Landrau v. Commissioner
T.C. Memo. 2021-72

On June 8, 2021, the Tax Court issued a Memorandum Opinion in the case of Landrau v. Commissioner (T.C. Memo. 2021-72). The primary issue presented in Landrau was whether the IRS correctly computed their allowable foreign tax credit for 2012.

Background to Landrau v. Commissioner

During 2014 petitioner-husband received wages of $74,680 for services performed in Puerto Rico for the U.S. Air Force. Petitioner-wife received a pension distribution of $10,380 and U.S. Social Security benefits of $14,698. The petitioners timely filed a joint Federal income tax return reporting the first two items of income as taxable but treating the Social Security benefits as nontaxable. They included with their return Form 1116, Foreign Tax Credit, reporting that they had paid income tax of $11,322 to Puerto Rico, of which they were bona fide residents during 2014. See IRC § 901(b)(2). Litigation ensued, and although the IRS timely filed its brief, the pro sese petitioners did not file a brief “by the due date or subsequently.” Knuckleheads.

Underlying Liability

IRC § 901(a) allows a credit for income taxes paid to foreign countries and U.S. possessions, including Puerto Rico. In the case of an individual “who is a bona fide resident of Puerto Rico during the entire taxable year,” income taxes paid or accrued to any U.S. possession are eligible for the credit. IRC § 901(b)(2). The IRS agreed that the petitioners were bona fide residents of Puerto Rico during 2014 and that they paid to Puerto Rico during that year income taxes of $11,322.

The allowable credit is “subject to the limitation of IRC § 904.” See IRC § 901(a), (b). IRC § 904(a) provides that the total amount of the credit taken under IRC § 901(a) may not exceed the same proportion of the tax against which such credit is taken which the taxpayer’s taxable income from sources without the United States bears to his entire taxable income for the same taxable year. In other words, the allowable credit is limited by the ratio of foreign-source taxable income to total taxable income. As Professor Lokken eloquently described, “[s]ince double taxation is eliminated by allowing foreign income taxes to be credited against U.S. tax on foreign source income only, IRC § 904 bars the credit from being taken against U.S. tax on U.S. income.” See Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates & Gifts, para. 72.6.1 (2021).

During 2014 petitioner husband received wages of $74,680 for performing services in Puerto Rico for the U.S. Air Force. This compensation was derived from a source without the United States. See IRC § 862(a)(3). However, it was taxable in the United States because received for services performed in Puerto Rico as an employee of the United States or an agency thereof. See IRC § 933(1).

Further, IRC § 861(a)(8) provides that any social security benefit (as defined in IRC § 86(d)) is treated as income from sources within the United States. IRC § 86(d)(1)(A) defines “social security benefit” to include any amount received by a taxpayer by reason of entitlement to a monthly benefit under title II of the Social Security Act. The benefits received by petitioner wife met this definition and accordingly are treated as U.S.-source income under IRC § 861(a)(8).

The Foreign Sourced Income Ratio

The IRC § 904 limitation is calculated using the ratio of foreign-source taxable income to total taxable income. IRC § 904(b)(1) provides that, for purposes of determining the FTC limitation, the taxable income in the case of an individual is computed without any deduction for personal exemptions. IRC § 904(a) provides that the denominator of the fraction must include the taxpayers’ “entire taxable income.” After allowance of specified deductions, the petitioners had approximately $49,000 of foreign source income and total taxable income for purposes of IRC § 904(a) of $56,000. Dividing $49,000 by $56,000 produces a ratio of 0.875. This ratio is applied to the U.S. tax liability “against which such credit is taken.” IRC § 904(a). The parties stipulated that petitioners’ U.S. tax liability for 2014, before application of the FTC, was $6,000. Multiplying that sum by 0.875 produces an allowable FTC of $5,250.

(T.C. Memo. 2021-72) Landrau v. Commissioner

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