San Carlos Corporation, a U.S. multinational, had pretax U.S. source income and foreign source income as follows. $$\begin{array} { l r }
\text { U.S. source income } & \$ 400,000 \
\text { Foreign source income--Country W } & \underline { 300,000 } \
\text { Total } & \$ 700,000
\end{array}$$ San Carlos paid $100,000 income tax to Country W. Calculate San Carlos' tax savings if it takes a foreign tax credit rather than deducting this tax.

Question

San Carlos Corporation, a U.S. multinational, had pretax U.S. source income and foreign source income as follows. $$\begin{array} { l r } 
\text { U.S. source income } & \$ 400,000 \
\text { Foreign source income--Country W } & \underline { 300,000 } \
\text { Total } & \$ 700,000
\end{array}$$ San Carlos paid $100,000 income tax to Country W. Calculate San Carlos' tax savings if it takes a foreign tax credit rather than deducting this tax.

Quizplus · Accepted Answer

The foreign tax credit is limited to the amount of U.S. tax that would be paid on the same foreign source income. So, we need to calculate the U.S. tax on the entire $700,000 income and compare it to the $100,000 foreign tax paid to determine the tax savings.
Assuming a marginal tax rate of 35%, the U.S. tax on $700,000 income would be $245,000. 
The foreign tax credit allowed would be the lesser of the foreign tax paid or the U.S. tax that would be imposed on the same income. Since the foreign tax paid is $100,000, and the U.S. tax that would be imposed on $300,000 of foreign source income is $105,000 (35% of $300,000), the foreign tax credit allowed is limited to $105,000. 
San Carlos can take a foreign tax credit of $100,000 to offset its U.S. tax liability. This would leave a remaining U.S. tax liability of $145,000 ($245,000 - $100,000 foreign tax credit), resulting in a tax savings of $66,000 ($145,000 - $79,000 U.S. tax on U.S. source income only). Therefore, the correct answer is B) $66,000.

San Carlos Corporation, a U San Carlos Paid $100,000 Income Tax to Country W