US Foreign Tax Credit and its Calculation for Expats

If you are living abroad, you are already familiar with some of the tax laws within your adopted country. Especially if you are working overseas – depending on your income – you most likely pay taxes to the country you’re living in. But did you know you can get credit towards your foreign income to prevent you from paying double tax? Yes, and we have info about this US foreign tax credit and how the calculations are done.

The Foreign Tax Credit (FTC) from the IRS in the United States is a dollar-for-dollar reduction towards your foreign earned income. For example, say you paid 200 Euros to the Italian government as a resident of a foreign country. You then can take a 200 dollar credit and apply it to any US taxes you owe. Thus, you can subtract 200 Euros (convert into USD) from your US tax bill.

It’s important to note, however, that you as an American expat cannot take credit for the income you excluded from the FEIE (Foreign Earned Income Exclusion). This particular credit is a tax benefit that helps you exclude up to $120,000 of foreign earned income for the 2023 tax season.

MyExpatTaxes is ready to help you file your taxes abroad. Our software automatically selects all the best tax credits and exclusions for your specific need.

How to Claim the Foreign Tax Credit

For your US expat taxes, in order to claim the Foreign Tax Credit, you’ll have to meet the following:

The tax…

• is owed and paid by you.
• must be income which is offered for taxation (ie: “assessed income” – calculating taxable income and then assessing tax liability from it).
• needs to originate in a foreign country legally (ie: foreign country taxes).

Additionally,

• You need to have a foreign tax liability that was accrued or paid.

Furthermore, refunds stay as refunds and cannot be included in the aggregate (amount) of the foreign taxes you paid. So if you had 1,000 euros withheld on your French taxes throughout the year and received 100 euros back in a tax refund, you will only be able to claim the net amount of 900 euros as a foreign tax credit.

Form 1116

Therefore, in order to claim the FTC, you can manually complete Form 1116. But in order to fill out this form, you will need to change the foreign taxes paid into US dollars. 

When converting foreign taxes paid into US dollars, it’s advisable to do so either on the precise date when the foreign tax was paid or using the average yearly exchange rate specified by the IRS. After completing the form, attach it to your federal tax return (Form 1040).

However, since our software covers the FTC, you can skip out on the manual labor and easily get your US taxes done through us.

Qualifying for FTC

How can you be sure you qualify for the Foreign Tax Credit? First, make sure that taxes you are paying in the foreign country you are working in, is imposed on you. Meaning, by law you must pay taxes in a foreign country and so, you carry forward this responsibility.

Then, only a certain type of finances can qualify for this credit. In the most common case, it is personal income, which includes everything from wages, and business income to investment income.

By using the Foreign Tax Credit calculation, you are reducing your US taxable income as an American abroad. Additionally, when you use the FTC for credit onto your own US taxes, you lessen the burden of your US tax liability.

If you want to deduct your foreign taxes, you can fill out Form 1040 (Schedule A – Itemized Deductions). However, we recommend against this as it usually results in a lower reduction than the Foreign Tax Credit approach.

Once you know for a fact you want to utilize the Foreign Tax Credit, you can fill out Form 1116. Another option is to use our online software to get it done smoothly! If you own a company abroad, you can use Form 1118 for Corporations.

Categorizing your Credit

Before you even get started on the math, you will need to put your foreign tax credits into different buckets. The most important being:

• General Income Category 
• Passive Income 

Why? The reason behind this is that the IRS, along with various tax authorities, applies different rules and rates to diverse types of income. Take long-term investment income, for instance, which might enjoy more favorable tax treatment compared to ordinary income. Consequently, it becomes crucial and mandatory to ensure that foreign tax credits are exclusively applied to the specific type of income to which they relate.

General Income Category income most commonly applies to income items such as salary, wages, self-employment income. While Passive Income Category income includes dividends, interest, royalties, rents, and annuities. 

US Foreign Tax Credit Calculation

Your tax credit cannot be more than your total U.S. tax liability multiplied by a fraction. The numerator of the fraction is your taxable income from sources outside the United States. The denominator is your total taxable income from U.S. and foreign sources.

IRS

In order to see how much you can claim, please multiply the total amount of your foreign source taxable income (before tax exemptions) with the total US tax you need to pay.

For the tax year, George made $100,000 in the US, but also made $50,000 in Italy (after converting Euros to US Dollars). He also owes $10,000 in US taxes.

Therefore, George’s total income is $150,000 and one-third of that income ($50,000) is foreign-sourced. He can receive $3,300 as the maximum credit ($10,000 x 1/3).

Carryback and Carryover of Unused Credit

US citizens abroad who are subject to tax and can’t claim a credit for the full amount of qualified foreign income taxes paid or accrued in the year are allowed a carryback and/or carryover of the unused tax. It is possible to carry back for one year and then carry forward for 10 years the unused foreign tax.

For more information on this topic (including taxes paid or accrued in years before 2007), see Publication 514, Foreign Tax Credit for Individuals.

Other Ways to Save on Your US Taxes

In addition to claiming credit for the taxes you pay to your country of residence, there are additional opportunities to owe a few taxes and receiver a larger refund. The Foreign Earned Income Exclusion is an excellent way to avoid paying income taxes to the IRS. If you are a parent there are excellent opportunities in 2024 for parents to receive a refund via the Additional Child Tax Credit.

You may want to file more than just Form 1116. We’ve got a guide for all of these forms and more.

To start the process of claiming your Foreign Tax Credit sign up through us at MyExpatTaxes. We help hundreds of American citizens living abroad on a daily basis deal with tax forms, filing status, tax rate, and more!

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