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Tax Credits for Individuals

  1. Child Tax Credit
  2. EITC
  3. Form 5405
  4. Foreign Tax Credit
  5. IRS Publication 970
  6. Publication 972
  7. Form 1095-A
  8. ACTC
  9. Bush Tax Cuts
  10. Hope Credit
  11. Non-Refundable Tax Credit
  12. Tax Credit

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Foreign Tax Credit: Definition & How to Claim It

Updated: January 17, 2023

The Foreign Tax Credit (FTC)  is a credit that you can claim on your tax return if you paid taxes to another country on the income received from that country. By claiming the credit, you will get the opportunity to avoid paying double-taxes on the same income. You can read more about the FTC in IRS Publication 514.

 If you qualify for the Foreign Tax Credit and have not yet done so, consider filing Form 1116. Here, we show you how to claim foreign tax liability on your tax return and more.

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    KEY TAKEAWAYS

    • A foreign tax credit allows a US taxpayer to offset taxes paid to a foreign government on income earned outside the United States.
    • To claim a foreign tax credit, taxpayers must file Form 1116 or Form 1118 with their federal income tax return.
    • The credit is generally limited to the amount of US tax liability attributable to the foreign-source income.

    What is Foreign Tax Credit?

    The Foreign Tax Credit (FTC) is a tax credit available to US taxpayers who have paid foreign taxes on income earned abroad. The credit intends to offset the double taxation. This would otherwise occur when foreign-source income is subject to both US and foreign taxes.

    This includes income from employment, business activities, investments, and more.

    To claim the Foreign Tax Credit, individual taxpayers must file Form 1116 with their annual federal income tax return. Corporations must file Form 1118. You claim the credit as a reduction in your tax liability rather than as a refundable credit like the Earned Income Tax Credit or the Child Tax Credit.

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    How Does Foreign Tax Credit Work?

    When you file your taxes, you may be able to claim a foreign tax credit if you’ve paid taxes to a foreign country. This credit can offset any US taxes that you owe on income from foreign sources.

    To claim the credit as an individual, you’ll need to file Form 1116 with your tax return. This form will allow you to calculate the amount of the credit that you’re eligible for.

    You’ll also need to have documentation of the taxes that you’ve paid, such as a tax return or a statement from the foreign government.

    The foreign tax credit is available for both federal and state taxes. However, you can only claim the credit for taxes that are actually paid. This means that you can’t claim the credit if you’re eligible for a refund of foreign taxes but have missed to claim the refund.

    The foreign tax credit is generally limited to the amount of US taxes that you owe on your income from foreign sources. This means that if you don’t owe any US taxes, you won’t be able to claim the credit.

    However, there are some circumstances in which you may be able to claim a portion of the credit in the following years even if you don’t owe any US taxes in that tax year. For example, you may be able to carry forward the credit to future years or allocate the credit to your spouse.

    Requirements For Foreign Tax Credit

    To take the foreign tax credit, you must meet the following requirements:

    • All taxes claimed as a Foreign Tax Credit must be imposed on income earned outside of the United States.
    • The taxes claimed as a Foreign Tax Credit must have been paid to a foreign country.
    • The taxes claimed as a Foreign Tax Credit must be an income tax or a tax similar to an income tax, such as taxes paid on your wages.
    • Have paid or accrued foreign taxes to a qualified country (see IRS Publication 514 for a list of unqualified countries).
    • The taxes paid cannot be on income that is excluded from the U.S Gross Income.
    • Not have claimed an itemized deduction for those taxes.

    In general, the foreign tax credit is available for any foreign taxes paid or accrued on income from sources outside the United States. This includes income from investments, as well as earnings from employment or business activities.

    The credit is not available for taxes paid on gambling winnings, penalties, or certain excise taxes.

    How To Claim Foreign Tax Credit

    To claim a foreign tax credit, you must file IRS Form 1116 and attach it to your income tax return. This form figures the amount of your credit. You will need to attach copies of your foreign tax return(s) and any other required documentation to Form 1116. Corporations need to file the form 1118. 

    You will have to calculate the income that qualifies for the tax credit based on each income class (e.g. wages, dividends, business income).

    The dollar tax credit is generally taken for taxes paid to the host country where the income was earned. However, there are some special rules that apply in certain situations. Suppose you’re a US citizen or resident alien and you live in one country but earn income in another country. You may be able to take the credit for taxes paid to either country.

    You may be able to claim a foreign tax credit even if you do not itemize your deductions on Schedule A (Form 1040). 

    If you’re married filing a joint return, you can choose to treat yourself and your spouse as two separate taxpayers. This may be beneficial if one spouse has a large amount of foreign taxes to claim and the other spouse has little or no foreign taxes to claim.

    To make this choice, you must file Form 1040 and attach two Forms 1116, one for you and one for your spouse. Each form must show only the foreign taxes paid by that particular spouse.

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    Who Can Claim Foreign Tax Credit?

    Any U.S. taxpayer who pays taxes to a foreign government on income earned from sources outside the United States can claim foreign income taxes. 

    This includes self-employed taxpayers and those who receive income from investments. Additionally, from working for a foreign employer.

    The only exception is if the individual is a nonresident alien who does not have an SSN or Taxpayer Identification Number (TIN). Taxpayers who meet the requirements listed above can claim a Foreign Tax Credit. Taxpayers who do not meet the requirements cannot claim a Foreign Tax Credit.

    Summary

    The foreign tax credit is a tax relief available to U.S. taxpayers who have paid taxes to a foreign country on income earned there. The credit can offset any U.S. taxes owed on that same income.

    To claim either type of credit, taxpayers must file Form 1116 with their federal tax return. They will also need to attach documentation of their foreign taxes paid. I.E., a copy of their foreign tax return or a statement from their employer.

    It’s important to note that the foreign tax credit for individuals is different from the earned income tax credit. The latter is available to U.S. taxpayers who have low-to-moderate incomes and meet certain other requirements.

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    FAQs on Foreign Tax Credit

    How much is the foreign tax credit worth?

    The credit is a dollar for dollar amount of credit for income taxes paid to the foreign government.

     Suppose you owe $2,000 in US taxes on income earned abroad, and you paid $1,500 in foreign tax rate on that same income. You can claim a $1,500 foreign tax credit amount. This would completely offset your country of residence tax liability.

    What happens to unused foreign tax credits?

    If a taxpayer has unused foreign tax credits at the end of the year, they can carry those credits over to future years for up to 10 years. This means taxpayers can continue to claim the credit for as long as they have qualifying foreign taxes paid in previous years.

    Do you have to carry back foreign tax credits?

    No, you do not have to carry back foreign tax credits but you have the option to carry back for up to 1 year. You can carry over the unused credit for 10 years. But if you don’t use your credits after 10 years, you lose them.

    How many years can you claim the foreign tax credit?

    You can claim the foreign tax credit for every year in which you paid taxes to the foreign government.

    What is the foreign tax credit limit?

    Foreign tax credit limitations are to the lesser amount of the foreign taxes you paid on qualified income. For example, if you paid taxes on income that’s considered reimbursement in the US (and is non-taxable), you won’t be able to deduct the portion of that tax payment. Also if you have paid foreign taxes on other items such as property or sales, you cannot claim a credit for those taxes.

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