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A sensible recommendation is to invest 20% to 50% in foreign markets. That seems reasonable on the surface. But, which of the 3 sources of funds is best to invest in foreign markets? Broadly speaking, there are 3 big sources of funds: Tax-Free (Roth), Qualified (401k, IRA), or taxable brokerages.
My preliminary conclusion: Investing Tax-free and qualified funds in foreign markets would incur double-taxation. Taxable brokerage funds seem best.
USA has tax-treaty agreements with about 70 countries that avoid double-taxation. If taxes were paid on income in a country with tax-treaty, you can claim that as a tax-credit for that income when filing US taxes. To claim that tax-credit, one has to use taxable brokerage account.
Even if we were to use mutual funds that invest in foreign markets (like Vanguard Emerging Markets Fund VEMAX), the fund company would have to pay taxes in the foreign country at the fund level for its realized capital gains and dividends from that country. And if Tax-free or Qualified accounts were used, those taxes cannot be claimed as a tax-credit – be it in the year the income was realized or in the year funds are dispersed from tax-free/qualified account.
For those investors with minimal funds in taxable brokerages, it is difficult to get invest 20% to 50% in foreign markets. Any suggestions on how to invest in foreign markets for such investors?
Bill Perry mentions the IRS matching the Form 1116 with 1099s, and of course that’s a big red flag when the figures don’t match.
A problem I have in regard to this is on the foreign income side. While my 1099s from Vanguard and Schwab clearly state the foreign tax paid, the foreign income is a different story.
E.g., my Vanguard 1099 states the total amount of income from VXUS (Total International Stock ETF) in the 1099. But in the Mutual Fund and UIT Supplemental Information, it provides the Foreign Source Income Percentage, as Jim Burrows points out below. I don’t know if this latter doc is even part of the 1099 that goes to the IRS. Even if it does, the end calculation of the percentage x the VXUS dividend amount isn’t anywhere on the 1099 for the IRS to match to what I input on the Form 1116.
With my Schwab 1099, it’s even more complicated. I hold an American Fund there which has international holdings. Nowhere in the 1099 does it give the foreign percentage of the dividends, so I have to get that from a worksheet on the American Funds (Capital Group) website. So this end calculation will likewise not appear in the 1099 for the IRS to match to my Form 1116.
I guess if red flags go up and I’m the unhappy recipient of a letter audit, I’ll get to explain all this to the IRS.
So Vanguard and all of the major brokerages typically issue a annual notice that breaks out the foreign percentages fund by fund. My understanding is that at Vanguard the ETF’s are just a different class of the same fund and their 2025 notice notes the EFT symbol but for some reason they just list the fund’s name but not the mutual fund symbol.
You can find a link to the 2025 Vanguard funds with percentages for foreign income and foreign tax withholding here. The Vanguard document is titled-
2025 Foreign tax credit information for eligible Vanguard funds
If there are multiple funds with foreign income and withholding you can just do the math on each fund and sum. Often included in a consolidated 1099 year end tax statement the broker will do the math for you and give you the foreign totals but I have not looked at any Vanguard consolidated 1099 for 2025 other than mine and I had no foreign income or withholding in our taxable account.
In addition to the 1099 totals you also have to separately input the foreign income items to feed the foreign information to the tax software for the foreign income section of form 1116 to work correctly. I have previously noted that in many tax software programs if there is any foreign tax withheld and you do not separately input the foreign income items the software defaults to the 1099-Div income items as entirely being foreign thus overstating the foreign income and possibility your allowable foreign tax credit.
Note that your overall level of income and your overall income that is taxed at the capital gains rates impacts the calculation that appears as the net foreign income on the 1116. A simple explanation of the 1116 foreign income amount is that the total foreign income is modified down to account for the lower capital tax rates.tax rates.
I think Andrew’s reference to VTI as Total International Stock ETF is likely a bifocal error. I expect you are referring to VXUS (ETF) or VTIAX (mutual fund).
Also, I noted in Jim Burrows below comment he refers to multiplying by 0.5405 regarding the capital gains adjustment in figuring the foreign with foreign qualified dividends or long term capital gains . What is happening here is the current maximum federal capital gains rate of of 20% divided by the current maximum ordinary income rate of 37%. The math is 0.20 / 0.37 = 0.5405 rounded.
Bill, thanks for your very detailed reply. And thanks for catching my error—I did indeed mean VXUS instead of VTI, and have made the correction.
All I can say is I’ve done my best to input the correct foreign income amounts and from there will put my faith in FreeTaxUSA. If the IRS later questions it, I may have to pay a penalty but don’t believe they’ll put me in prison. If they do, I’m going to request the one Ghislaine Maxwell’s in—close enough to our home that maybe my wife will visit me occasionally.
