Second opinion on TFX accountant's treatment of tax credits from sale of stock?

I have been a UK resident since 2013 (and citizen since 2019). In December and early January of 2020/2021, I sold some stock to fund the purchase of a house. Due to the mismatched US and UK tax year, I didn't pay taxes on this in the UK until mid-late 2021, and I paid full US taxes on these sales when I filed my 2020 return. I had planned to use the excess FTCs from the UK to offset some of this tax.

However, when filing my 2021 return, the CPA from TFX has assigned the taxes that I paid on the sales of the stock to HMRC to "Income Resourced by Treaty". He said this is necessary as the sales generated 1099s. In addition, he says that foreign tax credits in the "Income Resourced by Treaty" cannot be carried back or forward. He said the only way for me to offset these taxes is to switch to "Accrued"--which as I understand is non-revocable and requires a lot more headaches than sticking to Paid.

So my two questions are:

• Is it true that these taxes belong in the resourced by treaty category, even though they were taxed >10% by the UK?
• Is it really impossible to carry back/forward FTCs in the "Resourced by Treaty" basket? I cannot find this limitation anywhere else.

According to the CPA, the only choices are 1.) being double-taxed, or 2.) switching to Accrued--both of which are really awful options.

You didn’t say if the shares you sold were in the US or UK, but assuming they were in the US then I believe “Resourced by Treaty” is the correction designation. Most years I sell some shares in the USA resulting in some capital gains plus I have 2 US pensions. Because the cap gains and my US pensions are all US income then if it was not for the treaty I would pay US taxes and be unable to claim back the taxes I paid on the same income. I don’t know about the carried forward issue. I also have UK pensions which are taxed by the US and UK and I have another foreign tax credit that I use for that, marked as General Category. Resourced by treaty is really saying, “yes, I know this is US income but it is being treated as if it were foreign income due to a tax treaty”

On both 1116 forms the “Accrued” box is checked.  I have my taxes done by a tax pro in London so am just reporting what she does each year and that seems to be in line with what TFX are telling you.

It's curious why you can't carry back/forward. The “Resourced by Treaty” is just another basket, which would follow on the same as the other options. If you put an amount in the “Resourced by Treaty” box and explanation of that income, then how does the form know to not allow? My only idea would be if the amount was low enough not to use a 1116, in which case; correct there is no carried forward, yet no 1116 either.
“Resourced by Treaty” would be used on any U.S. sourced income like IRA's etc.

On another note, I hear so many mixed reports on where a U.K pension would go, Passive of General category.  Maybe there is no 'right' answer and each practitioner goes with what they believe correct

My experience of TFX is that a CPA and EA check your return, although I'm sure that you could dive in for a second option with them anyhow. They seem a pretty big firm and have been in the business for many years.

Let us know how it goes?

Thanks all!

From the research I've done, it seems that capital gains in particular should be treated as foreign source if you have a tax home outside the US. Regardless, I don't really care about the bucketing. I am just so confused about the lack of carryback for the Resourced By Treaty category. I have seen that nowhere else. And this isn't a super strange situation. Surely there are lots of American expats living in the UK who sell stock from a US brokerage account.

I just worry that I'm facing either being double-taxed or switching to Accrual, which I really don't want to do.

It's really strange. Here are the instructions for Form 1116:

https://www.irs.gov/instructions/i1116#en_US_2021_publink11441fd0e4670

Specifically, Line 10 discusses the carryback/carryforward. The only prohibitions on the carryback or carryforward are for Section 951A income. Surely it would mention Income Resourced by Treaty there as well?

This is going to cost me around $3k if I get this wrong. Honestly I'd be happy if I could find anyone else who takes this position, but I just can't.

I've been back and forth with TFX on this and it seems that they're pretty clear that they're not going to change: they're quite insistent that tax credits within the Resourced By Treaty basket are not eligible for carryover or carryback.

I had a conversation with a few other CPAs, including Neptune Tax (they're a great firm, but very expensive--really more for HNW clients maybe); none of them understand the reasoning of why carryback of Resourced By Treaty credits wouldn't be allowed.

I think I'm going to switch to another firm; unfortunately I've already pre-paid so I think that's $720 or so down the drain! But I really am not comfortable switching to the Accrued basis of accounting. It seems like it would bring a lot of pain and headaches for very little benefit--also, from what I understand, I'd be in the same bucket with Accrued as UK taxes don't technically meet the All-events test and are thus not considered Accrued until the end of the UK tax year.

