How to apply FTC in Canada and US

[lbeauvil]

I found several posts where nelsona stipulate "In either country, you perform the foreign tax credit calculation BEFORE applying the foreign tax credit (FTC)"

I thought I knew what this means but I'm still confused about the execution because this could mean deducting a tax on CAN return that I did not really pay to the US and vice versa.

Here is the scenario.
I do 1040 and T1 without FTC.  I owe taxes in both countries before deducting FTC and this tax is due to income from both countries.

If before FTC on 1040 (before form 1116) I owe US taxes with a portion from US income (401k), can I deduct this tax from CAN return even if after applying FTC using form 1116 I owe no more tax (or a lot less)?

For example, Assume I owe $200 US tax before applying the FTC (form 1116) and $150 of it is due to US income (401k).
After I deduct the FTC on CAN income on the US report (form 1116) I owe only $10 due to US income 401k.  Do I apply FTC to the amount of $150 or $10 on CAN report (using T2209)?

Do I need to do FTC in either country first based on residency to avoid circular motion?

Thanks

[nelsona]

You do the FTC once for each country, based on the returns you prepare without taking any FTC. Order does not matter.

[lbeauvil]

I apologize for going in circle but this has been bogging me for some times and I want to make sure. In my previous example I would claim $150 deduction on my CAN return even though I owe only $10 on my US tax when filling it?

[nelsona]

Well, in your example, you would not take any credit for the Cdn tax on your 401(k) on your US return, because it is US-sourced income. You would only file a 1116 for any Cdn income you reported on your 1040. You would get credit on your Cdn return for the 401(k) tax you pay in US, which wouldnt change in any of these calcualtions.

[lbeauvil]

Sorry if I was not clear and thanks for trying to explain it to me. Let me try again.

By the way, there are other incomes at play from US and Cdn source but I talk only about 401k with fictif numbers as an example and use only the prorated 401k tax portion.

The 401k is taxed in the US and Canada even if US sourced income. I do both taxes without FTC. Then I want to deduct from my Cdn tax the portion of US tax attributed to the 401k.

The issue I get into is because my Cdn source income is much bigger than my US source income, once I do FTC on the US tax, I owe almost no more US tax but before FTC I do.

On US tax I owe $150 before FTC (This is the portion of taxes allocated to 401k)
Then I take FTC on Cdn return. I can deduct on my Cdn return the tax paid to the US for the 401k portion, in this example $150.
Then I take FTC on US return for my other Cdn income. After applying FTC to US tax for Cdn income, my total tax liability is very low and the portion for the 401k is almost $0.

Is it still ok to deduct from the Cdn return $150 credit?

[nelsona]

As I sad now several times, your FTC is determined BEFORE applying FTC on any return.

[lbeauvil]

Thanks Nelsona, I think I understand why you say "You would only file a 1116 for any Cdn income you reported on your 1040. You would get credit on your Cdn return for the 401(k) tax you pay in US, which wouldnt change in any of these calcualtions."

1040 line 16 (Tax) is the same before and after FTC. So I guess I use line 16 and prorate it to the Cnd income to use as FTC on Cdn report.

It is still boggling to me that I end up deducting on my Cdn report taxes that I don't actually pay to the US because the 1040 FTC brings my tax to $0. But I'll take the gift.

Thanks

[nelsona]

The point of FTCs IS to reduce tax in one country on income from the other country.

So your results shou;d not be surprising.

[nelsona]

Do realize however, that if done properly foreign tax credits will not reduce the tax on the "home-sourced" income. So if you determine on the first pass that the tax on your 1040 due to US-sourced income is X, and the US tax on Cdn-sourced income is Y,, for a total of X+Y, foreign tax credits will only, at best, eliminate Y, never X.

Software will handle this correctly.

[lbeauvil]

I think I get it now but to make it extra clear and put the nail in the coffin on this one, let's look at this very simple example. There is plenty of Cdn tax on the interest to bring the US tax to $0 when using FTC. In this case I would use $147.60 as Cdn credit for the 401k income.

US tax 1040
--------------
Cdn earned income: $31,000 (FEIE excluded and not included in the total income. Not sure on this one?)

Income not excluded ( % from total not excluded)
Cdn Interest: $16,000 (54%)
Net rental: $1,500 ( 5%)
US Income from 401k: $12,000 (41%)
=======
Total income: $29,500 (excluded income not included - not sure this is correct?)

US Tax before FTC: $360 line 24
US Tax after FTC: $0 line 24

FTC for 401k income on Cdn tax = $360 * 0.41 = $147.60

Or should I include the excluded income of $31k in the total and % which would give 20% for 401k.
In this case FTC for 401k income on Cdn tax = $384 * 0.20 = $71.40

Could you please confirm that this is the correct understanding and if income excluded from FEIE should be included or not for the % to use for 401k credit.

Thanks for baring with me on this. This will benefit to a lot of people as well.

[nelsona]

I think the principles I've outlined, and the software you use, will get you the right solution.