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IRS Foreign Tax Credit for Individuals

Last Update Date : August 14, 2018

IRS Foreign Income Tax Credit

The grass is not always greener on the other side. But this cannot be learnt, unless you travel to the other side to realize it is basically the same; same people, same problems, same lives, same joys, same sorrows and same taxes. While taxes may be a common phenomenon across countries, an individual can run into complexities when tax returns must be filed and paid in two countries. To combat double taxation, there are many exclusions and credits, a U.S. expat or American Indian can avail off. Foreign Tax Credit is an option that many opt for to reduce the U.S. tax liability on foreign earned income, which will be discussed in detail in this guide.

What is Foreign Tax Credit?

When an individual decides to re-locate to a different country for work-related purposes, he/she is subject to the income tax laws of both the host country and home country. To save taxes in a person’s home country, for example the U.S., an individual can opt for Foreign Tax Credit (FTC), which is a tax credit on income tax that has been paid in the foreign country. The credit is generally non-refundable and can be used for anyone who has an income from salary or income from investments from foreign sources.

Eligibility Criteria for Claiming Foreign Tax Credit

To avail of FTC, there are certain criteria that must be met:

  1. Tax has been imposed by foreign country
  2. Taxes paid or accrued
  3. Tax on income Tax or investment Income
  4. The tax imposed legal

All the criteria above must be met in order to avail of FTC. For example, if Michael, owns a home in the foreign country and has to pay property taxes, he cannot avail of FTC, because the tax imposed while legal and paid, it isn’t on income earned.

U.S. Tax Filing Experts in India

How to Claim Foreign Tax Credit?

To claim FTC, form 1116 must be attached to your annual U.S. tax return.

Form 1116 Instructions

Click the above image to download Form 1116

Accrual Method

By choosing this method, you are limited to using it in the year for which the taxes are owed.

Cash Method

This method allows you to use the credit in the year the taxes are paid or carry the credit forward/back to the year it is owed in.

Carry Forward/Backward FTC

Any unused credit can be carried forward for a period of ten years and carried back to the previous year.

[ Read: How to File U.S. Tax Return ]

Foreign Tax Credit Calculation with Example

You can only use FTC on actual income earned in the foreign country, including income from investments. The credit utilized cannot exceed the amount of U.S. taxes owed. Credit is always depending upon the ratio of foreign taxable income and US source income. The credit is determined as follows:

Foreign taxable income / Total income Foreign as well as US x Total U.S. tax = U.S. taxes owed on Foreign income.

Filling Form 1116 for claiming Foreign Tax Credit

Form 1116 consists of four parts, which must be filled out.

  • Part 1 – Details of foreign earned income, including deductions/losses.
  • Part 2 – Amount of foreign taxes paid/accrued for the year.
  • Part 3 – Calculating the credit owed.
  • Part 4 – Details of other FTC’s claimed from other form 1116.

Advantages of Claiming Foreign Tax Credit

While, the FTC was introduced to avoid double taxation, there are several benefits in opting for FTC, versus deductions. By opting for FTC on income earned in the foreign country:

  1. Credit reduces the taxes while if you use the foreign tax deduction then in that case it reduces your income.
  2. If you use FTC as credit then in that case you can claim credit as well as avail the benefit of standard deduction or itemized deduction.
  3. If the credit is more than taxes paid then the remaining credit can be carried forward or back to another year.

Difference Between Foreign Tax Credit and Deductions

Foreign Tax Deductions are the itemized deductions that reduce your taxable income by utilizing the deductions available such as HRA, LTA, tax saving schemes, etc., whereas, FTC reduces the total tax payable.

No Double Dipping

Whether self-employed or earning a salary in the foreign country, you cannot avail of both Foreign Earned Income Exclusion (FEIE) and FTC on the same income. For the income that was taxed in the foreign country, you can avail of FTC on the U.S. taxes payable. You can claim FTC on balance income that was not excluded from FEIE or Foreign Housing Exclusion.

How H&R Block can help you?

Filing your annual income taxes in normal situations is already a complex process. When you mix foreign earned income into the mix, filing your income tax to include FTC, can give cause for headaches. To ensure your taxes are filed accurately while availing of every deduction and savings available to you, enlist the aid of U.S. Expat tax experts at H&R Block India.

Not sure how to file your U.S. Tax Return? Let H&R Block help you file your taxes.
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