Assume the Cupcake Store (U.S. based) has a foreign branch that earns income bef
ID: 2483991 • Letter: A
Question
Assume the Cupcake Store (U.S. based) has a foreign branch that earns income before income taxes of
$500,000 Mexican pesos. Income taxes paid to Mexico are $150,000 (30 percent). Sales and other
taxes paid to the Mexican government are $50,000 pesos. In determining its U.S. taxable income,
the Cupcake store can choose between taking a deduction for all foreign taxes paid or a credit only for
foreign income taxes paid. The U.S. corporate income tax rate in is 40%.
Required: Determine whether the cupcake store would be better off taking a deduction or a credit for taxes paid.
Explanation / Answer
1)As a general rule, you must choose to take either a credit or a deduction for all qualified foreign taxes.If you choose to take a credit for qualified foreign taxes, you must take the credit for all of them. You cannot deduct any of them. Conversely, if you choose to deduct qualified foreign taxes, you must deduct all of them. You cannot take a credit for any of them.
2)The foreign tax credit is intended to relieve you of the double tax burden when your foreign source income is taxed by both the United States and the foreign country.The foreign tax credit can only reduce U.S. taxes on foreign source income; it cannot reduce U.S. taxes on U.S. source income.
3)It is generally better to take a credit for qualified foreign taxes than to deduct them as an itemized deduction. This is because:
Therefore, the cupcake store would be better at taking a credit for taxes paid.