FTC limitations - additional credit worksheet vs resourcing US income

Hello all,

USC/UKR. First time tackling a return with UK + US source income. Previously only needed one general income f1116 to cover my UK pension and self employment income.

I now have to start taking IRA distributions (and this year have a small US capital gain) due to an inheritance. So I must take a treaty position to avoid double tax due to the FTC limit on US source income. I have concluded I likely will have to pay US tax on the CG as it's less than the UK allowance, but for the IRA distribution it seems like there are two treaty-based ways to increase the credit on f1116 to eliminate the US liability. I was wondering if anyone can elaborate on which is correct/preferred?

1) File a second f1116 with the the IRA income as "Certain income re-sourced by treaty" in order to use more of my tax as credit against that income.

2) Continue to use a single f1116 but  use the worksheet at the back of p514 (page 27 on the current addition) to add an "increase in limitation" on line 22.     

Searching this forum there seems to be a lot of discussion on approach (1) but no mention of the p514 additional credit worksheet that I can find. Wouldn't (2) actually be more appropriate since Article 24 just says the US needs to grant a credit for UK income taxes paid UK rather than "it really should be considered UK income instead" (i.e. resourced)".

 Thanks for sharing your experience/insight in advance. Fun, this treaty stuff!

I do number 1 as suggested. My US income from US pension and other US income is taxed in US and UK so I file a 2nd F1116 with “Certain Income Resourced By Treaty”.

Is this in respect to distributions for an inherited IRA?  For US taxes, I just report the distributions received as reported on the 1099-R forms.  For UK taxes, I've declared (to the HMRC) my inherited IRAs and annuities as inheritances (i.e. not taxable) and for distributions received I only report the gains (if any) within distributions.

I do number 1 as suggested. My US income from US pension and other US income is taxed in US and UK so I file a 2nd F1116 with “Certain Income Resourced By Treaty”.

@durhamlad - I know based on other posts that you're not yet in receipt of US Social Security - but when you do - which form and category do you record it on?

I'm just finishing off my 2021 return - I wasn't in receipt in 2021 - although it was due and was finally paid in March 2022 but backdated to November. I'm assuming that I won't report this until 2022 - but it will feature in my UK 2021/22 return - do you agree?

My wife is in receipt of SS as of 2021 tax year so when filing her IRS return she used the figures from her SSA 1099 and entered it on line 6a, and put zero in line 6b (taxable portion). No other forms needed, no F1116 since it is ONLY taxed in the UK in our situation.

Come the 2021/22 HMRC return she’ll be reporting it as a foreign pension, just like I do for my US pensions.

In your case I would report the SSA in the HMRC 21/22 return as you suggest.

@durhamlad - thanks for your response.

In terms of UK pensions - Government and private - where do you enter these? (if at all) F1116 resourced by Treaty?

@durhamlad - thanks for your response.

In terms of UK pensions - Government and private - where do you enter these? (if at all) F1116 resourced by Treaty?

I use F1116, resourced by treaty to claim FTCs on the UK taxes paid on my 2 private US pensions. I use another F1116, General Category to claim back the US taxes paid on my 2 UK private pensions which are also taxed by the UK. I also now am in receipt of my UK OAP and that is not even mentioned on my US return since it is only taxable in the UK.

Is this in respect to distributions for an inherited IRA?  For US taxes, I just report the distributions received as reported on the 1099-R forms.  For UK taxes, I've declared (to the HMRC) my inherited IRAs and annuities as inheritances (i.e. not taxable) and for distributions received I only report the gains (if any) within distributions.

Thanks Alan, you are right this is for distributions of an inherited IRA. Curious what is the basis for claiming these as not taxable in the UK though? And have you had it OK'ed by an tax advisor? This would save me a TON of money  as UK tax rate is much higher, but I've done a fair bit of reading on the subject and never seen this suggested before. Didn't cross my mind as as far as I can tell reading the tax treaty the HMRC considers this as inheriting a pension, not cash, which is usually taxable.

