In this post, we´re going to discuss how to find out the status of your 2020 tax refund and review Part 2 of foreign tax credit calculations.
Last Friday, May 17 was Tax Day, and you either filed your tax return, or you filed a request for an extension of time to file your tax return.
Congratulations!
For those of you living outside the USA, Tax Day is June 15, as usual. No special tax filing deadline postponement for Americans overseas this year.
If you have questions about tax filing deadlines and would like a refresher, feel free to refer to our June 14 2020 post of CBP, where we cover tax filing deadlines in detail.
If you have filed an extension request, keep in mind that extensions only provide additional time to file the tax return. They do not provide additional time to pay the tax due. You should pay as much of your expected tax balance as possible when requesting the extension.
For those of you outside the USA, the tax balance due date is also June 15. Penalties will not be assessed if you pay your tax in full by June 15, but interest starts to accrue if you haven’t paid your tax by May 17.
How much does the IRS currently charge in underpayment interest?
A 3% annual rate, compounding daily.
This is the same interest rate that the IRS pays on overpayments, which is a lot more than banks are currently paying. Banks are paying either close to zero, zero, or below zero.
When does the IRS pay YOU interest?
The IRS pays taxpayers interest when they fail to refund the overpayment of tax within 45 days of filing your tax return. You receive a refund from the IRS when you paid too much tax during the year. In those situations, the IRS owes you back the difference.
If you are owed a refund by the IRS, this may be your lucky year!
I’m referring to the possibility that you may need to wait a very long time to receive your IRS refund and, that while you wait, you are earning interest at a rate of 3%, courtesy of the US government. This rate is 30+ times what most banks are paying!
See? Not getting your refund fast enough can be good!
Yes, I’m being sarcastic, but, on the other hand, I try to find the silver lining in everything, and nothing beats the IRS in terms of interest payments right now. If you are going to be waiting for your refund any year, this might as well be the year. At least you are being compensated handsomely.
Normally, the IRS is very good at paying refunds quickly, usually within 21 days of filing a tax return.
This year?
Not so much.
Some people have been waiting for their refunds for more than eight weeks.
What is causing these unusual delays?
According to a recent report from the Government Accountability Office, GAO, the IRS pandemic-related challenges that began in 2020, continued into 2021, creating significant backlogs. In 2020, for example, the IRS paid $3 billion in interest to taxpayers because their refunds were delayed. This year, the interest expense for the IRS is likely to be greater and the delays are even longer than in 2020.
More than 29 million tax returns are being held back for manual processing either because:
- They require a Recovery Rebate Credit reconciliation – the difference between the EIP, or stimulus checks paid by the IRS and the EIP checks claimed on the tax return do not match, or
- Due to mid-tax season changes in the taxation of US unemployment benefits that forced the IRS to recalculate the refund amount on tax returns that had already been filed when the retroactive tax law changes were approved; or
- some other reason, like more people filing on paper instead of electronically. Paper returns require manual processing. Manual processing is slow….
What can you do if your refund is delayed?
Wait.
And not much more, unfortunately.
You can check the Where’s My Refund page on the IRS website to see if it provides any helpful information. It not always does. You can also try calling the IRS by phone to find out why your refund is being held back. Be prepared to be on hold for a while if you call.
If you used a tax return preparer, do not ask them. Their guess is as good as yours. Tax return preparers cannot influence the speed of a refund. There is nothing they can do to get you your money faster.
If you decide to call the IRS, what number should you call?
If you are calling from the USA: +1-800-829-1040
If you are calling from outside the USA: +1-267-941-1000
Then try to think about all that interest that you are earning while you wait.
It’s time now to go back to the subject we were discussing two issues ago: foreign tax credits.
You can find the first part of your foreign tax credit discussion here. We covered
- the concept of foreign tax credits and
- the different foreign tax credit baskets or categories.
This is where we will pick up today:
Avoiding double taxation through foreign tax credits (FTCs): how to allocate foreign income tax to the different foreign tax credit baskets.
