target retirement fund in a taxable account

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grabiner
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Re: target retirement fund in a taxable account

Post by grabiner »

retiredjg wrote: Wed May 05, 2021 11:46 am When you hold foreign stocks, there is some amount of tax that the fund pays to the foreign countries. For your US taxes, you get "credit" for that foreign tax that was paid on your behalf. A little bit of foreign tax does not require this form people are talking about. But if the foreign taxes go above a certain amount, you have to file a form to get credit for it.

I've never been involved with this, but I think I've got it close to right. Others will let us know if I've bungled this explanation.

I'm not at all sure that you would be in that category of needing to file that form. In fact, I'm a little bit confident that your $50k (even if all invested in international stocks) would not trigger that form. I am also not sure how much of a hassle that form is.
The threshold for filing Form 1116 is $300 of foreign tax withheld if you are single, $600 if you are married. An average foreign fund has a 3% yield and 8% of the dividend is withheld as foreign tax. Thus you would need about $125K in foreign stock if you are single, or $250K if married, to hit that limit.

If you use tax software, Form 1116 isn't that bad. You will need to identify how much of the income is foreign (which your brokerage may tell you, or you may need to look it up from the fund provider's website if you hold ETFs), and you may need to determine how to apportion deductions between US and foreign income, but you'll usually get the entire foreign tax back as a credit.
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retiredjg
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Re: target retirement fund in a taxable account

Post by retiredjg »

Thanks David. Exactly what I was wondering.

Is there a reason that this form seems to be an issue for some starting recently? I don't recall these complaints in years past.
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Re: target retirement fund in a taxable account

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retiredjg wrote: Thu May 06, 2021 6:35 am Thanks David. Exactly what I was wondering.

Is there a reason that this form seems to be an issue for some starting recently? I don't recall these complaints in years past.
In years past, the tax prep software didn't do much with the form. For instance years ago HRBlock said "expand whole form to view it and fill it out yourself." However, folks who had been doing their own taxes and Form 1116 before tax-prep software existed didn't seem to be fazed.

Many people do not understand what "Foreign Source Income" is. Not all mutual funds tell shareholders the numbers though they are available on the internet. Also I do not remember when "RIC" became a category of foreign source income.

Nowadays, tax-prep software at least appears to the user that it is filling out the form 1116 correctly and that is all most people care about: Don't make me read any of the instructions, especially if they come from the IRS.
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retiredjg
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Re: target retirement fund in a taxable account

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I think what you may be saying is that many people just didn't get the tax credit in the past and probably didn't even realize it.

:?:
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toot101
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Re: target retirement fund in a taxable account

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Thank you so much for that info. Now this is making a lot more sense to me.
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Re: target retirement fund in a taxable account

Post by cas »

retiredjg wrote: Thu May 06, 2021 6:35 am Is there a reason that this form seems to be an issue for some starting recently? I don't recall these complaints in years past.
I've seen several different categories of Form 1116 angst this year, some unique to this year and some that I remember from other years (although I don't remember in what relative quantity year-over-year).

Unique to this year:

1. Several big tax software companies had major problems with e-filing returns that included Form 1116. Hints are that there may have been some sort of widespread miscommunication between the IRS and the tax software companies over some change the IRS made. (The pandemic may have aggravated this whole miscommunication situation.)

In any case ... several mega thread with with "Form 1116" in the title got running. There were some comments in the threads by people who took *this* year's problems as a sign that Form 1116 was *always* a huge tax-filing headache (i.e. tended to cause e-filing failure). This seemed to make some people quite anxious about *ever* getting themselves in a situation where Form 1116 would need to be filed. Who knows how widespread this (incorrect) thinking was.

2. Vanguard, for accounts on the old platform, made a change (or perhaps had a one-year pandemic-related "oops") where they didn't send out a separate piece of paper showing some extra information needed for filling out Form 1116. Instead, they provided a worksheet that required people to do two multiplication actions to get to the numbers that used to be provided on the separate form. There was an initial complication that they posted this worksheet only under the "Advisors" Tax Center and not under the "Investors" Tax Center, plus there was an undefined term on the worksheet that required some additional brain cycles to figure out. Within a couple of weeks, they corrected both these problems, putting the worksheet in the "Investors" Tax Center and adding examples showing how to use it.

Nevertheless, the forces of social medial outrage had already been unleashed, tending to make pretty much any thread with the phrase "Form 1116" in the title more active that it would have been in previous years.

