If you pay taxes to a foreign jurisdiction, the IRS offers credits and deductions to help you avoid a double tax burden. The most utilized of these credits is the Foreign Tax Credit, which is claimed on Form 1116 for individuals.
We discuss the Foreign Tax Credit and Form 1116 in more detail below.
What Is the Foreign Tax Credit?
The Foreign Tax Credit is a dollar-for-dollar credit against your U.S. calculated tax equal to the amount of foreign income taxes paid or deemed paid by you.
The general premise of the Foreign Tax Credit is to provide a mechanism for you to avoid double taxation on foreign income.
What Is a Foreign Income Tax?
A foreign income tax means a foreign levy that is either an income tax or an in-lieu-of tax.
Foreign income taxes can include those taxes levied on foreign income tax returns, foreign withholding, or pay as you earn (PAYE) taxes.
The catch is that the tax must be imposed on you, and you must either pay or accrue the tax.
Who Qualifies for the Foreign Tax Credit?
Generally speaking, U.S. citizens or tax residents who earn income from a foreign source and pay tax on that income to a foreign jurisdiction are eligible to claim the Foreign Tax Credit.
How Do I Claim the Foreign Tax Credit?
In most cases you will claim the Foreign Tax Credit by filing Form 1116 as part of your U.S. tax return. This means the due date for filing the Form 1116 is the same as your tax return: April 15th or October 15th, if extended.
You must make sure that you convert the taxes paid from foreign currency to USD using the right exchange rate.
Are There Limits to How Much Credit I Can Claim?
Yes, there is a limit to how much you can claim in a single year. To find that limit, you must divide your taxable foreign income by your total taxable income, then multiply that by your U.S. tax liability.
Sound confusing? Don’t worry, we prepare these calculations for you to ensure you are getting the maximum credit allowed.
Do I Get a Refund of Extra/Unused Foreign Tax Credits?
Unfortunately, no. If you do not use the full Foreign Tax Credit that is available, the excess will carry over to future years up to a limit of 10 years.
Need Assistance?
The International Tax Services Team at Wolf & Company can help. We specialize in international tax reporting and can guide you on the right path to compliance.
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