If you’re indeed going to switch firms why not get the position in law from the other firms and also that of TFX. You can then look at the results side by side. There’s only one right answer and if TFX are in the wrong the startling correct facts must be taken on board. $720 is a great deal to flush away. I’d keep chipping at it.
Some tax pros on here may know the answer

If you’re indeed going to switch firms why not get the position in law from the other firms and also that of TFX. You can then look at the results side by side. There’s only one right answer and if TFX are in the wrong the startling correct facts must be taken on board. $720 is a great deal to flush away. I’d keep chipping at it.
Some tax pros on here may know the answer

I've been back and forth with the accountant on this one. Not sure what you mean by a statement in law, but below are some excerpts from the emails he's sent detailing this:

Technically, for the "resourced by treaty' category foreign tax credit (which applies in your case with US stock sales being taxed in the UK), this cannot be carried back nor can it be carried forward, as this is different type of foreign tax credit than the general category and passive (you don't have passive you don't technically have UK-sourced passive income). One possibility is that we could amend your 2020 US tax return and indicate "Accrued" on the type of foreign tax credit (both general and resourced by treaty), instead of Paid. In 2020, there was no foreign tax credit on the resourced by treaty but we could do this by amending and showing "Accrued". The Accrued is different from the Paid because it looks at what was the tax liability or assessment, rather than what was actually paid (which can be less). Right now, you are being double-taxed on the same income and using the "Accrued" would help resolve that. However, you have to use this going forward indefintely and can't switch back to the "Paid" type.

The resourced by treat type of foreign tax credit is not within the tax code. As well, 1.904-2 discusses separate category foreign tax credits but the 'resourced by treaty' is not part of this separate category (only general and passive). Two CPAs have reviewed the tax return as well, so we have confirmed all of this, as well as the "Accrued" solution.

Let me know and then we can move forward with the amendment of the 2020 return as I would recommend that.

Their reference to 1.904-2 gave a a good Google result of:
https://www.law.cornell.edu/cfr/text/26/1.904-2
It's heavy reading and I only see the Section 951A statement to the CB/CO.
Does this mean that anyone in receipt of an IRA/401(k) would need to select the 'Accrual' method? It would be interesting to know what others do, although previously stated by durham lad, his accountant does recommend this.

I assume this is your first year with TFX, what about your previous firm? You really have a choice of bad options indeed. I don't have any re-sourced category, so can't speak from experience. Either carry on and pay the $720 or have 2020 amended at extra cost and offset the 3k & accrual forever
I hope others more knowledgeable and experienced can way in.

Their reference to 1.904-2 gave a a good Google result of:
https://www.law.cornell.edu/cfr/text/26/1.904-2
It's heavy reading and I only see the Section 951A statement to the CB/CO.
Does this mean that anyone in receipt of an IRA/401(k) would need to select the 'Accrual' method? It would be interesting to know what others do, although previously stated by durham lad, his accountant does recommend this.

I assume this is your first year with TFX, what about your previous firm? You really have a choice of bad options indeed. I don't have any re-sourced category, so can't speak from experience. Either carry on and pay the $720 or have 2020 amended at extra cost and offset the 3k & accrual forever
I hope others more knowledgeable and experienced can way in.

This is my second year, actually! I filed myself when I was claiming the FEIE, but when I went over the threshold of income, I switched to TFX for 2020 and now 2021. Funnily enough, I actually mentioned to my 2020 CPA that I intended to carry these back and he indicated it'd be OK.

I've paid for consultations for other tax advisors who have agreed that credits in the Income Re-sourced by Treaty should carry back and forward just like any other bucket. I have the forms that TFX filled out for me, so I am thinking I'll just use TaxAct this year.

I really don't want to switch to the Accrual method. I'm fairly sure it wouldn't solve my problem. According to this (in Conclusion 2):

https://www.irs.gov/pub/irs-utl/am2008005.pdf

the taxes actually accrue on the last day of the foreign tax year - meaning I'd still have to carry them back.