3. I saw several threads from people who sold their international mutual funds (e.g. Vanguard Total International Stock), purchased from US-based mutual fund companies, then got all tied up trying to report "foreign" capital gains or losses on Form 1116. (This was a misunderstanding on their part: selling US mutual funds that hold foreign stock produces *US* capital gains/losses, not "foreign" capital gains/losses.) Maybe tax loss harvesting in March 2020 caused this situation to pop up more this year?


Some perennial issues that might or might not have been more discussed this year:

4. Form 1116 has several levels of complexity. Its most complex form is when someone has more that $20,000 in foreign source qualified dividends (a pretty high hurdle) *or* you are in 32% tax bracket or above. Bogleheads seems to have a pretty good population of people in high-income professions or living in very high cost of living places (e.g. all the techies in Silicon Valley). I would guess that getting high compensation (32% tax bracket or above once salary, stock-optiony-thingies, etc are considered) right out education and encountering that most complex version of Form 1116 early on in your tax-reporting life, even if you don't have all that much in international investments, could easily be angst-producing.

5. Retirees with low income (e.g. early retirees), especially when that income is mostly qualified dividends/long term capital gains, once their foreign tax exceeds the $300/$600 level, often get their ability to take the whole foreign tax credit phased out. At that point, they have to start learning about the carry-forward/carry-back rules and often get a lot more focused on the details of Form 1116 (e.g. exactly how deductions get allocated), trying to squeeze every possible dollar of foreign tax-credit out of it. I don't think this type of question was more prevalent that usual on the forums this year, but it is possible that it was and that the pandemic had something to do with income changes that caused people to encounter this situation.

6. I rarely see people bring up dodecahedon's point about inevitable aging and planning for other people to take over your investments and tax preparation. But, as someone who helps elderly relatives with their investments, finances, and tax preparation ... which causes me to think ahead to who might be helping *my* older self with investments and tax preparation ... and what type of capabilities they have ... and what type of burden I do or don't want to put on them ... I think she raises valid points worth considering. People's situations could easily cause them to come to different conclusions that she has, but they are still points worth considering, especially for older people who are approaching that $300/$600 threshold. (Inexpensive international mutual funds weren't available when now-older people were young investors, so I'm guessing now-older investors tend to have less of them in their taxable portfolios than young investors.) It might not be a feasible point to consider for younger investors, who start out their investing careers where international investment exposure is just as easy and cheap to acquire as US exposure, so they may pass that $300/$600 threshold pretty early on.
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Re: target retirement fund in a taxable account

Post by retiredjg »

Thanks for the education from dodecahedron, grabiner, livesoft, and cas. I have a much better understanding now. And I don't think I'll stop recommending total international index for taxable accounts, at least not yet. :happy

toot101, I hope this didn't take the thread too far away from your interests.
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toot101
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Re: target retirement fund in a taxable account

Post by toot101 »

retiredjg wrote: Thu May 06, 2021 12:17 pm Thanks for the education from dodecahedron, grabiner, livesoft, and cas. I have a much better understanding now. And I don't think I'll stop recommending total international index for taxable accounts, at least not yet. :happy

toot101, I hope this didn't take the thread too far away from your interests.
Nope, this was definitely both educational and somewhat confusing. I am slowly understanding a little more each day and that's all that matters.
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Re: target retirement fund in a taxable account

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3. I saw several threads from people who sold their international mutual funds (e.g. Vanguard Total International Stock), purchased from US-based mutual fund companies, then got all tied up trying to report "foreign" capital gains or losses on Form 1116. (This was a misunderstanding on their part: selling US mutual funds that hold foreign stock produces *US* capital gains/losses, not "foreign" capital gains/losses.) Maybe tax loss harvesting in March 2020 caused this situation to pop up more this year?
Forgive my ignorance if I am completely wrong on this... But does this mean that even if I bought something like VTWAX in my taxable account, I wouldn't have to worry about the foreign taxes? Since that is a US held fund? (I think?)
4. Form 1116 has several levels of complexity. Its most complex form is when someone has more that $20,000 in foreign source qualified dividends (a pretty high hurdle) *or* you are in 32% tax bracket or above. Bogleheads seems to have a pretty good population of people in high-income professions or living in very high cost of living places (e.g. all the techies in Silicon Valley). I would guess that getting high compensation (32% tax bracket or above once salary, stock-optiony-thingies, etc are considered) right out education and encountering that most complex version of Form 1116 early on in your tax-reporting life, even if you don't have all that much in international investments, could easily be angst-producing.
If I understand this correctly, unless I am a multi-millionaire/making over 500k a year, I wouldn't really have to worry about this type of tax regardless?
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Re: target retirement fund in a taxable account

