Foreign Tax Credit, Deduction
Are you subject to U.S. income taxes on foreign earned income?
The easiest and most accurate way to find out if you can take the Foreign Tax Credit is to start a 2022 Tax Return on eFile.com. Based on your answers to several questions, we will determine whether or not you can claim the credit and if so, we will prepare the forms to claim it on your return. With the eFile Tax App, we make it easy to report your earned income as well as your foreign earned income for your 2022 Taxes due April 15, 2023. If you need a tax extension, file before the deadline to potentially extend your due date to October 16, 2023. Avoid late tax penalties and pay as little or as much as you can as the late filing penalty is greater than the late payment penalty.
Should you take the Foreign Tax Credit or claim an itemized foreign income tax deduction on your next tax return? eFile will determine the best option for you when you prepare and e-file your taxes. The information below may be helpful in understanding your tax situation.
Credit for Foreign Earned Income
The foreign tax credit is an amount claimed on your return which is equal to the U.S. taxes on your foreign earned income or your foreign taxes paid, whichever is less.
This page provides an overview of the Foreign Tax Credit via Form 1116 as well as the Foreign Tax Deduction; an itemized deduction on Schedule A you might qualify for if you paid or accrued foreign taxes to a certain foreign country on foreign source income. When you file your taxes, you can only choose one option: claiming the tax credit or claiming the tax deduction. When taken as a tax deduction, foreign income taxes reduce your U.S. taxable income; taken as a tax credit, foreign income taxes reduce your U.S. tax liability. Learn more about foreign earned income as a U.S. Taxpayer.
The foreign tax credit was implemented to reduce a double tax burden for citizens earning income outside of the United States - income taxed once by the United States and again by the foreign country from which the income is derived. This is made possible by the U.S. Tax Treaties made with countries across the world. Click here for a full U.S. Tax Guide for Resident Aliens.
To easily determine whether or not to file, use the FILEucator tool to quickly find out after answering a few simple questions. Generally, if you have gross taxable income earned abroad that is equal to or greater than the amount indicated for your filing status for 2022, you must file a tax return. The income received must be from services performed in a foreign country and you must meet either the Bona Fide residence test or physical residence test.
Foreign Taxes That Qualify
Income taxes paid to a foreign country (or taxes paid in lieu of an income tax) are eligible for the foreign tax credit. Taxes that are disqualified from the foreign tax credit are those paid to a foreign country that are later reimbursed by an employer, or if:
- The Secretary of State has designated the country as one that repeatedly provides support for acts of international terrorism,
- The United States has severed or does not conduct diplomatic relations with the country, or
- The United States does not recognize the country's government.
Additionally, the following foreign taxes cannot have a foreign tax credit claimed or taken:
- Excluded income taxes (for example, the foreign earned income exclusion),
- Taxes that can only be taken as itemized deductions,
- Foreign mineral income taxes,
- International boycott operation taxes,
- A portion of taxes composed of combined foreign gas and oil income,
- Taxes that were failed to be filed by U.S. persons who control foreign corporations and partnerships,
- Taxes from or related to a foreign tax splitting event, or
- Social security taxes that were accrued or paid to a foreign country that shares a social security agreement with the U.S.
Claiming the Foreign Tax Credit
To claim the credit, individuals can utilize the eFile app to complete Form 1116, Foreign Tax Credit - after answering a series of questions, the app will input the necessary information and generate the proper form. eFile selects this form for you and reports your various entries on it to be e-filed with your return.
For corporations, use Form 1118, Foreign Tax Credit—Corporations.
Deducting Foreign Taxes You Paid
You can choose to take the amount of any qualified foreign taxes paid or accrued during the year as a foreign tax credit or as an itemized deduction, but not both. You may be able to use taxes paid or accrued as a carryover tax credit if they exceed the credit amount in a single year. The amount and time limit of the carryover or carry back depend on the year that you are filing.
The foreign tax deduction could be more beneficial if your the tax rate for the country you earned incomed in is high and your income earned there was minimal.
When preparing and filing with eFile.com, we handle this for you by generating and completing Schedule A, Itemized Deductions, and attaching it to your Form 1040. However, you can see a full list of forms related to living and/or working abroad.
You can not take either a credit or a tax deduction for taxes paid or accrued on income you exclude under the Foreign Earned Income Exclusion or the Foreign Housing Exclusion. There is no double taxation in this situation because the income is not subject to United States tax.
This publication on Foreign Tax Credits will give you a broader overview. Foreign Income Exclusions for US Citizens living abroad are discussed in detail.
See what other tax credits you may qualify to claim on your tax return.
Related Foreign Income Links
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