Both the United States and foreign countries may tax the foreign source income of U.S. taxpayers. To ease this double taxation burden, the Internal Revenue Code permits most U.S. taxpayers who pay income taxes to a foreign country to either deduct the taxes from gross income for U.S. purposes or claim a dollar-for-dollar tax credit against their federal income tax liability on foreign source income.
The foreign tax credit rules were significantly revised by the Tax Cuts and Jobs Act. In late 2019, the IRS issued final regulations (“regs”) regarding determination of the credit. The final regs are wide-ranging in scope and extremely detailed. One issue addressed is foreign tax redetermination.
Background and clarifying changes
Temporary regs issued in 2007 define “foreign tax redetermination” as a change in the foreign tax liability that may affect a taxpayer’s foreign tax credit. This includes:
- Accrued taxes that, when paid, differ from the amounts added to post-1986 foreign income taxes or claimed as credits by the taxpayer (such as corrections to over accruals and additional payments),
- Accrued taxes that aren’t paid before the date two years after the close of the tax year to which such taxes relate,
- Refunds of taxes paid, and
- Accrued taxes translated into dollars when paid and for which a difference arises between the dollar value of the accrued tax and the dollar value of the taxes paid attributable to fluctuations in the foreign currency’s value.
The final regs reflect several clarifying changes to what constitutes a foreign tax redetermination. First, a foreign tax redetermination includes certain situations covered by Section 905(c) that don’t involve a change in foreign tax liability. One example is the failure to pay accrued taxes within two years and the subsequent payment of any such accrued but unpaid taxes.
Second, a foreign tax redetermination includes adjustments such as a correction to an accrual that determined the tax due with reasonable accuracy but is revised after additional consideration to reflect the correct final tax liability.
Third, the final regs clarify that a foreign tax redetermination occurs if any tax that’s claimed as a credit or added to previously taxed earnings and profits (PTEP) group taxes is subsequently refunded. This clarification holds true regardless of whether the tax was properly treated as paid under the regulatory definition when claimed as a credit, or added to PTEP group taxes. The regs include, among other requirements, that the tax be owed and not refundable.
Adjustments to foreign taxes
One of the 2007 temporary regulations provides that, in the case of a foreign tax redetermination with respect to taxes paid or accrued by a U.S. taxpayer, a redetermination of U.S. tax liability is required “for the taxable year for which the foreign tax was claimed as a credit.” The final regs clarify how the rules apply when a U.S. taxpayer’s foreign taxes exceed the applicable limitation under Sec. 904(d) and the taxpayer carries unused foreign taxes back or forward to another year under Sec. 904(c).
The final regs also provide that, if a foreign tax redetermination occurs with respect to foreign tax claimed as a direct credit, a redetermination of U.S. tax liability is required for the tax year in which the credit was claimed and any year to which unused foreign taxes from such year were carried under Sec. 904(c).
Foreign tax imposed on refund
Temporary regulations issued in 1988 provide that tax imposed on a refund of foreign tax is considered to reduce the amount of the refund, and no other credit or deduction is allowed with respect to such tax imposed on the refund in question. This provision was included in the 2007 temporary regulations without change. The final regs, however, modify this rule to clarify that it applies in the case of any Sec. 901 taxpayer, which includes a specified 10% owned foreign corporation.
Many other issues
The final regs address many other issues related to the foreign tax credit. This includes the allocation and apportionment of expenses as well as rules regarding currency translation. Contact your Elliott Davis advisor to determine whether and how the regs may affect you.
The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.