Foriegn Tax Credit or Deduction for AMT

PRACTICE TIP: For most taxpayers, it is usually more advantageous to
take the foreign tax credit than to take a deduction for foreign
taxes paid. A deduction from income serves only to reduce taxable
income while the credit reduces actual tax liability. On a dollar
basis, a tax deduction is only worth the value of the taxpayer's
maximum tax bracket for that income. The credit, on the other hand,
reduces the taxpayer's actual U.S. tax liability by the dollar amount
of the qualifying foreign taxes paid.

EXAMPLE 1: A taxpayer is in the 27.5 percent U.S. income tax bracket
for 2001. His deduction of $1,000 in foreign taxes paid is worth, at
most, $280 (less in later years, when the brackets will be lower),
the value of his maximum income tax bracket. If he elects the foreign
tax credit, the $1,000 is worth $1,000. If qualifying, the taxpayer
deducts (credits) his overall U.S. tax liability by the full amount
of $1,000 for the foreign taxes he paid.

EXAMPLE 2: A U.S. taxpayer receives a $1,000 dividend from a foreign
corporation in 2001. He pays tax to the foreign country, at a 30
percent rate, a tax of $300. His U.S. marginal tax rate is 30.5
percent. If he deducts the $300 foreign tax (leaving him with a
taxable income of $700) he pays a $214 United States tax ($700 x 30.5
percent = $214). His total tax liability on $1,000 of taxable income
therefore, is $514 ($300 plus $214 = $514). If, however, the taxpayer
elects to credit the $300 foreign tax against his $305 United States
tax ($1,000 x 30.5 percent = $305) otherwise due, his United States
tax is $5 ($305 minus $300 = $5). His total tax liability is $305,
which is $209 less than if he had taken the deduction.

However, there are circumstances in which the deduction is more
beneficial than the credit. For example, although excess credit
carryovers are allowed, if a taxpayer has insufficient foreign source
income to claim the credit, the carryovers have time limits and might
expire before they can be absorbed. Also, if the taxpayer will suffer
an overall net operating loss (NOL), he would have no tax liability
against which to use the credit. A deduction in this case would
increase the NOL. Thus, in effect, the taxpayer would extend the time
period for a carryforward from the five-year period allowed the
credit to the twenty-year period allowed the NOL. Code Section
172(b)(1)(A)(ii). For most taxpayers however,
the credit will usually be preferable.

CAUTION: A taxpayer claiming the foreign tax credit may be liable for
the alternative minimum tax (AMT) under Code Section 55(a). A set of
special rules applies for the "alternative minimum
foreign tax credit." See Code Section 59. The AMT
generally is discussed in Ch. 60. The AMT foreign tax
credit is specifically covered in Section 60.13

In certain circumstances, the credit may be denied altogether. The IRS has
published its concerns that certain taxpayers (primarily multinational
corporations) may enter into arrangements that would lead to abuse of the
foreign tax credit. In the IRS's view, abusive arrangements generally are
those that yield little or no economic profit relative to the expected
U.S. tax benefits derived from the availability of the foreign tax credit;
they thus provide a shelter for low-taxed foreign-source income from a
residual U.S. tax. Such arrangements are more fully described in Notice
98-5, 1998-1 C.B. 334.


Read the full story here.