How to attribute tax paid to HMRC for passive income on 1116

I’d like to ask how others figure out tax paid on the passive income category of the 1116. As an example, between April and December the total income from all passive income sources would be £25,000 and from January to March of the following year it would be £500. (This total amount includes 401(k) & IRA distributions, interest income and also none HMRC taxable income such as normal ISA interest and any Premium Bond income, National Lottery winnings. The total tax paid to HMRC in this example for the April-to-April tax year is £2,500
How I would approach is I’d take the £2,500 tax paid to HMRC, divide by 12, and multiple by 9 (April to December – 9 months). So, £2,500 \ 12 = £208 x 9 = £1,875. Then the 3 remaining months (January to March) x £208 = £624 would be applied to the next tax return with £1,875 (total of £2,500 – assuming income and tax was exact although this is just an example).
So, for 2021 U.S. passive foreign income tax applied to the 1116 would be £1,875? (In this example, the is NO other income from any other source)
Is this as others would, do it? Any other methods would be appreciated.

I'll be interested to see the replies as I really don't know since I pay a tax account to do our return and form 1116 is a mystery to me.

First, it's my understanding 401k and IRA distributions taxed by HMRC are claimed in the "Income Resourced by Treaty" basket, and not the "Passive" basket. Interest taxed by HMRC is claimed in the passive basket. Income not taxed by HMRC is not included in any basket on 1116 for tax credit, other than on the lines asking for total gross income (3d and 3e).

From your description, it appears you may have income in two baskets. Your next decision is whether you are using the "cash" basis or the "accrued" basis of calculating the credit. Most use the cash method, and from your info above, it would appear cash would be best for you, but there are times when the accrued method is better. I use accrued, but that's because I was tax resident in France for a number of years, and at that time, French tax paid was very difficult to align to US requirements time wise.

You'll also need to "apportion" tax paid to the source (basket) of income. So, tax paid to HMRC on interest and tax paid to HMRC on IRA/401k must be apportioned to the total tax paid on all income combined. Apportioning according to the months the income was paid has no bearing on 1116. 1116 is concerned with when the tax was paid, according to which method of credit you use.

For example, in year 1 (April 6 to Dec. 31, 2020), you receive £25,000. In year 2 (Jan. 01 to Apr. 5, 2021) you receive £500 in interest. The tax payable to HMRC on the two amounts of UK tax year 2020/21 is not due until 31 Jan. 2022, year 3.

If you pre-pay the tax due to HMRC for 2020/21 by 31 Dec. 2021 (year 2), you may claim the credit on the 2021 US tax return, using the cash basis. If you only pay the tax due to  HMRC for 2020/21 during (up to the 31st) Jan. 2022 (year 3), you may claim the credit only on the 2022 US tax return, using the cash basis.  If you only pay the tax due to  HMRC for 2020/21 during (up to the 31st) Jan. 2022 (year 3), you may claim the credit on the 2021 US tax return, using the accrued basis, if you know the amount due.

Edit in bold 
 

 

Thank you for your detailed explanation. Isn’t re-sourced by treaty only for items such as Social Security? Income that under the DTA is only taxable to HMRC and is IRS tax exempt. I had thought that a 401(k), IRA and also U.K State Pension is taxable in both countries, (Passive category). As HMRC is the primary authority, tax paid to them, would then be used as a credit on the 1116.

Why not use an 1116 even if you paid no tax paid to HMRC? For example, if you have 10 years of 1116 tax credits, win a large premium bond prize, or lottery win that is obviously tax free in the U.K but not in the eyes of Uncle Sam. Then the IRS tax bill would be lowered by virtue of utilizing the past 1116 tax credits. All U.K passive income; taxed or untaxed by HMRC would then figure in part 1 section A of the 1116

I see that you simply use the credit in the year that tax is actually paid to HMRC to the same IRS reporting year in question. Thanks again OAP.

Thank you for your detailed explanation. Isn’t re-sourced by treaty only for items such as Social Security? Income that under the DTA is only taxable to HMRC and is IRS tax exempt. I had thought that a 401(k), IRA and also U.K State Pension is taxable in both countries, (Passive category). As HMRC is the primary authority, tax paid to them, would then be used as a credit on the 1116.

