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Tax Reporting For US Citizens With Foreign Pension Income

There are over 4 million tax returns filed every year with a taxpayer claiming a federal tax credit via Form 1116. It should come as no surprise that the source of the foreign income covers countries across the world, with Canada and the United Kingdom representing the largest portion of the mix. In fact, over 10% of the Form 1116 forms filed were due to foreign taxes paid in Canada (source: IRS statistics 2011). Do you qualify for the foreign tax credit?

form-1116-foreign-pensionCan you claim a tax credit for foreign pension income?
Generally, the answer is yes. In filing the Form 1116, you will be given the option of classifying the income in a certain category. For instance, if the pension income is due to a distribution, we can apply certain tax principles and the language in the publications to classify the income as general category (column B). Specifically, if we reference the Form 1116 instructions it states that, “General category income is income that is not passive category income or income described in categories c, d, and e, discussed later.” Foreign pension income is not defined in any of these other income categories. Furthermore, if we review the definition of passive income in IRC Section 469, pension income does not fall in the passive income category. This is just one example of the care that needs to be put forth in completing this form.

When do we file the Form 1116?
The first step is to file your foreign tax return reporting all of the income, deductions and exemptions, which results in a net tax that can be claimed on the Form 1116. If no foreign tax is due, then the Form 1116 is not applicable. See page 2 of Form 1116 under the Header, “Foreign Taxes Not Eligible for a Credit.”

What if foreign taxes are withheld?
If you are certain that the foreign taxes withheld with be your final foreign tax liability, then you may file the Form 1116. For instance, in Canada if you aren’t electing Section 217 treatment, the tax deducted would be considered your final tax obligation to Canada and no Canadian return is necessary to be filed. You would be able to claim the foreign tax credit for the amount on Form 1116.

More Questions? Ask your foreign tax questions or find a tax accountant online.

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