No one can serve two tax masters: How I zeroed out my 2010 US tax return using TaxAct (UPDATED)

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.

  1. 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.
  2. 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?
  3. 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.
  4. I added charitable contributions to my local church, which is a recognized charityAccording 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.

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34 thoughts on “No one can serve two tax masters: How I zeroed out my 2010 US tax return using TaxAct (UPDATED)

  1. BTW, I also tried to add my RRSP contributions in the IRA contribution line and that was a no-go. IRA contributions limits are based upon a percentage of earned income. Since the FEIE wipes out earned income, then no person who claims it can get any IRA cap space except, presumably, for income above the FEIE (i.e., over 90K). This means, I as I suspected yesterday, that RRSP contributions cannot be claimed on US taxes, even by forcing them into the IRA contribution line. The Tax Treaty is thus broken.

  2. It’s why metculous record-keeping is a must, especially for any one facing a long statute of limitations. I am all too aware that both the IRS and Fincen may contact me with various questions over the next several years. I have nothing to hide but am worried because a couple of my share and mutual fund administrators changed hands with records lost along the way.

    I don’t think it will be a major problem but if I had joined OVDI, the onus would havd been on me to prove duplication.

  3. I would have thought that it might sometimes be more advantageous just to rely on Form 1116, rather than 2555, especially if your earned income produced even more FTC’s though also had the impression that IRS is getting stricter about only allowing foreign tax credits from earned income to be used for earned income instead of also being used to offset passive income, etc.

  4. @All, I am wondering about Canada Savings Bonds – re FBARs and FATCA. Are Canadian Savings Bond reportable (before they are cashed in and deposited into a bank account). I don’t have any, but haven’t seen any discussion of them in relation to IRS reporting.

  5. @Badger, I would have thought that they still would be reportable because they are both an asset and account of sorts.

    @Petros, you’re correct that you can’t claim any of the tax you pay on earned income in the FTC if you claim the FEIE. But my accountant has explained to me that most people in higher income tax countries such as Canada or the UK actually actually fare better just using 1116 via FTC.

    I’m not sure if low earners would benefit though because (at least in UK) our personal allowance is substantially higher than for a USC filing married separate. So if I only earned up to my local allowance which is around $13000, I could wind up owing US tax on the $3000 difference between the allowances. True, it would only be about $300 but it still rankles me that I would owe US tax, whereas a high earner earning $100,000 would have their total US liability more than offset due to now being in the higher 40% band of taxation.

    I would start paying income tax in the UK at 20% vs the US’s 10% but would have to have earned around $19,000 before it all balanced out, due to the difference in personal allowances.

    But high income earners are probably better off just using 1116 rather than the FEIE in the UK.

  6. This may sound mad, but if you’re filing from a country without automatic information exchange (like the UK) and you think you may owe the US not big money (say less than $5000), I would file leaving off ISAs or Mutuals and let the IRS work for it. The odds are in you favour they won’t find out. And if they do, and you’re not worried about going to the US, they’re powers of collection are quite limited.

    If you”re a bona fide resident of the UK and only have UK financial products, I wouldn’t pay the IRS.

    The final story about dual citizen’s rights have not been decided yet on the FATCA issue. If the EU goes part way with the US what can the US really do about it?

  7. Why is that mad? Consider my above contribution to my church? I have a feeling that the IRS is not going to allow that even though it is a bonafide mainline denominational church. I’ve added a couple of other charitable contributions that are allowed here in Canada to organizations which have sister organizations in the United States. The problem with the tax treaty that allows the US to tax Canadian residents is it does not permit us any of the benefits of living in Canada, such as giving to our own church? Excuse me!

    This is what I would want ideally: I want the IRS to go after me or someone else who is high profile, and for them to be rebuke in arbitration for their greedy ways. I am just utterly disgusted by arbitrary and arrogant treatment that I we get as citizens abroad (in my case, a ex- citizen).

