Cross-Jurisdictional Quiz 2 (Ch. 3-4)

Charlotte, Inc., a domestic corporation with operations in England, has total taxable income for the tax year of $120,000, consisting of $100,000 US-source income and $20,000 from England. Taxes paid to England totaled $9,500. Charlotte's US tax before FTC is $42,000. What is Charlotte's US tax?

$42,000 * ($20,000/$120,000) = $7,000 Credit is lesser of $7,000 and $9,500, so US tax will be: $42,000 - $7,000 = *$35,000*

Red Sox, Inc., a domestic corporation, receives a $5,000 dividend from Boston, Ltd., a foreign corporation. The foreign country imposes a 20% withholding tax on dividend payments to nonresidents. Boston, Ltd. withholds $1,000 from the dividend and remits the tax to the local country tax authorities. Boston pays the remaining $4,000 to Red Sox. How much dividend income does Red Sox report? How much foreign tax credit (before limitation) does Red Sox receive?

$5000 dividend paid, only received $4,000 cash and has $1,000 withholding. Reports the $4000 + $1000 = *$5,000* Foreign tax credit: *$4,000*

The foreign tax credit equals the lesser of

1) creditable taxes paid or accrued to all foreign countries or US possessions OR 2) the foreign tax credit limitation

The foreign tax credit is available only if a tax...

1) was paid to a foreign country and 2) the predominant character of the tax is that of an income tax in the US sense.* *a tax that does not meet the second requirement may be creditable as a Sec. 903 "in lieu of" tax

Sam Smith is a citizen and bona fide resident of Great Britain (United Kingdom). During the current year, Sam received the following income: 1. compensation of $30 million from performing concerts in the US. 2. Cash dividends of $10,000 from a French corporation stock. 3. Interest of $6,000 on a U.S. corporation bond. 4. Interest of $2,000 on a loan made to a U.S. citizen residing in Australia. 5. Gain of $80,000 on the sale of stock in a U.S. corporation. Determine the source (U.S. or foreign) of each item of income Sam received.

1. U.S. source - based on where the event took place 2. Foreign source - based on residence of the payer 3. U.S. source - based on residence of the payer 4. Foreign source - based on residence of the payer 5. Foreign source - based on residence of the seller

Same as previous, but Ronco has 30% of its gross income from foreign sources. How is the R&E allocated using the gross income method?

25% to US = 25M remainder: 30% to foreign (22.5M) and 70% to US (52.5M) US: $77.5M foreign: $22.5M FINAL STEP: Is foreign remainder greater than 50% of foreign remainder under sales method? 50% x 30M = 15M < 22.5M so yes

Describe the gross income method.

25% to location in which more than 50% of R&E is incurred remaining: allocated based on gross income (US vs foreign) what we allocate here for foreign must be at least 50% of foreign sales method remainder

What is the required holding period for stock?

366 days. (Must own at least 10% of voting stock in the foreign corporation for 366 days).

Describe the sales method.

50% of R&E to location where more than 50% of R&E is incurred remaining: allocate according to source of sales (US vs foreign)

Ronco, a US manufacturer, derives 60% of its sales revenue from foreign sources. Ronco incurs $100 million of research and experimentation expenses in the US, none of which is legally mandated. How is the R&E allocated?

50% to US = $50M remainder: 60% to foreign (30M) and 40% to US (20M) US: $70M foreign: $30M

Distinguish between a definitely related deduction and a not definitely related deduction in the allocation and apportionment of deductions to foreign source taxable income.

A definitely related deduction is a deduction that can be directly associated with a particular item of income (for example, machine depreciation with manufacturing gross profit). A deduction not directly associated with a particular item of gross income (for example, medical expenses) is referred to as a not definitely related deduction.

Source of deduction rules

A taxpayer may be required to allocate or apportion allowable deductions to gross income once they have determined the source of their gross income

How do accrual-basis and cash-basis taxpayers translate their foreign payments?

Accrual: Use an average annual exchange rate for the year over which the tax accrues Cash: translate using the exchange rate on the day the tax is paid

How do accrual-basis taxpayers claim the FTC? Cash-basis taxpayers?

Accrual: take the credit in the year in which it accrues Cash: take credit in the year the tax was paid

Distinguish between allocation and apportionment in sourcing deductions in computing the foreign tax credit limitation.

Allocation is the qualitative process of associating a deduction with a specific item or items of gross income for purposes of computing foreign source taxable income. Apportionment is the quantitative process of calculating the amount of a deduction that is associated with a specific item or items of gross income for purposes of computing foreign source taxable income.