Have you looked at the IRS forms and instructions (new for 2021) for Schedule B (form 1116)?

https://www.irs.gov/pub/irs-pdf/f1116sb.pdf
https://www.irs.gov/pub/irs-pdf/i1116sb.pdf

This is the first time the IRS has provided forms to reflect carryforward/carryback and it maybe gives a little more assistance. There is certainly a box (f) for certain income resourced by treaty - which indicates that it IS possible to carryforward & carryback taxes against this category - big question is whether the income to which you refer is one of the 'certain types'

Have you looked at the IRS forms and instructions (new for 2021) for Schedule B (form 1116)?

https://www.irs.gov/pub/irs-pdf/f1116sb.pdf
https://www.irs.gov/pub/irs-pdf/i1116sb.pdf

This is the first time the IRS has provided forms to reflect carryforward/carryback and it maybe gives a little more assistance. There is certainly a box (f) for certain income resourced by treaty - which indicates that it IS possible to carryforward & carryback taxes against this category - big question is whether the income to which you refer is one of the 'certain types'

I have seen this, and pointed it out, however the accountant seems quite firm that this is still impossible. I don't understand why the IRS would include a tickbox on the Form 1116 Schedule B that is impossible to use! Especially as they've specifically not included the Section 951A bucket. I'm going to file myself this year, I think, and amend my 2020 return to do the carryback.

He seems quite sure that this taxes should be in the Resourced by Treaty bucket rather than the Passive bucket--and honestly I don't really care which bucket it goes into. I just don't see how that should affect the carryback.

Accountants (and I'm one  ) have a tendency to always err on the side of caution  - ultimately though, this is YOUR tax return and you are the one that signs it - I can see no reason why you can't tick the Resourced by Treaty box and include carryback/carryforward any non-S951A taxes which the instructions to the form specifically mention :

Note. Don’t complete Schedule B for
section 951A category income because
the carryover provisions of section 904(c)
don’t apply to foreign taxes assigned to
section 951A category income.

I believe that your tax advisor is incorrect on both counts: (1) that the gains should be in the income resourced by treaty and (2) that if the gain should be in that category that the excess foreign tax credits cannot be carried back or forward.

For the source of the gain, I believe that the gain should be passive foreign-source income because you have a tax home outside the US and you paid at least a 10% tax to the UK on the gain.  This means that you are considered a nonresident of the US under Section 865(g)(2) for purposes of sourcing the gains.  Since you are considered a nonresident, the gains are considered foreign-source income.  It doesn’t matter that a 1099 was issued or that the sale was through a US brokerage account.

With respect to whether you can carryback the excess foreign tax credits for income that is resourced by a treaty, Section 904(d)(6) is the statute that provides the rule that the foreign tax credit limitation applies separately to this type of income.  Section 904(d)(6) states:

If (i) * * * any item of income would be treated as derived from sources within the United States, [and] (ii) under a treaty * * * such item would be treated as arising from sources outside the United States * * * [then] subsections * * * (c) of this section * * * shall be applied separately with respect to each such item.

Subsection (c) of section 904 contains the rule that says excess foreign tax credits can be carried back 1 year and forward 10 years.  Therefore, the statute (Section 904(d)(6)) explicitly provides that excess foreign tax credits in the resourced by treaty category can be carried back / forward.

These rules are complicated.  It is not surprising that they are screwing it up.

Thanks for all the replies! I tried to boil down exactly their position and sent him these three points to clarify TaxesForExpats' position:

• TFX's position is that only the General and Passive FTC baskets are eligible for carryover/carryback of excess credits.
• Thus, excess credits within the Income Resourced by Treaty basket are not eligible​​​​​​​ for any carryover or carry-back in any circumstance (even if that income is not Section 951A income).
• Taking an irrevocable Accrual election for FTC accounting will fix this, as UK taxes are deemed to accrue on the last day of the UK tax year (presumably per AM2008-005, Conclusion 2), but can be pro-rated throughout the preceding US tax year to offset that year's tax liability, i.e. even though UK taxes accrue in April 2021, we can pro-rate the credit in the 2020 US tax year.

He confirmed that all of these points accurately described their position, and that if I wanted to take a different position to the above I'd have to have my return filed elsewhere. So that's $720 down the drain unfortunately! The amount I'd recoup from the carryback is significant enough that I'll look elsewhere, and I really don't want to switch to Accrued (and tbh I find the pro-rating a bit suspect as well--IRS rules seem pretty clear that the credits should apply to the US tax year in which the end of the foreign tax year falls).

Sadly I think you've been badly let down by TFX - they appear to be a cookie cutter organisation - good enough for bog standard returns, but as soon as it gets a little more complex they become as useful as a chocolate teapot.

Their position appears to be to protect themselves, and not necessarily to be concerned about what is best for you .

They might have a  UK telephone number, but they only have a New York address - I even wonder about the legality of them conducting business in the UK - do they pay UK taxes or charge VAT on their services? - thought not.