U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

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AvalonJeff
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U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by AvalonJeff »

Here’s the scenario… A dual citizen of the United States and Canada (Dual-USC) is resident in Canada and uses U.S. filing status MFS. This Dual-USC is married to a Canadian-only spouse (Non-USC). Both are resident in Canada. The Non-USC spouse identifies as a Non-Resident Alien (NRA) for U.S. tax purposes and does not file a U.S. return.

The Dual-USC has only Canadian source income except for U.S. SS payments which are reported only on Dual-USC’s Canadian return (with the 15% adjustment). Both spouses receive Canadian OAS and CPP. The Dual-USC reports the OAS and CPP payments only on the Canadian return. Both spouses receive defined benefit pension payments from Canadian corporation pension plans. The Dual-USC has considerably more corporate pension income than the Non-USC. Because of this, the Dual-USC uses Revenue Canada’s Pension Splitting rules to shift some of their Canadian tax liability to the Non-USC spouse.

The U.S. FTC claimed by the Dual-USC does not include any of the Canadian tax paid by the Dual-USC on the OAS, CPP, and U.S. SS income because none of these amounts are included as income on the Dual-USC’s U.S. tax return.

Here’s the important question... How is the amount of the U.S. FTC calculated for the Dual-USC’s U.S. tax return? If all of the Dual-USC’s corporate pension income must be reported on the U.S. tax return, it seems like all of the Canadian tax paid on that income should be allowable as part of the Dual-USC’s U.S. FTC, even if part of that tax was shifted to (and paid by) the Non-USC spouse. Is this correct?

Is anyone willing, and able, to provide specific steps for how to correctly calculate the Dual-USC’s FTC in this situation? Are there any comments or suggestions related to the overall scenario described?

TIA
nelsona
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Re: U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by nelsona »

This is a known problem for US taxpayers living in Canada and using pension-splitting for their Cdn pensions.

By filing MFS, you are in effect losing the tax "paid" by your spouse on your pension. You must however still report the entire pension on your US return, since it is your income.

There is one elegant solution:

Most filers use tax ACCRUED on their 1116 (using the results of their Cdn tax return to figure the max credit), but there is another option: tax PAID by you in the tax year (and not refunded). This is usually in the form of withholding tax. You could use the tax that was withheld from your pension, minus any that would be refunded (to you or your spouse) attributable to the pension splitting. So the portion if tax you report on your return related to your share of your pension, plus the portion of tax your spouse pays on her share of your pension (if the total is equal to or less than was withheld by your pension fund) can be used on your general limitation 1116.


This *should* be enough to result in most of your tax payments to be 1116-eligible, to reduce your US tax on the pension to zero. Other incomes of course would impact this.


Using a quick example:
you had 100K pension, and 50K was withheld during the year. (you'll have a tax slip that says so) When you do the pension splitting you end up each paying 22K on the pension (of course your other source of income will change these numbers -- and you need to prorate), then you can claim the 44K as foreign tax PAID on your 100K pension income.


Here are other strategies that rely more on the tax accrued method:

Hopefully, the Cdn tax on the other CDn income you are reporting will be sufficient to result in enough tax to write off the US taxes that arise on all your Cdn income. Not likley unless you have other general limit income (wages)

If not, perhaps you could reduce the amount of pension income you split with your spouse. This would lower her Cdn tax bill, raise yours tax slightly, enough to cover the US tax.

Otherwise, your other choice is to file jointly in US, which has its own set of disadvantages of course.
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nelsona
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Re: U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by nelsona »

I do not believe there is any wording in the treaty (article 18) that would allow you to report only your "after-split" portion of your pension, so you do need to report all of it.
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AvalonJeff
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Re: U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by AvalonJeff »

Thank you, nelsona, for the detailed information you’ve provided.

I’d like to ask you a couple further questions about the tax PAID approach, but I’ll respond first with 4 comments about your suggested variations on the tax ACCRUED approach.

1. MFJ is not an option in the scenario that we’re discussing for reasons that I won’t get into.

2. The Dual-USC in my scenario has only passive income, no general limit income.

3. I’m not surprised to hear that the tax treaty (article 18) requires the Dual-USC to report all their pension income, not just the non-split portion. I expected this.

4. Reducing the amount of pension income that the Dual-USC splits on his Canadian return seems like a compromise strategy that penalizes MFS filers by increasing the total Canadian tax payable in order to reduce the Dual-USC’s U.S. tax payable. Better than nothing I guess, but not great

Questions regarding the Tax PAID method of calculating the FTC...

