How to allocate state income taxes between U.S.‐ and foreign‐source income

Abstract

AbstractDue to the reductions in federal income tax rates, many corporations find themselves with excess foreign tax credits. In order to use the foreign tax credits, corporations attempt to maximize foreign‐source income and to minimize expenses allocated to foreign‐source income. Allocation of expenses between U.S.‐ and foreign‐source income is governed by Treas. Reg. Sections 1.861‐;8 and 1.861.8T. The allocation methods for state income tax expense are complex. Each method results in a different amount of state income taxes being allocated to foreign‐source income. This article discusses the intricacies of three allocation methods, which should be considered when selecting a method.