This blog post discusses elections that can be made with respect to foreign income taxes.

Deduction vs. Credit

Taxpayers are generally allowed to deduct foreign income taxes.^[1] However, taxpayers may elect to claim a credit for foreign income taxes.^[2] If taxpayers elect to claim a credit, they cannot also claim a deduction.^[3]

Taxpayers can make the election to claim a deduction or credit on an original or amended return.^[4] The election can generally be made within 10 years of the due date of the return for the year in which the taxes were paid or accrued.^[5]

The election to claim a credit is made by filing Form 1116 or Form 1118 with the return.^[6]

Cash Method Taxpayer Electing FTCs On An Accrual Basis

Individuals and certain corporations may use the cash method of accounting.^[7] Under the cash method of accounting, expenses are generally deductible for the year paid^[8] and foreign tax credits (“FTCs”) are generally allowed in the year paid.^[9]

Cash method taxpayers can elect to claim FTCs on the accrual basis.^[10] The election is made by checking the appropriate box on Form 1116 or Form 1118 indicating the taxpayer’s choice to claim the FTC in the year the foreign income taxes accrue.^[11]

A cash method taxpayer generally cannot elect to use the accrual basis for FTCs on an amended return.^[12] However, the accrual election can be made on an amended return if the return is the first year for which the taxpayer has ever claimed the FTC.^[13] Once made, the accrual election for FTCs is irrevocable and must be followed for all future years.^[14]

It may seem severe that the accrual election generally cannot be made on an amended return and that once made, the election is irrevocable for all future years. However, the courts don’t have much sympathy for taxpayers regarding elections. In Estate of Stamos v. Commr.,^[15] the Tax Court stated:

Oversight, poor judgment, ignorance of the law, misunderstanding of the law, unawareness of the tax consequences of making an election, miscalculation, and unexpected subsequent events have all been held insufficient to mitigate the binding effect of elections * * *.

Consequently, taxpayers should not be surprised that they typically cannot make (or revoke) an election on an amended return.

Spot Rate Election (Translating Foreign Income Taxes)

Taxpayers claiming FTCs on the accrual basis generally must translate foreign income taxes using the average exchange rate for the year.^[16] However, these accrual basis taxpayers can elect to translate foreign income taxes using the spot rate on the date of payment.^[17]

The spot rate election is made by attaching a statement to the taxpayer’s timely filed return for the first year to which the election applies.^[18] Once made, the election applies for all future years unless revoked with the consent of the IRS.^[19]

De Minimis FTC Election

Taxpayers who have paid a small amount of foreign income taxes can elect to claim an FTC without filing Form 1116. This de minimis election is available only if:

1. All of the taxpayer’s foreign source gross income was “passive category income” (which includes most interest and dividends);^[20]
2. All the income and any foreign taxes paid on it were reported on a payee statement (such as Form 1099-DIV, Form 1099-INT, Schedule K-1, or Schedule K-3);^[21] and
3. The taxpayer’s total creditable foreign taxes for the year aren’t more than $300 ($600 if married filing a joint return).^[22]

The election is made by directly entering the foreign tax paid on Form 1040, Schedule 3, Part I, line 1 and not including Form 1116.^[23]

Code §962 Election (To Be Subject to Tax at Corporate Rates)

Individual taxpayers that have Subpart F Income or GILTI inclusions can elect under Code §962 to treat the inclusions as if they were received by a domestic corporation.^[24] This election permits the individual to be taxed at the corporate rate under Code §11 and to claim indirect FTCs under Code §960.^[25]

The election is made for the year by filing a statement with the return^[26] and including Form 1118 with the return.^[27] The preamble to Treasury Decision 9901 indicated that, until further guidance is published, a Code §962 election can be made on an amended return.^[28] The election for a year can be revoked only with the consent of the IRS.^[29]

Subpart F Income High Tax Election

Under the Subpart F Income rules, U.S. shareholders of controlled foreign corporations (“CFCs”) may be currently taxable on certain income earned by the CFCs.^[30] However, the income of the CFC does not need to be included in the U.S. shareholder’s income if it is subject to a high rate of tax (greater than 90% of the maximum tax rate in Code §11) and an election is made to exclude the high-taxed income from Subpart F Income.^[31]

The election is made by the CFC’s controlling domestic shareholder and is binding on all U.S. shareholders.^[32] The controlling domestic shareholder attaches a statement to their original or amended income tax return.^[33]

GILTI High Tax Election

Under the GILTI rules, U.S. shareholders of CFCs may be currently taxable on certain “tested income” earned by the CFCs.^[34] However, the income of the CFC is not included in tested income if it is subject to a high rate of tax (greater than 90% of the maximum tax rate in Code §11) and an election is made to exclude the high-taxed income from tested income.^[35]

The election is made by the CFC’s controlling domestic shareholder and is binding on all U.S. shareholders.^[36] The controlling domestic shareholder attaches a statement to their original or amended income tax return.^[37] If the election or revocation of the election is made on an amended income tax return, the amended return must be filed within 24 months of the unextended due date of the original return.^[38]

