Everyone knows it is better to take a credit than a deduction for the same amount of expenses. But with foreign taxes, sometimes it is better to claim a deduction in years when a credit cannot be claimed because of net operating losses.
If events subsequent to the filing of the original return result in a foreign tax credit being more beneficial, a taxpayer can file an amended return to claim a foreign tax credit due to the 10-year period for claiming credits under Reg. Sec. 1.901-1(d). Since electing to claim a foreign tax credit and deducting foreign taxes are mutually exclusive return positions (i.e., one can either choose to credit or deduct foreign taxes on a year-by-year basis), issues can arise when subsequent events result in it being more beneficial for a taxpayer to claim a credit which falls within the 10-year statute of limitations period, but outside the standard three-year statute of limitations period for the originally claimed deduction. This issue was addressed in proposed regulations issued in 2020 covering “redeterminations.”
In the preamble to the proposed regulations, Treasury stated the following:
“Currently, the law is unclear how section 275(a)(4), equitable doctrines such as the duty of consistency, or the mitigation provisions under sections 1311 through 1314 operate to prevent taxpayers from obtaining a double benefit (through both a deduction and a credit) for a single amount of foreign income tax paid. These uncertainties have led taxpayers to request guidance from the IRS to clarify the effect of a timely change in election on their US tax liabilities. The proposed regulations provide a clear and efficient process by which taxpayers can eliminate uncertainty with respect to the tax consequences of changing from claiming a credit to claiming a deduction, or vice versa, for foreign income taxes, within the time period allowed.”
The problem is these proposed regulations have not yet been finalized. This is probably the reason an Office of Chief Counsel Memorandum was issued in August 2021 to the National Taxpayer Advocate, who was trying to assist a taxpayer in resolving a situation where the Internal Revenue Service (IRS) was refusing to process amended corporation income tax returns.
In essence, the IRS is trying to force taxpayers to enter into a “closing agreement” under Sec. 7121(a) in order to open up certain closed years before they will allow the taxpayer (in certain situations) to file amended returns to change from deducting to claiming a credit for foreign taxes. Under a closing agreement, the parties can agree to almost anything, even those issues not provided for or allowed under the Code and Regulations. The CCM states the following:
“Closing agreements are intended to dispose of debatable matters. IRM 8.13.1.2.1(4). Section 7121(b) provides that a closing agreement is “final and conclusive…[and] except upon a showing of fraud or malfeasance, or misrepresentation of a material fact… the case shall not be reopened as to the matters agreed upon or the agreement modified….”
While it is understandable why the IRS is doing this, are they really trying to do something not authorized under the Code? Also, by opening up an otherwise closed year, can the IRS raise other issues on different items than foreign taxes?
Therefore, if you are like many taxpayers that have made an appropriate decision to change from deducting to crediting foreign taxes at a later time because of subsequent events and have the situation where some deduction years are closed, you would be wise to proceed slowly and carefully at this time because of the IRS position on not accepting certain amended returns. If the regulations become finalized, even at that point you may want to analyze the situation to determine if the US Treasury and the IRS have the authority to classify the situation as a tax redetermination that allows them to open up closed years.
For more information on how this may impact your specific filing situation, contact the tax advisors at Moore Doeren Mayhew.
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