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ONE OF THE GREATEST business books I’ve ever read is Antifragile by Nassim Nicholas Taleb. In it, he postulates the idea that, while things that become damaged by stress are considered fragile and things that resist stress are considered resilient, “there is no word for the exact opposite of fragile,” things that become stronger due to stress. So, he coined the word “antifragile” and then wrote an entire book about the subject.
Well, we’re all familiar with a tax loophole, which has been defined as an “unintentional omission or obscurity in the law that allows the reduction of tax liability to a point below that intended by the framers of the law.” The backdoor Roth IRA is a good example. It allows those who wouldn’t ordinarily be able to make regular annual contributions to a Roth, because their income is too high, to instead contribute to a traditional IRA and then—voilà!—convert it to a Roth.
What’s a word for an “unintentional omission or obscurity in the law that allows the increase of tax liability to a point above that intended by the framers of the law”? There is none, so I’ve coined the word “antiloophole,” though I won’t be writing an entire book about it.
Like many of you, I own shares in publicly traded foreign stocks and have therefore had to pay foreign income taxes on my foreign dividends. Since I was filing a joint return with my wife and we paid less than $600 in foreign income taxes, we claimed the entire credit for these foreign taxes directly on our 1040. I like the diversification that foreign stocks afforded me, so I kept buying more and more, comforted by the innumerable articles and experts that stated that—if we lost more than $600 to foreign income taxes—all we need do was to file Form 1116. And as long as I was working, they were right.
Form 1116 calculates your foreign tax credit based on some convoluted formula that can leave you with a credit that’s less than the total foreign income tax paid. (Trust me, it’s too complicated to explain here.) In 2017, when I was still working, we were able to claim a tax credit for $799 of the $861 in total foreign income tax we paid. While I certainly didn’t like this development, it wasn’t catastrophic. But in 2018, after I retired, we were only able to claim $74 of our total foreign income tax paid, out of a total of $872.
That didn’t seem fair. After all, if a hypothetical taxpaying couple surrendered $599 to foreign income taxes, they would get to skip Form 1116 and claim the entire $599 as a tax credit, but if they paid $601, they would be kicked over to Form 1116 and would possibly get to claim much less.
It all seemed very personal, so I scoured the internet to find similar tales of woe, gain solace from the misery of others and, almost as important, resolve this tax conundrum. I couldn’t find a single mention of this issue on the entire internet. Was I the only one suffering from this injustice? Were others too ashamed to speak of it?
I contacted a good friend, who is a partner at a New York City accounting firm, for a second opinion. He congratulated me on the accuracy of my tax forms and my foreign tax knowledge. But in the end, he confirmed that—in my case—Form 1116 was a screw job (not necessarily the words he used). He gave me two options, live with it or sell some of the offending foreign stocks.
I’m not a live-and-let-live kind of guy and therefore couldn’t let this injustice continue. In January 2020, I sold one of my larger foreign stock holdings, Canadian real estate investment trust RioCan (symbol: RIOCF), which reduced my foreign income tax below $600. Problem solved.
Epilogue: In the end, this actually worked out quite well, as I used the proceeds from my sale of RIOCF to buy an S&P 500-index fund. As the once offending RIOCF has since fallen precipitously, in addition to coining the word antiloophole, I have the added benefit of being able congratulate myself on my investing acumen. Which in the latter case is quite rewarding, as boosting one’s ego can be even more important than reducing one’s taxes.
Michael Flack blogs at AfterActionReport.info. He’s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. His previous articles were Making the Call and Trading Places.
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I believe, but I am not sure, that you can use all your foreign investments vs all your foreign taxes. Still, this takes a lot of work, and all because you didn’t qualify for the simple deduction any more. I think another commenter is right in pointing out that there is a blurry line in the tax code between paying foreign taxes as an investor and as earned income. Of course, you don’t have to fill out the form–it just provides a tax benefit if you do the work, and the benefit may not be as great as the cost of filling out the form, especially if you pay someone else to do it.
However, as someone who did live internationally for years, I know governments see no reason why they should limit their tax collection just because someone else is also tax collecting. And in every jurisdiction, I prefer to pay less taxes.
Why does my first statement matter? It turns out some jurisdictions want foreign investors bad enough not to tax them, or tax them less. Accidentally this balanced things out last year. Now, though, I have a nagging concern I don’t know how much extra I’ll be paying every time I invest in a foreign company. Maybe form 1116 is actually having its intended effect in my case?!
Steve Spinella, not sure what your first sentence means. I checked with an expert on my article and they confirmed it was 100% accurate. Thanks for your comments.
Michael, We encountered the same situation as you did with international equities. The formula is actually fairly simple, you can only get credit for the proportion of foreign taxes withheld that is the same ratio as your total federal tax divided by your income. Our energy holdings used to include BP, Royal Dutch Shell, and Total in addition to U.S. firms. We sold all our foreign energy holdings, and just use U.S. firms, with their international exposure, for our energy investments. Problem solved!