Noh Review Taxation: Foreign Tax Credit

Today, we will briefly go over the concept of foreign tax credits.

If you paid taxes in a foreign country, you may be eligible to claim the Foreign Tax Credit. The purpose is to eliminate the double taxation of the same income by both the US and Canada. It alleviates the US taxpayer of taxes owed in the US when taxes are required on that same income in Canada. This means that the taxes payable on your US tax return will be lowered. You do not have to necessarily live or work in that foreign country in order to claim this benefit. For example, you can claim this credit if you paid foreign taxes from a mutual fund. The Foreign Tax Credit reduces your US tax liability on a dollar-for-dollar basis.

Maximum Allowable Foreign Tax Credit:

Your foreign tax credit cannot go over a certain amount, which is your US tax liability mutlipled by the percentage of your total foreign-source income divided by your total world income. Any foreign tax credit amount in excess may be carried back or carried forward.

Real Life Example: You are a U.S resident/taxpayer who has exited Canada. You have $10,000 in a Canadian Mutual Fund which pays a 5% dividend ($500 at the exchange rate of CAD $1 = USD $0.75)

Canadian Tax Implications:

• The withholding on dividends is 15%. Hence, CAD $500 * 0.15 = CAD $75 must be remitted to CRA.

U.S. Tax Implications:

• Dividend Income on US return = CAD 500 * 0.75 exchange rate = USD $375
• 25% tax bracket for non-qualified dividends = USD $375 * 0.25 = USD $93.75 tax liability
• Passive foreign tax credits on US return = CAD $75 * 0.75 exchange rate = USD $56.25.
• Use U$56.25 in foreign tax credits to offset USD $93.75 in tax = USD $37.50 Tax Liability