IRS Form 1116: How To Claim The Foreign Tax Credit (With Examples)

Written by Olivier Wagner | Posted in IRS Form 1116

When talking about US taxes and taxation of US citizens who live abroad, you may have heard of the Foreign Tax Credit. A U.S. citizen or resident alien who pays income taxes in another country can claim a tax credit against their U.S. federal income tax bill to avoid double taxation, ensuring they are not taxed twice on the same income. Double taxation refers to the situation where income is taxed both in the country where it is earned and again in the U.S. You can offset your US tax liability by claiming the foreign taxes paid to another country. This way, you can bring your tax owing down to zero.

WHAT IS FORM 1116 AND WHO NEEDS TO FILE IT?

You must complete Form 1116 in order to claim the foreign tax credit on your US tax return for foreign income tax paid. The form requests information about the country your foreign taxes were paid in, the value of foreign income tax paid, and the types of income.

Most of the US international tax experts prefer claiming a Foreign Tax Credit (Form 1116) on a client’s U.S. tax return rather than the Foreign Earned Income Exclusion

Read further to learn about how to file Form 1116 Foreign Tax Credit and why it is a better way to save money on your US expat taxes.

ADVANTAGES OF FOREIGN TAX CREDIT AND GENERAL RULES

Claiming the Foreign Tax Credit will not only bring your tax owing to zero, it will allow you to make tax-deductible IRA contributions, claim the additional child tax credit and carryforward those excess credits to future years. Individuals who pay foreign taxes may be eligible for significant benefits under the Foreign Tax Credit, highlighting the importance of understanding one’s legal obligations and opportunities when living abroad.

THE ADDITIONAL CHILD TAX CREDIT

In order to qualify for the additional child tax credit, taxpayer must have at least $3,000 of earned income. If you exclude all your foreign earned income with the foreign earned income exclusion, you have no taxable income on your tax return that would qualify you for the ACTC. Many expats miss out on the ACTC each year not knowing they could claim the FTC and the ACTC.

IRA CONTRIBUTIONS

The same rules apply to your IRA contribution. You must have earned income in order to make contribution to your IRA. If you use the FEIE, you won’t have earned income that could be contributed.

FOREIGN TAX CERDIT CARRYOVERS

You have an FTC carryover if you paid more foreign taxes (that is, taxes that were not subject to US income tax) than what you would have been liable for had you lived in the United States. An FTC carryover allows you to use that excess FTC from one year to offset one year’s prior tax liability or carry forward those excess credits to future years. You can find more on the advantages of the foreign tax credit here

Remember that you need to convert all of the foreign taxes paid to US dollars. The IRS prefers that you convert each transaction at the foreign exchange rate at the date of the transaction. However, if you choose to claim foreign income taxes on an accrual basis, you will have to use the annual average foreign exchange rate.

The eligible taxes include only passive category income and general category income.

Passive category income includes dividends, interest, rents, and royalties. Capital gains that are not considered active conduct of a trade or business also fall under Passive income. General category income may include wages, salary, and overseas allowances. The latter category also includes income earned in the active conduct of a trade or business

There are other limitations on certain foreign taxes that you cannot claim as a foreign tax credit. For example, the Foreign Tax Credit doesn’t apply against any tax paid to North Korea, Iran, Sudan or Syria.

YOU CAN EASILY CALCULATE THE AMOUNT OF FOREIGN TAX CREDIT LIMITATION:

Divide Foreign Sourced Taxable Income by Total Taxable Income Before Exemptions
Multiply it by Total US tax and you will have the final amount of Foreign Sourced US Tax.

WHAT TO KNOW ABOUT FILING FORM 1116

You claim Foreign Tax Credit on your US expat taxes by filing Form 1116
You attach the Foreign Tax Credit Form 1116 to a Form 1040, your individual US tax return
One of the benefits of Foreign Tax Credit is that it reduces your US tax liability on expat income dollar for dollar.
You cannot take Foreign Tax Credit against foreign income which you have previously excluded by the Foreign Earned Income Exclusion
And you can’t receive a refund of foreign taxes paid through your US tax return

Have a question? Contact Olivier Wagner, 1040 Abroad.

Olivier Wagner

Certified Public Accountant, U.S. immigrant, expat, and perpetual traveler Olivier Wagner preaches the philosophy of being a worldly American. He uses his expertise to show you how to use 100% legal strategies (beyond traditionally maligned “tax havens”) to keep your income and assets safe from the IRS. Before obtaining my U.S. citizenship and traveling all over the world, he was born and raised in France. His experience learning the intricacies of the U.S. immigration process combined with his desire to travel freely lead me to specialize in taxes for Americans living and working abroad. He helps Americans Abroad file their taxes and devise strategies that make sense for their lifestyle. These strategies encompass all aspects of registering an offshore business, opening a bank account abroad, and planning out new residencies and citizenships. He is operating the accounting firm 1040 Abroad. 1040 Abroad exists to help you make sense of an incredibly large world of possibilities. Find out more by visiting www.1040abroad.com