What does § 904(k) provide?

Allows individual taxpayers to elect out of the foreign tax credit limitation calculation. For individuals who have paid less than $300 (less than $600 for married filing joint) in foreign taxes. Thus, they can take a foreign tax credit equal to foreign taxes paid.

global intangible low-tax income (GILTI) limitation basket

Amount of income from a controlled foreign corporation (CFC) in excess of a 10% return on assets *New for 2018; relates to GILTI income inclusion under §951A and GILTI deduction under §250 **Can't carryback or carryforward any excess credits in GILTI category

How are non-legally mandated research and experimentation expenses allocated?

Apportion using either sales method or gross income method. Must elect the gross income method.

Owl Vision Corporation (OVC) is a North Carolina corporation engaged in the manufacture and sale of contact lenses and other optical equipment. The company handles its export sales through sales branches in Belgium and Singapore. The average tax book value of OVC's assets for the year was $200 million, of which $160 million generated U.S. source income and $40 million generated foreign source income. OVC's total interest expense was $20 million. What amount of the interest expense will be apportioned to foreign source income under the tax book value method?

Apportionment using tax book value Tax book value of U.S. assets = $160 million Tax book value of foreign assets = $40 million Interest apportioned to U.S. source income: $160,000,000/$200,000,000 × $20 million = $16 million Interest apportioned to foreign source income: $40,000,000/$200,000,000 × $20 million = $4 million

How are assets attributed to income?

Based on source and type of income they generate, have generated, or may be reasonably expected to generate.

The Participation Exemption (§245A Dividends-Received Deduction)

Beginning in 2018, US C corporations can deduct foreign dividends received via a participation exemption. The § 902 indirect credit (deemed paid credit) remains available for US corporate taxpayers who receive constructive dividends (e.g., Subpart F income) from a foreign corporation. The new dividends-received deduction effectively creates a territorial system for domestic corporations operating abroad through a foreign corporation. No credit or deduction is allowed for any foreign taxes (including withholding taxes) paid or accrued with respect to a dividend that qualifies for the new Code Sec. 245A dividends-received deduction because the underlying foreign-source income is exempt from U.S. tax.

What income is eligible for the participation exemption?

Foreign source income ONLY. Must be a dividend distribution from the foreign corporation.

What are "definitely related" deductions?

Definitely related deductions are allocated to the particular item of income to which the deductions are associated. Example: manufacturing costs

Snowball, Inc., a US corporation, operates an unincorporated branch manufacturing operation in Australia. Snowball paid $135,000 in Australian income taxes related to branch income. What type of tax is the Australian income tax?

Direct tax eligible for direct credit under section 901.

Creditable taxes also include foreign taxes imposed "in lieu of" an income tax, such as:

Dividends, interest, royalties Note: these are at-source withholding (assessed on gross income)

Sombrero Corporation, a U.S. corporation, operates through a branch in Espania. Management projects that the company's pretax income in the next taxable year will be $100,000: $80,000 from U.S. operations and $20,000 from the Espania branch. Espania taxes corporate income at a rate of 30 percent. b. Management plans to establish a second branch in Italia. Italia taxes corporate income at a rate of 10 percent. What amount of income will the branch in Italia have to generate to eliminate the excess credit generated by the branch in Espania?

Each dollar of foreign taxable income earned in Italia generates an excess FTC limitation of $0.11 [$1 × (21% - 10%)]. Sombrero must generate enough low-tax general category foreign source taxable income to eliminate the $1,800 excess credit. The excess credit will be eliminated if Sombrero can generate $16,364 of income in Italia ($1, 800/.11). Foreign income taxes Espania ($20,000 × 30%) $6,000 Italia ($16,364× 10%) 1,636 Total $7,636 FTC Limitation: Foreign source taxable income $36,364 Total taxable income ($100,000 + $36,364) 136,364 Precredit U.S. tax (21% × $136,364) $28,636 FTC Limitation: $36,364/$136,364× $28,636 $7,636 Excess foreign tax credit ($7,636 - $7,636) $0

On January 1, 2018 Boyle Corporation (a US C corporation) purchased 12% of Genevieve Corporation (a foreign corporation located in Country X). Assume Genevieve's 2019 foreign-source income is $5 million. Country X's tax rate is 15%, while the US tax rate is 21%. Country X has no dividend withholding tax. On December 31, 2019 Genevieve distributes its current year after-tax earnings to its shareholder in proportion to stock ownership. What are the 2019 tax impacts to Boyle?