I do number 1 as suggested. My US income from US pension and other US income is taxed in US and UK so I file a 2nd F1116 with “Certain Income Resourced By Treaty”.

Thanks for sharing your experience durhamlad. Any particular reason you choose 1) over 2)? Crunching the numbers it seems like 2) would let me use more of the credit in my specific case.

Thanks Alan, you are right this is for distributions of an inherited IRA. Curious what is the basis for claiming these as not taxable in the UK though? And have you had it OK'ed by an tax advisor? This would save me a TON of money  as UK tax rate is much higher, but I've done a fair bit of reading on the subject and never seen this suggested before. Didn't cross my mind as as far as I can tell reading the tax treaty the HMRC considers this as inheriting a pension, not cash, which is usually taxable.

Thanks for sharing your experience durhamlad. Any particular reason you choose 1) over 2)? Crunching the numbers it seems like 2) would let me use more of the credit in my specific case.

I think it is a cleaner solution, but if the 2nd method works better for you then go for it.  By cleaner I mean one F1116 for all my foreign income and a 2nd for all by US income deemed as resourced by treaty.

On the inherited IRA my thoughts would be that the inheritance of IRAs would be treated as any other inheritance and not taxable. However, after that the IRA is treated the same as any IRA and distributions are taxed as regular income, gains and losses within an IRA are irrelevant.

I think it is a cleaner solution, but if the 2nd method works better for you then go for it.  By cleaner I mean one F1116 for all my foreign income and a 2nd for all by US income deemed as resourced by treaty.

Thanks. I think I that the second F1116 is also cleaner in the sense that the worksheet is not an official form and I dislike having to attach "extra" pages to the return. I'll update on which approach I ultimately use for posterity.

On the inherited IRA my thoughts would be that the inheritance of IRAs would be treated as any other inheritance and not taxable. However, after that the IRA is treated the same as any IRA and distributions are taxed as regular income, gains and losses within an IRA are irrelevant.

Yes this is my opinion too. Particularly as newcomer link: https://www.gov.uk/tax-on-pension-death-benefits [nonactive] specifically mentions income tax due on inherited pensions in most cases where the deceased is over 75 (they were in my case). There is no detail I can find on foreign inherited pensions but per the treaty, IRA distributions should be considered under these brackets (payments from a drawdown, defined contribution plan). No income tax due on the gross inheritance of due to the deceased having no presence or assets in the UK.

HOWEVER, I'm very interested to hear details from anyone who has successfully used a different strategy - It's a relatively large inheritance, so UK tax on much of the drawdown balance will be at least at the 40% rate (due to the US requirement to empty the IRA in 10  years), so it would be very preferable to only pay US tax rates instead.

Also curious to hear more from Alan or others on "declaring the inheritance". I couldn't find any way to do this as a beneficiary. IHT400 appears to only be for the executor of the estate (and there is no way they are going to do that as an entirely US based person dealing with a US based estate with no UK IHT liability). Topic for a different thread perhaps.

Also curious to hear more from Alan or others on "declaring the inheritance". I couldn't find any way to do this as a beneficiary. IHT400 appears to only be for the executor of the estate (and there is no way they are going to do that as an entirely US based person dealing with a US based estate with no UK IHT liability). Topic for a different thread perhaps.

 My wife has been a beneficiary in 3 instances, with her lawyer brother being the executor of the estate in each case. The recipients have nothing to report or declare to HMRC, all taxes due are paid for out of the estate before distribution. These inheritances were all from UK relatives but I believe the same is true in the USA, that the estate is liable to pay any taxes, not the recipients. It is the same when receiving gifts from someone, nothing to declare as it is the giver who has the responsibility of reporting or recording gifts.

Also curious to hear more from Alan or others on "declaring the inheritance".

