The Internal Revenue Service has issued a set of tips to help with foreign tax credit compliance.
In an email to tax professionals Tuesday, the IRS pointed out that the foreign tax credit laws are complex and provided summaries of some of the more complex areas of the law along with links to Web pages on IRS.gov containing additional resources.
Foreign Sourced Qualified Dividends and Gains
If a taxpayer receives foreign sourced qualified dividends and/or capital gains (including long-term capital gains, unrecaptured Section 1250 gain, and/or Section 1231 gains) that are taxed in the U.S. at a reduced tax rate, the taxpayer must adjust the foreign source income that is reported on Form 1116, line 1a. Otherwise, the allowable foreign tax credit may be significantly overstated which can trigger a substantial underpayment penalty.
Interest expense must be apportioned between U.S. and foreign source income using an asset method. See Publication 514 for more information on the asset methods.
Other Compliance Issues
• Charitable contributions are not apportioned against foreign source income.
• The amount of foreign tax that qualifies is not necessarily the amount of tax withheld by the foreign country. If a taxpayer is entitled to a reduced rate of foreign tax based on an income tax treaty between the U.S. and a foreign country, only that reduced tax qualifies for the credit.
• If a foreign tax redetermination occurs, a redetermination of U.S. tax liability is required in most situations. The taxpayer must file a Form 1040X or Form 1120X. Failure to notify the IRS of a foreign tax redetermination can result in a failure to notify penalty.
For more details about these topics, visit the Foreign Tax Credit Compliance Tips page on IRS.gov. Also see the Foreign Tax Credit page, What Foreign Taxes Qualify for the Foreign Tax Credit?, Foreign Tax Credit - How to Figure the Credit, Foreign Tax Credit - Special Issues, and Foreign Tax Credit - Choosing to Take Credit or Deduction.