7946 / How is a shareholder taxed when a mutual fund passes through a foreign tax credit?
When a mutual fund makes this election, each shareholder, in addition to reporting any ordinary income and capital gains dividends, includes in income his or her proportionate share of foreign taxes paid by the fund. Each shareholder then treats the proportionate share of foreign taxes paid by the mutual fund as if paid by the shareholder for which he or she may take a tax credit or an itemized deduction. (In calculating the credit or deduction, each shareholder treats his or her share of the foreign taxes and the amount of any dividends paid with respect to the foreign income of the fund as foreign income.)2 The shareholder may take the deduction or the credit, but not both.3
A mutual fund that makes this election must notify each shareholder of his or her share of the foreign taxes paid by the fund and the portion of the dividend that represents foreign income.4 The Service released regulations in 2007 that generally eliminate country-by-country reporting by a mutual fund to its shareholders of foreign source income that the mutual fund takes into account and foreign taxes that it pays. Accordingly, the regulations require that a mutual fund provide aggregate per-country information on a statement filed with its tax return, and require that only summary foreign income and foreign tax amounts be reported to the fund’s shareholders.5
1. IRC § 853.
2. IRC § 853(b); Treas. Reg. § 1.853-2(b).