A number of thoughts I have had about about preparing a 1040 for tax year in which you have had foreign tax withheld after reading the HD comments to date-
Jim Burrows appears to have a good understanding of how foreign taxes withheld interact with the credit that is allowable in the current year. A good understanding of what you have to do to get the proper answer of the correct amount of your foreign tax credit is key to how you input your data. I would expect based on his comments that Jim knows his proper amount answer before the software kicks its answer out and thus he will be appropriately critical if the answers do not agree.
There are a lot of potential gotchas that can vary based on which tax software provider you are using and our current year tax inputs. We often become knowledgeable about the provider we are using so we become a bit of an expert on that system but be aware that tax software providers update software (sometimes daily) for discovered glitches after the software is initially released. The more complex a return the more I would lean in to waiting to file because of the potential impact of a different tax matter changing the return as prepared. My consideration falls in the “its better to extend than to have to amend”.
Things you may want to consider that I have run into on this topic-
Some software will automatically exclude the 1116 if the current year foreign tax withheld is below the $600/$300 thresholds (MFJ/single). Some software may require the preparer to check a box to exclude the 1116. Most tax software will default to filing a 1116 if there are any FTC carry-forwards.
Susanne notes in her below comment “I never qualify for the full amount and have remaining balances back 8 or 9 years that will apparently never be used.” This situation is quite common in that once a return has a foreign tax credit carry-forward (even $1) all tax software I have ever used assumes that 1116 should be filed for the current year to preserve the carry-forward even when the current year foreign tax withheld is below the $600/$300 threshold and thus without the carry-forward amount the current year foreign tax credit allowable without the 1116 happens to be more than the foreign tax credit with the filing of the 1116 with the carry-forwards.
Jim’s below comment about imputing tax information from a consolidated 1099 reminds me of one tax software package I used where the pass-though foreign capital gains distributions were zero but the overall consolidated 1099 input had a long term capital gain distribution. Assuming leaving the separate foreign LTCG distribution blank was incorrect. To get the proper foreign income result on the 1116 amount correct the preparer had to input “0” in the foreign LTCG income input otherwise the system assumed the total consolidated LTCG was foreign thus overstating the foreign income on the 1116.
Those pesky unused limited foreign tax credit (FTC) carry-forwards for regular tax are duplicated for alternative minimum tax (AMT) purposes in that the AMT for FTC calculation is often slightly different and results in a slightly different AMT carry-forward for the FTC and is a lot of calculations for zero benefit. This is a headache for a DIY tax preparer but could actually cost you dollars you pay a preparer based on hours worked if you are paying them to prepare your annual return.
Final comment – Michael1 asked in his comment If your objective is to not file the form, can’t you just ignore the foreign tax paid, or only report up to $600?. Per the 2025 form 1116 instruction, my bolding –
This election is available only if you meet all of the following conditions.
• All of your foreign source gross income was “passive
category income” (which includes most interest and
dividends). See c. Passive Category Income, later. However, for this purpose, passive income also includes (a) income subject to the special rule for high-taxed income, described later; and (b) certain export financing interest.
• All the income and any foreign taxes paid on it were
reported to you on a qualified payee statement. Qualified payee statements include Form 1099-DIV, Form 1099-INT, Schedule K-1 (Form 1041), Schedule K-3 (Form 1065), Schedule K-3 (Form 1120-S), or similar substitute statements.
• Your total creditable foreign taxes aren’t more than $300($600 if married filing a joint return).
So those are some of the reasons I wrote in my earlier comment “It is a unlikely event that I will have future foreign tax withheld in a taxable brokerage account”.
I hope this helps.
Best, Bill
Bill, thanks for writing all that. Lots to unpack.
Regarding my specific question about ignoring foreign tax paid, or only reporting up to $600 (MFJ), you wrote
“Per the 2025 form 1116 instruction, my bolding –
This election is available only if you meet all of the following conditions...
• Your total creditable foreign taxes aren’t more than $300($600 if married filing a joint return).”
That reads to me as though the answer is,
No – if you pay >$300/$600 of foreign tax, you’re supposed to report the full amount, whether you want the credit or not.
Am I reading that correctly?
Thinking now with the benefit of coffee, I suppose even if I’m understanding correctly, I’m hardly going to be audited and penalized for failing to accurately report something that would have reduced my tax.
You are reading my response correctly in that I believe the IRS position is that if your tax year foreign tax withheld exceeds $600 that the regulations require you to file form 1116 to claim any foreign tax credit.
