State Foreign Tax Credit

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SlowMovingInvestor
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Joined: Sun Sep 11, 2016 11:27 am

State Foreign Tax Credit

Post by SlowMovingInvestor »

I'm doing the state return for an elderly relative, who is a part-year NC resident.

It seems that NC is a state that allows foreign tax credits. It seems that the formula is (roughly):

The lower of [ (Total Foreign Income when NC resident subject to tax)/(Total NC Income) * Actual NC tax, actual foreign taxes] can be credited.

So if total foreign income subject to NC tax = 10000, total NC income = 50000, actual NC tax paid = 3000, and actual foreign taxes = 1000

State Foreign tax credit = lower of (10000/50000 * 3000, 1000) = lower of (600,1000) = 600

Does that seem OK ?

It honestly seems almost too good to be true that one can credit foreign taxes against both Federal and State taxes. [ I know most states don't allow this]
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grabiner
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Re: State Foreign Tax Credit

Post by grabiner »

Yes, this is how it works, just as for the federal credit. (You may have to see how various deductions apply against US or foreign income; it varies by state.)

The net effect is that you usually pay almost no state tax on foreign income if your state has a flat tax and a foreign tax credit, and much less if your state has a progressive tax. (In the example above, if your tax is 6% of your income but a progressive tax rate means that you are in an 8% bracket, the credit is limited to 6% even though the marginal tax rate on the income was 8%; your net tax rate is 2% of the dividend.)

If you are in such a state, it is better to hold foreign stock in a taxable account and US stock in an IRA to benefit from the double credit. Conversely, if you are in a high-tax state without a foreign tax credit, it is usually better to hold US stock in a taxable account and foreign stock in an IRA, since the state will tax the higher dividend yield of the foreign stock at its full tax rate.
Wiki David Grabiner
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