Calculating Canadian Dividend Tax Credit for Tax Paid on Form 1116

[AvalonJeff]

Taxpayer is US/CDN duel national, resident in Canada, trying to calculate the Canadian tax paid on Dividend income for use with FTC on U.S. Form 1116. Taxpayer files MFS with NRA spouse who does not file in the U.S. Taxpayer splits his pension income with spouse on Canadian return. This causes the taxpayer's average tax rate to get quite low.

The issue is that when the average tax rate of a Canadian return gets low enough, the Canadian Dividend Tax Credit becomes greater than the product of the average tax rate times the grossed-up dividend. The taxes paid on that dividend becomes a negative number. Or perhaps I'm doing this calculation incorrectly? If not, what number does the taxpayer enter into his U.S. return as the foreign taxes paid on his dividend income? Incidentally, this dividend is the only passive income to be reported to the IRS. The taxpayer has no interest income nor capital gains.

Example:
Actual Canadian Qualified Dividends $10,000
Gross-up % = 38%
Grossed-up dividend amount: $13,800
Federal Tax Credit Gross-up % = 15.0198%
Federal Tax Credit amount = $2,072.73
Provincial Tax Credit Gross-up % = 6.5%
Provincial Tax Credit amount = $745.20
Total Dividend Tax Credit amount = $2,817.93
Avg tax rate for this return = 20%
Avg Tax Rate multiplied by Grossed-up Dividend = $2,760.00
Tax Credit exceeds the tax by $57.93

[pokka]

I think what matters here is the *marginal* tax rate for the return, not the *average* tax rate - that is the amount of extra tax that you are paying for this dividend. Maybe the marginal tax rate is more than the 21.5% credit you are getting?

[nelsona]

In calculating foreign tax with regard to foreign tax credits, generally the marginal rate that matters, it is always the effective rate.

In the case of dividends, if the credit reduces the Cdn tax to zero ON DIVIDENDS, then the foreign tax reported on 1116 would be zero. It also reduces the effective tax rate on regular income.

Don't forget, on the US side that some or all of his dividends may be qualified dividends, taxed at a lower rate, probably zero. Many Cdn stock dividends are considered qualified (if, for example, they also trade on US markets).