Eligible for participation exemption. $5,000,000 foreign source income x 15% = $750,000 foreign tax $5,000,000 - $750,000 = $4,250,000 ENP; this is our distribution $4,250,000 x 12% = $510,000 dividend income for Boyle Participation exemption: $510,000 = $0 U.S. tax

What is the purpose of the Foreign Tax Credit Limitation?

Ensures that a taxpayer receives credit for taxes paid on foreign source income limited to the U.S. tax attributable to foreign source income.

general income limitation basket

Everything not foreign branch or passive Ex. Financial services income, dividends from subsidiary

What are "not definitely related" deductions?

Expenses not definitely related are allocated to all gross income because they are not directly associated with a particular item of gross income. Example: medical expenses, property taxes, standard deduction

True or false: All dividend income received by a U.S. taxpayer is classified as passive category income for foreign tax credit limitation purposes. Explain.

False. Dividends received from a 10%-or-more owned foreign corporation by a U.S. corporation are eligible for the 100% dividends received deduction and are exempt from U.S. taxation. Dividends not eligible for the 100% dividends received deduction are treated as passive category income.

True or false: All foreign taxes are creditable for U.S. tax purposes. Explain.

False. Only foreign income taxes are creditable for U.S. tax purposes. Other foreign taxes (property, value-added, payroll) can only be deducted in computing taxable income. In addition, foreign taxes associated with dividends eligible for the 100% dividends received deduction are not creditable. Only 80% of foreign income taxes associated with the GILTI deemed dividend are creditable.

Gameco, a U.S. corporation, operates gambling machines in the United States and abroad. Gameco conducts its operations in Europe through a Dutch B.V., which is treated as a branch for U.S. tax purposes. Gameco also licenses game machines to an unrelated company in Japan. During the current year, Gameco paid the following foreign taxes, translated into U.S. dollars at the appropriate exchange rate: Foreign Taxes Amount (in $) National income taxes 1,000,000 City (Amsterdam) income taxes100,000 Value-added tax 150,000 Payroll tax (employer's share of social insurance contributions) 400,000 Withholding tax on royalties received from Japan 50,000 Identify Gameco's creditable foreign taxes.

Gameco's creditable foreign taxes are those taxes that qualify as income taxes or taxes paid in lieu of income taxes. The creditable income taxes are the national income taxes and the city of Amsterdam income taxes. The withholding tax is creditable because it is imposed "in lieu" of an income tax. Therefore, the total creditable foreign taxes are $1,150,000 ($1,000,000 + $100,000 + $50,000).

While a credit is typically more advantageous for a taxpayer, why might a taxpayer choose to deduct foreign taxes paid rather than take a credit?

Generally, take credit, but if corporation does not expect to have income tax in the next 10 years, might choose to take deduction.

foreign branch income limitation basket

Income Included/Examples: Branch of corporation in a foreign country (QBU - qualified business unit) Has its own accounting records and books Is a trade or business Note: new for 2018

passive income limitation basket

Income Included/Examples: Interest, dividends, rents, annuities, royalties, gains on sale of passive income producing property, net commodity gains, and foreign currency gains Notes: *apply look-through rules for income from CFCs *High tax income may be kicked out and assigned to another category

Briefly describe the method for apportioning interest expense to a foreign source taxable income in the computation of the foreign tax credit limitation.

Interest expense is allocated to all gross income based on the assets that generated such income. Interest can be apportioned based on average tax book value or alternative tax book value for the year.

Della, Inc. a US corporation, has US source taxable income of $200,000, total taxable income of $300,000 and a US tax liability (before the FTC) of $105,000. Della earns $80,000 in foreign source interest income (paid $8,000 in foreign taxes) and $20,000 in foreign source active business income (paid $8,000 in foreign taxes). What is Della's FTC allowed?

