Form 1116 - TaxACT users

[FEDUKE404]

Question relates to correct entry on line 3a of Form 1116. ("Some deductions do not definitely relate to either your foreign source income or your US source income.")

Schedule A has been completed.

The automatic calculation (no worksheet found) for the line number includes neither the total contributions (line 19) nor the personal property tax (line 7) as shown on Schedule A.

An override is the only way to get to what I (and, ahem, TurboTax also via a separate worksheet) deem to be the correct amount, i.e. inclusion of both missing numbers.

Am I (or TaxACT folks) missing something here?

FE

[Mo Sheets]

Send them an e-mail...or try Q&A

I use TaxAct and although I've never needed to use the form you mentioned, I had to e-mail them a couple of years ago when I took on an Amish client who did not pay into Social Security. They told me to use the "Q&A" for that section only and it did guide me to where I needed to be. On your toolbar, go under "RETURN" and the third line down should be "Federal Q&A".

Good luck!

Mo

[Koss]

Deductions on line 3a

My reading of the instructions for Form 1116, and more detailed discussion in Publication 514, leads me to the conclusion that the entry on line 3a should only be one of two amounts:

(1) the standard deduction, or
(2) the total of the following amounts from Schedule A:

(a) medical expenses
(b) general sales tax
(c) new motor vehicle sales tax
(d) real estate tax

Only certain deductions need to be accounted for on this line.

Here's the relevant text from the instructions for Form 1116:

Lines 3a and 3b

Some deductions do not definitely relate to either your foreign source income or your U.S. source income. Enter on lines 3a and 3b any deductions (other than interest expense) that:

Are not shown on line 2, and

Are not definitely related to your U.S. source income.

Line 3a. Enter the following itemized deductions (from Schedule A (Form 1040)) on line 3a.

Medical expenses (line 4)

General sales taxes (line 5)

Real estate taxes (line 6)

If you do not itemize deductions, enter your standard deduction on
line 3a.

Line 3b. Enter on line 3b any other deductions that do not definitely relate to any specific type of income (for example, the deduction for alimony paid from Form 1040, line 31a).

And here's the text from Pub. 514:

Deductions not definitely related. You must apportion to your foreign income in each separate limit category a fraction of your other deductions that are not definitely related to a specific class of gross income. If you itemize, these deductions are medical expenses, general sales taxes, new motor vehicle taxes, and real estate taxes for your home. If you do not itemize, this is your standard deduction. You should also apportion any other deductions that are not definitely related to a specific class of income, including deductions shown on Form 1040, lines 23-35.

The numerator of the fraction is your gross foreign income in the separate limit category, and the denominator is your total gross income from all sources. For this purpose, gross income includes income that is excluded under the foreign earned income provisions but does not include any other exempt income.

It is something of an understatement to say that these instructions are not well written. The use of the phrases any deductions and any other deductions definitely creates some real ambiguity.

One way of interpreting these instructions would be the following:

For purposes of Form 1116, there are two classes of deductions:

(a) itemized deductions or the standard deduction, whichever is applicable, and
(b) other types of deductions.

If you do not itemize, then you enter the standard deduction on line 3a. If you itemize, then the only itemized deductions that need to be accounted for on Form 1116 are those listed above. Other types of deductions, which do not appear on Schedule A, get entered on line 2 or line 3b. But no deductions from Schedule A are relevant here except for those listed in the instructions.

Another way of interpreting these instructions would be that other deductions from Schedule A do indeed have to be accounted for, but that they are entered on line 2 or line 3b, as applicable. Having read these instructions a half dozen times, I don't see this as a reasonable interpretation.

Regardless of how you read it, and regardless of how ambiguous it may be, it's actually pretty clear that only certain deductions go on line 3a--those that appear in the list.

I use TaxAct, and I did a return today that had the Foreign Tax Credit. I went in and played around a bit, and I did find a way to get into a section of the interview where you can manually enter "other deductions," without having to enter data directly into the form. So there is some support for this in the interview. You may e-mail me if you'd like, and I can try to provide some details or some screenshots.

But the entries in that part of the interview are associated with "other deductions" on line 3b. I really don't think you can enter anything on line 3a except the items that are in that list.

BMK

[Koss]

Observation

The whole point of line 3a is that you have to "apportion to your foreign income in each separate category limit a fraction of your other deductions that are not definitely related to a specific class of gross income," in order to calculate your taxable income from foreign sources.

We are accustomed to thinking of taxable income as

Adjusted Gross Income
minus Standard or Itemized Deductions
minus Personal Exemptions

But for purposes of Form 1116, this definition is not applicable. Some deductions just don't count. The instructions explicitly state that you don't get to use any portion of the personal exemptions when performing this calculation.

I think you have incorrectly assumed that all deductions on Schedule A can be used on Form 1116.

How would a charitable contribution be related to foreign source income?

A charitable contribution might be associated with a foreign country. For example, there are many eligible organizations that use contributions to provide humanitarian assistance in other countries.

But one of the key criteria for a charitable contribution is...

You can't get anything in return.

