Foreign Tax Credit, Deduction
Foreign Tax
Credit
The Foreign Tax Credit is a U.S. tax benefit that helps reduce double taxation on income earned abroad. If you pay taxes in another country, you can claim this credit to offset your U.S. tax liability. It ensures you aren't taxed twice on the same income by different countries.
The key difference between this tax credit for foreign income and the exclusion for it is that the exclusion reduces your foreign taxable income while the FTC reduces your taxes dollar-for-dollar as a tax credit.
But the question is, how do you find out if you are subject to U.S. income taxes on foreign earned income?
Some of the ways to determine this are by checking if your income meets the Foreign Earned Income Exclusion criteria, reviewing any tax treaties between the U.S. and the country where you earned the income, and consulting IRS guidelines or a tax professional for detailed advice.
But the easiest and most accurate way to find out if you can take the Foreign Tax Credit (FTC) is to file a tax return for free on eFile.com. Based on your answers to several questions, we will determine whether you qualify for the credit. If you are eligible, we will prepare the necessary forms for your return.
Additionally, if you need a tax extension, we recommend filing before the deadline to potentially extend your due date to the following October. This helps avoid late tax penalties. You can choose to pay as little or as much as possible, as the late filing penalty is greater than the late payment penalty.
KEY TAKEAWAYS:
- The FTC is designed to prevent double taxation for US taxpayers earning income abroad. It allows them to offset U.S. taxes by the amount of foreign taxes paid on the same income.
- To qualify for the FTC, taxpayers must have paid income taxes to a foreign country or a possession of the United States. Certain conditions apply, such as compliance with IRS guidelines and tax treaties.
- Individuals can claim the FTC by filing Form 1116 with their US tax return, while corporations use Form 1118. These forms detail the foreign taxes paid or accrued and calculate the credit amount.
- Unlike the Foreign Earned Income Exclusion (FEIE), which reduces taxable income, the FTC directly reduces tax liability dollar-for-dollar.
- When choosing between the FTC and a tax deduction for foreign taxes, it's generally more beneficial to claim the credit as it directly reduces US tax liability, but individual circumstances may vary.
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 you might qualify for if you paid or accrued foreign taxes to a certain foreign country on foreign source income. There is also a deduction for foreign taxes paid as an itemized deduction on Schedule A which is generally less beneficial than the credit. 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.
Suggested Reading:
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 worldwide; see 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, you must file a tax return if you have gross taxable income earned abroad that is equal to or greater than the amount indicated for your filing status. 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 an employer later reimburses 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,
- The United States does not recognize the country's government.
The following foreign taxes cannot be claimed or taken as a Foreign Tax Credit:
- 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,
- 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.
Related Foreign Income Links:
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