Foreign Tax Credit

Expatriate Tax  
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Ralph Sayers, CPA

Foreign Tax Credit

The foreign tax credit is intended to reduce the double tax burden that would otherwise arise when foreign source income is taxed by both the United States and the foreign country from which the income is derived.

Generally, only income taxes paid or accrued to a foreign country or a U.S. possession, or taxes paid or accrued to a foreign country or U.S. possession in lieu of an income tax, will qualify for the foreign tax credit.

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. To choose the deduction, you must itemize deductions on Form 1040 Schedule A. To choose the foreign tax credit you generally must complete Form 1116 and attach it to your Form 1040, or Form 1040NR..

You can claim the credit for qualified foreign taxes without filing Form 1116 if all of the following requirements are met:

1.     All of your foreign source income is passive income, such as interest and dividends,

2.     All of your foreign source income and the foreign taxes are reported to you on a qualified payee statement, such as  Form 1099-INT  or Form 1099-DIV, and

3.     The total of your qualified foreign taxes is not more than the limit given in the Form 1040 Instructions for the filing status you are using, or in the Form 1040-NR Instructions (if you file Form 1040-NR).

If you claim the credit directly on Form 1040 or Form 1040-NR without filing Form 1116, you cannot carry back or carry over any unused foreign tax to or from this year.

If you use Form 1116 to figure the credit, 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. This limit is computed separately for each type of foreign income.

If you cannot use the full amount of qualified foreign taxes paid or accrued, you may be allowed a carryback and/or carryover of the unused foreign tax. How far you can carryback or carryover the unused foreign tax depends on the tax year for which you are filing.

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. There is no double taxation in this situation because the income is not subject to United States tax.