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I am an EA doing taxes for an American living in Canada,

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with some US investments who...
I am an EA doing taxes for an American living in Canada, with some US investments who is expressing shock that he owes US taxes because his US investment inocme went up. I believe his US Investment income from Indianna is not taxed in Canada, but only in the US. I basically entered the data into my tax program and relied on my progrram to give a correct answer. But II would like a simple explanatioin on how US based income is handled for an american in Canada. The income was reported ot IRS on K-1s. They also have earned income in Canada and are filing taxes in both countries. I am not asking you if they have a filing requirement, but whom does he pay tax to basedon his US k-1 income.My client thinks his tax foreing tax credit, which he has in abundatnt quanitity rolling over year to year, should sheld him from paying IRS tax. A related questoin, is there any way an Amercan living in Canada could make $25,000 in US sourced income and not pay tax. There are no dependents but is married. and would have self and spouse on return.
Submitted: 10 months ago.Category: Tax
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9/23/2017
Tax Professional: Stephen G., Sr Income Tax Expert replied 10 months ago
Stephen G.
Stephen G., Sr Income Tax Expert
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Hello, my name is***** goal is to give you a complete & accurate answer. I am working on your request now & I will respond as soon as possible.

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Customer reply replied 10 months ago
thank you.
Tax Professional: Stephen G., Sr Income Tax Expert replied 10 months ago

Not to oversimplify but in the circumstances you describe, the first thing I would determine would be whether or not he qualified for the Foreign Income Exclusion.

Presuming he doesn't qualify for the moment, then you start with the principle that as US Citizens, they are taxed on their worldwide income.

That said, if he has income subject to Canadian income taxes, and they have foreign income tax withheld and/or paid, then since that income is initially taxed in both jurisdictions (US & Canada), then the related income tax paid to Canada would be available to support his foreign income tax credit to offset the US income tax on the same income. Note that the foreign tax credit (FTC) can only offset any US tax on the related foreign income. In other words, the computations using Form 1116 will work to limit the FTC to the amount of US tax on the foreign income, so if the foreign tax is higher than the US tax, the entire foreign tax may not be able to be used.

So, on an overall basis, the only US income tax that may be offset by the FTC is the income that has been taxed in both Canada & the US with the potential of the US tax either being fully or partially eliminated by the FTC. If the FTC exceeds the US income tax on the foreign income, then that FTC will not be available to offset US tax in the current year.

It's very possible (in fact likely), that he'll never be able to use the excess FTC. The bot***** *****ne is that you can never use the FTC to offset US income taxes on income that was never subject to foreign taxes. So his premise of the FTC shielding him from US taxes is simply wrong.

There are situations where the 25K in US sourced income would not be taxed, but it would require sufficient losses and/or deductions (standard or itemized) to offset the income. You could ask the same question for 10K or 50K and get the same possibility.

Also, the US source income could never be offset by the foreign income exclusion (which pertains to earned income only), not could the related income tax be offset by the FTC. The fact that he resides in Canada does not make any difference in the tax on his US source income.

Hope this helps.

Please let me know if you have any follow-up questions.

Please remember to rate my response.

Thanks very much,

Steve G.

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Tax Professional: Stephen G., Sr Income Tax Expert replied 10 months ago

Correction:

not should be nor below:

exclusion (which pertains to earned income only), nor could the related

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Customer reply replied 10 months ago
OK. I THINK I got it. As a practical matter, if an Amercan living in Canada has positive American investment income and positive Canadian income from working in Canada, his American income is not shielded from American taxes. I believe this is implied in your answer above. I realize it is more complex than that. The client had maybe 7gs in American income the year before, and wound up with no tax liability. I believe because of his marital status and exemptions. But if he is making a postive investmetn income in the US of say 20Gs and postive busines sincome in Canada of 20 gs, with no balancing losses, then I see no way he could have zero tax liability. Do you agree?
Tax Professional: Stephen G., Sr Income Tax Expert replied 10 months ago

Well, I'm not sure what point you're making, in that you would still have to consider the affect of his personal exemptions and standard or itemized deductions; I hesitate to generalize about these matters without actually preparing a tax return with specific figures as the minute you try to make these kinds of projections, the actual figures may prove you wrong. The point being the best way to deal with this situation is to run the actual numbers and provide your client with a "draft copy" of his tax return so he can see how his actual numbers flow resulting in whatever income tax is reflected in the return. Discussing this issue in "general terms" is never going to satisfy him; you're not running a tax school, you're preparing returns; it's impossible to anticipate all situations and how they effect one another; it involves way too much time & you'll never have a supportable result without doing the actual return; it's not like you're negotiating the results with him.

Steve G.

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Customer reply replied 10 months ago
I did the return and the client is moaning never had to pay US taxes before and beleives- I must be wrong. That is why I am askng last question, not to avoid return. I do not have a lot of expereience with 1040s of Amercans abroad, so I was double chekcng this point. Maybe it is not generalizable like I want. I just have the idea that the system is not set up so an Amercan can make 30gs in Canada and 20gs from American investmetns and not pay tax on his American income.
Tax Professional: Stephen G., Sr Income Tax Expert replied 10 months ago

Well, if you've got experience in preparing these type of returns, then you know that he's barking up the wrong tree.

First thing I would do is take a look at his prior year return & see whether that's prepared correctly or not? It should be easy to determine any differences from the current year. I suspect that the prior year returns may be incorrect and/or the data is completely different.

It's pretty much impossible to answer his questions without seeing what he's comparing the current year to.

Why would you think that he wouldn't have tax to pay in the USA? 100% of his income is reported on his US Return and the only credit is his FTC on the income taxed by Canada. Many people think that in this situation the Canadian income doesn't even appear on his US return, which is of course incorrect.

Steve G.

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