Form 1116, cap gains adjustment

[lw06880]

Does Proconnect make the adjustment to foreign capital gains automatically, or is it something we have to input? I believe I need to make this adjustment but it is not happening.  I don't know whether to override or believe that Proconnect is correct?

[itonewbie]

Are you referring to foreign-source qualified dividends and CGD?  If so, ProConnect Tax does make the necessary adjustments when the conditions for exception are not met.  If the conditions are met, however, it assumes an election not to adjust will be made.  Either way, you'd find an informational diagnostic about that.

On the other hand, if your client has foreign-source capital gains/losses, you will need to compute the necessary adjustments offline and plug them in under Credits > Foreign Tax Credit (1116).

Part of the problem is that ProConnect Tax has not been programmed to identify whether CG/CL on Sch D is US or foreign source.  And, heck, it won't even know your breakdown for gains vs losses when you choose to enter a lump sum for summary attachment (e.g. from Consolidated 1099), so you will need to do the grunt work yourself.  Again, ProConnect Tax will generate an informational diagnostic to remind you that's something you need to consider if it applies to your client.

[lw06880]

Hi. Thank you. Very helpful. Yes I have a foreign CGD over $20k. So I have to calculate the adjustment and input it in the FTC section. 
My next problem is that I can see the adjustment to income on form 1116 but Proconnect has not adjusted the total income accordingly. So the denominator is incorrect, even though I selected to Force line 18 adjustment worksheet checkbox. Have you had any luck with working around this issue?  I was on a 3 hour call trying to sort this line 18 worksheet but no resolution unfortunately. Any thoughts much appreciated 

[itonewbie]

Like I said, ProConnect Tax does manage adjustments for qualified dividends and CGD.

Who do you think Line 18 isn't adjusted?  Have you checked the Worksheets?

While the adjustments for Line 1a are shown on the Statements, those for Line 18 are found on the Worksheets instead.  And you should see that Line 18 will not tally with F.1040 when adjustments have been made.

[lw06880]

Yes I have checked the worksheets. There isn’t one for line 18. And the line still tallies with the 1040 even though the I made the adjustment. It’s like the line 18 adjustment isn’t happening. Maybe there is a reason for this or have I inputted something wrong?

[itonewbie]

Can you give us some numbers or redacted screenshots?

[lw06880]

$76k foreign CGD

$288k line 15 1040

$14k foreign tax paid, being reduced to $5k on form 1116 due to adjustment, which seems too low 

[itonewbie]

It sounds about right.  Of course, your client's filing status and actual deductions allowed on the return will all make a difference.

Did a quick mock up with your numbers and my Line 18 is adjusted automatically, as with Line 1a.  The assumption is that your client is single and has only S/D.  If you're certain your Line 18 is not adjusted, you may want to check your input and overrides to make sure nothing is amiss.

Just as a note, the foreign tax is not being "reduced" to $5k.  It is merely the credit that is being "limited", which is exactly the intention of the regs.

[lw06880]

Thank you for sending this.  Yes understood, credit is being limited.  So the Line 18 worksheet should work, however it is definitely not working for me currently.  Weirdly the AMT Line 18 worksheet is generating if I select the box (however not an AMT client).  Client is MFJ with SD, 24% upper bracket.

The only override I have that might be causing an issue is this below, could that make a difference here?  Large release of prior year passive losses due to rental property sale.

Schedule E #1: An override entry of 2 has been made in Federal "1=To Delete This Year, 2=To Delete Next Year"

I really appreciate your help.

[itonewbie]

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@lw06880 wrote:

Large release of prior year passive losses due to rental property sale.

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Domestic or foreign loss?

[lw06880]

Domestic. No other foreign income except $300 interest income.

[lw06880]

I have removed this override and it hasn't made any difference.  There is a cap gain on 4797 of $230k and a Sch E loss of $250k related to the sale of a US rental property.  Could this be effecting my Line 18 worksheet? 

[itonewbie]

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@lw06880 wrote:

Domestic. No other foreign income except $300 interest income.

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That will not affect the adjustment on Line 18.

[lw06880]

Thank you for your help.  I don't know of any other reason why this Line 18 worksheet would not be produced in this situation.  Without it the calculation of the FTC is lower than it should be, which is not what we want.  I have asked Proconnect but they couldn't help.

[itonewbie]

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@lw06880 wrote:

I have removed this override and it hasn't made any difference.  There is a cap gain on 4797 of $230k and a Sch E loss of $250k related to the sale of a US rental property.  Could this be effecting my Line 18 worksheet? 

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This is new info you never told us.  Having this info would have save us so much time.

Given that the taxable income is $288k, it would mean that your client's ordinary income taxable at marginal rates is fully offset by the release of PAL c/o.  What is left then is CGD and cap gains from the sale of rental property taxable at cap gain rates.

That should mean that not only would there not be an adjustment for Line 18, there should also not be any for Line 1a.

[lw06880]

Thank you and apologies for that, I haven't done this adjustment before, unsure what is impacting the calculation.

The only thing being taxed at the reduced 15% cap gain tax rate is the $75k foreign CGD. The rest of the income is being taxed at the marginal rates.  So I assumed there would still be need for the adjustment.  Are you saying I do not need to do this differential adjustment at all on Form 1116?

[itonewbie]

So, where is the $230K of cap gain from F.4797?

[lw06880]

Its on Sch D with the CGD, going to Line 7 on 1040

[itonewbie · Accepted solution]

You didn't tell us but I suppose the gain from the sale of property is mostly, if not all, unrecaptured §1250, which got taxed at lower marginal rates because, as you said, your client is a 24% taxpayer.  On that basis, there's no tax rate differential to adjust for either Line 1a or 18.

You mentioned previously that there is an adjustment for Line 1a.  I think you may have mistaken.  There is a statement for Line 1a but it probably only shows what it consists of and there'd be no adjustment.

[lw06880]

Thank you. Yes correct, all unrecaptured 1250 gain. 
I made the adjustment for line 1a on 1116 as I was told it needed to be made. But given your explanation and assistance I’m going to take it out. 
Last question if you willingly :), without the adjustment the FTC is now $12k, which is greater than the 15% tax charged on the foreign income. This that ok?

Thank you!!

[itonewbie]

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@lw06880 wrote:

...without the adjustment the FTC is now $12k, which is greater than the 15% tax charged on the foreign income. This that ok?

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These rules are meant to mitigate the effect of tax rate differentials but are not structured to be exact.  You don't need to dig deep into §1.904(b)-1 to find evidence of that.  For example, instead of considering the actual tax bracket of the taxpayer, tax rate differentials are adjusted based on the top marginal rate.  I suppose the Congress and the Treasury could have been more precise but the rules are already complicated enough as they stand (not that convolution ever deterred either party).

[lw06880]

Thank you, I much appreciate your time and help.