I previously referenced the IRS form 1116 instructions which typically are an easier read than the IRS regulations. Both IRS instructions and Pubs are not authoritative meaning you cannot cite either as a legal basis in a disagreement with the IRS.
So in a disagreement with the IRS you can cite the law or the regulations as a basis for a position you take on your return. The relevant regulation in your question can be found in 26 U.S. Code § 904(j)(2)(B) which reads, in relevant part, as follows (my bolding)–
(j) Certain individuals exempt (from filing form 1116)
(2) Individuals to whom subsection applies
This subsection shall apply to an individual for any taxable year if—
(A)the entire amount of such individual’s gross income for the taxable year from sources without the United States consists of qualified passive income
(B)the amount of the creditable foreign taxes paid or accrued by the individual during the taxable year does not exceed $300 ($600 in the case of a joint return), and
(C)such individual elects to have this subsection apply for the taxable year.
My concern is if your foreign tax withheld from 1099-Div’s exceeds $600 and you claim just $600 when the IRS matches the 1099 data with your 1040 that could cause an exception which would kick out your return for review by a human who will follow a protocol that if the amount exceeds $600 then a 1116 must be filed to claim any foreign tax credit.
I agree that it is unlikely that claiming no foreign tax credit when you have foreign tax withheld makes it unlikely the IRS will not accept or change your return as filed. I also expect that if the IRS receives 1099-Div’s for a tax year where the combined foreign tax withheld exceed $600 and you claim any foreign tax credit on your 1040 and did not file a 1116 that the IRS will administratively disallow the claimed credit. The additional problem is some IRS matching of 1099’s with your 1040 may occur much later (think over a year) at which time a notice would ask for you to repay the credit plus any appropriate penalty and interest.
A better approach in my opinion is to use tax software that generates a 1116 and to follow Andrew’s earlier comment below when he wrote “I’m just hoping/expecting that whatever FreeTaxUSA comes up with is right!”.
I hope this helps.
Best, Bill
Thanks Bill. I’ve filed for 2025 and let TurboTax generate a 1116. Still I’m curious. Doesn’t “and (C)…” in your excerpt suggest it’s a taxpayer choice?
“This subsection shall apply to an individual for any taxable year if-
…does not exceed $300 ($600 in the case of a joint return), and
(C)such individual elects to have this subsection apply for the taxable year.”
My understanding is the choice is if you are at or below the $300/$600 threshold you can choose to still file a 1116 and not choose to elect claim a foreign tax credit (FTC) without filing the 1116.
The foreign tax credit is a nonrefundable credit meaning if you otherwise have no or limited use of the available FTC because you do not otherwise a a current year tax liability that you can file a form 1116 to preserve the current year potential FTC for a future year if you have appropriate foreign income in a future year.
Thanks. I’ll take your advice and stick to letting the tax software generate a form. As I mentioned, TurboTax did so, but I feel like it may have let me take more credit than it should have. If I really want to know I guess I’ll have to do it by hand.
Every once in a while, foreign stocks will outperform domestic stocks, but I don’t think that is sufficient to justify an outsized exposure to foreign stocks. If you aren’t aware of the historic performance of foreign stocks versus domestic stocks, I would strongly urge you to look it up pronto. On a total portfolio basis, investing 60-70% of the portfolio in stocks with exposure to foreign stocks limited to 15-20% seems about right to me, absent particular reasons to skew the portfolio one way or another.
Where did you get the advice “A sensible recommendation is to invest 20% to 50% in foreign markets.”? 20-30% is a more common recommendation, certainly nothing near 50%. As far as where to hold foreign stocks, it is likely what the best place to keep it is where it will be the simplest and easiest to manage (rebalancing, etc.) in your portfolio. Albeit, the general recommendation is in taxable brokerage accounts so you can claim the foreign tax credits.
That 20%-50% advice is in the hyperlink I provided. Also repeated here for easy reference: https://humbledollar.com/money-guide/great-debates-how-much-abroad/
Sam, I’m glad you reposted that. It’s a good article, and I hadn’t clicked on the link the first time as I didn’t question your numbers.
We’ve actually let our international allocation run higher in retirement. Unlike most Americans, much of our spending isn’t in U.S. dollars.
I focus more on dividend yield when it comes to asset location than foreign taxes. I simply consider foreign taxes a cost of owning those funds, and it’s not double taxing in a US tax-sheltered account since one is not paying US taxes twice.
This appears to be incorrect for tax-free accounts. If your investments in foreign markets are held in a tax-free account, such as a Roth IRA, your foreign income will be subject to foreign taxes, and you will get no US tax credit. However, if you withdraw that foreign income from your Roth it will be tax free. Thus, you do avoid US taxes but not the foreign taxes.
I agree that foreign income in a qualified account (traditional IRA) would be subject to double income taxation.
Given the above, I keep most of my Vanguard Total International Fund holdings in my regular brokerage account and the rest in my Roth.
Thank you. I see your point: There is no double-taxation on the capital gains when using Roth funds. But when investing in foreign markets using Roth funds, we lose the benefit of using Roth, i.e., zero tax on capital gains.
However, I noticed that some countries may have 0% withholding when US investors use retirement funds. For example, I believe when US investors use retirement funds to invest in Canadian stocks (not REITs) there is no Canadian withholding tax. Still researching this. It gets hairy depending on the type of income. Different sources of income have different treatments. Taxable: Canadian “participating interest”, capital gains from “Taxable Canadian Property”, etc.
Not taxable: capital gains on publicly listed stocks (not REITs). See https://ca.rbcwealthmanagement.com/documents/1435520/3126711/NAV0157_non-resident_withholding_tax_aoda_EN.pdf
I mentioned here recently that I held an international fund in taxable for the tax credit, and was informed that there was a limit on how much I could deduct. I am well below the limit, but others may want to read this explanation.
You make a good point that having your international funds or ETFs in a taxable account gets you the foreign tax credit. One thing I’ve come across, though, is that once you exceed a certain amount in foreign holdings in a taxable account, the calculation required to figure the foreign tax credit is migraine inducing.
I long did our tax returns by hand with no software (dinosaur, I know). The above issue had me keeping much of my VXUS in my SIMPLE IRA and Roth accounts. Now that I’m a happy user of FreeTaxUSA, maybe I shouldn’t worry so much.
I’m hoping Bill Perry or one of our other tax pros might weigh in on this one.
Andrew, how does keeping international in your IRAs help? If your objective is to not file the form, can’t you just ignore the foreign tax paid, or only report up to $600?
I’d ask Bill the same question I suppose. Both your comments and Rick’s article that Bill linked to have me thinking about this.
Michael, I’m not sure about just ignoring the foreign tax paid. As to claiming only the $600 credit, I actually thought about doing that one year so as to avoid the Form 1116. But the Form 1116 Instructions caused me to believe that wasn’t allowed.
I’d think either would be permissible, since this isn’t a compliance issue like reporting a foreign bank account, but can only benefit the taxpayer. But I don’t know either.
Sorry for the slow comment Andrew.
Rick Conner wrote an article on 2/4/25 where I made an extended comment about form 1116. That comment included the following –
One tax form you note you file the 1116 regarding the claiming the foreign tax credit which can be a bear. In my career I have worked with numerous major tax software packages and I have often seen errors related to the 1116. In a nutshell return preparers input the broker statement amounts correctly into the tax software including the foreign tax withheld but the broker statement totals for dividends, qualified dividends and capital gain dividends then flow automatically to the 1116 but the actual foreign source income is usually a different amount and is buried deep in the bowels of the broker statement. Separate input may be required. Often the foreign source income (that is eligible to be included as foreign income on form 1116) ends up being overstated on the 1116.
So I joined you in filing my 2025 return using FreeTaxUSA. As I had no foreign tax withheld in my taxable account in 2025 I did not look at their software in regards to form 1116.
As I am now fully retired I do not plan to ever deal with form 1116 again. My belief is the best 1116 is the one I never have to file. As I am currently a married filing jointly filer that means keeping any foreign tax withheld in our taxable brokerage at $600 or less so that we are eligible for the exemption from having to file form 1116 to claim a foreign tax credit.
It is a unlikely event that I will have future foreign tax withheld in a taxable brokerage account.
Bill, thanks for your detailed reply.
I used FreeTaxUSA for the first time last year and it handled the Form 1116 painlessly, for which I was most grateful. I suppose the IRS could one day question their calculation, but at least I can say I was in good faith in relying on it.
Bill, thanks for chiming in. My knowledge of the 1116 is too shallow to be of any help to readers. Well, maybe beyond just telling them to avoid it.
Bill, this sounds like you intentionally keep most international holdings in tax-protected accounts, and just forego any tax credit beyond $600 rather than deal with the form. Is that right?
I’m surprised only because I figure a pro would breeze through it. Now I don’t feel bad.
To answer your question about my reasoning I would reference the equity portion alternative noted in the Humble Dollar Guide, Portfolio Builder step 5. I want the investment equity portion of my portfolio to reflect the world’s entire equity universe re-balanced automatically at a low cost without me having to do further work. I have started this financial journey to my destination goal with the Vanguard VTWAX mutual fund class and converted to the VT ETF class in early 2026 with equity investments housed in both our traditional and Roth IRAs, none in taxable
When I leave this world my wife does not need to do make investment changes except to transfer my IRA accounts to hers as she is the sole primary beneficiary of my IRA as I am of hers.
