Claiming the Foreign Tax Credit on your US Tax Return

Working in more than one country may subject an individual's income to double taxation, as each jurisdiction would want to get a piece of the pie.

Calculating and claiming the foreign tax credit on a US tax return can be complex. It’s not always as high as you’d think!

Working in more than one country may subject an individual’s income to double taxation, as each jurisdiction would want to get a piece of the pie. For US citizens and permanent residents (green card holders) who are taxed on their worldwide income regardless of where they live/work, double taxation will occur even if they have worked only in one foreign country for the entire tax year. Thankfully, the US Code allows two mechanisms to avoid double taxation:

1. The Foreign Tax Credit (Section 901)

2. The Foreign Earned Income Exclusion and Housing Exclusion (Section 911)

Unlike a tax deduction that reduces taxable income, a tax credit is a dollar by dollar reduction of an individual’s tax liability. For US tax purposes, the foreign tax credit if limited to the lower of either the actual foreign tax paid/accrued, or the US tax on the foreign source income.

For example, a taxpayer who is a US citizen, earns $100,000 annually, and worked in France for 220 days and in the US for 20 days, for a total of 240 workdays in the year. His effective tax rate in France is 35%, and his effective US Federal rate is 25%.

French tax liability = $100,000 @ 35% = $35,000

US Federal tax liability on foreign income = $100,000 / 240 x 220 = $91,667 @ 25% = $22,917

Foreign tax credit limitation is lower of $35,000 (actual foreign tax) or $22,917 (US tax on foreign income)

US Federal tax liability on entire income = $100,000 @ 25% = $25,000

Less: foreign tax credit = ($22,917)

US Federal balance due = $2,083

The foreign tax credit can be claimed on a US Federal tax return by attaching Form 1116 along with the return. Preparation of Form 1116 can be complex, as it involves things such as calculation of the foreign source income and determination of whether to choose the “paid” or the “accrued” method for claiming the credit. It is important that you discuss your specific situation with an experienced tax consultant before filing this form with your tax return.

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