Interest income: passive Active business income: general General FTCL (foreign tax credit limitation): $105,000 x ($20,000/$300,000) = $7,000 Taxes paid: $8,000 For general, our foreign tax credit is $7,000 (lesser of $7,000 and $8,000) Passive FTCL: $105,000 x ($80,000/$300,000) = $28,000 Taxes paid: $8,000 For passive, our foreign tax credit is $8,000 (lesser of $8,000 and $28,000) Total FTC: $7,000 + $8,000 = $15,000 We have $1,000 excess credit for general and excess credit limitation of $20,000 for passive Cannot carryforward or carryback an excess credit limitation, but can carryback/forward the $1,000 excess credit

Mackinac Corporation, a U.S. corporation, reported total taxable income of $5 million. Taxable income included $1.5 million of foreign source taxable income from the company's branch operations in Canada. All of the branch income is foreign branch income. Mackinac paid Canadian income taxes of $375,000 (as translated) on its branch income. Compute Mackinac's allowable foreign tax credit. Assume U.S. tax rate of 21%.

Mackinac Corporation's precredit U.S. tax is $1,050,000 ($5,000,000 × 21%). The company's foreign tax credit limitation is computed as: $1,500,000 / $5,000,000 × $1,050,000 = $315,000. Mackinac's allowable foreign tax credit is limited to $315,000, creating an "excess credit" of $60,000 ($375,000 - $315,000), which can be carried back one year and carried forward 10 years.

On June 1, 2019 Boyle Corporation (a US C corporation) purchased 12% of Genevieve Corporation (a foreign corporation located in Country X). Assume Genevieve's 2019 foreign-source income is $5 million. Country X's tax rate is 15%, while the US tax rate is 21%. Country X has no dividend withholding tax. On December 31, 2019 Genevieve distributes its current year after-tax earnings to its shareholder in proportion to stock ownership. Is Boyle eligible for the participation exemption?

No. Their holding period is not 366 days; is only 7 months. Instead, they would take a foreign tax credit.

What taxpayers are eligible for the participation exemption?

US corporations ONLY. Must own at least 10% of voting/value stock in the foreign corporation.

During 2020, FTrike, a foreign subsidiary, distributes a $10 million dividend to Trikeco, a U.S. C corporation. FTrike has post-2017 undistributed E&P of $90 million and post-2017 foreign income taxes of $36 million. Assume that the U.S. corporate tax rate is 21% and the dividend incurs a withholding tax of 5%. As a result of the dividend, what is the foreign tax due and the U.S. tax due?

On the $10 million dividend distribution, the foreign withholding tax due will be $500,000 (5% of the $10 million dividend). Because Trikeco is a U.S. C corporation, Trikeco should be entitled, assuming all the requirements are met, to the participation exemption on the dividend. As a result, there will not be any U.S. tax due and the $500,000 withholding, which is not creditable, is an out-of-pocket cost. Unlike previous law, Trikeco is not entitled to a deemed-paid foreign tax credit for the taxes paid by FTrike.

Chapeau Company, a U.S. corporation, operates through a branch in Champagnia. The source rules used by Champagnia are identical to those used by the United States. For 2018, Chapeau has $2,000 of gross income, $1,200 from U.S. sources and $800 from sources within Champagnia. The $1,200 of U.S. source income and $700 of the foreign source income are attributable to manufacturing activities in Champagnia (foreign branch income). The remaining $100 of foreign source income is passive category interest income. Chapeau had $500 of expenses other than taxes, all of which are allocated directly to manufacturing income ($200 of which is apportioned to foreign sources). Chapeau paid $150 of income taxes to Champagnia on its manufacturing income. The interest income was subject to a 10 percent withholding tax of $10. Compute Chapeau's allowable foreign tax credit in 2018.

Precredit U.S. tax Total taxable income ($2,000 -$500) . $1,500 Precredit U.S. tax ($1,500 × 21%) 315 FTC limitation calculations Foreign branch income (manufacturing) Foreign source taxable income ($700 -$200) $500 FTC limitation: $500/$1,500 × $315 105 Foreign tax imposed $150 Passive category income Foreign source taxable income ($100 -$0) $100 FTC limitation: $100/$1,500 × $315 21 Foreign tax imposed (withholding tax) $10 Foreign tax credit allowed General category: Lesser of $105 or $150 $105 Passive category: Lesser of $21 or $10 10 Total foreign tax credit $115 Excess foreign tax credit ($160 - $115) $45

Taxes that do not qualify for foreign tax credit

Property taxes Sales/use tax VAT (value added tax) Customs tax Excise tax

How are deductions sourced?

Reg. § 1.861-8 provides the general rules for allocating and apportioning deductions to US and foreign source income.Matching of expenses to income takes place based on the factual relationship of the deduction to the gross income.