Capital Gain Rate Differential Election

Capital gains and qualified dividend income are taxed at reduced rates.^[39] The foreign tax credit limitation is computed as the U.S. tax on foreign-source income.^[40] For individuals who receive foreign-source qualified dividends or foreign-source capital gains, the U.S. tax on those items is reduced. Accordingly, the foreign tax credit limitation is correspondingly lower for foreign qualified dividends and capital gains (because the U.S. tax on that income is lower).^[41] The lower limitation is achieved by reducing the gross foreign-source qualified dividends and capital gains on Line 1a of Form 1116 by a fraction.^[42]

An individual can make an election to avoid this adjustment if:

1. The taxpayer is not subject to the alternative minimum tax;
2. The highest rate of tax imposed on the taxpayer’s taxable income (excluding net capital gain and qualified dividend income) does not exceed 28% (under current law); and
3. The amount of the taxpayer’s foreign-source qualified dividends and capital gains is less than $20,000.^[43]

The election is made by not making the adjustment on Line 1a of Form 1116.

Simplified AMT FTC Election

Taxpayers can elect to use a simplified Code §904 limitation to compute the alternative minimum tax foreign tax credit (“AMT FTC”).^[44] The election allows the taxpayer to use the same net foreign-source income for AMT as used for regular tax.^[45]

The election must be made for the first tax year after 1997 for which the taxpayer claims an AMT FTC.^[46] If the election is not made for that year, it cannot be made for any year. Once made, the election applies to all later tax years and may be revoked only with the consent of the IRS.^[47]

1. Code §164(a)(3). All section references are to the Internal Revenue Code of 1986, as amended (the “Code”) and the regulations promulgated thereunder. ↑

2. Code §901 and Treas. Reg. §1.901-1(d). ↑

3. Code §275(a)(4). ↑

4. Treas. Reg. §1.901-1(d)(2). ↑

5. Code §6511(d)(3) and Treas. Reg. §1.901-1(d)(1); Hart v. U.S., 585 F.2d 1025 (Ct. Cl. 1978). ↑

6. Treas. Reg. §1.901-1(d)(2). ↑

7. Code §§446-448. ↑

8. Treas. Reg. §1.461-1(a)(1). ↑

9. Treas. Reg. §1.905-1(c)(1). ↑

10. Code §905(a) and Treas. Reg. §1.905-1(e). ↑

11. Treas. Reg. §1.905-1(e)(1). ↑

12. Treas. Reg. §1.905-1(e)(1); Vento v. Commr., 147 T.C. 198 (2016), footnote 5; Strong v. Willcuts, 36-1 U.S. Tax Cas. (CCH) para. 9032 (D. Minn. 1935); Rev. Rul. 59-101. ↑

13. Treas. Reg. §1.905-1(e)(2). ↑

14. Code §905(a) and Treas. Reg. §1.905-1(e)(1). ↑

15. 55 T.C. 468 (1970). ↑

16. Treas. Reg. §1.986(a)-1(a)(1). A cash method taxpayer that has not elected to claim FTCs on an accrual basis must translate foreign income taxes into dollars using the spot rate on the date of payment. Treas. Reg. §1.986(a)-1(b). ↑

17. Treas. Reg. §1.986(a)-1(a)(2)(iv)(A). ↑

18. Treas. Reg. §1.986(a)-1(a)(2)(iv)(C). ↑

19. Id. ↑

20. Code §904(j)(2)(A) and (3)(A). ↑

21. Code §904(j)(3)(B) and (C). ↑

22. Code §904(j)(2)(B). ↑

23. Instructions to Form 1116. ↑

24. Code §962 and Treas. Reg. §1.962-1. ↑

25. Id. ↑

26. Treas. Reg. §1.962-2(b). ↑

27. Treas. Reg. §§1.901-1(d)(2) and 1.905-2(a)(1). ↑

28. See Section X of the preamble. ↑

29. Code §962(b) and Treas. Reg. §1.962-2(c)(2). ↑

30. Code §§951(a) and 954(a). ↑

31. Code §954(b)(4) and Treas. Reg. §1.954-1(d)(1). ↑

32. Treas. Reg. §1.954-1(d)(5). ↑

33. Treas. Reg. §1.954-1(d)(5)(i). ↑

34. Code §951A. ↑

35. Code §951A(c)(2)(A)(i)(III) and Treas. Reg. §1.951A-2(c)(7). ↑

36. Treas. Reg. §1.951A-2(c)(7)(viii)(A)(1) and (B). ↑

37. Treas. Reg. §1.951A-2(c)(7)(viii)(A)(1)(i). ↑

38. Treas. Reg. §1.951A-2(c)(7)(viii)(A)(2)(i) ↑

39. Code §1(h). ↑

40. Code §904(a). ↑

41. Code §904(b) and Treas. Reg. §1.904(b)-1. ↑

42. Instructions to Form 1116. ↑

43. Treas. Reg. §1.904(b)-1(b)(3). ↑

44. Code §59(a)(3). ↑

45. Code §59(a)(3)(A). ↑

46. Code §59(a)(3)(B)(i). ↑

47. Code §59(a)(3)(B)(ii). ↑