am i getting double taxed on my foreign income?
If you are a U.S. citizen or resident who earns income abroad, you may be subject to income tax in both the foreign country and the United States. To avoid double taxation, you can claim a foreign tax credit on your U.S. tax return. Here is what you need to know about this tax break.
What Is the Foreign Tax Credit?
The foreign tax credit is a dollar-for-dollar reduction of your U.S. tax liability based on the amount of income tax you paid or accrued to a foreign country or a U.S. possession. A U.S. possession is Puerto Rico, the U.S. Virgin Islands, Guam, the Northern Mariana Islands, or American Samoa.
The foreign tax credit applies to income, war profits, and excess profits taxes imposed by a foreign government or a U.S. possession. It also applies to taxes on wages, dividends, interest, and royalties that are similar to U.S. income taxes.
The foreign tax credit is intended to relieve you of the double tax burden when your foreign source income is taxed by both the United States and the foreign country.
How to Claim the Foreign Tax Credit?
To claim the foreign tax credit, you must file Form 1116, Foreign Tax Credit, and attach it to your Form 1040 or 1040-SR. You must report your foreign income and taxes in U.S. dollars using the exchange rate in effect when you paid or accrued the taxes.
You can choose to take either a credit or a deduction for all your qualified foreign taxes. You cannot take both a credit and a deduction for the same taxes, nor can you take a credit for some taxes and a deduction for others.
In most cases, taking the credit is more beneficial than taking the deduction because the credit directly reduces your tax bill, while the deduction only lowers your taxable income.
However, there are some limitations and restrictions on the foreign tax credit that you should be aware of:
- You can only claim the credit for foreign taxes that are legally owed and actually paid or accrued.
- You cannot claim the credit for taxes paid on income that you exclude under the foreign earned income exclusion or the foreign housing exclusion.
- You cannot claim the credit for taxes that are refunded or forgiven by the foreign country.
- You cannot claim the credit for taxes that are not imposed on you personally or that are payment for a specific economic benefit.
- You cannot claim the credit for taxes that are imposed by a country that is sanctioned by the United States or that supports terrorism.
- You cannot claim more than your U.S. tax liability on your foreign source income.
Example of Calculating the Foreign Tax Credit
Suppose you are a U.S. citizen who lives and works in France. In 2023, you earned $100,000 from your French employer and paid $25,000 in French income tax. You also received $10,000 in dividends from U.S. stocks and paid $1,500 in U.S. tax withholding.
Your total worldwide income is $110,000 and your total foreign income is $100,000.
To calculate your foreign tax credit, you need to determine your foreign source taxable percentage
Foreign source taxable income / Worldwide taxable income
$100,000 / $110,000 = 0.909090
Your US tax is $17,415
Foreign portion is $17,415 X 0.909090 = $15,832
Your foreign tax credit is the lesser of:
- Your total foreign tax paid or accrued ($25,000), or
- Your U.S. tax liability on your foreign source income ($15,832)
Therefore, your foreign tax credit is $15,832.
You can use this credit to offset your U.S. tax liability on your Form 1040 or 1040-SR as follows:
| Line | Description | Amount |
|---|---|---|
| 1 | Total worldwide income | $110,000 |
| 2 | Standard deduction | -$12,550 |
| 3 | Taxable income | $97,450 |
| 4 | Total U.S. tax liability | $17,415 |
| 5 | Foreign tax credit | -$15,832 |
| 6 | Net U.S. tax liability | $1,583 |
Since your foreign tax paid exceeds your foreign tax credit by $9,168, You can either carry this amount back one year or forward up to 10 years to offset your future U.S. taxes on foreign income.
Alternatively, you can choose to take a deduction for your foreign taxes instead of a credit. In that case, your foreign taxes would reduce your taxable income by $25,000, However, you would still owe the IRS, whereas with the credit, you would have a smaller tax due.
Conclusion
The foreign tax credit is a valuable tax break for U.S. taxpayers who earn income abroad and pay foreign income taxes. It can help you avoid double taxation and lower your U.S. tax bill. However, the rules and calculations for the credit are complex and subject to limitations and restrictions. You should consult a qualified tax professional or use a reputable tax software to help you claim the credit correctly and maximize your tax savings.
For more information on the foreign tax credit, you can refer to the following sources:
