The Foreign Tax Credit Information
Do you qualify for the foreign tax credit?
Some people live on more than one patch of soil, residing in different countries at different times during the year. This can complicate your tax situation, but here's a bit of good news: You might be eligible to claim the foreign tax credit.
The tax can be claimed as a credit against their U.S. federal income tax when an American pays income tax to a foreign government. The purpose of this foreign tax credit is to reduce the impact of having the same income taxed by both the United States and by the foreign country where the income was earned.
Qualifying for the Tax Credit
Not all taxes paid to a foreign government are eligible for the foreign tax credit. Ask yourself the following questions to find out if you qualify:
- Is the tax imposed on you?
- Did you pay or accrue the tax?
- Is the tax a legal and actual foreign tax liability?
- Is the tax an income tax or a tax in lieu of an income tax?
The IRS refers to these questions as "tests." You must affirmatively pass each of them. You won't qualify if you can't answer yes to all four of these questions.
Taxes That Don't Qualify
The nature of the tax matters as well. You might meet the above criteria but still not be able to claim the foreign tax credit due to a few reasons:
- The tax was refundable or otherwise returned to you as a subsidy to you or a member of your family.
- Paying the tax wasn't required by law.
- The tax was withheld from dividends, gains, or income that didn't meet required minimum holding periods.
Other rules apply to the country to which you paid the taxes, and they're multilayered and complicated. Always consult with a tax professional or attorney to be sure your country isn't disallowed for some reason. This can happen because it's known to support acts of terrorism, or because the U.S. doesn't recognize the country's government.
Jorge and Roberta own a house in Germany and they pay property tax on their home there each year. The tax is imposed on Jorge and Roberta and they actually pay it, and the amount paid is the legal and actual amount of their tax liability, but this tax is not an income tax. Their property tax payments therefore aren't eligible for the foreign tax credit.
It used to be that Jorge and Roberta could deduct their property taxes as an itemized deduction for real estate taxes instead, but that tax provision was eliminated by the Tax Cuts and Jobs Act (TCJA) that went into effect in 2018. The deduction for U.S. real estate taxes still exists, but foreign property taxes no longer qualify.
Speak with a tax professional if you find yourself in this position because you can still claim this deduction if you amend your 2017 tax return.
How to Claim the Credit
You can claim the foreign tax credit if you qualify by completing and filing IRS Form 1116 with your tax return. This form calculates the various limitations placed on the amount of the tax credit that you're eligible for.
Your foreign tax credit will be the U.S. tax attributable to your foreign source income or the amount of foreign tax paid, whichever is less.
You Might Not Need Form 1116
You might not have to use Form 1116 to claim the credit. You can claim a tax credit for the full amount of foreign taxes paid directly on your Form 1040 without calculating the various limitations if each of the following statements on Form 1116 is true:
- All your foreign source gross income was from interest and dividends.
- All 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, or $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 owned and were not eligible for a refund or a reduced tax rate under a tax treaty, and they were paid to countries recognized by the United States and do not support terrorism.
You can't carry forward or carry back any unused foreign tax credit to another tax year, however, if you don't submit Form 1116. This credit isn't refundable, so you can only claim the amount up to your tax liability for that year with the IRS. But the balance isn't wasted if you also file Form 1116 because you can then roll the leftover portion to another tax year.
The Credit vs. the Exclusion
The IRS also offers a 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 the foreign governments, and these people can exclude some or all of their foreign earned income from their U.S. federal income tax. They can't claim both the foreign tax credit and the foreign earned income exclusion on the same income, however.
You can claim a foreign tax credit on the income that was not excluded from tax, however, if only part of your wages or self-employed income is excluded.
The Credit vs. the Deduction
You can still claim an itemized tax deduction for foreign income taxes rather than claim the credit. The TCJA only prohibits the itemized foreign property tax provision from the tax code. Even the IRS acknowledges that claiming the credit is generally better for most taxpayers, but speak to a tax professional to make sure this is the case for your personal tax situation.
Include your foreign taxes on Schedule A with your tax return if you do decide to claim the itemized deduction rather than the tax credit.
IRS. "Topic No. 856 Foreign Tax Credit." Accessed March 18, 2020.
IRS. "Publication 5307: Tax Reform Basics for Individuals and Families." Page 5. Accessed March 18, 2020.
IRS. "Foreign Tax Credit." Accessed March 18, 2020.
IRS. "Publication 514 (2018), Foreign Tax Credit for Individuals." Accessed March 19, 2020.
IRS. "Foreign Tax Credit - Choosing To Take Credit or Deduction." Accessed March 18, 2020.