We are still making Roth conversions annually as appropriate to minimize our lifetime taxes. The big guess is how long we both will be alive.
I am still building out a TIPS ladder bought at auction as part of the fixed asset portion of my portfolio within IRA accounts.
Yes, I could currently zip through a 1116, I just don’t want to spend my limited time doing so as I think such potential benefit would be nominal.
Best, Bill
Thanks Bill. You note, unless I misunderstand, that none of your equity investments are in taxable; what is in taxable? I wouldn’t have assumed that’s where most of your bond holdings are given their inherent tax inefficiency.
Currently, our joint taxable has a nominal balance consisting of just VMFXX the Vanguard federal money market settlement fund. In the past I have had some T Bills also in taxable. The taxable through 2025 has primarily been where I parked cash pending contributions to various retirement accounts and as part of my emergency fund thinking. As I do not expect earned income after 2025 I will likely need to start holding equities in a taxable as a result of RMDs in 2027. I am thinking about adding a separate taxable account as a I will likely never spend during my life so that my wife or children can inherit and get a step up in basis upon my death. Time and future needs/wants will tell the outcome. I worry about future long term care costs as I failed to consider the appropriate LTC insurance decades ago when we might have been able to pass policy requirements.
Thanks. I can see how one could have a taxable brokerage that’s too large a percentage of the total portfolio to have all in a money market; sounds like you’re headed there.
I’ve been filing an 1116 for years and don’t find it all that complicated. I will caveat that statement that the fact that all my foreign holdings are mutual funds.
Jim, Form 1116 is bad enough but I can wade through it. What concerns me is qualifying for the “adjustment exception.” If you don’t qualify, just a quick preview of the diabolical calculations involved triggers the beginnings of that migraine I referenced.
One of the requirements for qualifying for the adjustment exception (per Form 1116 Instructions) is:
The amount of your foreign source capital gain distributions plus the amount of your foreign source qualified dividends is less than $20,000.
I want to remain under that threshold; hence, my limiting the amount of foreign holdings I have in my taxable accounts.
Incidentally, my understanding is that while dividends count as foreign income, capital gain distributions do not. So, including CGDs in figuring eligibility for the adjustment exception, as per the IRS language above, seems odd.
I’m just glad you quoted that part with the $20,000 figure. Now I know I don’t have to go back and see if I did mine right, nor do I have to worry about next year, or the next 😂
If you don’t qualify for “adjustment exception” then
This is from page 9 of the instructions. Looks like just straight multiplication. What am I missing?
Don’t think that is so. On page 6 of the instructions under Categories of Income c. Passive Income it says,
Jim, you may well be correct and I freely admit this topic is pretty much over my head.
I went back and looked at some long ago notes and found a copy of a discussion in the “Accountant Forums” where it was stated:
When the mutual fund you invested in (Vanguard Total International Stock Index Fund) buys and sells stocks at a gain or loss, it is U.S. source income. When a foreign stock pays a dividend, that is foreign source income.
Just now I posed the question to Google’s AI, and got a similar response:
Capital gains distributions from foreign-investing U.S. mutual funds/ETFs are generally not included as income on Form 1116 in the same way as foreign dividends. These distributions are usually treated as U.S. source long-term capital gains, reported on Schedule D (Form 1040), because they result from the fund selling assets, not foreign withholding on income.
So beats me. I’m just hoping/expecting that whatever FreeTaxUSA comes up with is right!
That sheds some new light on the US verses foreign source income. However, I don’t think that this is an issue that we as the shareholders of a US mutual fund have to sort out. The mutual fund company sorts it out.
Looking at my consolidated 1099 from Vanguard this year I find in the Mutual Fund and UIT Supplemental Information section for Total International that 81.96% of the total income from that fund is foreign source income. From the Detail for Dividends and Distributions section I find that the Total Dividends & distributions from this fund is X amount. Thus, my foreign source income from whatever qualifies as foreign source income is 81.96% of X.
Thanks. That’s helpful.
I only had to file an 1116 for clients about one time per year, so never became proficient with that form. Even with software, it can be a PIA (pain in the …. ).
What? You don’t like form 1116 and its convoluted instructions?
I own VXUS in a taxable account. Yes, the tax write-off is very nice. I just wish I could understand the IRS calculation (Form 1116). I never qualify for the full amount and have remaining balances back 8 or 9 years that will apparently never be used.