ExPat CPA discusses new Foreign Tax Credit Restriction | Structured Passive Investment Arrangement | IRS Form 1116 or Schedule A

As an ExPat CPA, I stay current with new developments on the Foreign Tax Credit, reported on IRS Form 1116, or Schedule A, as an itemized deduction. There are final IRS regs that end using foreign taxes paid on a structured passive investment arrangement to qualify for the Foreign Tax Credit.

Brief Overview Foreign Tax Credit

Per the IRS: The foreign tax credit is intended to reduce the double tax burden that would otherwise arise when foreign source income is taxed by both the United States and the foreign country from which the income is derived.

Four tests must be met to qualify for the credit:

• The tax must be imposed on you.
• You must have paid or accrued the tax.
• The tax must be a legal and actual foreign tax liability.
• The tax must be an income tax.

What is a Structured Passive Investment Arrangement?

I base the following on an article in the October 2011 Journal of Accountancy.

If a foreign investment meets all the following six criteria, it is a Structured Passive Investment Arrangement, and the foreign taxes paid on it don’t qualify for exclusion on Form 1116.

1) The arrangement uses a special purpose vehicle or technique that meets two requirements. First, all the income is generated through passive investments. Second, there is a foreign payment or tax attributable to the entity.

2) The investor is a “US Party”.

3) The amount of foreign tax paid by the special purpose vehicle is higher than what the investor would reasonably expect if the income producing assets were held personally. So, this is a gray area open to the vagaries of estimates.

4) The arrangement is reasonably expected to generate a tax benefit under the tax laws of the foreign country.

5) The investor directly or indirectly owns equity in the assets of the Structured Passive Investment Arrangement.

6) The treatment to calculate taxes in the foreign country is less, or inconsistent, compared to tax treatment in the US.

ExPat CPAs will continue to help define these regs by challenging them when appropriate. Foreign tax and banking are dynamic issues with the IRS that deserve continual monitoring.

I’m an ExPat CPA with a virtual office to accommodate international clients. For a free initial phone consult, call (910) 399-2705.