What is a High-Tax Kickout?

What is a High-Tax Kickout?

The high-tax kickout is a provision within the U.S. Foreign Tax Credit (FTC) regulations. It reclassifies foreign residual income taxed at a rate exceeding the highest U.S. tax rate into the “general category” for FTC purposes. This ensures accurate tax credit allocation and compliance.

 

Why Does the IRS Use the High-Tax Kickout Rule?

• Prevent Misuse of Credits: Stops taxpayers from using foreign tax credits on U.S. source income.
• Fair Tax System: Ensures equitable treatment across foreign and domestic tax liabilities.
• Income Reclassification: Properly categorizes high-taxed residual income.

 

 

Criteria for High-Tax Kickout Classification

To determine if the high-tax kickout applies, the following criteria must be met:

Criteria	Explanation
Residual income	Earning residual income comes from a project that requires little effort to run.
High Foreign Tax Rate	The foreign tax rate exceeds the highest U.S. tax rate applicable to the income after expenses.

How the High-Tax Kickout Affects Taxpayers

• Separate FTC Limitation: Requires a distinct Foreign Tax Credit calculation for reclassified income.
• Additional Form Filing: Taxpayers must file a separate Form 1116 for general category income.
• Record-Keeping: Meticulous tracking of foreign income and taxes paid is essential.

 

Key Considerations for High-Tax Kickout Compliance

Checklist for Compliance:

• Allocate expenses accurately to determine the effective foreign tax rate.
• Review applicable U.S. tax treaties to understand their impact on classification.
• Keep detailed records of:
  • Foreign income types.
  • Tax rates applied by foreign governments.
  • Allocable expenses.

 

Frequently Asked Questions About High-Tax Kickout

 

What is residual income?

Residual income is money that continues to flow after an investment of time and resources has been completed.

How does the high-tax kickout affect my tax return?

High-taxed residual income is moved to the general category, requiring separate reporting on Form 1116.

Do all foreign taxes qualify for the Foreign Tax Credit?

No, only foreign income taxes are eligible for FTC.

Can I claim FTC without Form 1116?

Yes, if foreign taxes are $300 or less ($600 if married filing jointly) and all foreign income is passive.

 

Need clarity on the high-tax kickout and its impact on your Foreign Tax Credit? Contact us for personalized guidance on compliance and tax planning strategies!