36.12 Exchange Rates and Blocked Currency

Income reported on your federal income tax return must be stated in U.S. dollars. Where you are paid in foreign currency, you report your pay in U.S. dollars on the basis of the exchange rates prevailing at the time the income is actually or constructively received. You use the rate that most closely reflects the value of the foreign currency—the official rate, the open market rate, or any other relevant rate. Be prepared to justify the rate you use.

Fulbright grants.

If 70% or more of a Fulbright grant is paid in nonconvertible foreign currency, U.S. tax may be paid in the foreign currency. See IRS Publication 54 for details.

Blocked currency.

A citizen or resident alien may be paid in a foreign currency that cannot be converted into American dollars and removed from the foreign country. If your income is in blocked currency, you may elect to defer the reporting of that income until: (1) the currency becomes convertible into dollars, (2) you actually convert it into dollars, or (3) you use it for personal expenses. Purchase of a business or investment in the foreign country is not the kind of use that is treated as a conversion. (4) You make a gift of it or leave it in your will. (5) You are a resident alien and you give up your U.S. residence.

If you use this method to defer the income, you may not deduct the expenses of earning it until you report it. You must continue to use this method after you choose it. You may only change with permission of the IRS.

You do not defer the reporting of capital losses incurred in a country having a blocked currency.

There may be these disadvantages in deferring income:

• Many years’ income may accumulate and all be taxed in one year.
• You have no control over the year in which the blocked income becomes taxable. You usually cannot control the events that cause the income to become unblocked.

You choose to defer income in blocked currency by filing a tentative tax return reporting your blocked taxable income and explaining that you are deferring the payment of income tax because your income is not in dollars or in property or currency that is readily convertible into dollars. You must attach to your tentative return a regular return, reporting any unblocked taxable income received during the year or taxable income that became unblocked during the year. When the currency finally becomes unblocked or convertible into a currency or property convertible to dollars, you pay tax on the earnings at the rate prevailing in the year the currency became unblocked or convertible. On the tentative return, note at the top: “Report of Deferrable Foreign Income, pursuant to Revenue Ruling 74-351.” File separate returns for each country from which blocked currency is received. The election must be made by the due date for filing a return for the year in which an election is sought.

Filing Tip

Choosing Credit or Deduction

If you qualify for a credit or deduction, you will generally receive a larger tax reduction by claiming a tax credit rather than a deduction. A deduction is only a partial offset against your tax, whereas a credit is deducted in full from your tax. Also, taking a deduction may bar you from carrying back an excess credit from a later year. However, a deduction may give you a larger tax saving if the foreign tax is levied at a high rate and the proportion of foreign income to U.S. income is small. Compute your tax under both methods and choose the one providing the larger tax reduction.

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