Foreign Tax Credit Information
If a person pays income tax to a foreign government, that foreign tax can be claimed as a credit against the US federal income tax.
The purpose of the foreign tax credit is to reduce the impact of having the same income taxed both by the United States and by the foreign country where the income was earned.
How to Qualify for the Foreign Tax Credit
Not all taxes paid to a foreign government are eligible for the foreign tax credit.
To analyze whether a foreign tax is eligible for the foreign tax credit, ask yourself the following questions:
- Is the tax imposed on you?
- Did you pay or accrue the tax?
- Is the tax the legal and actual foreign tax liability?
- Is the tax an income tax (or a tax in lieu of an income tax)?
If you can answer yes to each of these four questions, then those taxes can be included in your calculation of the foreign tax credit.
For example, Jorge and Roberta own a house in Germany, and they pay property tax each year. Even though the property tax is a tax imposed on Jorge and Roberta (question 1), and they actually pay this tax (question 2), and the amount paid is the legal and actual amount of their tax liability (question 3), this tax is not an income tax (question 4). Thus their property tax payments are not eligible for the foreign tax credit. However, they may be able to deduct this as an itemized deduction for real estate taxes.
(For more details on the qualifying factors, see Publication 514, Foreign Tax Credit for Individuals, especially the section on What Foreign Taxes Qualify for the Credit?)
What's the Best Way to Claim the Foreign Tax Payments?
You can choose between deducting foreign taxes as an itemized deduction or taking the foreign tax credit.
In general, you can figure your US tax both ways (by taking a deduction or by taking the tax credit), and then choosing whichever method results in the least amount of tax.
The choice to deduct or take a credit can be made each year.
For more details, see Foreign Tax Credit - Choosing to Take the Credit or Deduction on the IRS.gov Web site.
When Claiming the Tax Credit, Sometimes You Can Skip Form 1116
The foreign tax credit is calculated using Form 1116. This form calculates the various limitations placed on the amount of the tax credit. "If you use Form 1116 to figure the credit," the IRS explains in tax topic 856, "your foreign tax credit will be the smaller of the amount of foreign tax paid or accrued, or the amount of United States tax attributable to your foreign source income."
But sometimes we don't need to use Form 1116 to claim the credit. In that case, we claim a tax credit for the full amount of foreign taxes paid directly on the Form 1040 without calculating the various limitations. Now we can skip Form 1116 only if each of the following statements are true:
- All of your foreign source gross income was from interest and dividends.
- All of that income and the foreign tax paid on it were reported to you on Form 1099-INT, Form 1099-DIV, or Schedule K-1.
- The total of your foreign taxes is equal to or less than $300 ($600 if married filing jointly).
- You held the stock or bonds on which the dividends or interest were paid for at least 16 days and were not obligated to pay these amounts to someone else.
- You are not filing Form 4563 or excluding income from sources within Puerto Rico.
- All of your foreign taxes were legally owed and not eligible for a refund or a reduced tax rate under a tax treaty, and paid to countries recognized by the United States and do not support terrorism.
Adapted from the foreign tax credit section of the Form 1040 Instructions.
No Double Benefit if Claiming the Foreign Earned Income Exclusion
People who work in foreign countries and earn wages or self-employment income will often pay taxes on that income to foreign governments.
Such people can exclude some or all of their foreign earned income from their US federal income tax. In this situation, the person cannot claim both the foreign tax credit and the foreign earned income exclusion on the same income. "You may not take either a credit or a deduction for taxes paid or accrued on income you exclude under the foreign earned income exclusion or the foreign housing exclusion," the IRS explains in tax topic 856.
However, if only part of their wages or self-employed income is excluded, the individual can claim a foreign tax credit on the income that was not excluded from tax.
On the IRS.gov Web site
- Publication 54, Tax Guide for US Citizens and Resident Aliens Abroad
- Form 1116, Foreign Tax Credit
- Foreign Tax Credit (brief overview)
- Choosing to Take Credit or Deduction
- What Foreign Taxes Qualify for the Credit
- How to Figure the Credit
- Foreign Tax Credit - Special Issues
- Foreign Tax Credit Compliance Tips