Question

Explain the alternatives available to individual taxpayers in accounting for foreign taxes paid or accrued on their taxable income.

A. A taxpayer who uses the accrual method of accounting claims the foreign tax credit in the year in which the tax is? paid, no exceptions. A taxpayer who uses the cash method of accounting claims the foreign tax credit in the year in which the tax? occurs, no exceptions.

B. The U.S. Government taxes foreign source income but allows a credit for foreign income taxes paid or accrued that can exceed the amount of U.S. taxes owed on all? foreign-source income. The credit system requires that a taxpayer report the? income, file a tax?return, and apply the total credit to reduce his or her U.S. tax liability.

C. An annual election is available to individual? taxpayers, allowing them to deduct or credit any foreign income taxes that have been?paid, no exceptions. The credit system requires that a taxpayer report the? income, file a tax? return, and apply the credit to reduce his or her U.S. tax liability.

D. An annual election is available to individual? taxpayers, allowing them to deduct or credit any foreign income taxes that have been paid or accrued. Simplified reporting rules apply to taxpayers with small foreign tax credit amounts from passive income sources.?However, almost all taxpayers elect to claim the foreign tax credit.

Answer 1

A. A taxpayer who uses the accrual method of accounting can claim the foreign tax credit in the year in which taxes are accrued. In accrual method of accounting expenses can be deducted, when they are incurred rather than when they are paid.

A taxpayer who uses the cash method of accounting can claim the foreign tax credit in the year in which the tax is paid or in the year the tax is accrued. The choice can be made to take the credit of either when it is paid or when it is accrued.

B. A taxpayer can apply the foreign tax credit to reduce his or her US tax liability, but only upto foreign tax credit limit.

Foreign tax credit limit = Foreign tax credit x Foreign source income/total taxable income(US income and foreign source income)

If the foreign tax credit is more than foreign tax credit limit, than the taxpayer can either carryback the credit available to the previous tax year or can carryforwar it to the next 10 years.

C. The credit system requires that the taxpayer report the foreign source income, the taxpayer must complete the Form 1116, Foreign tax credit, attach it to Form 1040, federal tax return to allow him to take credit of foreign taxes paid that have been paid.

To take the deduction of foreign taxes paid, the taxpayer must use Schedule A, form 1040, itemized deduction.

D. If the taxpayer has foreign tax credit from passive income source, then the taxpayer can claim the credit even without filling Form 1116 and can take full credit without any foreign tax credit limit.