Exchange rates

The instructions for form 1116 are quite clear that you're supposed to convert foreign taxes paid using the exchange rate on the day you paid them (if using the cash basis). But then it also says the same for your income in publication 54 and form 2555, yet I understand it's OK to use the average exchange rate for the year in this case.

So do I really have to go through each of my wife's weekly payslips looking up the exchange rate, or is it acceptable to just take the average?

Assuming your wife earned income in relatively even amounts over the course of the entire year, the difference using the average or the spot rate should be minimal; so the average is fine.  In the example where there are no bonuses and each paycheck is exactly the same amount as the other, the difference using the average or the spot is zero, and thus 100% a-okay to use average.

I usually use the average for the year, and spot rate for any substantial payments (i.e., bonus, options, or the amount due on 31 Jan 06).  When I say "substantial", I mean $20,000 or more.  The net tax difference (the increase or decrease to your US tax bill) is usually nil on smaller amounts.

The best place to get spot rates is www.oanda.com.  The best place to get the IRS approved annual exchange rate to four digits of accuracy is http://www.federalreserve.gov/RELEASES/g5a/

Good luck.

I thought we were supposed to use an average for the year.  Does this mean to just use the rate listed in January 2007 for taxes to be filed for the 2006 -2007 tax year?

Thanks!

Criostin,

I give the website where the IRS approved averages can be found.  For 2006, use the 2006 average.  The 2007 average has not been published yet, as we still have several months to go.

For UK taxes, you would use an average covering 6 Apr 06 - 5 Apr 07, which you can get on www.oanda.com in their historical section.

Just a quick point of order; for UK taxes, the HMRC wouldn't mind if you used OANDA because it is reaonable, but they prefer if you used HMRCs official exchange rates because they are based on figures published in the Financial Times.  So for 2006/07 it was 1.8932.