One important benefit for US taxpayers living abroad is the foreign tax credit. The foreign tax credit prevents the dreaded double taxation by allowing taxpayers a dollar for dollar tax credit for foreign taxes paid. For most taxpayers, claiming a tax credit is more beneficial than claiming a tax deduction. The foreign tax credit is claimed on IRS Form 1116. The following explains a few rules regarding the foreign tax credit:
What is the maximum credit I can receive?
Taxpayers can reduce their US tax liability using the foreign tax credit, but the credit cannot be more than the amount of US taxes due. For example, if a taxpayer’s US tax liability is $1,500 US in 2012, the foreign tax credit can only be up to $1,500 US for that year.
The foreign tax credit is calculated by taking total foreign source taxable income and then dividing this amount by worldwide taxable income. Take this ratio and multiply it by US income tax before foreign tax credit. The remainder will be the foreign tax credit limitation.
One additional limitation to keep in mind is that the foreign tax credit cannot be taken for income that is excluded. For taxpayers claiming the foreign earned income exclusion (excluding $95,100 US on Form 2555 in 2012), the foreign tax credit is not allowable for this excluded income.
Carryover or Carryback of Foreign Tax Credit
For tax years where there is excess foreign tax credit, taxpayers may be able to carry the credit back one year or carry it forward to a future year (up to 10 years). This carryback and carryover allows taxpayers to utilize the credit in another year there is tax liability to prevent losing the tax credit. One of the requirements of carrying back or carrying forward the credit is that taxpayers must file Form 1116.
Interest and Dividend Income
The foreign tax credit is available for US taxpayers even when living in the US. For investors investing in foreign securities and investments, they will usually receive a 1099 DIV or INT. The form will report the total foreign taxes paid. These taxpayers can also claim the foreign tax credit for foreign taxes paid on interest and dividend income.
Please contact us today if you have additional questions and would like to talk to a qualified CPA about the foreign tax credit.
The information contained herein serves as a guideline and is only provided for general informational purposes. It should not be considered as offering any tax advice. Since tax laws are complex, you should consult your tax advisor on specific issues related to your tax situation.