US year end planning, Part One: Foreign Tax Credit review
In 2018 and 2019, many individuals and their advisers have been grappling with the impact of the Tax Cuts and Jobs Act, the largest overhaul of the US tax code in 30 years, signed into law by President Trump on 22 December 2017. As the end of 2019 approaches, many individuals will be looking at their 2019 US tax position to see if they need to consider any actions before 31 December 2019.
In this note, we take a look at international assignees where it is essential that Foreign Tax Credit positions are reviewed before the end of 2019 to reduce the potential risk of double taxation arising. Individuals (Or employers with tax equalised assignees) should act before the end of 2019 to optimise their position.
Foreign Tax Credit review
US citizens and green card holders are liable to US tax on their worldwide income no matter where they are residing or where the income arises. Additionally who are not US citizens or green card holders but are US tax resident are generally also liable to US tax on their worldwide income received as a US tax resident even if it was earned prior to their arrival in the US (for example a bonus or share award). As a consequence potential double taxation can arise.
US tax law recognises this and has a set of rules that allow such individuals to claim a foreign tax credit to offset their US income tax liability on foreign income. On paper, the rules appear to be manageable but there are often practical difficulties that can catch some people out, resulting in actual double taxation or a cash-flow impact of funding both US and Foreign taxes while they wait for a credit to be claimed.
‘Paid’ versus ‘accrued’
Under these US rules, an individual may choose to claim foreign tax credits using a ‘paid’ basis or an ‘accrued’ basis. Applying the ‘paid’ basis means individuals can claim credits for all foreign tax payments made. This would include foreign withholding and tax payments resulting from a tax return, albeit refunds received reduce the amount that can be claimed. Under the ‘accrued’ method, taxpayers claim a credit for foreign taxes for the foreign tax year ended in a US tax year. For example, with the Netherlands where the tax year is a calendar year you claim a credit for the total tax for 2019 in the Netherlands even if the tax is paid in 2020. The ‘accrued’ method is therefore popular in countries that use a calendar year and taxes are paid in arrears. The ‘paid’ basis is popular for countries that operate withholding taxes or for unusual tax year ends, such as the UK, where the tax year ends on 5 April where under the ‘accrued’ method, the total UK tax for the year ended 5 April 2019 is eligible to be claimed as a foreign tax credit.
When claiming a foreign tax credit, the individual should look at eligible foreign taxes paid or accrued in the year and compare this to the US tax on the foreign income for that year. The individual is only allowed a credit to the extent of the US tax on the foreign income for that year so if their eligible foreign taxes are higher than this, they have an excess credit. Fortunately, the US rules allow people to use this excess in the prior year and carry it forward any remainder for up to 10 years. The excess may be used in years where the foreign tax one pays or accrues are lower than the US tax on foreign income for that year.
There is, nevertheless, a risk, that some individuals claim a credit too late and are unable to claim the credit against the income for the year in which it arises. So, for example, where an individual realises a capital gain in 2018 but does not settle the foreign tax until 2020 and uses the ‘paid’ basis, he may not be able to realise a credit against the 2018 liability. If the tax were settled in 2019, it may be possible to carry it back to 2018 if unused in 2019 under the ‘paid’ basis..
This exercise is not just relevant to US taxpayers residing overseas. It is also important for assignees to settle home country tax liabilities on earnings taxable there if not done so or personal income such as rental income. Examples of employment income where significant foreign tax liabilities can arise include bonuses or share awards that relate to the pre-assignment period.
Individuals and employers should review their foreign tax credit position for 2019 prior to 31 December 2019 to see if they should settle any outstanding foreign tax liabilities prior to 31 December 2019.
How can we help
Abbiss Cadres has the expertise to support you and your assignees with these aspects. Please contact Matthew Fox or call +44(0)203 051 5711