So how could a charitable contribution possibly be associated with the production of any kind of income at all?

BMK

[FEDUKE404]

Further musings on Form 1116 entries

Koss -

I agree the ambiguity is between the wording of the IRS instructions you cited. If you go Route A, and enter "some deductions...." you get one number. If you go Route B, and enter only the three items specified (line 4, 5, and 6), you get another (smaller) number.

Since my original post, I have found out where the difference (logic vs TaxACT) lies. TaxACT has excluded the amounts of contributions (line 19 of Sch A) and amount of personal property taxes (line 7 of Sch A). They have dutifully included only the amounts of lines 4,5, and 6 consistent with Route B above.

FWIW, the gurus at Intuit (TurboTax) have a very nice worksheet, and without any effort on my part the numbers that automatically appeared there are consistent with Route A. To reiterate: The sum of lines 4,5,6,7, and 19 on Schedule A.

Perhaps someone who is more familiar with the Intuit software (TurboTax and/or Intuit's professional software) can shed some light.

We could always let the Intuit software support experts and the TaxACT software support experts go into battle on the topic.

For now I have forced overrides on the TaxACT entries on line 3a of Form 1116. I plan to sleep on it - it's been a long day/week - but most likely I will leave the numbers which are also consistent with the "automatic" numbers generated by Intuit. As for their "manual" interview option - that is a minefield of sorts as it essentially negates a lot of things that should be entered automatically. I had enough trouble finding where to enter the carryforwards (line 10) from prior years. Another thing I don't understand is why they do NOT automatically pick up entries from lines 27 and 29 of Form 1040, and deposit them as needed onto line 3b of Form 1116. Once more, a separate "TaxACT workaround" is necessary....

Overall, theory wise, I fear we are up against one of those "it's not what they said but what they meant" scenarios.... One would think Sch A contributions and personal property tax payments would NOT be related in any way to foreign income??

Thanks for your input!

FE

[David1980]

Line 3a. Enter the following itemized deductions (from Schedule A (Form 1040)) on line 3a.

Medical expenses (line 4)

General sales taxes (line 5)

Real estate taxes (line 6)

If you do not itemize deductions, enter your standard deduction on
line 3a.

It seems perfectly simple to me, no ambiguity at all with regards to line 3a. 3b is less clear, but ultimately if you determine that lines 7 and 19 of Schedule A should be included, what difference does it make whether they show on 3a or 3b? Since you're going to add them on 3c anyway. I'd follow the instructions for 3a and make my "other deductions" entries on 3b.

As far as why they break it apart between 3a and 3b, I would have to guess the IRS wants to track those 3 specific deductions separate from the rest. Much like how salaries paid owners in a corporation get their own special line. I mean, they could have just combined 3a and 3b, but they didn't, so they must have a reason to separate those 3 deductions from the rest listed on 3b?

If the IRS instructions weren't clear enough, Publication 541 (which is still a 2010 version, but do you believe line 3a has changed with regards to charitable contributions from 2010 to 2011?) has a comprehensive example. Specifically Robert Smith, on Page 25.

His itemized deductions are home mortgage interest $5,900, real estate tax $1,500, charitable contribution $461, and employee business expenses $732. Note on page 16 for Robert, under the title "Line 3a-g", "Robert enters $1,500 on line 3a. This is his real estate tax, which is not definitely related to income from any source."

So the IRS in Publication 461 actually has a comprehensive example that includes charitable contributions. The IRS did not include the charitable contributions on line 3a in their own comprehensive example. Granted, IRS instructions and IRS publications are inferior to actual tax code, so maybe the actual tax code contradicts the IRS instructions and the IRS publication?

Even More Information: The comprehensive example of Robert Smith has existed in Publication 514 for years. You'll note that in 2004 and prior years the comprehensive example included the charitable contributions on 3a. Take a look at Pub. 514 for 2005. "Robert enters $940 on line 3a. This is his real estate tax which is not definitely related to income from any source. (He does not apportion his charitable contributions to foreign source income." - Pub 514 for all subsequent years after 2005 does not include the charitable contribution for Robert Smith on 3a. In the "What's New for 2004" section of the 2004 IRS Publication 514, there is a change for gifts to charity.

"Gifts to charity. Do not apportion to your foreign source gross income any deduction for charitable contributions you made after July 27, 2004. You can elect to also apply this rule to charitable contributions made before July 28, 2004, but only for the tax year ending after July 27, 2004. See Deductions not definitely related under Determining Taxable Income From Sources Outside the United States."

Looks like the IRS changed what they want on 3a in 2004, per their Publication 514. If you take a look at the 2004 instructions for 1116 it does say to include "Gifts to charity (line 18) you made before July 28, 2004. However for the tax year ending after July 27, 2004, you can elect to omit these contributions from line 3a." In the 2003 instructions for 1116, it includes "Gifts to charity (line 18)". So going off the 1116 instructions, the change occurred in 2004. So, the question comes down to, did Intuit miss this change, or are they basing their calculation on something in the tax code that contradicts the instructions/publications? 8 years is a long time to miss a change.