In 2017 I phoned the HMRC helpline and eventually spoke with a seemingly knowledgeable tax inspector with whom I explained about my inherited IRAs and annuities.  He said that because it's inherited capital, the only element the HMRC would look at is anything above the capital distribution; i.e. I would not need to pay tax on the capital but I would need to pay tax on any gains.  I explained further that I would be receiving some distributions as so-called minimum required distributions (MRDs), but he said that didn't matter; just report any gains and pay tax on that.

He added that Article 17 (which I can't remember is about) is not applicable to inherited accounts (but it would be if it was a pension I established myself).

He said to make a white space to that effect.  I thus wrote in Box 19:
"I recently inherited accounts in the USA. From a UK perspective, I am treating these accounts as an inheritance, i.e. there is no tax on capital but I need to pay tax on any gain. I determined the growth within distributions received during the 2016-17 tax year to be £XX (rounded), hence I have declared this amount in form SA106."

That's about all I know.  I don't stake claim as to correctness, but that's the feedback I had from the HMRC.

In 2017 I phoned the HMRC helpline and eventually spoke with a seemingly knowledgeable tax inspector with whom I explained about my inherited IRAs and annuities.  He said that because it's inherited capital, the only element the HMRC would look at is anything above the capital distribution; i.e. I would not need to pay tax on the capital but I would need to pay tax on any gains.  I explained further that I would be receiving some distributions as so-called minimum required distributions (MRDs), but he said that didn't matter; just report any gains and pay tax on that.

He added that Article 17 (which I can't remember is about) is not applicable to inherited accounts (but it would be if it was a pension I established myself).

He said to make a white space to that effect.  I thus wrote in Box 19:
"I recently inherited accounts in the USA. From a UK perspective, I am treating these accounts as an inheritance, i.e. there is no tax on capital but I need to pay tax on any gain. I determined the growth within distributions received during the 2016-17 tax year to be £XX (rounded), hence I have declared this amount in form SA106."

That's about all I know.  I don't stake claim as to correctness, but that's the feedback I had from the HMRC.

Thanks for this.

That was a good explanation. Sounds like when a person inherits an IRA it loses its pension wrapper and becomes a regular taxable account as far as HMRC is concerned.

Yes thanks Alan for elaborating. I will also phone HMRC before submitting my self assessment this year and see if I get the same information. Will report back.

Mook,

Thank you for pointing out the worksheet in IRS Publication 514.  I was not aware of this worksheet.  Page 13 of Publication 514 states:

Certain Income Re-Sourced by Treaty

If a sourcing rule in an applicable income tax treaty treats U.S. source income as foreign source, and you elect to apply the treaty, the income will be treated as foreign source.

You must figure a separate foreign tax credit limitation for any such income for which you claim benefits under a treaty, using a separate Form 1116 for each amount of re-sourced income from a treaty country. This rule does not apply to income that is re-sourced by reason of the relief from double taxation rules in any U.S. income tax treaty that is solely applicable to U.S. citizens who are residents of the foreign treaty country.

The last sentence quoted above seems to be saying that if you are a US citizen living in the UK and you have some US-source income, you should not file a second Form 1116 with the income re-sourced by treaty to avoid double tax.

Page 23 of Publication 514 states:

Tax Treaties

The United States is a party to tax treaties that are designed, in part, to prevent double taxation of the same income by the United States and the treaty country. Many treaties do this by allowing you to treat U.S. source income as foreign source income. Certain treaties have special rules you must consider when figuring your foreign tax credit if you are a U.S. citizen residing in the treaty country. These rules generally limit the amount of U.S. source income that is treated as foreign source income. * * * There is a worksheet at the end of this publication to help you figure the additional credit that is allowed by reason of these limited re-sourcing rules.

This part of the publication seems to be saying that US citizens living in the UK that are receiving US-source income should use the worksheet to claim credits to avoid double taxation.

Both places in the publication seem to be saying not to complete the second Form 1116, but instead to complete the worksheet.  This view is new to me.  The current version of IRS regulation 1.904-4(k)(1)(iv)(A) supports this interpretation.  The worksheet has been in Publication 514 for many years, but the regulation was updated to be consistent with this treatment only in 2019.