  8. Also another moment of madness – if you’re a dual citizen in the UK and you’re really worried, change your name by deed poll. If the bank insists, change your name, close down your old ones, open news ones with new name and address, give bank incorrect SS number, the odds of the IRS matching up that are slim. So you have one name on your US passport, and your new alter ego on your British. Alter egos in the UK can be obtained for about £80 online the same day.

    Let’s hope we don’t have to resort to such measures.

  9. @John, I understand your way of thinking and even considered not declaring my ISAs as well but concluded that it had to be all or nothing. Otherwise, I would definitely be guilty of fraud if I hadn’t made a full disclosure. The moment I became aware of my filing and reporting obligations was the precise moment I realized that to not fully report all my income would have been willful.

    And with FATCA, America will have all sorts of ways to find things out because the financial institutions themselves would have had to file information about my mutual fund accounts directly to the IRS, even if held in ISAs.

    And unlike yourself, I still need to be able to visit the States to see my parents, plus will eventually be inheriting from them…I thus decided that it was wisest to become compliant and correct the past.

  10. @ Mona “Fraud” is a strong word. Perhaps “omission” would be suitable. You omitted something that would have otherwise resulted in the IRS defrauding you of your savings. I think that is justifiiable. Let’s say a thief asks you if you have any money. And you say “no”! Did you commit fraud against the thief by failing to tell him of a thousand dollars that you had in one of your pockets? If he goes away without killing you and searching your pockets, I would say what you did was self defense and very wise indeed.

  11. @monalisa1776 – It’s not an easy decision. As circumstanses worked in my favour, the inheritence issue has already been settled so I have no real financial connections with the US anymore. If they want the lousy $200 in my savings accounts fine, and I accept they may attach the nothing SS pension I’ll receive in the event of a dispute – most of my working life has been abroad.

    But if bugs me – why does it have to come to this level? I don’t hate home, but what are you suppose to do? Buckle under the usual pressure people have in the States and “go with the flow.” While at the same time I see people abroad not as concerned about the American “tow the line” attitude.

    My favourite in the UK is I sued all my credit card companies and got back about £3000 in fees. People in the US can’t believe that such a thing could ever happen – revenge on your credit card companies.

    It just goes to show how the US Congress is totally in the pockets of the lobbyists. I hope the lobbyists in Parliament never get the same power. As I can vote in the UK, I would never vote for a MP that would favour relaxing campaign regulations.

  12. @Petros and @John, I appreciate both your sympathy very much. 🙂 My situation might have seemed less innocent as I had already been filing all those years but had only listed my US-based investments. I thus felt that I had to demonstrate my complete honesty by even declaring the likes of travel cards and phone card sims, to demonstrate that I was revealing virtually ALL my foreign accounts and assets.

    In a perverse way, people who simply haven’t been filing at all have a stronger reasonable cause argument because they can quite believably say that they hadn’t known of the filing requirements while living abroad. With their FATCA tentacles in everywhere plus FBAR I concluded that I had no choice but to amend the returns and make a disclosure.

    But the irony is that had I not been filing, I would have owed even more tax and penalties because I would have also had to pay the non-filing penalty on top of the owed tax which would have pushed things up by another 25%.

    I don’t like the law but believe in doing the honest thing. Though I agree with Petros that it’s effectively robbery on the UK economy.

  13. I have not filed any US taxes since 1979, required to file 5 years back taxes and final for 2012 with the 8854 form. I do not owe any taxes over last 5 year, income below filing threshold for last 3 years. I am seriously thinking of sending letter with 8854 stating fully compliant with requirements because on no tax owing.
    Then the IRS can respond.

  14. @rivka88 Form 8854 asks for tax liability, I do not think it actually asks if you have filed taxes. I have thought of putting zero on those five lines with a letter saying that the zero dollars is based on my own calculations. If I understand you, I think you are saying the same. As each day goes I seem to change my mind. The same week I renounced I was all set to start doing my taxes, after a few phone calls to IRS I hit some roadblocks. I may just wait to see if anything comes in the mail with the CLN. It is there system not mine! They can send me a letter telling me what forms they want if they want forms so bad.

