Many Americans working in Hong Kong earn passive income beyond their paychecks. Without the right plan, you could face double taxation on dividends, rental income, or royalties. In this guide, you’ll learn how to unlock the foreign tax credit passive income benefit to offset your US tax dollar for dollar on taxes you pay overseas. For every $1 you pay in foreign passive taxes, you can reduce your US tax by $1 up to the IRS limit. As of 2019, the IRS lets you carry unused credits back one year and forward 10 years (publication 514).
Key takeaway: Passive income taxes you pay in Hong Kong or elsewhere can directly cut your US tax bill when you claim the foreign tax credit.
Identify qualifying passive taxes
Passive income sits in its own IRS category. Common types include:
- Dividends (stock distributions)
- Rental income (property you own)
- Royalties (intellectual property fees)
- Interest (certain long-term bonds)
You can claim a credit for foreign taxes on these earnings. For example, rental property in Hong Kong incurs property tax at 15% of the net assessable value. That 15% qualifies as a foreign tax credit on passive income. Likewise, if another country withholds tax on your dividends or royalties, those amounts can qualify. Keep in mind you must separate passive income into its own “passive basket” and track your foreign taxes accordingly.
| Passive income type | Example | Qualifying tax |
|---|---|---|
| Dividends | Stock payouts | Withholding tax |
| Rental income | Hong Kong property | 15% property tax |
| Royalties | Book or patent royalties | Royalties tax withheld |
| Interest | Foreign bond interest | Interest tax withheld |
Calculate your available credit
Your credit equals the smaller of:
- The foreign taxes you paid or accrued on passive income
- The US tax attributable to that foreign passive income
Use this formula to find your limit:
Credit limit = Total US tax × (Foreign Passive income / Total taxable income)
Follow these steps:
- Sum your qualifying foreign taxes for the year.
- Total your foreign-sourced passive income.
- Find your overall US tax liability on Form 1040.
- Apply the ratio to determine the maximum credit.
See our guide on foreign tax credit calculation for a worked example. When you’re ready to report, complete Form 1116, passive income section, and attach it to your 1040.
Choose cash or accrual basis
You can take the credit in the year you pay the tax (cash basis) or the year it accrues (accrual basis). Check the “Accrued” box in Part II of Form 1116 if you prefer to match the credit to when you earned the income.
Handle credit limits and carryover
The IRS caps your credit at the calculated limit. If your foreign tax exceeds that, you won’t lose it. Instead, you can carry it back one year and carry it forward up to ten years. Good news, this lets you smooth out years when passive income spikes or foreign taxes rise.
- For details on carry rules, visit foreign tax credit carryover
- For special baskets and limitations, see foreign tax credit limitations
- IRS guidance is found in Publication 514 (Foreign Tax Credit for Individuals)
File and optimize your credit
Staying organized makes claiming your credit easier than it sounds.
- Gather proof of foreign taxes paid (official statements, receipts)
- Fill out Form 1116 (attach to your Form 1040)
- Choose cash or accrual basis in Part II
- File by the usual tax deadline (or request an extension)
If your foreign taxes are low, you might opt to deduct them on Schedule A instead. Often the credit yields a bigger benefit for passive income. Compare your options in our foreign tax credit vs deduction guide.
Next step: Start tracking your foreign passive income and taxes now so you’re ready come filing season. You’ve got this—leveraging the foreign tax credit can be one of the smartest moves in your expat toolbox.
Frequently asked questions
What passive income taxes qualify for the credit?
You can claim the credit on foreign taxes paid for dividends, rental income, royalties, and certain interest. In Hong Kong, property tax on rental earnings (15% of net assessable value) is a common example.
How do I report the foreign tax credit?
Use Form 1116 with your Form 1040. Complete the passive income section, choose cash or accrual basis, and attach proof of foreign taxes paid. For step-by-step details, see how to claim foreign tax credit.
Can I use the foreign tax credit alongside the FEIE?
You cannot claim the credit on income excluded by the Foreign Earned Income Exclusion. Passive income generally doesn’t qualify for FEIE, so the foreign tax credit is often your best path for those earnings. For more, check foreign tax credit vs deduction.
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