Claiming FTCs for taxes paid on US dividends. Is this correct?

[skierbob]

I'm a dual citizen living in Canada. This year I claiming FTCs for the first time. (I've always used FEIE in the past, as my income is always below the FEIE threshold. It was easier than using FTCs. But I now have a young child, and I'd like to claim the child tax credit.)

I want to ensure I'm correctly applying Canadian FTCs to my US dividend income. I'd appreciate some feedback to make sure I'm understanding this correctly.

As I understand, the process is to first determine the amount of US taxes allocated to my US dividends.

If the US tax determined above is less than 15%:
- On the Canadian return, claim the full amount as foreign tax credit.
- On the US return, do not file a Form 1116 for re-sourced income, and pay that tax to the IRS.

If the US tax determined above is more than 15%:
- On the Canadian return, claim a foreign tax credit for the first 15% of US taxes paid on the dividends.
- Determine how much Canadian tax will be paid that is allocated to the dividends and is in excess of that 15%.
- On the US return, on a Form 1116 for "re-sourced" income, include only enough of the US dividend income on line 1a so that the tax credit is equal to the amount of US tax that would be owed that is in excess of 15%.

This seems weird to me, as I'd be claiming tax credits on my Canadian return before I actually pay anything to the US. Is that the right way to do it? It seems rather overly complicated. It would be much simpler if I could just pay the full tax to Canada, then claim a foreign tax credit for the amount owed to the US. But after some looking around, that seems like not the correct way to do it.

To help me understand it, I've worked out some examples. Can someone please confirm that these examples are correct? I'll put the examples in replies below.

I've already filed my Canadian tax return for 2023 without claiming any credit, and only figured out this stuff now as I'm completing my US return. I will have to amend my CRA return to claim a credit for the US taxes I will pay.

[skierbob]

Example 1: Effective US tax rate is less than 15%.

Suppose my income in a year is $99,000 USD in Canadian-sourced wage income, and $1,000 USD in dividends from US sources.

Suppose the total taxes owed (before FTCs) are:
- to US is $14,000.
- to Canada is $25,000.

Allocate US taxes (the calculations here are the same as the "maximum amount of credit" that would be completed in Part III of form 1116 for the different categories):
- US taxes allocated to general category income: (99,000/100,000)*14,000 = $13,860.
- US taxes allocated to US dividends: (1,000/100,000)*14,000 = $140.

On the Canadian return, claim a foreign tax credit of $140, pay a total of $24,860 in taxes to the CRA.

Allocate Canadian taxes paid to general category income: (99,000/100,000)*25,000 = $24,750.

On the US return,
- On form 1116 for "general category" income, claim a tax credit of the lesser of $13,860 (amount of US tax allocated to general category) and $24,750 (amount of Canadian taxes adjusted to general category). Carry forward the remaining tax credits.
- Pay a total of $140 in taxes to the IRS.

At the end of the day, $140 is paid in tax to the IRS, and $24,860 paid to the CRA. Total taxes paid is $25,000.

[skierbob]

(Oops, I accidentally posted my first example twice, and I can't figure out how to edit/delete a post. Ignore the repeat.)

Example 2: Effective US tax rate is more than 15%.

Suppose that the situation is exactly the same as above, except that the total US tax liability is $16,000.

The total US tax on the US dividends is more than 15%, so a maximum of $150 is claimed on the Canadian return for foreign taxes.

On the Canadian return, claim a foreign tax credit of $150, pay a total of $24,850 in taxes to the CRA.

Canadian taxes allocated to general category income is the same as above: (100,000/101,000)*25,000 = $24,750.

On the US return, on form 1116 for "general category" income, the amount of US tax allocated to the general category is (100,000/101,000)*16,000 = $15,840. This is less than the Canadian taxes allocated to this income, so I claim a credit of $15,840 and carry forward the rest.

The remaining US tax liability is $160. A credit of $150 was claimed on the Canadian return, so a credit of $10 can be claimed on the US return. This is done as follows:
- On form 1116 for "re-sourced income", include "just enough" of the US dividend income on line 1a so that the amount of US tax allocated to this income is exactly $10.
- In this example, this amount is $63. So $63 is included on line 1a for the Form 1116 for re-sourced income. The amount of US tax allocated to this income is $10.
- Canadian taxes paid that are allocated to all US dividend income is (1,000/100,000)*25,000 - 150 = 250 - 150 = $100. Here, the minus $150 is due to the foreign tax credit already claimed.
- Claim a credit of $10. The remaining $90 is carried over.

In the end, the IRS is paid $150 on the return after all tax credits have been claimed, and 24,850 paid to the CRA. Total taxes paid is $25,000.

[nelsona]

Looks right but don't forget that most US dividends -- even many from Cdn firms -- are 'qualified" in US, so you pay a lower rate than on ordinary income.

So it is unlikely that once you combine all your US dividends income, that you will reach the 15% tax rate on those dividends.

[skierbob]

Thanks for the response. I was already assuming that the dividends would be qualified.

In the example, $99,000 USD of wage income would have a total tax of $14,041, while the $1,000 of dividends (if qualified) would be taxed at 15% for a total tax of $150. Total tax on all income is $14,191, for an effective tax rate of 14.2%.

