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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.