I finally figured out how to zero out my taxes using TaxAct. I consider doing a tax return a game that expensive accountants and their clients play in order to create either a zero tax return or even better, to get a refund. I figured that I just needed to continue playing with TaxAct until I owed zero tax. That way I could just send my 2010 and 2011 retunrs with the completed Form 8854 and be done with the IRS, once and for all time. My problem is that nearly half of my income is unearned, passive income that is not counted in the Foreign Earned Income Exclusion (FEIE).
Remember in my last post, I couldn’t get a zero return because I was trying to apply either the FEIE or the Foreign Tax Credit (FTC)? Well I realized that I’d probably get a much better result if I applied both/and rather than either/or. So this is what I decided to do.
- I applied the FEIE to the 50% of my return which is earned income. This takes income right off the top of the tax return. The reason that probably I still owed taxes when I applied only FTC but not FEIE was that my income for US tax purposes was too high, jetting me into a higher tax liability. By applying the FEIE, I reduce my gross income by 50%. All that remains is passive income.
- One problem is that you may not claim the FTC on tax on earned income that benefited from the FEIE. But how do I calculate how much of the taxes that I paid in Canada was for earned income and how much was for passive income and can thus count for the FTC? Since my Canadian Notice of Assessment does not distinguish between taxes paid on passive (unearned) and earned income, I decided I would pro rate the Canadian tax. Thus I used the following formula: p=passive income reported on CDN return; e=earned income on CDN return; i=gross income CDN return; y=taxes paid in Canada. p=i-e; FTC=y*(p/i). This came to about 42.8% of the taxes paid in Canada on the Notice of Assessment. Then, I added this using TaxAct, Form 1116 (use manual setting, selected foreign tax on passive income category). Can anyone see anything wrong with this calculation?
- I figured out how to apply interest carry charges to my investment income. There is a category for this in deductions. Once I did these things (1-3), I had a taxes due at $667. Success! I just need some more deductions and then we’re there.
- I added charitable contributions to my local church, which is a recognized charity . According to the Tax Treaty, the IRS should thus recognized it as a charitable contribution. This was the coup de grace which finally killed the IRS beast of a tax liability for my 2010 tax return. Now I go to print, do RRSP forms, etc.
I would appreciate any comments or objections to what you read here. As I say, this whole tax thing is just one big game. In principle, I believe I should have to pay zero taxes to the IRS. Therefore, I’ve tried to play the Form Nation game in such a way as I don’t lose.
Now everything that I’ve done is reasonable. It may not be allowed. But as I said, if the IRS doesn’t like it, they will have to collect what they think I owe them through the CRA. Since the principle of the FTC is that a person not be subject to double taxation, my return is within the spirit of the law, if not the letter. I will never send a cheque to the IRS directly. I may even send a cover letter saying to them that they can challenge and audit my returns all they like, but if they want to collect, they will have to use the provisions in the Canada US tax treaty and use the CRA to do their dirty work for them. I think those of us in Canada need to present a high level of resistance and make the IRS understand that we are not the low hanging fruit. Then perhaps, they will spend their resources trying to collect on people who can’t resist them because they live within the boundaries of their jurisdiction.
UPDATE: I have recalculated the percent of tax on passive income by providing the numbers from my Canadian tax return for total gross income (which includes adjustments for Canada eligible dividends and 50% only of capital gains). The resultant percentage of tax on passive income is 42.8% instead of 50% (based on higher numbers for passive income reported in US return). This increased the tax calculations before charitable gifts from about $200 to $667 because of the lower Foreign tax credit. The charitable gifts however wipes out taxes owed in both cases.
Perhaps I’m a coward in many ways in that I have made my choices based on fear. But I also realize that I probably have more assets than most posting on here…had I not had to worry about filing 8938, then I agree that I probably could have got away with not listing the PFICs…but the da*n form insists on my listing out each assets and account separately and specifically asks for the number of 8621 PFIC forms that I was supposed to fill in, thus making me more accountable had I not filled it out honestly.
They’re making it harder and harder not to make a full disclosure with each year’s return. The stakes for not doing it correctly are getting much higher and will be even worse once FATCA takes full effect.
I really don’t blame people for wanting to renounce but I don’t yet have the gall to do it, myself…one of my grandfathers served as Chief Judge of the US Tax Court so I feel a sense of duty, it’s just how I was raised.
