on line 42 leaving you with your taxable income on line 43. In a simple case such as that presented by Jyrki21, as long as the unearned income is less than the applicable deductions and exemptions ($8350 for an individual) line 43 will be zero and your tax will be zero (line 1 of Foreign Earned Income Tax Worksheet is zero, lines 2 and 3 are equal so lines 4 and 5 are equal in most cases and line 6 is zero).

I understand that if your unearned income is higher than the standard deductions and exemptions that that amount will be taxed at a higher rate but as far as I can tell that first portion is still what I would consider "tax free". But maybe I'm missing something?

BTW I appreciate all the great information on this message board and the work you put into it Nelson.
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Post by proximityinfotech6 »

f the taxpayer wants to change their tax accounting method, section 446(e) requires the taxpayer to acquire the consent of the Secretary of the Treasury. There are two kinds of changes, one where you must receive a letter of approval from the Secretary of the Treasury. Another type of change comes from a series of more routine changes each of which is an automatic change. To get the automatic change the taxpayer must fill out a form and return it to the Secretary of the Treasury.

The taxpayer can adopt another method if the taxpayer files a tax return using that method for two consecutive years. This is different from changing a tax accounting method under the release of the Secretary of the Treasury because in the case of adopting another method the IRS may assess fines and reallocate taxable income. If the taxpayer wants to return to the previous method the taxpayer must ask for permission from the Secretary following the 446(e) procedure.
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nelsona
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Post by nelsona »

Disk,

If your other income is indeed less than your deduction you might pay nothing. However if it is not, your throw away the tax tables, and use the worksheet for 2555 users.

So many of the deductions are impacted by 2555 however that not using software is bound to have you use a credit/deduction that a 2555 user is not entitled to (like the child tax credit for example).
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Jack Pengy
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Post by Jack Pengy »

Per IRS re FBAR and amounts to be reported: "The account value is the largest amount of currency and/or monetary instruments that appear on any quarterly or more frequently issued account statement for the applicable year. If a periodic account statement is not issued, the maximum account value is the largest amount of currency and/or monetary instruments in the account at any time during the year. If the aggregate value of accounts exceeds $10,000 at any time during the calendar year an FBAR must be filed."

Can I conclude this means that I should exclude the value of stocks or mutual funds etc from the amounts reported?
nelsona
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Post by nelsona »

you MUST include these.
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