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There is a real difference between taking a foreign tax credit and a foreign tax deduction. But there's no effective difference between getting a foreign tax deduction in a taxable account and having the fund in a traditional IRA or having it in a Roth.
Basically, taxes that funds pay are a cost of doing business. They can pay it the same way as they pay their electric bill, subtract the expense from revenue (divs and interest), and pay their investors the rest as dividends. This is what most global funds and some international funds do.
Alternatively (if they meet legal requirements for a high enough percentage in foreign investments), they can execute an accounting fiction. Instead of paying the, say $1 in foreign taxes and distributing say $9 in divs to you, they can declare (on paper) that they're distributing $10 in divs to you, but then you pay the $1 in taxes (on paper). Either way, you've netted $9 in divs.
In an IRA (either traditional or Roth), your investment has increased $9 in value. When you withdraw your money from your traditional IRA, you pay taxes on that $9 increase (as well as your original contribution). In a taxable account, you declare that $10 div that's only on paper (your net is just $9). If you take the deduction, you subtract $1 from your declared income and pay taxes on $9. Same as the traditional IRA.
The foreign tax credit is a different story. As Schwab explains, it is worth more to you.
It's like having an investment in a "foreign" state. If you earn income on real estate in another state, you pay income taxes to that state. Your home state gives you a dollar for dollar credit for that tax (up to certain limits).
The foreign tax deduction is like a SALT deduction. You earn money and pay taxes under one sovereignty (your state), and you get to deduct it from your federal taxes. You don't get a dollar for dollar credit.
I don't know if any of that makes things clearer - I'm just suggesting that these taxation ideas are not necessarily "foreign".
@msf : You didn't mention form 1116 & tracking which countries were paid what tax.. This pops up when over $300 in credit is claimed . That sounds like a big pain in the BUTT ! Thanks for chiming in. Have a good one, Derf Added : As I mentioned I'll still be removing FMIJX from Roth to Taxable account to get the foreign tax credit as of 2020 Schwab shows no foreign tax .
Long ago, the IRS eliminated the requirement for filers to break down registered investment company (RIC, i.e. mutual fund) income by country. You just give "RIC" as the "country".
In 2007, the IRS even stopped requiring mutual funds to report this breakdown to investors. So you couldn't give a detailed breakdown by country even if you wanted to.
Taking a credit usually is more advantageous, but to qualify you must have held your shares in a fund for at least 16 days of the 31-day period starting 15 days before the ex-dividend date of the fund. For additional information, refer to IRS Publication 514, Foreign Tax Credit for Individuals, and the Instructions for Form 1116, Foreign Tax Credit (Individual, Estate, or Trust).
I'm not sure this is more arcane, but it's certainly in the running:
The special rules described on this page may convert some or all of your short-term loss into long-term loss — or into a nondeductible loss — when you sell shares held six months or less after receiving certain kinds of dividends.
Kaye Thomas goes on to give a clear explanation, even adding an exception where these rules don't apply to a sale within six months of a purchase.
Then there's this one, for treating fund dividends as qualified:
All of the following requirements must be met:
The fund must have held the security unhedged for at least 61 days out of the 121-day period that began 60 days before the security’s ex-dividend date. (The ex-dividend date is the date after the dividend has been paid and processed and any new buyers would be eligible for future dividends.)
For certain preferred stock, the security must be held for 91 days out of the 181-day period, beginning 90 days before the ex-dividend date. The amount received by the fund from that dividend-generating security must have been subsequently distributed to you.
You must have held the applicable share of the fund for at least 61 days out of the 121-day period that began 60 days before the fund’s ex-dividend date.
Comments
Basically, taxes that funds pay are a cost of doing business. They can pay it the same way as they pay their electric bill, subtract the expense from revenue (divs and interest), and pay their investors the rest as dividends. This is what most global funds and some international funds do.
Alternatively (if they meet legal requirements for a high enough percentage in foreign investments), they can execute an accounting fiction. Instead of paying the, say $1 in foreign taxes and distributing say $9 in divs to you, they can declare (on paper) that they're distributing $10 in divs to you, but then you pay the $1 in taxes (on paper). Either way, you've netted $9 in divs.
In an IRA (either traditional or Roth), your investment has increased $9 in value. When you withdraw your money from your traditional IRA, you pay taxes on that $9 increase (as well as your original contribution). In a taxable account, you declare that $10 div that's only on paper (your net is just $9). If you take the deduction, you subtract $1 from your declared income and pay taxes on $9. Same as the traditional IRA.
The foreign tax credit is a different story. As Schwab explains, it is worth more to you.
It's like having an investment in a "foreign" state. If you earn income on real estate in another state, you pay income taxes to that state. Your home state gives you a dollar for dollar credit for that tax (up to certain limits).
The foreign tax deduction is like a SALT deduction. You earn money and pay taxes under one sovereignty (your state), and you get to deduct it from your federal taxes. You don't get a dollar for dollar credit.
I don't know if any of that makes things clearer - I'm just suggesting that these taxation ideas are not necessarily "foreign".
This pops up when over $300 in credit is claimed . That sounds like a big pain in the BUTT ! Thanks for chiming in.
Have a good one, Derf
Added : As I mentioned I'll still be removing FMIJX from Roth to Taxable account to get the foreign tax credit as of 2020 Schwab shows no foreign tax .
In 2007, the IRS even stopped requiring mutual funds to report this breakdown to investors. So you couldn't give a detailed breakdown by country even if you wanted to.
2007 rule change (no more country reporting to investors)
Not sure how 2020 got in there. In 2022, 100% of FMIJX's ordinary income was from foreign sources.
https://www.fmimgt.com/fmi/funds/other/2022_FMI_Tax_Insert.pdf
I'm not sure this is more arcane, but it's certainly in the running: Kaye Thomas goes on to give a clear explanation, even adding an exception where these rules don't apply to a sale within six months of a purchase.
Then there's this one, for treating fund dividends as qualified: https://www.fidelity.com/tax-information/tax-topics/qualified-dividends