What is the Foreign Tax Credit?

Definition of the Foreign Tax Credit

The Foreign Tax Credit (FTC) is a non-refundable tax credit available to U.S. taxpayers who have paid or accrued income tax to a foreign country or U.S. possession. The credit is intended to mitigate the double taxation of income that is taxed both abroad and in the United States. The FTC can be claimed for income, war profits, and excess profits taxes paid or accrued to a foreign country or U.S. possession.

Key Points of the Foreign Tax Credit:

Eligibility:

The credit is available to individuals, estates, or trusts that have paid or accrued certain foreign taxes to a foreign country or U.S. possession.

Qualifying Taxes:

Generally, the credit applies to income taxes, war profits, and excess profits taxes. Other types of taxes, such as VAT or sales taxes, do not typically qualify for the FTC.

Credit or Deduction:

Taxpayers have the option to claim the foreign taxes paid as a deduction or as a credit. However, the credit usually provides a greater tax benefit than the deduction.

Limitations:

The FTC is subject to various limitations, ensuring that it does not exceed the amount of U.S. tax liability on the foreign income.

Forms to File:

To claim the FTC, individuals must file Form 1116, "Foreign Tax Credit," with their federal income tax return. Corporations use Form 1118, "Foreign Tax Credit—Corporations."

Interaction with Foreign Earned Income Exclusion:

If a taxpayer elects to exclude foreign earned income or foreign housing costs, they cannot take a foreign tax credit for taxes on the excluded income.

Carryover Provisions:

If the full amount of the FTC cannot be used in the current year due to limitations, the unused portion may be carried back one year and carried forward for up to ten years.

Special Considerations:

The FTC laws are complex, and there are specific compliance tips provided by the IRS to help understand the more intricate areas of the law.

For more detailed information on the Foreign Tax Credit, taxpayers can refer to the IRS's official page on the Foreign Tax Credit and consult the relevant IRS publications and forms.