  15. @Rivka and @TrueNorth, you might believe you didn’t owe any taxes when in fact you may well have done. If you had any Canadian mutual funds, for instance, you could have owed tax on phantom capital gains.

    I really do think that people are making too many assumptions when they say they definitely owe no tax…I also believed the same till I learned about PFIC taxation and form 8621, for instance.

    I’d imagine that many have filed without even realizing this…in some ways, I think having a little knowledge can be worse than being completely unaware because it comes with accountability. Once I knew about PFIC taxation, to not have been completely honest with my accountant would have willful.

  16. This is an open question, is the IRS run by humans or computer. An number of people here at the IBS have had computer generated letters from the IRS asking for a specific piece of information or requesting a certain action, When I talked to humans at the IRS they seemed not to know anything. When they did think that they knew something they were usually wrong. At least the state department knew what forms I had to fill out, what hand I had to raise, and could point to the spot on the form for me to sign.

  17. I’m with Rivka and True North. How the h*** are they going to know about your pfic s unless you make the mistake of telling them. Remember , they’re the crooks, not you. If you feel the need to fill in a 8854, make your best effort. Let them try to do something about it and then tell them to bugger off.

    “one of the beginnings of human emancipation is the ability to laugh at authority”– C Hitchens

  18. @monalisa1776, @TrueNorth
    I renounced March 1.
    I did all the forms and calculations for the last five years, I do not owe any taxes. Helped by living in poverty with minimum income and no savings of any kind. Now retired with QPP, OAS and small income from a part-time job. Going forward, any savings plan would quickly put me over the FBAR limit, and generate multiple tax forms which would still result in no tax owed. The filling cost wheather in LCU`s or $$ would be to much to pay.

  19. @Petros.

    Thanks for sharing that you have figured out your own income tax returns, without expending dollars that are required to get the job done by expensive professionals. If the US cannot give some simple method for ‘US persons’ in other countries to comply with their convoluted requirements for $0.00 or very little end result to them, what are the choices? Many cannot pay huge dollars to have tax returns, etc. done by professionals — what are they to do? Many still think they can stick their heads in the sand and hope they are not noticed.

    Make an easier, more humane way for people to come into compliance. Each of us can only do what we can do with the resources we have. When does common sense return and the insanity end?

    When will the US figure out it is really in their very best interests for many, many reasons to admit citizenship-based taxation doesn’t work so well. Seems there could be a few intelligent congressmen elected out of the big population to figure out how to obtain the revenue needed from the citizens in the homeland, the very ones who receive US services. Some fair way for all. Perhaps, oh my, even try a value-added tax.

    Or, continue down the same road and continue to prove the only sensible way to get our lives back is to renounce an extraneous, increasingly toxic US citizenship.

  20. 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.

  21. Pingback: Canadian Charitable donations may be claimed on USA taxes | The Isaac Brock Society

  22. 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:

    Line 12
    You may have to reduce the foreign taxes you paid or accrued by the following items.

    Taxes on income excluded on Form 2555 or Form 2555-EZ. Reduce taxes paid or accrued by the taxes allocable to any foreign earned income excluded on Form 2555 or Form 2555-EZ. If only part of your foreign earned income is excluded, you must determine the amount of tax allocable to excluded income. To do so, multiply the foreign taxes paid or accrued on foreign earned income received or accrued during the tax year by the following fraction.

    Numerator: Foreign earned income and housing amounts you excluded for the tax year minus otherwise deductible expenses (not including the foreign housing deduction) allocable to that income.

    Denominator: Your total foreign earned income received or accrued during the tax year minus deductible expenses (including the foreign housing deduction) allocable to that income. However, if the foreign jurisdiction charges tax on foreign earned income and some other income (for example, earned income from U.S. sources or a type of income not subject to U.S. tax) and the taxes on the other income cannot be segregated, the denominator is the total amount of income subject to foreign tax minus deductible expenses allocable to that income.

    See Pub. 514 for a comprehensive example.

    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.

  23. @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.

  24. @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.

  25. @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.

  26. @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.

  27. 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.

  28. 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.

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