What exactly is the foreign tax credit?
The U.S. foreign tax credit offsets foreign income tax. U.S. citizens and resident aliens can claim income tax credits from other countries or U.S. possessions. The credit can lower your U.S. tax obligation and prevent double taxation on the same income.
Foreign Tax Credit Functions
You can deduct or credit taxes paid to a foreign nation or U.S. territory on the same income. Foreign tax credits apply to Puerto Rico, the USVI, Guam, NM, and American Samoa.
Foreign income tax deductions on Schedule A of your 1040 or 1040-SR lessen taxable income. Take the credit—foreign income reduces IRS taxes. Add Form 1116 to your U.S. tax return to claim the credit.
Credit or deduct qualified foreign taxes. Avoid crediting certain foreign taxes and deducting others.
It usually makes sense to utilize the credit since it decreases your tax burden, not just your income. The tax advantage reduces double taxation on income.
Credit is usually limited to income, war earnings, and surplus profits. Foreign wages, dividends, interest, and royalties count. The IRS says “the tax must be a levy that is not payment for a specific economic benefit,” and it must seem like a U.S. payment.
The credit is available if the foreign tax is “in lieu” of income, war gains, or excess earnings. This tax must replace the country’s income tax.
Most overseas taxes are in foreign currency. Use a foreign tax payment, withholding, or estimated tax payment date currency rate.
After claiming the international tax credit, you can deduct foreign real and personal property taxes on Schedule A of your income tax return. Non-business foreign real property taxes are deductible. Other taxes must be corporate charges.
Individuals, estates, and trusts pay less income tax using foreign tax credits. Unused foreign taxes can be carried back one year and forward 10.
Can I get a foreign tax credit?
Not all foreign taxes can be deducted from the U.S. income tax. Foreign tax credit eligibility:
- The tax must be from a foreign or U.S. post.
- The tax must be paid or incurred abroad or in the U.S.
- You mU.S pay or accumulate the year’s legal and factual foreign tax.
- There must be an income tax or a tax substitute.
You compute your credit limit on Form 1116. You can claim the smaller foreign tax paid or your calculated limit unless you qualify for an exemption.
- This tax year, you have passive overseas income.
- You qualify for foreign taxes of under $300 for the year, or $600 if you are married and filing jointly.
- A Form 1099-DIV or 1099-INT payee statement shows your gross foreign income and taxes.
- You chose this tax-year process.
Use Form 1040 to claim tax credits if you qualify for exemptions.
Using the foreign-earned income and housing exclusions prevents you from taking a foreign tax credit for taxes on the income you excluded. The IRS may revoke one or both of your options.
Tax Credits: Refundable or Non-refundable
Tax credits are refundable or non-refundable. Refundable tax credits are given when the tax credit exceeds the tax bill. If you pay $3,000 in taxes and get a $3,400 tax credit, you get $400 back.
Non-refundable tax credits do not give a refund but lower the tax owed to zero. A non-refundable $3,400 tax credit would make you owe nothing to the government. The $400 remaining after the credit would be forfeited. Foreign tax credits are non-refundable, like most others.
How Are Tax Credits and Deductions Different?
Tax deductions cut taxable income, whereas tax credits lower taxes. Since credits lower your tax bill, they save you more. A $1,000 tax credit reduces your bill. However, a $1,000 tax deduction decreases taxable income. A $1,000 deduction saves $220 on the 22% tax rate.
How Are Foreign Tax Credits and Foreign Earned Income Exclusions Different?
Consider the international tax credit and foreign-earned income exclusion to prevent double taxes on overseas income. Income is a significant difference. Dividends and interest are eligible for the foreign tax credit. Foreign-earned income exclusion applies solely to earned income.
Who should I get?
If you are a U.S. citizen, the U.S. taxes your worldwide income, no matter where you live. To avoid double taxation, the U.S. lets you tax credit for foreign taxes you pay or accrue. U.S. citizens and resident aliens who paid foreign income tax and are subject to U.S. tax on that same income can take the foreign tax credit. A nonresident alien can take the credit if they were a bona fide resident of Puerto Rico for the entire tax year or paid foreign income taxes connected to a trade or business in the U.S.
The U.S. foreign tax credit offsets foreign income tax. The tax must be from a foreign country or U.S. possession and paid to qualify. Income, earnings, dividends, interest, and royalties are usually eligible for this tax credit.
- The U.S. foreign tax credit offsets foreign income tax. U.S. residents who earn and pay international income taxes can claim the credit.
- Foreign tax credits apply to income, wages, dividends, interest, and royalties.