Sourcing and FTC Questions for first timer

Canadian Newbie · Post by **Canadian Newbie** » Thu Mar 12, 2015 12:20 pm

Great forum. I am excited I found it.
I am a US Citizen and hold a PR Card in Canada. I figured I would be daring and prepare my US 1040 and T1.
I became a resident in Sept 2014.

I have US interest income and some Canadian interest income earned after I became a PR. My wife has some earnings from employment in Canada.

After reading the treaty and other publications it looks like I prepare as follows:

1040 will report all interest from Canadian and US sources for entire year and the wages earned in Canada.

The T1 will report interest income from US and Canadian earned from the time I landed in Canada and the earning from Canadian employment.

Here is where I get confused but I will give it a shot.....

The T1 will report no FTC since the interest income from both US and Canadian banks (earned since landing) is sourced and taxed based on residency and Canada gets the tax. Same with the employment income.

The US 1040 will report a FTC on the wages and the US and Canadian interest income reported on the T1 on Form 1116. I understand the exchange rate conversion and the FTC baskets.

From other posts, it appeared that the correct answer is that the 1040 would show a FTC on the wages and only the Canadian interest income that is on both the 1040 and T1 but I am not sure.

Thanks for any help in advance.

nelsona · Post by **nelsona** » Thu Mar 12, 2015 1:24 pm

"The T1 will report no FTC since the interest income from both US and Canadian banks (earned since landing) is sourced and taxed based on residency and Canada gets the tax. Same with the employment income."

Not quite. the Cdn wages and the Cdn bank intersts are cdn-sourced. But the US bank interst is indeed US-sorced. The reaon canada will not give you any credit, is that a non-US citizen living outside US would not be subject to US tax on bank interest, and Canada has a treaty clause that allows them to deny any tax credit for tax paid sopleyl because you are a US citizen. So no tax credit on your Cdn retunr for any US tax paid on US bank interest.

"The US 1040 will report a FTC on the wages and the US and Canadian interest income reported on the T1 on Form 1116. I understand the exchange rate conversion and the FTC baskets."

Again, not quite. IRS will grant you FTC on the Cdn tax on wages (general limit) and Cdn bank interest (passive). For the FTC on US bank interst, you will need to use the "re-sourced by treaty" clause, to decrease the US bank interest to zero. that is assuming you have any US income tax at all. The re-sourcing of the US interset soes not mean the interest is US-sourced, it is re-sourced only for the purposes of FTC. because canada refused to accept the US tax.

All this pre-supposes that you will have any US tax to pay at all.

May I ask why you would use 1116 for your Cdn wages, rather than 2555, exmpting it from US tax altogether. Either way should yield no tax (assuming you had no other US income pre-move). In future years, you will likely use 2555, so it may be best satrt now.

Canadian Newbie · Post by **Canadian Newbie** » Thu Mar 12, 2015 5:55 pm

Thank you very much. I was correct in that there is no FTC on the T1 for the US tax paid on Canadian and US interest income but I was wrong regarding the legal reason why as you have pointed out.

I just need to figure out how the "resourced by treaty" part of the US FTC works.

For the sake of discussion lets say there is 20K of Canadian interest and 30K of US interest earned by a US Citizen/Cdn PR and a rate of 15% for both Cdn and US rates and no effect of exchange rates.

The US FTC on the Cdn source interest would be 3K.

When you say that the US interest is resourced under the treaty, does this change how the US FTC is calculated?
Would it not simply be a FTC of 4,500?

Or do you reduce the amount of interest income reported based on a treaty position?

I don't understand the mechanics how to reduce the US tax to zero on the tax paid on US sourced interest income.
Is it by deduction, exemption or FTC?

Once again, thanks for your response.

nelsona · Post by **nelsona** » Fri Mar 13, 2015 12:17 am

There is a form in the ftc/1116 guide from IRS, and software will take care of it.

because interst is zero taxed for Cdn residents, by IRS regs, you will simply re-source ALL of the US interest gained after residency in Canada.

You need to realize however that FTC rarely gives back all tax, especially if you also have other US-sourced that is taxable.

IN the other case you have, the IRA money, you will re-source only enough to reduce your US tax to 15%. Since it unlikely that that will be your effective tax rate (marginal doesn't matter), you won; be re-sourcing.

Canadian Newbie · Post by **Canadian Newbie** » Sat Mar 14, 2015 11:45 am

Thanks for the response Nelsona.
I am just starting to get familiar with the treaty and how it works.

I am surprised that the answer is I am taxed at a top rate of 15% on the US return on the IRA distribution.
I thought the saving clause would apply and the usual rates would apply. As you said, I probably will not get above 15% as it is but I was not sure if the rate could be higher.

Just to be sure- I assume that on the T1 I could be taxed above %15 if my income was high enough. However, I get the FTC on the T1 for the US tax up to 15%.
However, it could be possible to be taxed at a higher rate on the T1. Is this correct?

This treaty effect seems to fly in the face of logic to me......I would have thought since I got deductions from my federal US income all these years-sometimes with benefits above %15-that the US would want the income to be taxed at whatever rate applies normally. But, that apparently is not the case. In this case, Canada could get more tax on the distribution than the US.

nelsona · Post by **nelsona** » Sat Mar 14, 2015 2:46 pm

You will only use the special resourcing of pension income if BOTH your Cdn and US tax rate is over 15%. Otherwise Canada will give you credit for your US tax (since it will be less than 15%), and there is no issue.

We are talking US pensions here. Wages have no limit, and nor do Cdn pensions. And di you really have a US taxrate of more than 15% while living in Canada?

Canadian Newbie · Post by **Canadian Newbie** » Sat Mar 14, 2015 3:12 pm

Thanks again.

Yes, my marginal rate on the US return may get to the 25% bracket for 2015. I may decide to take a large lump sum distribution from my IRA if the exchange rate gets to 1.3-1.4. I will pay the tax and them move the money into a Canadian bank account.

I will not think of doing this if the tax is too high. I am over 59 and 1/2 and will not be subject to any early withdrawal penalties in the US.

nelsona · Post by **nelsona** » Sat Mar 14, 2015 6:20 pm

Its not the marginal rate that matters in any foreign tax credit scenario, either in US or Canada. It is ALWAYS based on effective tax rate. So that is what you would look at. depending on your marital status and your deductions, you don't hit 15% effective rate until in the mid-100's.

And, of course, if you are excluding Cdn wages with 2555, this is done before determining your taxrate.