Why not use an 1116 even if you paid no tax paid to HMRC? For example, if you have 10 years of 1116 tax credits, win a large premium bond prize, or lottery win that is obviously tax free in the U.K but not in the eyes of Uncle Sam. Then the IRS tax bill would be lowered by virtue of utilizing the past 1116 tax credits. All U.K passive income; taxed or untaxed by HMRC would then figure in part 1 section A of the 1116

I see that you simply use the credit in the year that tax is actually paid to HMRC to the same IRS reporting year in question. Thanks again OAP.

For sure “resourced by treaty” is for all US sourced income. This informs the IRS that the US income on the form has been treated as foreign income and taxed as such in a foreign country. You can’t normally take a foreign tax credit against US income. My US return has 2 forms 1116, one for passive income for our UK pensions and interest, and one marked as resourced by treaty for our US pensions, dividends and capital gains.

I was of the opinion that as a U.K resident, you are taxed on worldwide income. As a U.S. Citizen, you are too taxed on worldwide income. My reading of the DTA only shows (in this case) U.S. SS as taxable ONLY in the U.K and  tax exempt in the U.S, (so 1116 re-sourced by treaty can be used). Other income like 401(k), IRA, U.K State Pension income is fully taxable in both countries and has nothing to do with the treaty (Savings Clause) and therefore the re-sourced option of the 1116 would not apply., (no resourcing rule).

I'm not taking Social Security, so can't speak from experience. I'd hazard a guess that you could could state the amount on 6a of the 1040, putting 0 on line 6b. Then writing a note to say something about tax exemption to article 17 of the DTA. Or state the full amount on line 6b and then file an 1116 (re-sourced by treaty) to claim up to the U.S. tax limit.

I was of the opinion that as a U.K resident, you are taxed on worldwide income. As a U.S. Citizen, you are too taxed on worldwide income. My reading of the DTA only shows (in this case) U.S. SS as taxable ONLY in the U.K and  tax exempt in the U.S, (so 1116 re-sourced by treaty can be used). Other income like 401(k), IRA, U.K State Pension income is fully taxable in both countries and has nothing to do with the treaty (Savings Clause) and therefore the re-sourced option of the 1116 would not apply., (no resourcing rule).

I'm not taking Social Security, so can't speak from experience. I'd hazard a guess that you could could state the amount on 6a of the 1040, putting 0 on line 6b. Then writing a note to say something about tax exemption to article 17 of the DTA. Or state the full amount on line 6b and then file an 1116 (re-sourced by treaty) to claim up to the U.S. tax limit.

I also am not receiving SS yet so can't comment except to say that I know it is not taxed in the US so no foreign tax credit and it won't appear in any forms 1116. I have asked TurboTax users how it they report it and they say they put a negative amount in "other income" to zero out SS with a comment that it is per the tax treaty. (TurboTax can't be forced to put a zero in 6b when you enter the details from the SSB form you have received.

I am receiving other income from the US which is taxed in both countries such as US private pensions, dividends and capital gains.  It is not my opinion on which income should be resourced by treaty but that of our US/UK dual qualified tax accountant who we pay to file our taxes each year so I can't argue the toss, simply stating what our tax pro does.  (My wife and I are both dual UK/US citizens living in the UK)

Income not taxed by HMRC is not included in any basket on 1116 for tax credit, other than on the lines asking for total gross income (3d and 3e).

Ignore this comment. It's total rubbish!

I know what I meant to say, but what I've actually typed above is bollocks. Put it down to a senior moment.

For sure “resourced by treaty” is for all US sourced income. This informs the IRS that the US income on the form has been treated as foreign income and taxed as such in a foreign country. You can’t normally take a foreign tax credit against US income.

I agree, although I never have had any 401K, IRA distributions, etc.

I was of the opinion that as a U.K resident, you are taxed on worldwide income. As a U.S. Citizen, you are too taxed on worldwide income. My reading of the DTA only shows (in this case) U.S. SS as taxable ONLY in the U.K and  tax exempt in the U.S, (so 1116 re-sourced by treaty can be used). Other income like 401(k), IRA, U.K State Pension income is fully taxable in both countries and has nothing to do with the treaty (Savings Clause) and therefore the re-sourced option of the 1116 would not apply., (no resourcing rule).