1. Let’s modify your example slightly and say that the Dual-USC has 100K in corporate pension income but it comes from 2 separate pension plans. The T4A for Pension Plan X shows pension income of 80K and 40K of tax withheld. The T4A for Pension Plan Y shows 20K in pension income and 0 (zero) tax withheld. The Dual-USC makes voluntary payments totaling 10K during the tax year to his Revenue Canada account. This is done in anticipation of the tax obligation associated with the pension plan that had zero withholding. Is the 10K payment part of what is considered "Tax PAID" when calculating the U.S. FTC?

2. How can the amounts withheld on T4A’s be considered "Tax PAID"? Couldn’t the Dual-USC just call his plan administrator and ask to have more tax withheld?

3. Your description of the "Tax PAID" solution included the phrase, “...use the tax that was withheld from your pension, minus any that would be refunded (to you or your spouse) attributable to the pension splitting.” How is the amount of tax refunded that is attributable to pension splitting calculated for each spouse?

Thanks once again for your help!
nelsona
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Re: U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by nelsona »

1. Yes. It would be better if you had the other pension withhold funds., if twhat is already being withheld would be insufficient to cover your US tax.
Any tax forwarded to the government, through quarterly payments during the calendar year is considered tax paid during that year, but it is harder to make the case that this was paid for the pension. You would need to split it over all your other income sources. It would be better if you contacted the admin of the pension and had them withhold the money. You would reduce this amount by any refunded amount. You will notice this on the form 1116 where you allot your foreign tax.

2. Yes, and if you are underpaying, you should do this. The caveat is that any refunds reduce the tax paid. The phrase is "tax paid but not refunded"

3. Really it is calculated by looking at the two Cdn tax returns, like in the example I gave. By prorating your tax over all your income, you know how much tax was owed for your part of the pension, and how much was owed on her part. The rest would have been refunded to you. The important thing is to have actually paid (had withheld) sufficient tax during the year to cover the US tax related to the entire pension income.

On your other comments, that is one of the "penalties" of filing MFS, along with the higher tax rate.

I presume you mean the Dual-US person has only passive income OTHER THAN the pension, which is considered general limit income.
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AvalonJeff
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Re: U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by AvalonJeff »

Thank you again for your help. In response to your question, I did think that all pension income was passive. Thank you for correcting me on this point. Does this mean that using the FEIE instead of FTC is another possible solution of Dual-USC?
nelsona
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Re: U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by nelsona »

No. It is general limitation income for 1116 purposes, but it is not considered earned income, so not eligible for 2555.
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ND
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Re: U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by ND »

RE: Most filers use tax ACCRUED on their 1116 (using the results of their Cdn tax return to figure the max credit), but there is another option: tax PAID by you in the tax year (and not refunded).

Note that IRS says (e.g., in IRS FTC webinar available on IRS site) once accrued or paid is selected on first-filed 1116, the same must be continued each subsequent tax year. One cannot switch from year to year.
nelsona
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Re: U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by nelsona »

Excellent point regarding IRC Section 905(a).

Unless our poster has never used 1116 (unlikely), or has always elected paid method (also unlikely), that leaves only the other scenarios I listed.
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AvalonJeff
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Re: U.S. FTC Calc for Dual Citizen, MFS, Canadian Pension Splitting with NRA Spouse

Post by AvalonJeff »

Thank you to ND for the warning about switching between an accrued basis and a paid basis when filing 1116’s. Thank you also to nelsona for confirming the importance of this limitation on switching. Your comments are extremely helpful and your participation in this forum is much appreciated.

It seems like the Dual-USC taxpayer in my scenario is stuck with the accrued election and can not take advantage of nelsona's scenario that uses the paid election.

For the benefit of third-parties who may be following this discussion, I’d appreciate clarification of one detail. The IRS FTC discussion located at https://www.irs.gov/taxtopics/tc856 includes the following text: “If you're a cash basis taxpayer, you can only take the foreign tax credit in the year you pay the qualified foreign tax unless you elect to claim the foreign tax credit in the year the taxes are accrued. Once you make this election, you can't switch back to claiming the taxes in the year paid in later years.”

This IRS discussion seems to be in agreement with nelsona's comment but slightly different than ND's. Am I correct in thinking that taxpayers filing form 1116 are allowed to make a one-time switch from paid to accrued but a switch from accrued to paid is never allowed?
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