Harbor Funds | Frequently Asked Questions - Foreign Tax

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Foreign Tax
Foreign Tax
How do I report a foreign tax credit? Show
You may be eligible to claim your foreign tax credit directly on Form 1040, line 47, without filing Form 1116. If you are not eligible to report a foreign tax credit directly on Form 1040, you must file Form 1116 as part of your income tax return. Corporations must use Form 1118.
Do I need to do any work before filling out Form 1116? Show
Shareholders completing Form 1116 for tax year 2012 are not required to report foreign taxes paid on a country by country basis on income paid from a mutual fund. To complete Part I of Form 1116, calculate your total income from foreign sources paid by the fund by multiplying the amount on Box 1a of your 1099-DIV by the percentage found in the following table and enter the result on line 1a. Enter "RIC" on line g. Enter foreign taxes paid from Box 6 of 1099-DIV in Part II of the form.

Please see the attached table for information on foreign sourced income and foreign qualified dividends.

Please note, however, that completing Form 1116 (or Form 1118) still involves several other steps, which are detailed in the IRS Instructions of these Forms.
Do I qualify to claim the foreign tax credit without filing Form 1116? Show
In general, in order to qualify to claim credit on Form 1040, line 47 without filling out Form 1116, you must meet the following requirements:
  1. All of your foreign source gross income was from the "passive income" category (which includes most interest and dividends);
  2. All of the income and any foreign taxes paid on it was reported to you on a qualified payee statement (e.g., Form 1099-INT, Form 1099-DIV, Schedule K-1 or similar substitute statement);
  3. Your total creditable foreign taxes from all such statements was not more than $300 ($600 if married filing a joint return);
  4. You held your Harbor Funds shares for at least 16 days including the ex-date of the dividend which was December 17, 2012;
  5. You are not filing Form 4563 or excluding income from sources within Puerto Rico;
  6. All of your foreign taxes were legally owned and not eligible for a refund, and paid to countries that are recognized by the United States and do not support terrorism.

See instructions for Form 1116 and Form 1040 for additional information.
How do I report a foreign tax deduction? Show
To take a foreign tax deduction, you list the foreign taxes with other deductible taxes on Schedule A of your individual income tax return. (Corporations can deduct foreign taxes by listing them on the appropriate line of Page 3 of Form 1120.) Generally, if you take a credit for any portion of your allowable foreign taxes, you may not take any part of your remaining allowable foreign taxes as a deduction. However, an exception exists in the situation where you were disallowed a credit because you did not meet the holding period requirement. In such case, you will be allowed to take a credit for the allowable foreign taxes and a deduction for the amount of foreign taxes disallowed as a credit.
Why is there such a big difference between the amount of the dividend I received and the foreign source income that foreign taxes were paid on? Show
There are several factors that can affect this relationship. For example, it can be related to the specific tenets of a tax treaty between the U.S. and a foreign country the fund is trading in. It could also be related to the holding period of the underlying security or dividends received from U.S. holding or other factors.

In 2012 two Harbor funds, the International Fund and the International Growth Fund, elected to pass through to their respective shareowners, foreign taxes paid by the funds in 2012. As a result, the total taxable income reported to you in "Box 1a" of Form 1099-DIV includes not only the distributions you received, including the reinvestment in additional fund shares, but also the amount of foreign taxes passed through to you. The taxes passed through to you are included in "Box 6" of your Form 1099-DIV and can generally be claimed by you on your income tax return as if you had directly paid that amount as tax to a foreign country. This amount can generally be claimed by you as either an itemized deduction or as a foreign tax credit. You may only claim the amount in "Box 6" as a deduction or a credit if you held your shares for at least 16 days during the 31-day period beginning 15 days before the ex-dividend date. For Harbor International and International Growth Funds the ex-dividend date was December 17, 2012.

You should consult your tax adviser regarding your specific situation.
What should I do if I have further questions about completing the income tax return forms to report foreign taxes for my shares of Harbor Funds? Show
Please see IRS Publication 514, Foreign Tax Credit for Individuals, or consult your tax adviser. Be sure to give to your adviser the materials you received from Harbor Funds.
My Total Ordinary Dividends, in Box 1a of my Form 1099-DIV include (or are grossed up for) Foreign Tax Paid in Box 6. Why? I did not receive this amount in a dividend. Show
We are required to include this amount in Box 1a in order to provide a tax benefit to shareholders.
If my account is an IRA or a retirement plan, can I take a deduction or a credit? Show
No, you may not take a deduction or credit if your account is an IRA or a retirement account. Since earnings within a tax qualified plan are not currently taxable, you are not allowed to take a foreign tax credit or deduction on your individual income tax forms.
What tax benefit can I obtain from my share of the foreign taxes paid by my Harbor fund(s)? Show
The foreign taxes that Harbor Funds paid can be used by certain shareholders of Harbor Funds as either a tax credit or a tax deduction on their U.S. income tax return. Using the foreign taxes as a deduction or credit enables shareholders to reduce or eliminate any double taxation on the distribution by Harbor Funds of its earnings which had already been subject to a foreign tax.
What tax form do I need to file in order to take a deduction or credit? Show
You cannot take this deduction or credit if you file Form 1040A. You must file Form 1040 (for individuals) or Form 1120 (for corporations) to take this deduction or credit.
I am a non-resident alien. Can I take a credit? Show
IRS instructions for Form 1116-Foreign Tax Credit - Individuals state that generally you cannot take the credit. The instructions further state that you may, however, be able to take the credit if you are a resident of Puerto Rico during your entire tax year, or you are a nonresident alien who pays or accrues tax to a foreign country or U.S. possession on income from foreign sources that is effectively connected with a trade or business in the United States. Please see the Instructions for Form 1116 and IRS Publication 519, U.S. Tax Guide for Aliens, for more information, including certain exceptions.
Are there holding period requirements for claiming a foreign tax credit? Show
You must have held your shares of Harbor Funds for at least 16 days including the ex-dividend date (December 17, 2012) between December 2, 2012 and January 1, 2013 to claim a foreign tax credit. If you are eligible to file Schedule A - Itemized Deductions, and if you did not satisfy the holding period requirement with respect to all of your shares of Harbor Funds, you may be able to take the amount of "Foreign Tax Paid" on your Form 1099-DIV as a tax deduction on Schedule A. If you satisfied the holding period requirement for some, but not all of your shares of Harbor Funds, you may claim a credit for the foreign taxes paid which are attributable to the shares allowed, and a deduction for the remaining disallowed shares.
Are there situations in which I am better off taking a deduction rather than a credit? Show
Yes. One situation is when you are not eligible to take a credit. Another situation in which a deduction should be considered is when the credit you can take is limited to an amount which is less than your share of foreign taxes paid.  There may be other situations where a deduction may be more beneficial. You should consult your tax adviser to determine which approach is more beneficial to your individual situation.
Which treatment will reduce my taxes the most -- a deduction or a credit? Show
A tax credit is generally more beneficial than a tax deduction. A foreign tax credit might allow you to reduce your U.S. income taxes by one dollar for each dollar of foreign taxes paid. A foreign tax deduction, on the other hand, generally reduces taxable income by one dollar for each dollar of foreign tax paid. The deduction allows you to reduce your U.S. income taxes by an amount directly related to your tax bracket.