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This week I received a stern warning from a pro that my means of calculating how much FTC I should get was probably not following the correct “sequence”: I want to point out the following instructions for line 112 of the Form 1116:
My situation where half the income is from unearned income is not dealt with in Pub. 514, but a person who makes a great deal of earned income above the FEIE limit. So the instructions, as above, do not apply to me. So as I suggested, the correct fraction should be:
Numerator: unearned income =total income minus earned income.
Denominator: Total income
My way of calculating how much of the tax is on the unearned income proportion of my tax bill is correct. But as I said, I will await the verdict from the IRS.
The second warning that I got from the pro is that I am being too provocative and this may result in my becoming a target. I would suggest however that it is right for me to encourage Canadians to stand up for themselves based on the protections that the Canadian government has promised to us. Thus, I stand on the other side of a firewall from the IRS, that firewall is the Canadian government. I am fighting for my country and for my fellow Canadians who have become victims of a predatory and desperate foreign power. So, Go ahead, make my day.
@Petros, I have not signed up online yet to try the online software, but I have done some approximate calculations of my taxes. Using the FEIE is not mandatory, It both reduces your income and so your US taxes, but using it also reduces your foreign tax credit. I have done calculations both ways, and in either case I do not seem to owe any US tax. I am far from an expert, but it would seem to me that both options should be explored, anyone finding they owe tax should try the alternate approach and see if that works out better them.
@TrueNorth: Agreed. I tried one way, with FEIE. I owed taxes Then I tried it with Foreign Tax Credit, and to my chagrin, TaxAct said I still owed. It wasn’t until I did both that I was able to come to a reasonably low level. But doing both requires that you reduce the tax paid by the amount paid on earned income. Thus, the calculation to determine how much tax Canada charged me on each part of my income.
Then the rest was wiped out by the charitable contributions. The nice thing is that TaxAct automatically created the itemized deduction form when I entered the charitable donations.
@TrueNorth, precisely. But don’t forget there you’d also have to determine your overall tax under AMT..believe there’s also a separate 1116 you’d have to fill out in both the earned income and passive income baskets. I believe AMT cuts in at below $40,000 taxable income but am hopefully mistaken!
@Petros, I hope the pro is wrong but have mentioned to you before how I fear you could be targeted by being so provocative…yet, I have to say that I admire your guts. You’re still willing to fight to the very end for your principles whereas I’ve taken the ‘complain but comply’ route.
@monalisa1776
you are not a coward, discretion is the better part of valor. We both wish these issues not exist or have some stealthy way to avoid them. Yours is a more difficult path than mine. strength and courage to you.
Meh, I just create a bunch of expenses to cover anything they know about that is taxable and never report shit they have no way of ever knowing about. I pay taxes over here anyways so I really don’t care. Good luck tracking down financial records that have no papertrail leading back to me personally that are scattered about in about 8 different countries.
Am I correct that once you use the FEIE, if you “revoke” that choice by using the Foreign Tax Credit, you can’t change for another 5 years? Or am I confused about the various teminologies? I’m considering doing the FTC for one or two years only of my 5 years of amended returns. Any idae if that’s possible? From Pub. 54:
Effect of Choosing the Exclusion
Once you choose to exclude your foreign earned income, that choice remains in effect for that year and all later years unless you revoke it.
Foreign tax credit or deduction. Once you choose to exclude foreign earned income, you cannot take a foreign tax credit or deduction for taxes on income you can exclude. If you do take a credit or deduction for any of those taxes, your choice to exclude foreign earned income may be considered revoked. See Publication 514, Foreign Tax Credit for Individuals, for more information.
Earned income credit. If you claim the foreign earned income exclusion, you will not qualify for the earned income credit for the year. For more information on this credit, see Publication 596.
Figuring tax on income not excluded. If you claim the foreign earned income exclusion, the housing exclusion (discussed later), or both, you must figure the tax on your nonexcluded income using the tax rates that would have applied had you not claimed the exclusions. See the instructions for Form 1040 and complete the Foreign Earned Income Tax Worksheet to figure the amount of tax to enter on Form 1040, line 44. If you must attach Form 6251, Alternative Minimum Tax — Individuals, to your return, use the Foreign Earned Income Tax Worksheet provided in the instructions for Form 6251.
Revoking the Exclusion
You can revoke your choice for any year. You do this by attaching a statement that you are revoking one or more previously made choices to the return or amended return for the first year that you do not wish to claim the exclusion(s). You must specify which choice(s) you are revoking. You must revoke separately a choice to exclude foreign earned income and a choice to exclude foreign housing amounts.
If you revoked a choice and within 5 years again wish to choose the same exclusion, you must apply for IRS approval. You do this by requesting a ruling from the IRS.