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cas wrote: Thu May 06, 2021 8:03 am Some perennial issues that might or might not have been more discussed this year:

4. Form 1116 has several levels of complexity. Its most complex form is when someone has more that $20,000 in foreign source qualified dividends (a pretty high hurdle) *or* you are in 32% tax bracket or above. Bogleheads seems to have a pretty good population of people in high-income professions or living in very high cost of living places (e.g. all the techies in Silicon Valley). I would guess that getting high compensation (32% tax bracket or above once salary, stock-optiony-thingies, etc are considered) right out education and encountering that most complex version of Form 1116 early on in your tax-reporting life, even if you don't have all that much in international investments, could easily be angst-producing.
This isn't a major extra complexity on the form; it's an adjustment which your tax software will make. (However, if you have moderate income and $1M in foreign stock paying $20K in foreign source qualified dividends, you might get into the limitation of the foreign tax credit.)
5. Retirees with low income (e.g. early retirees), especially when that income is mostly qualified dividends/long term capital gains, once their foreign tax exceeds the $300/$600 level, often get their ability to take the whole foreign tax credit phased out. At that point, they have to start learning about the carry-forward/carry-back rules and often get a lot more focused on the details of Form 1116 (e.g. exactly how deductions get allocated), trying to squeeze every possible dollar of foreign tax-credit out of it. I don't think this type of question was more prevalent that usual on the forums this year, but it is possible that it was and that the pandemic had something to do with income changes that caused people to encounter this situation.
Since foreign dividends were cut in 2020, this issue is less likely to have come in 2020 than it would usually be; many investors who filed Form 1116 in 2019 didn't have to file it in 2020. (I noticed the effect in a different way. I still had to file Form 1116 since most of my taxable stock is foreign. However, I set my 2020 withholding based on my 2019 dividend income, and when 2020 dividends were lower, I got a big tax refund.)
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Re: target retirement fund in a taxable account

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toot101 wrote: Thu May 06, 2021 2:14 pm
3. I saw several threads from people who sold their international mutual funds (e.g. Vanguard Total International Stock), purchased from US-based mutual fund companies, then got all tied up trying to report "foreign" capital gains or losses on Form 1116. (This was a misunderstanding on their part: selling US mutual funds that hold foreign stock produces *US* capital gains/losses, not "foreign" capital gains/losses.) Maybe tax loss harvesting in March 2020 caused this situation to pop up more this year?
Forgive my ignorance if I am completely wrong on this... But does this mean that even if I bought something like VTWAX in my taxable account, I wouldn't have to worry about the foreign taxes? Since that is a US held fund? (I think?)
This means that you wouldn't have to worry about foreign capital gains. If you hold a US-based fund holding foreign stock, your capital gains are US income, because they are not taxed by a foreign country. In contrast, if you sell something such as real estate in a foreign country, you might owe foreign capital-gains tax and have to take a credit on Form 1116.

(Incidentally, VTWAX, Vanguard Total World Stock Index, is ineligible for the foreign tax credit since it is more than half US stock.)
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Re: target retirement fund in a taxable account

Post by toot101 »

grabiner wrote: Thu May 06, 2021 6:15 pm
toot101 wrote: Thu May 06, 2021 2:14 pm
3. I saw several threads from people who sold their international mutual funds (e.g. Vanguard Total International Stock), purchased from US-based mutual fund companies, then got all tied up trying to report "foreign" capital gains or losses on Form 1116. (This was a misunderstanding on their part: selling US mutual funds that hold foreign stock produces *US* capital gains/losses, not "foreign" capital gains/losses.) Maybe tax loss harvesting in March 2020 caused this situation to pop up more this year?
Forgive my ignorance if I am completely wrong on this... But does this mean that even if I bought something like VTWAX in my taxable account, I wouldn't have to worry about the foreign taxes? Since that is a US held fund? (I think?)
This means that you wouldn't have to worry about foreign capital gains. If you hold a US-based fund holding foreign stock, your capital gains are US income, because they are not taxed by a foreign country. In contrast, if you sell something such as real estate in a foreign country, you might owe foreign capital-gains tax and have to take a credit on Form 1116.

(Incidentally, VTWAX, Vanguard Total World Stock Index, is ineligible for the foreign tax credit since it is more than half US stock.)
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