I'm not taking Social Security, so can't speak from experience. I'd hazard a guess that you could could state the amount on 6a of the 1040, putting 0 on line 6b. Then writing a note to say something about tax exemption to article 17 of the DTA. Or state the full amount on line 6b and then file an 1116 (re-sourced by treaty) to claim up to the U.S. tax limit.

I am receiving US SS in the UK. I've also had discussions with the IRS about reporting this on a 1040.

I do the following:
On line 6a of the 1040 (2020), I put the gross amount received from SSA (1099). On line 6b, taxable income, I put "0". I refer, in pencil next to 6a, to Article 17(3) of the treaty. From this point onwards, I ignore US SS, except to apportion UK tax paid on the US SS and deduct it from total tax paid to HMRC for Part II of 1116. There may be another place on the 1116 to rectify the UK tax on US SS (line 12 0f 1116) but I've never used it. That's all. No from 8833, no additional lines on other forms (other income), nothing more. It's not taxable by the US, end of.

I am receiving US SS in the UK. I've also had discussions with the IRS about reporting this on a 1040.

I do the following:
On line 6a of the 1040 (2020), I put the gross amount received from SSA (1099). On line 6b, taxable income, I put "0". I refer, in pencil next to 6a, to Article 17(3) of the treaty. From this point onwards, I ignore US SS, except to apportion UK tax paid on the US SS and deduct it from total tax paid to HMRC for Part II of 1116. There may be another place on the 1116 to rectify the UK tax on US SS (line 12 0f 1116) but I've never used it. That's all. No from 8833, no additional lines on other forms (other income), nothing more. It's not taxable by the US, end of.

How do you determine how much of your UK taxes are apportioned to SS?  I  have just started OAP, my wife is starting OAP and SS this year. (and in 3 years I will start SS).  With the first £12,500 tax free  can you use OAP and SS to fill the tax free portion first?

e.g.
Total income £22,000

OAP+SS = £12,000
UK interest + private pension =£5,000
US private pension =£5,000

100% of UK tax paid can be used as a foreign tax credit?

How do you determine how much of your UK taxes are apportioned to SS?  I  have just started OAP, my wife is starting OAP and SS this year. (and in 3 years I will start SS).  With the first £12,500 tax free  can you use OAP and SS to fill the tax free portion first?

e.g.
Total income £22,000

OAP+SS = £12,000
UK interest + private pension =£5,000
US private pension =£5,000

100% of UK tax paid can be used as a foreign tax credit?

I'd be keen to learn how to formulate this too. I'm guessing that you'd need to allocate each part of income into the specific group, and then figure the tax paid on that group. something like the income in question over total income with a multiplier of foreign tax paid. Perhaps there is an online calculator!

How do you determine how much of your UK taxes are apportioned to SS?  I  have just started OAP, my wife is starting OAP and SS this year. (and in 3 years I will start SS).  With the first £12,500 tax free  can you use OAP and SS to fill the tax free portion first?

e.g.
Total income £22,000

OAP+SS = £12,000
UK interest + private pension =£5,000
US private pension =£5,000
100% of UK tax paid can be used as a foreign tax credit?

I break it down to the basics for each individual source of income (even ISA vs. non-ISA interest). In your example:
UK OAP = £3,000 or 13.6% of £22,000
US SS = £9,000 or 40.9% of £22,000
UK Interest = £2,500 or 11.4% of £22,000
UK private pension = £2,500 or 11.4% of £22,000
US private pension (taxed in UK) = £5,000 or 22.7% of £22,000

UK tax on £22,000 (@20% bracket) = 22,000 - 12,500 (tax free) = £9,500 (taxable) @ 20% = £1,900

US SS = 40.9% of £1,900 = £777.10
rinse, repeat for each source of income.

For 1116, if there are more than one baskets, the remaining 59.1% of tax paid (£1,900 - £777) £1,123 would need to be additionally apportioned between each of the baskets.  The UK tax allowed for credit in Part II  (if only one basket is required) would be (1,900 - 777) £1,123 (then converted to $US).

I haven't double checked the figures, so beware another senior moment, but you'll see the method. Of course, tax free amounts on interest, etc., will change the calculations, but we've kept it simple.

I use a spreadsheet I made for my unique situation to make all the calculations. Once you have it, and are confident it is correct, filling in the cells and arriving at workable tax return figures takes little time.

Thanks Mr OAP -very logical indeed 

Sounds about right.