Foreign Tax Credit
Avoiding Double Taxation on Foreign-Source Income
What Is the Foreign Tax Credit?
U.S. taxpayers are generally taxed on worldwide income, which means income earned abroad can be taxed twice — once by the foreign country where it was earned, and again by the IRS. The foreign tax credit exists to relieve that double taxation, allowing taxpayers to offset U.S. tax liability with income taxes already paid or accrued to a foreign government. It’s claimed using Form 1116 for individuals, or Form 1118 for corporations.
Who Can Claim the Foreign Tax Credit
Individuals, estates, and businesses with foreign-source income and foreign tax obligations may be eligible, including:
- U.S. citizens and resident aliens working or investing abroad
- Expatriates receiving foreign wages or self-employment income
- Taxpayers with foreign investment income, including dividends and interest
- Businesses with foreign branch or subsidiary income subject to local taxation
Credit vs. Deduction: Choosing the Right Approach
Taxpayers generally have the option to either claim a credit or a deduction for foreign taxes paid, but not both in the same year. A credit reduces U.S. tax liability dollar-for-dollar, while a deduction only reduces taxable income — in most cases, the credit produces significantly greater tax savings, but the right choice depends on your overall income mix, filing status, and other credits or limitations already in play.
Common Complications
The foreign tax credit isn’t unlimited — it’s capped based on the ratio of foreign-source taxable income to total taxable income, and unused credits can often be carried back one year or forward up to ten. Taxpayers with income from multiple countries, passive income categories, or foreign tax redeterminations frequently find the calculation more complex than it first appears, and errors here can mean leaving real tax savings on the table or, in the other direction, triggering IRS scrutiny.
How We Help
Our CT tax attorneys and CPAs help individuals and businesses properly calculate, claim, and defend foreign tax credit positions, including cases involving prior-year corrections or IRS inquiries. If your foreign income also involves account or entity reporting obligations, we regularly handle related FBAR and foreign information return matters as part of the same engagement. Contact us today to discuss your foreign income tax situation.
