You are the director of a Washington, D.C., think tank focusing on tax and econo

Question

You are the director of a Washington, D.C., think tank focusing on tax and economic policy issues. You were recently (and informally) contacted by staff of the Congressional Joint Committee on Taxation to weigh in on a number of issues currently under consideration by a number of congressmen and congresswomen sitting on the committee. In particular, the committee asked you to reflect upon the following proposed changes and/or issues. (I) The committee has proposed phasing out the PAD for domestic corporations. (II) The committee has considered separating the gift and estate tax systems from one unified system to two completely independent, separate systems. (III) The committee is intrigued by the idea of eliminating the double taxation of corporate earnings. The members are, however, unsure which level of taxation should be eliminated. The committee would like for you to summarize your conclusions regarding the potential effects

Explanation / Answer

U.S. income tax is imposed on income expressed in U.S. dollars, while in most cases the foreign tax is imposed on income expressed in foreign currency. Therefore, fluctuations in the value of the foreign currency relative to the U.S. dollar will affect the foreign tax credit. Translating foreign currency into U.S. dollars.If you receive all or part of your income or pay some or all of your expenses in foreign currency, you must translate the foreign currency into U.S. dollars. How you do this depends on your functional currency. In most cases, your functional currency is the U.S. dollar unless you are required to use the currency of a foreign country. You must make all federal income tax determinations in your functional currency. The U.S. dollar is the functional currency for all taxpayers except some qualified business units.A qualified business unit is a separate and clearly identified unit of a trade or business that maintains separate books and records. Unless you are self-employed, your functional currency is the U.S. dollar. Even if you are self-employed and have a qualified business unit, your functional currency is the U.S. dollar if any of the following apply. You conduct the business primarily in dollars. The principal place of business is located in the United States. You choose to or are required to use the dollar as your functional currency. The business books and records are not kept in the currency of the economic environment in which a significant part of the business activities is conducted. If your functional currency is the U.S. dollar, you must immediately translate into dollars all items of income, expense, etc., that you receive, pay, or accrue in a foreign currency and that will affect computation of your income tax. If there is more than one exchange rate, use the one that most properly reflects your income. In most cases, you can get exchange rates from banks and U.S. Embassies. If your functional currency is not the U.S. dollar, make all income tax determinations in your functional currency. At the end of the year, translate the results, such as income or loss, into U.S. dollars to report on your income tax return.

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