© Kristina Shroyer 2011 VITA: Winter 2011 Lesson 25: Foreign Tax Credit Winter 2011 Kristina Shroyer

© Kristina Shroyer 2011 Introduction to Credits Income from all sources – Exempt income/Exclusions = GROSS INCOME – Deductions for AGI AGI Deductions from AGI (Greater of Itemized or Standard Deduction) – Personal and Dependency Deductions = TAXABLE INCOME * Tax Rate (tax rate schedule, or tax tables) TAX LIABILITY - NON REFUNDABLE TAX CREDITS + Additional Taxes - Tax Payments/Refundable Credits = FINAL TAX DUE/REFUND This is the formula the Form 1040 Follows and that we've been going over piece by piece in class *This chapter is the first of the tax credits we're going to cover *It's a good idea to keep the big picture in mind as we go over things in class

© Kristina Shroyer 2011 Introduction to Credits Deductions vs. Credits What is the difference between a deduction (standard or itemized) and a credit?  Deductions reduce taxable income  Credits reduce tax liability - Credits may be refundable or non-refundable In general (don't over think it), how much does $1000 tax deduction save a taxpayer: in the 28% tax bracket? in the 15% tax bracket? How much does $1000 tax credit save a taxpayer that otherwise owes $2000 of tax: in the 28% tax bracket? in the 15% tax bracket? IMPORTANT: In many cases, there are two ways to account for foreign taxes paid on a taxpayer's return, either on Schedule A as an itemized deduction or as a credit (the one we're going to talk about now), in most cases which is better for the taxpayer?

© Kristina Shroyer 2011 Introduction to Credits There are two types of tax credits Refundable Credits and Non Refundable Credits Non Refundable Credits The foreign tax credit which we're going to discuss in this chapter is a non refundable credit A non refundable credit is a a dollar for dollar reduction of a taxpayer's tax liability but it CANNOT reduce a taxpayer's tax liability below zero (so they cannot generate a refund) ♦ So a non-refundable credit cannot reduce a taxpayer's tax liability below zero Non refundable credits are general applied against federal tax in the order they are listed in in the tax and credits section on page two of the Form 1040 ♦ Lines Refundable tax credits can result in a refund for the taxpayer in excess of tax paid in So a refundable tax credit can reduce a taxpayer’s income liability below zero You'll talk about refundable tax credits in some other chapters coming up later today Make sure you know which type of credit you are dealing with

© Kristina Shroyer 2011 Lesson 25: Foreign Tax Credit Introduction to the Foreign Tax Credit This credit goes on line 47 of Form 1040 This credit applies to taxpayers who have paid or accrued foreign taxes to a foreign country on foreign sourced income and are subject to US taxes on that income US Citizens and resident aliens are required to pay tax on WORLDWIDE income Sometimes this results in them having to potentially pay tax twice on that income (once in the United States and again the foreign country) The purpose of the credit is to avoid this double taxation Our VITA scope for this topic is very limited unless you go off on our own and get the International Certificate So these slides don't go through the whole chapter just over the one situation applicable to the Intermediate/Advanced Certificates I'll explain when you can do this credit and when it is in scope for those with Intermediate and advanced certificates

© Kristina Shroyer 2011 Lesson 25: Foreign Tax Credit To calculate a the foreign tax credit for a taxpayer for many situations a Form 1116 is required to compute and calculate that credit The type of foreign tax credit you'll learn about that is in the VITA scope does not require a Form 1116 ♦ the credit just requires a special election be made and then the credit will go directly to line 47 of Form 1040 VITA Scope for Intermediate and Advanced: If the foreign tax is reported on a Form 1099-INT and a 1099-DIV (line 6) a Form 1116 may not need to be completed to claim the foreign tax credit (instead an election will be made not to file Form 1116) – we'll go over specific rules on the next slide This is the situation in which you will deal with the foreign tax credit ♦ The taxpayer will NOT need to File a form 1116  Instead they can make an election not to file the form and report the credit directly on line 47 ♦ The credit will be reported on line 47 of the Form 1040 In your book the part of Lesson 25 within the scope of VITA is only pages 25-1 and 25-2 NOTE: A taxpayer living and working outside of the US will need to file a Form 1116 so they are out of scope unless you have an International Certification (ask around the site before you send the taxpayer to a professional, another student may have the required certification)

© Kristina Shroyer 2011 Lesson 25: Foreign Tax Credit Foreign Taxes Reported on Form 1099-INT or Form 1099-DIV Taxpayers who receive a Form 1099-INT or a Form 1099-DIV may have amounts reported in Box 6 (let's take a look at the form – this is VERY COMMON) ♦ This means foreign taxes have been paid on their behalf by the issuer of the 1099-INT and 1099-DIV ♦ Let's look at a 1099-INT and 1099-DIV Box 6 When the taxpayer does not need to file a Form 1116 to get the Foreign Tax Credit The taxpayers does not need to file a Form 1116 if both of the following are true: 1. The only foreign taxes paid the taxpayer has are reported on Form 1099-DIV or Form 1099-INT (They can have multiple 1099-INTs and 1099-DIVs with amounts in Box 6) AND 2. The total amounts from all of these documents is not more than $300 (or $600 if the taxpayer's filing status is Married Filing Joint)

© Kristina Shroyer 2011 Lesson 25: Foreign Tax Credit If the taxpayer is not required to File a Form 1116 for their Foreign Tax Credit it is reported on Line 47 of Form 1040 and they will make a special election for this In Taxwise this special election is at the top of the Form 1116 worksheet (you'll need to know this when you take the intermediate exam, make a note) Any taxpayer with foreign taxes NOT eligible for the above (meaning the Form 1116 needs filed) should be referred to a professional tax preparer OR a Vita Volunteer with an International Certification Don't forget Foreign taxes can be claimed as a Credit or on the Schedule A as a deduction In this case the Credit is usually better but you should still make sure you give the taxpayer the better of the two options IMPORTANT: The credit is usually better, don't do a disservice to your client by putting the foreign taxes on the schedule A when they should be used as a credit How to use Taxwise to report the Foreign Credit Look in your Volunteer Resource Guide and Go to Tab 5 (Taxwise Non-Refundable Credits) – it's a YELLOW TAB Look at page 5-4 – notice that even though you are not filing the Form 1116, Taxwise has the election on Form 1116 All you do is in that top portion put the amount of qualified foreign tax paid on the line the arrow is pointing to ($300 or less for not married filing joint, $600 or less for married filing joint) ♦ Taxwise will do the rest for you Look at Exercises 1-3 on page 25-2