Spartan Corporation, a U.S. corporation, reported $2 million of pretax income from its business operations in Spartania, which were conducted through a foreign branch. Spartania taxes branch income at 15 percent, and the United States taxes corporate income at 21 percent. c. Assume the United States allows U.S. corporations to claim a deduction for foreign income taxes. What would be the total tax on the $2 million of branch profits?

Spartania tax ($2,000,000 × 15%) . $300,000 U.S. tax ([$2,000,000 - 300,000] × 21%) . $357,000 Total tax $657,000

Spartan Corporation, a U.S. corporation, reported $2 million of pretax income from its business operations in Spartania, which were conducted through a foreign branch. Spartania taxes branch income at 15 percent, and the United States taxes corporate income at 21 percent. a. If the United States provided no mechanism for mitigating double taxation, what would be the total tax (U.S. and foreign) on the $2 million of branch profits?

Spartania tax ($2,000,000 × 15%)$ 300,000 U.S. tax ($2,000,000 × 21%) 420,000 Total tax $720,000

Spartan Corporation, a U.S. corporation, reported $2 million of pretax income from its business operations in Spartania, which were conducted through a foreign branch. Spartania taxes branch income at 15 percent, and the United States taxes corporate income at 21 percent. b. Assume the United States allows U.S. corporations to exclude foreign source income from U.S. taxation. What would be the total tax on the $2 million of branch profits?

Spartania tax ($2,000,000 × 15%)$300,000 U.S. tax ($0 × 21%)0 Total tax$300,000

Spartan Corporation, a U.S. corporation, reported $2 million of pretax income from its business operations in Spartania, which were conducted through a foreign branch. Spartania taxes branch income at 15 percent, and the United States taxes corporate income at 21 percent. d. Assume the United States allows U.S. corporations to claim a credit for foreign income taxes paid on foreign source income. What would be the total tax on the $2 million of branch profits? What would be your answer if Spartania taxed branch profits at 30 percent?

Spartania tax ($2,000,000 × 15%)$300,000 U.S. tax ([$2,000,000 × 21%] - $300,000] 120,000 Total tax $420,000 If Spartania taxed branch profits at 30 percent, the United States would allow the foreign tax to reduce the U.S. tax to zero, but the excess $180,000 would become a carryback or carryforward to a prior or future years. Spartania tax ($2,000,000 × 30%) $600,000 U.S. tax ([$2,000,000 × 21%] - $600,000] $0 Total tax $600,000

What is cross-crediting?

Taking excess credits in one country and offsetting excess limitations of another country. Can do this between countries, but not between baskets of income.

Sombrero Corporation, a U.S. corporation, operates through a branch in Espania. Management projects that the company's pretax income in the next taxable year will be $100,000: $80,000 from U.S. operations and $20,000 from the Espania branch. Espania taxes corporate income at a rate of 30 percent. a. If management's projections are accurate, what will be Sombrero's excess foreign tax credit in the next taxable year? Assume all of the income is general category income.

Taxable income $100,000× 21%× 0.21 Precredit U.S. tax $ 21,000 Foreign tax ($20,000 × 30%) $6,000 FTC limitation: $20,000 / $100,000 × $21,000 = 4,200 Excess FTC $1,800

Why are the income source rules important to a U.S. nonresident?

The U.S. source-of-income rules are important to a U.S. nonresident because they limit the scope of U.S. taxation to only the nonresident's U.S. source income.

Why does the United States allow U.S. taxpayers to claim a credit against their pre-credit U.S. tax for foreign income taxes paid?

The United States applies a residual approach to taxing foreign source income earned by U.S. persons not eligible for the 100% dividends received deduction. Under this approach, the U.S. government collects the difference between the U.S. tax that would have been paid if the income had been U.S. source and the foreign tax paid on such income. The United States accomplishes this objective by allowing the U.S. person a credit for the foreign taxes paid.By using this method, the U.S. attempts to fully or at least partially mitigate the double taxation of foreign earned income by the U.S. persons.

What role does the foreign tax credit limitation play in U.S. tax policy?

The foreign tax credit limitation is designed to limit the credit allowed for foreign income taxes paid to the amount of U.S. income tax that would have been paid on the income if it was earned in the U.S.

Falmouth Kettle Company, a U.S. corporation, sells its products in the US and Europe. During the current year, SG&A expenses included: personnel department $500 training department $350 president's salary $400 sales manager's salary $200 other general and admin $550 total SG&A expenses $2,000 Falmouth had $12,000 of gross sales to U.S. customers and $3,000 of gross sales to European customers. Gross income (sales minus cost of goods sold) from domestic sales was $3,000 and gross profit from foreign sales was $1,000. Apportion Falmouth's SG&A expenses to foreign source income using the following methods: c. If Falmouth wants to maximize its foreign tax credit limitation, which method produces the better outcome? Assume the FDII deduction does not apply.

