US Foreign Tax Credit for Taxes paid in India

Posted by Sanket Shah | General | Monday 26 December 2011 6:17 pm

Let me first give you all a brief background of tax system in both countries (i.e. India and USA).

In India, the income tax is levied on the income that is generated during a fiscal year which commences on 1st April and ends on 31st March of each year. The due date of filing the Individual tax return is 31st July.

In USA, the income tax is levied on the income that is generated during a calendar year which commences on 1st January and ends on 31st December of each year. The due date of filing the Individual tax return is 15th April.

Firstly, a taxpayer who pays or accrues a foreign income tax may not take the tax into account in calculating the foreign tax credit or deduction until the related income is taken into account for USA income tax purposes.

So let us assume that you have disclosed all your income generated in India in your USA Tax Return. This includes income that is tax free in India e.g. Dividend Income, PPF (Public Provident Fund) interest, Long Term Capital Gain (on listed Companies), etc.

Now the question, how can you claim the benefit of taxes paid in India on your USA Tax Return.

USA tax payer is allowed a credit or deduction against USA income liability for foreign taxes paid or accrued to a foreign country. Qualified foreign taxes do not include taxes that are refundable to you or used to provide a subsidy to you.

You can choose to take the amount of any qualified foreign income taxes paid or accrued during the year as a foreign tax credit or as a deduction.

To choose the deduction, you must itemize deductions on Form 1040, Schedule A.

To choose the foreign tax credit you generally must complete Form 1116 and attach it to your Form 1040.

If you use Form 1116 to figure the credit, your foreign tax credit will be the smaller of the amount of foreign tax paid or accrued, or the amount of United States tax attributable to your foreign source income. Penalties, interest, fines and similar obligations are not creditable foreign taxes.

Generally, it is more advantageous for a USA tax payer to claim the tax credit because it is taken against the tax payers USA liability on a dollar-for-dollar basis. In contrast, a deduction for foreign taxes merely reduces a taxpayers income subject to tax.

Credit or Deduction shall be taken as follows:

  1. Interest Income: In India on the interest income the payer is required to deduct TDS (Tax deducted at source) and pay only the net amount to the payee. At the end of the year (i.e. 31st March ) the payee receives a statement referred to as Annual TDS Certificate. This TDS Certificate shall reflect the amount of TDS deducted from payee on a quarterly basis. So, if a USA person has included the Income for the three quarters say April to December, then he should take TDS amount paid as foreign tax credit or deduction for only period April to December.
  2. Capital Gains and Other Income: Take the income that is generated in your Calendar Year as Income and take TDS paid on that income as a credit or deduction.
  3. Advance Tax: The Term Advance tax in India is similar to Estimate Tax in USA. Now here I have couple of examples for everyone:
    1. For income such as interest, let us assume that you have earned income of Indian Rupees (“INR”) 5,00,000 in a fiscal year and total tax you paid on your Indian income is INR 25,000. Average rate of tax thus comes to 5%. If in the calendar year, you have earned income of INR 3,50,000 then you need to show this income in your US tax return and claim foreign tax credit of Rs. 17,500.
    2. Let us take another scenario, say you sold a property on 15th October 2011 and tax liability on the sale of the property came to INR 100,000. In India, you would pay Advance Tax on 15th December of INR 60,000 and on 15th March of INR 40,000. Now for USA point of view, as you would have disclosed the entire income of Capital Gain in calendar year 2011. You would able to take the entire tax paid or accrued as credit or deduction. In this case the INR 60,000 would be regarded as Paid and INR 40,000 would be regarded as Accrued.
  4. Self Assessment Tax: The Term Self Assessment tax in India is similar to Amount you Owe on your line 76 of Form 1040 in USA. You can take proportionate credit of the taxes paid, for the income that you have disclosed in your USA tax return.

Now someone may ask after reading 1 to 4 above, what if I had a refund in the foreign country. Well then you need to find out what is your Average Rate of Tax and take credit only to that extent.

So what is Average Rate of Tax:

Let us take an example: You have following Income:

Interest INR 300,000

Other Income INR 200,000

Short Term Capital Gain INR 500,000

Total Income INR 1,000,000

Tax on the Above Income INR 150,000

Less: TDS on Interest INR 60,000

Less: TDS on Other Income INR 40,000

Less: Advance Tax paid INR 200,000

Refund Due INR 50,000

Now you cannot claim the entire TDS and Advance Paid as your credit as you got a refund of INR 50,000. Your Average Rate of Tax would be 15% and not 20%. You can claim credit to the extent of 15%.

The bottom line is that you can take credit or deduction of taxes paid in the foreign country towards the foreign income disclosed in your USA tax return. The credit or deduction should not be more that the Average Rate of Tax that you paid in the foreign county.