As we discussed earlier, foreign tax credits can reduce US income tax on foreign source income dollar for dollar on different categories of foreign income.
Of the seven foreign tax credit categories, the four most commonly used by individual US taxpayers are the following:
- Passive income
- Foreign branch income
- Income re-sourced by treaty
- General limitation
How should you allocate your total foreign income tax to the different foreign tax categories?
Treasury Regulations 1.904-6 and 1.861-20 provide the rules for the allocation and apportionment of foreign income taxes to calculate foreign tax credits.
As you will verify if you follow the regulations linked above, the explanations are complicated and the examples are about corporations or businesses, not individuals, so they are not very helpful.
These are the basic concepts you need to understand:
You are required to apportion the total foreign income tax to each one of the different foreign tax credit baskets that apply to you in a particular tax year. The allocation is made at the taxable foreign income level.
How do you determine the taxable foreign income in each category?
In the simplest of situations, you would start with the gross income reported on the foreign tax return and classify each item of gross income into its relevant foreign tax credit category: rents into the passive category, wages into the general category, etc.
Once you have broken down the gross income by category, you need to allocate the tax deductions on your foreign tax return to each one of those categories. Deductions that are directly related to a specific item of income get assigned to that category. For example, if the foreign country allows an investment expense deduction, that deduction would be allocated to the passive category.
Deductions that are not directly related to specific items of income need to be prorated reasonably. For example, if the foreign country allows a standard deduction, the standard deduction can be apportioned proportionally to each one of the different foreign income categories.
Let’s use a quick example for a taxpayer living in a treaty country:
Total foreign income tax paid: $10,000
Total foreign gross income: $60,000
Total foreign standard deduction: $10,000
Total foreign taxable income: $50,000
The $10,000 standard deduction is not directly allocable to any particular category, so we are going to allocate it proportionally to each income category by reducing the gross amount by 16.6667% ($10,000/$60,000). We thus arrive at the following breakdown:
- $ 5,000 attributed to taxable foreign dividends
- $30,000 attributed to taxable foreign wages
- $10,000 attributed to taxable profit from foreign self-employed business
- $ 5,000 attributed to taxable US dividends taxed by the foreign country
- $50,000 total taxable income
Foreign dividends (10% of total taxable income) are passive category income. Foreign wages (60%) are general category income. The profit from self-employment (20%) is foreign branch category income, and the US dividends (10%) are income that can be resourced by treaty.
The $10,000 total foreign income tax would therefore be proportionally apportioned in this manner:
- $1,000 to the passive category,
- $6,000 to the general category,
- $2,000 to the foreign branch category, and
- $1,000 to the income-resourced-by-treaty category.
You would use each one of these tax amounts on a different Form 1116 to calculate the foreign tax credit for each one of the relevant categories.
The tax amounts are entered in part II of Form 1116, located at the bottom of the first page of the form.
And then you apply the math!
This was a very simple example, and it was a lot of work. Wasn’t it?
In real life, things get more complicated.
Sometimes the foreign tax credit category is not obvious. Other times it’s difficult to allocate deductions: is the deduction directly allocable to a category or is it indirectly allocable?
What happens when you file a joint tax return in a foreign country with a foreign spouse who is not a US taxpayer? How do you segregate the income tax that belongs to your foreign spouse? You can’t use their tax on your US tax return!
You get the idea. My suggestion?
Take what you have learned in this newsletter about income tax categories and foreign tax apportionment and then use common sense to apply this knowledge to your situation.
Once you have made chosen your methodology, document it and use it consistently.
Do not try to get cute.
Do not change your criteria every year based on whatever is more beneficial due to changes in your facts.
Be reasonable. Be consistent. Act in good faith.
Be prepared to defend your methodology.
This will reduce the odds that you will get in trouble with the IRS, should you be unlucky enough to get audited.
And with this, I let you be until our next post.
Be well, live well. Un abrazo y buena onda,
Marina