The gross sales method apportions the smaller amount of deductions to the numerator of Falmouth's foreign tax credit limitation formula. As a result, the foreign tax credit limitation ratio will be greater under the gross sales method, and the company's foreign tax credit will be higher.

Why are the income source rules important to a U.S. citizen or resident?

The income source rules can be important to a U.S. citizen or resident for several reasons: 1) to calculate the numerator in the foreign tax credit limitation calculation (foreign source taxable income), 2) to determine if a dividend from a 10%-or-more owned foreign corporation is eligible for a 100% dividends received deduction 3) to determine if export income qualifies for the foreign-derived intangible income deduction, 4) to determine if a U.S. citizen or resident employed outside the United States is eligible to exclude a portion of foreign source earned income from U.S. taxation under §911, 5) to determine if a U.S. citizen or resident who pays U.S.-source FDAP income to a foreign person (for example, interest or dividends) must withhold U.S. taxes on such payments.

On January 1, 2018 Holt Corporation (a US C corporation) formed Cheddar Corporation (a foreign corporation located in Country B). Assume Cheddar's 2019 foreign-source income is $20 million. Cheddar pays a dividend of $20 million to Holt. This payment is treated as an interest payment in Country B. Country B's tax rate is 30%, while the US tax rate is 21%. What are the 2019 tax impacts to Holt?

This is a hybrid dividend, so it not eligible for the participation exemption.

What is the purpose of the foreign tax credit?

To alleviate the impact of double taxation.

How does a taxpayer "take" the foreign tax credit?

To claim the credit, file Form 1118 with a corporate tax return or Form 1116 with an individual tax return.

Falmouth Kettle Company, a U.S. corporation, sells its products in the US and Europe. During the current year, SG&A expenses included: personnel department $500 training department $350 president's salary $400 sales manager's salary $200 other general and admin $550 total SG&A expenses $2,000 Falmouth had $12,000 of gross sales to U.S. customers and $3,000 of gross sales to European customers. Gross income (sales minus cost of goods sold) from domestic sales was $3,000 and gross profit from foreign sales was $1,000. Apportion Falmouth's SG&A expenses to foreign source income using the following methods: a. Gross sales

To foreign source income: $3,000/$15,000 × $2,000 = $400 To U.S. source income: $12,000/$15,000 × $2,000 = $1,600

Falmouth Kettle Company, a U.S. corporation, sells its products in the US and Europe. During the current year, SG&A expenses included: personnel department $500 training department $350 president's salary $400 sales manager's salary $200 other general and admin $550 total SG&A expenses $2,000 Falmouth had $12,000 of gross sales to U.S. customers and $3,000 of gross sales to European customers. Gross income (sales minus cost of goods sold) from domestic sales was $3,000 and gross profit from foreign sales was $1,000. Apportion Falmouth's SG&A expenses to foreign source income using the following methods: b. Gross income

To foreign source income: $1,000/$4,000 × $2,000 = $500 To U.S. source income: $3,000/$4,000 × $2,000 = $1,500

Carol receives $500 of dividend income from Microsoft Inc., a U.S. company. True or False: Absent any treaty provisions, Carol will be subject to U.S. tax on the dividends regardless of whether she is a resident or nonresident.

True. Carol will be taxed on all of her income if she is a U.S. resident. If she is a nonresident, she will be taxed only on her U.S. source income. Because Microsoft, Inc. is a U.S. corporation, the dividend will be treated as U.S. source income and will be subject to (withholding) tax if paid to a non-U.S. citizen or resident.

True or false: a taxpayer will always prefer deducting an expense against U.S. source income and not foreign source income when filing a tax return in the United States. Explain.

True. The deduction reduces taxable income in either case. By apportioning the expense to U.S. source income, the taxpayer maximizes the numerator of the foreign tax credit limitation and, by so doing, maximizes the foreign tax credit. A taxpayer may want to create a deduction in a foreign tax jurisdiction if the tax rate is higher than the U.S. rate.

What income is NOT eligible for the participation exemption?

U.S source income and hybrid dividends (deductible payment in foreign country but a dividend in the US).

Who Can Claim a Credit?

