In this video, I explain the sourcing of deduction as it relate to internation taxation.
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When dealing with both U.S. and international income, taxpayers need to figure out their taxable income, which is their total income minus any allowed deductions. To do this, they first identify and categorize their income based on whether it's from U.S. sources or from other countries. After that, they distribute their allowable deductions to each category of income. This process helps in determining the net taxable income from both U.S. and foreign sources.

For U.S. taxpayers, these deductions are important because they can reduce the amount of income subject to foreign tax, which in turn can impact the foreign tax credit they might claim. The foreign tax credit is a mechanism to avoid double taxation on the same income by the U.S. and a foreign country.

For non-U.S. taxpayers, such as foreign individuals or entities engaged in business within the U.S., these deductions are used to lower their effectively connected income. Effectively connected income is income that is linked to a non-U.S. taxpayer's business activities in the U.S., and it is subject to U.S. taxation.

The process of distributing deductions involves two main steps:

Allocation: This means linking each deduction directly to the type of income it relates to. For example, if a deduction is for expenses related to generating foreign income, it should be allocated to foreign source income.

Apportionment: This involves dividing the deductions between U.S. and foreign income using a fair method, such as the proportion of sales made in the U.S. versus abroad. This step ensures that deductions are spread out in a way that reflects where the income was earned.

By carefully allocating and apportioning deductions, taxpayers can accurately determine their taxable income from both U.S. and foreign sources, ensuring they only pay the necessary amount of tax and take advantage of tax credits available to them.



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