Understanding the Foreign Tax Credit Limit Calculation

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dualblues
Posts: 23
Joined: Tue Mar 16, 2021 1:50 am

Understanding the Foreign Tax Credit Limit Calculation

Post by dualblues »

Thanks for your support!

I am a dual citizen (US person) becoming a Canadian tax resident. Eventually, I will make qualified 401k/IRA withdrawals. Here is my understanding:
i) I would pay Canadian/Ontario income taxes based on the withdrawal amount.
ii) I would calculate my US taxes based on the withdrawal amount.
iii) I would use a foreign tax credit for the Canadian taxes that I paid in order to avoid double taxation.

The IRS describes the foreign tax credit calculation here:
https://www.irs.gov/individuals/interna ... the-credit

It indicates:
"Your foreign tax credit cannot be more than your total U.S. tax liability multiplied by a fraction. The numerator of the fraction is your taxable income from sources outside the United States. The denominator is your total taxable income from U.S. and foreign sources."

Question:
Would the IRA distribution be considered "taxable income from sources outside the United States"? For example, assuming my only income was
a 100K IRA distribution (ignoring currency conversion). In this case, the fraction would be 100k/100k. This would mean that I could use the full foreign
tax amount as my foreign tax credit.

Did I get the calculation correct? (It seems to make sense, but, I am not sure why the (numerator) IRA distribution is considered taxable income from sources outside the US(?). (Am I missing something? It seems this should be described as "taxable income subject to foreign tax").

Thanks!
nelsona
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Re: Understanding the Foreign Tax Credit Limit Calculation

Post by nelsona »

Not quite.
For US sourced income, like your 401(k) etc, You will not get credit on your US return. You will instead get credit on your Cdn return for any US tax that you pay (or more accurately, that you calculate on your 1040).
I am taking my usual break from this site until May. Always too many tax-form specific questions at this time of year...
nelsona non grata. Non pro. Search previous posts. Happy Browsing :D
nelsona
Posts: 16947
Joined: Wed Oct 27, 2004 2:33 pm
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Re: Understanding the Foreign Tax Credit Limit Calculation

Post by nelsona »

Not quite.
For US sourced income, like your 401(k) etc, You will not get credit on your US return. You will instead get credit on your Cdn return for any US tax that you pay (or more accurately, that you calculate on your 1040).
I am taking my usual break from this site until May. Always too many tax-form specific questions at this time of year...
nelsona non grata. Non pro. Search previous posts. Happy Browsing :D
dualblues
Posts: 23
Joined: Tue Mar 16, 2021 1:50 am

Re: Understanding the Foreign Tax Credit Limit Calculation

Post by dualblues »

Thanks for your clarification, nelsona.

I was able to find the CRA's document on discussing the foreign tax credit calculation:

https://www.canada.ca/en/revenue-agency ... tml#N10C64

Basically, Canada limits foreign tax credits based on the ratio of foreign income to world-wide income. (Effectively, this means that if you paid foreign income tax at a high rate, you may not be able to get a tax credit for it all).

Would the IRS' foreign tax credit calculation (in the original post) come into play if I earned Canadian income and wanted to get a credit for the Canadian taxes paid?

(Perhaps this is straight-forward :). For dual citizens, residing and working in Canada, if they took an IRA withdrawal (or had other US based income). They would:
i) Get foreign tax credits for Canadian income and apply to their US taxes;
ii) Get foreign tax credits for their IRA distributions and apply to their Canadian taxes;

(Per your previous comment) The credit on your Canadian return would be based on calculations from your 1040 (meaning you would have to finish calculating US taxes before filing your Canadian taxes).

Cheers
nelsona
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Re: Understanding the Foreign Tax Credit Limit Calculation

Post by nelsona »

FTCs in both countries are designed to limit the credit to the effective rate, and not fully recompense you. That's just how it is.

When determining FTC, you always do so BEFORE applying any FTC. So you do both countries without FTC, this determines the various income buckets the taxes are assigned, and the FTCs are done in one or both returns.
Your software will handle this.
I am taking my usual break from this site until May. Always too many tax-form specific questions at this time of year...
nelsona non grata. Non pro. Search previous posts. Happy Browsing :D
Numbersman61
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Joined: Wed Sep 09, 2020 1:02 pm

Re: Understanding the Foreign Tax Credit Limit Calculation

Post by Numbersman61 »

One useful practice to consider is pension splitting with your spouse in order to utilize the entire foreign tax paid as a foreign tax credit on the Canadian tax return. By transferring about $11,000 of pension income from my spouse to me, her taxable income was reduced and I was able to claim the entire foreign tax paid. Thanks to a knowledgeable cross border tax specialist.
dualblues
Posts: 23
Joined: Tue Mar 16, 2021 1:50 am

Re: Understanding the Foreign Tax Credit Limit Calculation

Post by dualblues »

Thanks nelsona and Numbersman61 for your helpful posts!

Numbersman61, nice to hear that you were able to make use of the pension splitting. Recently, nelsona shared a link on this topic: viewtopic.php?t=11014 Cool that you can use pension splitting for your 401k too!

This raises a couple of interesting questions, but, I will follow up in a more appropriate thread rather than polluting this one :).

Cheers!
nelsona
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Re: Understanding the Foreign Tax Credit Limit Calculation

Post by nelsona »

You can use splitting for pension and 401(k) but NOT IRA.
I am taking my usual break from this site until May. Always too many tax-form specific questions at this time of year...
nelsona non grata. Non pro. Search previous posts. Happy Browsing :D
nelsona
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Re: Understanding the Foreign Tax Credit Limit Calculation

Post by nelsona »

btw, the tax paid in US is also split when doing pension splitting.
I am taking my usual break from this site until May. Always too many tax-form specific questions at this time of year...
nelsona non grata. Non pro. Search previous posts. Happy Browsing :D
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