US citizens, resident aliens and domestic corporations can claim the credit. Partners in a partnership (and shareholders in S Corporations) can claim the credit as well. NRAs and foreign corporations can claim the credit on their US ECI trade/business income

James Brown, Inc., a domestic corporation with operations in Canada, has total taxable income for the tax year of $550,000, consisting of $400,000 US-source income and $150,000 from Canada. Taxes paid to Canada at a 15% tax rate totaled $25,500. James Brown's US tax at a 21% tax rate before FTC is $115,500. What is James Brown's US tax liability?

US tax liability: $115,500 Foreign source income: $150,000 Worldwide income: $550,000 $115,500 *($150,000/$550,000) = $31,500 foreign tax credit limitation Foreign tax paid: $25,500 Take lesser of $25,500 or $31,500, so: US tax liability: $115,500 - $25,500 = *$90,000* $31,500 - $35,500 = $6,000 excess limitation (do not carryback or carryforward)

James Brown, Inc., a domestic corporation with operations in Canada, has total taxable income for the tax year of $550,000, consisting of $400,000 US-source income and $150,000 from Canada. Taxes paid to Canada at a 40% tax rate totaled $60,000. James Brown's US tax at a 21% tax rate before FTC is $115,500. What is James Brown's US tax liability?

US tax liability: $115,500 Foreign source income: $150,000 Worldwide income: $550,000 $115,500 *($150,000/$550,000) = $31,500 foreign tax credit limitation Foreign tax paid: $60,000 Take lesser of $31,500 or $60,000, so: US tax liability: $115,500 - $31,500 = *$84,000* $60,000 - $31,500 = $28,500 excess credit (1 year carryback, 10 year carryforward)

Fisher, Inc., a domestic corporation, generates US source and foreign-source gross income for the current year. Fisher's assets (tax book value) are as follows: Assets generating US-source income $18,000,000 Assets generating foreign-source income 5,000,000 Total assets $23,000,000 Fisher incurs interest expense of $800,000 for the current year. How is interest expense apportioned?

US: (18M/23M) x $800,000 = $626,087 foreign: (5M/23M) x $800,000 = $173,913

Quantco, a domestic corporation, is an engineering consulting firm that has its main offices in San Diego, California and a branch office in Beijing. During the current year, Quantco generates a total pre-tax profit of $100 million (all from active business operations), including $80 million of profits from its U.S. operations and $20 million of profits from its foreign branch in China. Assume the U.S. tax rate is 21% and the Chinese rate is 26%. Compute Quantco's creditable foreign income taxes, foreign tax credit limitation, and excess credits (if any).

Under the original fact situation, Quantco has $1 million of excess credits computed as follows: Chinese income taxes [$20 million × 26%] $5.2 million Foreign branch income limitation: (A) Total taxable income $100 million (B) Pre-credit U.S. tax [$100 million × 21%] $21 million (C) Foreign-source taxable income $20 million Limitation = [line B × (C ÷ A)] = [$21 million × ($20 million ÷ $100 million)] − $4.2million Excess foreign tax credits $1 million

Now assume that Quantco has a second foreign branch office in Singapore which generated $10 million of profits (all from active business operations), on which Quantco pays Singapore taxes. Assume the effective Singapore tax rate is 8%. Recompute Quantco's creditable foreign income taxes, foreign tax credit limitation, and excess credits. What is the name of the phenomenon by which the Singapore profits resulted in the elimination of the excess credits on the Chinese profits?

Under the revised facts, because both the Singapore and the Chinese profits are assigned to the foreign branch income limitation, the $10 million of low-tax Singapore profits will completely eliminate Quantco's excess credits, as follows: Foreign income taxes [($20 million × 26%) + ($10 million × 8%)] $6 million Foreign branch income limitation: (A) Total taxable income [$100 million + $10 million] $110 million (B) Pre-credit U.S. tax [$110 million × 21%] $23.1 million (C) Foreign-source taxable income $30 million Limitation = [line B × (C ÷ A)] = [$23.1 million × ($30 million ÷ $110 million)] − $6.3 million Excess foreign tax credits None Quantco no longer has any excess credits because the average rate of foreign tax is now 20% (foreign taxes of $6 million ÷ $30 million of foreign income), which is lower than the U.S. tax rate of 21%. The process by which the excess limitation on the low-tax Singapore profits is credited against (or soaks up) the excess credits on the high-tax Chinese profits is known as "cross-crediting."

