All Americans, including those living abroad, must file taxes with the IRS. This includes reporting their total income, as well as any money earned abroad. American expats must report their foreign registered bank accounts, investments, business interests, and financial assets based on ownership thresholds and minimum IRS value. Double taxation is one of the most common issues U.S. expatriates face, and no one wants to pay taxes twice on a single income. Fortunately, many tax deductions and credits help expatriates avoid this expensive burden. Using the foreign tax credit, many Americans living abroad can erase their tax debt entirely. Keep reading to learn more about the foreign tax credit.
What Is the Foreign Tax Credit?
The foreign tax credit refers to a tax credit for income taxes paid by U.S. citizens to other countries. The tax credit can help to offset the income tax Americans have paid abroad. Claiming this tax credit can help you lower your U.S. tax liability and ensure you avoid double taxation on a single income.
Who Can Claim the Foreign Tax Credit?
For U.S. citizens, the IRS taxes worldwide income, irrespective of where you live. To minimize overpaying or double taxation, the government allows citizens to claim tax credits for the foreign taxes they accrue. Additionally, resident aliens who pay foreign income tax and are subjected to IRS tax on the same income can register for the foreign tax credit. A non-resident alien can also take this tax credit if they were a bona fide resident of specified countries for the whole tax year or paid foreign income taxes linked to business or trade in the U.S. To get the foreign tax credit, you need to meet the following criteria:
- You are a U.S. citizen or tax resident
- You earn income from one or multiple foreign sources
- You pay income taxes to a foreign government
How Can You Claim a Foreign Tax Credit?
The foreign tax credit in the U.S. can be claimed by an individual, estate, or trust for taxes paid or accrued in a foreign country. You can claim your tax credit by filing Form 1116 for Foreign Tax Credit if you are an individual. If you were filing the tax credit on behalf of a corporation, you should file Form 1118, Foreign Tax Credit for Corporations.
Foreign tax credits are non-refundable and are used to pay for income taxes paid to foreign governments. Foreign tax credits are available to American citizens working internationally and those with investment income from foreign sources. Taxpayers within the country who also accrue or pay taxes in foreign countries may also be eligible for tax credits or deductions.
One major benefit of the foreign tax credit is that it will lower your final tax bill by the amount you claim, dollar for dollar. However, there are limitations to the forms of tax you can count toward foreign tax credit and the maximum amount you may claim. Working with seasoned tax experts with extensive experience in using foreign tax credits will help you reduce or eliminate your U.S. tax obligations and maximize available tax credits and deductions.