Foreign Taxes and Basis

Today TaxMama® hears from RJ in the TaxQuips Forum, who asks an intriguing question. “I understand that both reinvested dividends and reinvested capital gains distributions get added into a mutual fund’s Cost Basis. But what about Foreign Tax Paid? Does Foreign Taxes Paid also get directly added into a fund’s Cost Basis?”

Hi RJ,

Although the answer was obvious to me, I had to think about this for a bit in order to give an explanation that would be clear. So…

What do reinvested dividends and reinvested capital gains have in common?

Before they are reinvested, you report the income and pay tax on that income.
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Then, you use those dividends or capital gain proceeds to buy more shares.
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The basis is increased because you are BUYING more shares.
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Can you see that clearly?

Now, when it comes to the foreign taxes, are you reporting income from the foreign taxes?  No.

You get to take a DEDUCTION or better yet, a CREDIT.  You get a tax benefit, not a tax hit.
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So…nope. You don’t add them the basis.

And remember, you can find answers to all kinds of questions about foreign tax credits, basis, and other tax and business issues, free. Where? Where else? At www.TaxMama.com.

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