But if the wage income had instead been $125,000 USD (with net ordinary income tax at $20,076), the $1,000 of dividends still add $150 of qualified dividend tax. The net tax on all income would be $20,226, for an effective tax rate of 20,226/126,000 = 16.1%. So in this case the US tax allocated to the dividends is more than the 15%.

[nelsona]

Because dividends are taxed differently than ordinary income, you don;t lump it in with your other income. You would use the flat taxrate in your FTC. So as long as you are in the 15% dividend taxrate, you your 15% on your Cdn tax return for FTC.

[skierbob]

I'm not so sure about your conclusion.

If my average US tax rate is less than 15%, this would lead to me claiming a larger tax credit on my Canadian taxes than I actually pay to the US.

Using my example:
- $99,000 USD general category Canadian wage income
- $1,000 USD US-sourced dividends

At this income level, my qualified dividends are taxed at 15%.

Using your logic, suppose I claim a tax credit of $150 on my Canadian return.

Now I fill my IRS return. Before computing foreign tax credits, I have $14,191 in taxes to the IRS on line 16 of 1040.

Using Form 1116 for general category, if I follow the instructions precisely, I would compute a foreign tax credit of $14,049 (= 99,000/100,000 * 14,191) that I apply to this category.

Then I would pay only $142 (= 14,191 - 14,049) to the IRS. Even though I claimed $150 on my Canadian return.

[skierbob]

Sorry for being rather academic about this, but it actually reflects my current situation. My effective US tax rate is less than 15%, even though I have qualified US dividends that are taxed at 15%.

What I would *rather* do on my US return this year (because I already filed my Canadian taxes this year without claiming any FTCs) is to simply re-source *all* of my US dividend income so that I can claim a tax credit of ~$140 for Canadian taxes paid on the US dividend income.

It's such a miniscule amount... I think I will go ahead and do just that. And if the IRS wants to go after me for $140 in taxes I'll let them do that. I'm just annoyed that the process for doing it "correctly" is so complicated.

[nelsona]

No, you can't "choose". The US tax on your dividend income is 15%, according to your example. It can only be claimed on your Cdn tax return. When using software, it allows you to claim the amount specific to each bundle of US income. It will limit the tax to 15%. I trust you are using software on bith sides to do this.

The only US dividend related FTC you claim in US is if, due to higher dividend bracket, or due to having some ordinary "un-qualified" dividends that bumped up the tax on dividends above 15%; then you would claim the overage on your re-sourced by treaty 1116. You would still claim only 15% in canada as a credit.

the example you show is fine. EXCEPT that when you calculate line 16 tax, and you have dividend tax, then the software should be using a chart which splits the "table" tax on ordinary income vs. dividend tax. So, don't worry about that your calculation doesn't add up. See page 37 of the 1040 Instruction manual.

I'm going to leave it at that. June 14th seems to be driving this more that necessary.

[skierbob]

I've already applied for the October extension, so the June 15 deadline is not important for me. I just happen to be looking at my US taxes this week. Maybe I'll wait until a time when deadlines for others are less pressing to continue.

I appreciate your feedback, but I still disagree with your conclusion. Your suggestion contradicts the instructions for Form 1116 on how the taxes are allocated to different categories. Yes, I understand that page 37 of instructions for 1040 indicate how to compute tax on long term capital gains and qualified dividends. But that amount is added into line 16 on the 1040. The instructions for Form 1116 direct you to allocate the taxes on line 1116 in a specific way. There's nothing that discusses "splitting" the tax as you have described.

I usually use OLT.com. The software requires me to specify, for each category, how much income to include on line 1a for that category, and how much foreign tax to allocate to that category. It then automatically computes the foreign tax credit for that category by allocating the US tax (from line 16 of 1040) to the different categories by determining what fraction of the total income that that category represents.

I think what I've learned here is that I just need to go pay for some advice. I'll report back in this thread what I end up learning after consulting with a professional.

Thanks for the discussion.

[nelsona]

So the software has a discrepancy (most do); I wouldn't stress over it. You will pay much more than you need to just to determine 0.5% difference on your tax bill in US.

As long as you end up paying only 15% dividend tax in US, and nothing more, you will be fine.

[nelsona]

,.. and while you can file in October, you need to pay any tax April 15 when you file the extension.

[skierbob]

[quote=nelsona post_id=530679 time=1718455259 user_id=30]
,.. and while you can file in October, you need to pay any tax April 15 when you file the extension.
[/quote]

True, but I'm getting a refund due to the refundable child tax credit, so I'll have no late penalties.

I've already scheduled a consultation with a local cross-border accountant to walk me through it. I want to make sure I'm doing it right this time so I can do it myself in the future.

[nelsona]

Seems to me you have all the info you need. Since you are only filing one 1116 (general limitation for you wages), you don;t have to worry about dividends.
Don't forget that the child credit reduces the US tax for any Cdn FTC credit.

[sk8man]

Claiming Foreign Tax Credits for US dividends on your Canadian return, even if you haven't paid US taxes yet, is standard practice to avoid double taxation. Amending your Canadian return makes sense now that you're sorting out the details.