Foreign Tax Credit in Retirement

[Neill]

I wonder if anyone has met this situation.
Significant taxable portfolio generating ~$5k foreign taxes paid / year. While working this is no problem. The whole thing gets eaten by the tax bill.
On retirement though the earned income disappears and the tax rate falls to zero despite having about $130k passive (kids, qualified dividends, standard deduction, HSA, capital loss carry over).
The foreign tax credit will carry one year back then build up year after year it seems. Have some foreign pensions to halt it a bit after 5 or so years.
Do others see foreign taxes paid carry over in retirement?
I haven't retired. Just running the numbers.

[FUEGO]

Wow, I didn't know it carries over! I'll have to check into that.

We're dipping into the ER waters (I'm there, DW is about to join me). We'll be in the position of having foreign tax credits go partially or fully unused in most years since I'll be managing AGI for ACA subsidy purposes (and to keep taxes low more generally).

[Neill]

Quote:

Originally Posted by FUEGO Wow, I didn't know it carries over! I'll have to check into that.

You're supposed to help me not the other way around .
My under standing is the FTC can carry back one year and into the future for 10 years. So that covers my first year with carry back.
I tried realizing income with Roth conversions. That works for some of it but not much in comparison to how much I want to do. Tax goes positive but FTC remains because there isn't enough foreign sourced income and too little tax. Too little tax is obviously a goal of mine.
I don't know how much of the form 1116 carry forward is handled by tax s/w.

[M Paquette]

They carry over for up to 10 years, as I recall, then the oldest ones start dropping off the unused balance. It's one of the weirder items in our tax returns.

[pb4uski]

Why can't you just increase Roth conversions and therefore increase taxes to offset the credit until the credit is fully used?

[Neill]

Quote:

Originally Posted by pb4uski Why can't you just increase Roth conversions and therefore increase taxes to offset the credit until the credit is fully used?

Not a very good result. I would have to expand the income further than I may want. Remember form 1116 does a calc like ((foreign income) / (total income)) * tax to calculate the maximal credit.
So you might end up with quite a large effective tax rate to eat up the FTC as the denominator expands. If you can realize foreign income though then you get a much better result since the numerator expands as well as the denominator.

[Texas Proud]

IIRC you have to match the kind of tax with the kind of income....


I worked overseas and had a big FTC carryover.... something like $60K.... but I could not use it for anything but foreign earned income.... foreign investment income was on a separate form....


Does your income match

[Neill]

Quote:

Originally Posted by Texas Proud Does your income match

It's passive income (dividends) that I get each year. Foreign pensions, if I don't take a lump sum would be passive also.

[kaneohe]

Quote:

Originally Posted by Neill Not a very good result. I would have to expand the income further than I may want. Remember form 1116 does a calc like ((foreign income) / (total income)) * tax to calculate the maximal credit. So you might end up with quite a large effective tax rate to eat up the FTC as the denominator expands. If you can realize foreign income though then you get a much better result since the numerator expands as well as the denominator.

I guess you'd have to work the numbers to see........is it possible that the total tax will increase faster than the foreign income fraction falls? If you have
large component of QDIV/LTCG taxed at 0%, it seems possible.
Also as a last ditch tactic.... but at least consider deducting the foreign taxes. Typically retirees don't itemize but ymmv.......it's my impression that you can only deduct for the current yr.......too bad you can't deduct carryovers when they build up large enough.

[adrift]

I don't know about foreign pensions. So, I'm going to comment just on passive dividend income from investments in a taxable account.

This is complicated. So, I hope I do it justice.

There are 2 important thresholds with respect to taking the Foreign Tax Credit. First, if you have more than $300/$600 (single)/(joint) in Foreign taxes you have to use Form 1116.

I find Form 1116 to be complicated. But, as you've noted, its general idea is to determine what percentage of your income is Foreign sourced and then applies this percentage to the tax you owe to compute the credit. The credit is taken first against Foreign taxes paid in the current year. If the amount of the credit exceeds the current year's Foreign tax paid, you can apply it against Foreign tax you were not able to utilize in the prior 10 years.

The second threshold is that if your Foreign investment income exceeds $20,000 and you were able to treat some or all of it favorably as Qualified Dividends you can no longer claim all of that income as Foreign income.

Quote:

To adjust your foreign source qualified dividends or capital gain distributions, multiply your foreign source qualified dividends or capital gain distributions in each separate category by 0.3788 if the foreign source qualified dividends or capital gain distributions are taxed at a rate of 15%, and by 0.5051 if they are taxed at a 20% rate. Include the results on line 1a of the applicable Form 1116. You adjust your foreign source qualified dividends or capital gain distributions taxed at the 0% rate by not including them on line 1a.

From your initial post, I suspect you have crossed the $20,000 threshold. Depending on your situation, this threshold is potentially a cliff.

Here's my experience. For several years, we've been doing ROTH conversions up to the top of the 15% bracket. Some portion of our Foreign dividends were qualified. This portion was taxed at 0%. We were keeping our taxes very low and were able to only partially utilize the tax credit.

Then, in 2013, we exceeded the $20,000 threshold for the first time by just a small amount. This was essentially a cliff for us. We had to exclude
all of our foreign qualified dividend income on Form 1116 and were able to take only a very small tax credit.

We've made some adjustments in 2014 because of this. We've shifted part of our international allocation from taxable to tax deferred to get under the $20,000 threshold. After some analysis, we've increased our ROTH conversions (partially because of this and partially because our state's tax law). We now expect to utilize all of 2014's tax and to reach back and use some from 2009.

Quote:

Originally Posted by Neill I don't know how much of the form 1116 carry forward is handled by tax s/w.

For TurboTax, this is tracked quite well. However, TurboTax doesn't handle the case of exceeding the $20,000 threshold at all well (at least in the 2013 version). If you google the scenario, you can find out how to trick it into doing the right thing.

[theOAP]

Quote:

Originally Posted by Neill Foreign pensions, if I don't take a lump sum would be passive also.

You've just walked into a very large and very grey area.

On which part of the Code is the above based? Many well respected cross boarder tax professionals will offer an argument, based on the Code, that foreign pensions are "general limitation" and not passive.

This is NOT to say you are incorrect, but you need a basis for your statement.

[Neill]

Quote:

Originally Posted by adrift From your initial post, I suspect you have crossed the $20,000 threshold. Depending on your situation, this threshold is potentially a cliff.

For last year I hit $48k foreign income with $31k qualified. These are rough as foreign tax information is only just being published for funds.
Since my taxes when working are so high I always consumed my foreign tax credit completely before. It's only now that I am starting to study this area in detail as I see it presents a problem in retirement. It's a pretty minor problem though.

[Neill]

Quote:

Originally Posted by theOAP You've just walked into a very large and very grey area. On which part of the Code is the above based? Many well respected cross boarder tax professionals will offer an argument, based on the Code, that foreign pensions are "general limitation" and not passive. This is NOT to say you are incorrect, but you need a basis for your statement.

I haven't done much research on this. I am basing my categorization on the inclusion of annuities in the description of for 1116. Foreign pension distributions look like these. My plans may only offer me the choice of lump sums or creation of an annuity anyway since those were the only options available in the UK 25 years ago. So if FTC accumulates I can go this way to get tax free cash.

I am not using TurboTax but their high end product Lacerte.

I am 5 years off being able to withdraw from my UK pensions. I am just investigating my options at present.

Thanks for the info. If you have a link that would help me get all my ducks in a row.