Fleming Corporation, a U.S. multinational, has pretax U.S. source income and foreign source income as follows. Fleming paid $200,000 income tax to Country

Question

Fleming Corporation, a U.S. multinational, has pretax U.S. source income and foreign source income as follows.  Fleming paid $200,000 income tax to Country

Quizplus · Accepted Answer

The foreign tax credit is calculated by dividing the foreign tax paid by the amount of foreign source income, and then multiplying that by the U.S. tax liability on the foreign source income. In this case, the foreign tax credit is calculated as follows:

Foreign tax credit = (200,000 / 600,000) x (35% x 400,000) = 23,333.33

The U.S. tax liability on the $400,000 of foreign source income is $140,000. Therefore, the U.S. tax liability after the foreign tax credit is:

U.S. tax liability = $140,000 - $23,333.33 = $116,666.67

The effective tax rate is then calculated as the total tax liability (U.S. and foreign) divided by the total income (U.S. and foreign):

Effective tax rate = ($116,666.67 + $140,000) / $1,000,000 = 25.67%

Since the maximum foreign tax credit that can be claimed is limited to the U.S. tax liability on the foreign source income, the calculation must be done in steps. The highest effective tax rate in the answer choices is 36%, which is the correct answer.