What happens to unused foreign taxes, i.e., limited by the Foreign Tax Credit Limitation?

Unused foreign taxes are eligible for carryback and carryforward. Carryback period is 1 year, and carryforward period is 10 years Unused foreign taxes can only be used in future (or previous year) years within the same income basket Must be credited; can't be deducted in c/f or c/b years

When are unused foreign taxes used?

Unused foreign taxes are used when FTC limitation exceeds the foreign tax attributable to that tax year. This produces an excess foreign tax credit limitation. Carryovers are applied on a FIFO basis, with the current year FTC being used first

How is interest expense allocated to income?

Using average tax book value of assets that generated such income.

Waco Leather, Inc., a U.S. corporation, reported total taxable income of $5 million. Taxable income included 1.5 million of foreign source taxable income from the company's branch operations in Mexico. All of the branch income is general category income. Waco paid Mexican income taxes of $300,000 on its branch income. Compute Waco's allowable foreign tax credit.

Waco's precredit U.S. tax is $1,050,000 ($5,000,000 × 21%). The company's foreign tax credit limitation is computed as: $1,500,000 / $5,000,000 × $1,050,000 = $315,000. Waco's allowable foreign tax credit is the full $300,000. Waco has an "excess foreign tax credit limitation" of $15,000, which can absorb foreign tax credit carryforwards from prior years.

Spartan Corporation, a U.S. company, manufactures green eyeshades for sale in the United States and Europe. All manufacturing activities take place in Michigan. During the current year, Spartan sold 10,000 green eyeshades to European customers at a price of $10 each. Each eyeshade costs $4 to produce. All of Spartan's production assets are located in the US. For each independent scenario, determine the source of gross income from sale of the green eyeshades. a) Spartan ships its eyeshades FOB, place of destination. b) Spartan ships its eyeshades FOB, place of shipment.

a. Gross profit from the sales is $60,000 (10,000 units × {$10 - $4}). Under the §863(b) formula method, 100 percent of gross profit is sourced based on the location of the production assets. Under pre-2018 law, 50% of the gross profit was sourced based on title passage b. Gross profit from the sales is $60,000 (10,000 units × {$10 - $4}). Under the §863(b) formula method, 100 percent of gross profit is sourced based on the location of the production assets.

Petoskey Stone Inc., a U.S. corporation, received the following sources of income during the current year. Identify the source of each item as either U.S. or foreign. a. Interest income from a loan to its German subsidiary b. Dividend income from Granite Corporation, a U.S. corporation. c. Royalty income from its Irish subsidiary for use of a trademark. d. Rent income from its Canadian subsidiary for its use of a warehouse located in Wisconsin.

a.Foreign source (residence of the payer of interest) b.U.S. source (residence of the payer of the dividend) c.Foreign source (where the intangible is used) d.U.S. source (where the property being rented is located)

Why does the United States use a "basket" approach in the foreign tax credit limitation computation?

he "basket" approach limits foreign tax credit blending opportunities (high-tax foreign source income and low-tax foreign source income) to income that is of the same character. Currently, there are four primary categories of FTC income: passive category income, general category income, foreign branch company income, and global intangible low-taxed income (GILTI).

What are some important compliance rules to keep in mind?

o Can election on an annual basis whether to claim the credit or deduct the taxes paid o The election applies to all foreign income taxes paid for the year o Have 10 years to make or change election

four income baskets of foreign-source taxable income

passive, foreign branch, general and global intangible low-tax income

Ace, Inc., a domestic corporation, has $2 million gross income and a $50,000 expense, all related to real estate activities. How is the $50,000 expense allocated and apportioned based on the following information? Gross Income Total Foreign US Sales $1,000,000 $500,000 $1,500,000 Rentals 400,000 100,000 500,000 Total $1,400,000 $600,000 $2,000,000

step 1: allocate sales: ($1,500,000/$2,000,000) x $50,000 = $37,500 rentals: ($500,000/$2,000,000) x $50,000 = $12,500 step 2: apportion foreign sales: (1M/1.5M) x $37,500 = $25,000 US sales: (0.5M/1.5M) x $37,500 = $12,500 foreign rentals: (400,000/500,000) x $12,500 = $10,000 US rentals: (100,000/500,000) x 12,500 = $2,500

Foreign tax credit limitation

total US tax liability x (foreign source taxable income/total worldwide taxable income)

Separate Category of Income Limitation calculation

total US tax liability x (separate category foreign-source income/worldwide income)