As you would only come to know about your Average Rate when you file the return in the foreign country (in India by July 31st ), you have two alternatives: Either file for an automatic extension of six months in USA or estimate what your Average Rate of Tax is going to be in the foreign county (if it turns out that your estimate was incorrect then the final arrived percentage, then you will have to revise your return).

Foreign Tax Credit involves complex analysis of each transaction. There are special rules for allow credit only of fulfillment of certain criteria’s. Please consult knowledgeable USA – India Tax advisor for proper tax disclosure and maximum tax benefits. 

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Who must file a US Individual Tax return?

Posted by Sanket Shah | General | Wednesday 14 December 2011 6:51 pm

We are often asked as to who must file an Individual Tax Return in US.

Generally, all US Citizens and resident aliens (refer to our blog in October 2011 as to who is regarded as resident alien) are liable for federal income tax on their world wide income, without regard to whether the income arose from sources within or outside of United States. For each tax year, a return must be filed by them who has at least a specified minimum amount of gross income.

The filing threshold for most individuals is the sum of the applicable exemption amount plus the applicable standard deduction amount for the tax year.

 

Generally, the gross income levels at which individuals must file income tax returns for 2011 are:

If the applicable gross income test is met, then a return must be filed even though the individuals exemptions and deductions are such that no tax is due.

If the applicable gross income test is not met, then a return is required to filed whenever a refund of tax or refundable credit such as earned income credit is available.

A return is also required to be filed if:

  1. Net earnings from self-employment are at least $400.
  2. Liability for Alternative Minimum tax is incurred, etc.
  3. You received advance earned income credit payments from your employer. These payments are shown in Form W-2, box 9
  4. Recapture of first time home buyers tax credit.
  5. Social security and Medicare tax on tips you did not report to your employer or on wages you received from an employer who did not withhold these taxes. etc.
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Individual Tax Return, Due Date and Forms

Posted by Sanket Shah | General | Wednesday 7 December 2011 5:22 pm

Income tax returns for individual calendar year taxpayers are due by April 15 of the next year. Should April 15 fall on a Saturday, Sunday, or a legal holiday in Washington D.C. or in the state to which the return is required to be filed, the returns are due on the next business day. For example, in 2012, April 15 is on a Sunday. April 16 is a legal holiday, Emancipation Day, in Washington D.C. Because Monday, April 16, 2012 is a legal holiday in Washington D.C., Form 1040 income tax returns filed on Tuesday, April 17, 2012, will be treated as timely filed on Sunday, April 15, 2012.

Regular Form

The Form 1040 – U.S. Individual Income Tax Return:

It is the starting form for individual federal income tax returns filed with the IRS. It consists of two full pages not counting attachments. It has 11 attachments, called “schedules”, which may need to be filed depending on the taxpayer. The most commonly used schedules are:

  • Schedule A – It is used to claim itemizes deductions which are allowable against income. Taxpayers may choose to take a standard deduction instead of an itemize deduction. Basic standard deductions range between $5,800 and $11,600 (for tax year 2011), depending on filing status.
  • Schedule B – Enumerates interest and/or dividend income. It is required if either interest or dividends received during the tax year exceed $1,500 from all sources or if the filer had certain foreign accounts.
  • Schedule C – Lists income and expenses related to self-employment, and is used by sole proprietors.
  • Schedule D – It is used to compute capital gains and losses incurred during the tax year.
  • Schedule E  - It is used to report income and expenses arising from the rental of real property, royalties, or from pass-through entities (like trusts, estates, partnerships, or S corporations).
  • Schedule SE – It is used to calculate the self-employment tax owed on income from self-employment (such as on a Schedule C, etc.).

There are other, specialized forms that may need to be completed along with Schedules and the Form 1040.

Short forms

The Form 1040A called “short form” – U.S. individual income tax return, is a shorter version of the Form 1040. Use of Form 1040A is limited to taxpayers with taxable income below $100,000 and who take the standard deduction instead of itemizing deductions.

The Form 1040EZ called “easy form” – Income Tax Return for Single and Joint Filers With No Dependents, is the simplest, six-section Federal income tax return. It is used by taxpayers with taxable income below $100,000 (as of tax year 2011) and who take the standard deduction instead of itemizing deductions.

Other

The Form 1040NR – U.S. Nonresident Alien Income Tax Return.

The Form 1040NR-EZ called “easy” – U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents. It is used by nonresident aliens who have U.S. source income and therefore have to file a U.S. tax return. Joint returns are not permitted, so that husband and wife must each file a separate return.

The Form 1040X – Amended U.S. Individual Tax Return. It is used to make corrections to Form 1040, Form 1040A, and Form 1040EZ tax returns that have been previously filed.

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