The Foreign Tax Credit is a credit given to taxpayers to help prevent double taxation. When a taxpayer pays taxes to another country then the Foreign Tax Credit can be used to offset the taxpayers US tax liability.
The Foreign Tax Credit (FTC) is most useful for a taxpayer who live in a country with a high tax rate and therefore paid a larger percentage of taxes to that country than they would have if they lived in the US. Examples of countries with high tax rates include Belgium, Finland, Sweden, and Luxembourg. In addition, it is also useful for taxpayers trying to claim a credit which requires the taxpayer to have income, such as the Child Tax Credit or the Earned Income Credit.
Foreign Tax Credit vs. Foreign Earned Income Exclusion
While the Foreign Earned Income Exclusion is limited to $100,800 in 2015, the FTC has no limit. So taxpayers making well above $100,800 should consider using the Foreign Tax Credit instead.
If the taxpayer chooses to exclude foreign income using the Foreign Earned Income Exclusion or the if the taxpayer chooses to exclude foreign housing costs, then the taxpayer cannot take the FTC.
If the taxpayer does use the FTC, the Foreign Earned Income Exclusion is considered revoked and the taxpayer may not claim the Foreign Earned Income Exclusion for the five years after the revocation.
How do I claim the Foreign Tax Credit?
The FTC is claimed by using form 1116 to determine the credit, and the credit is deducted from taxes owed on line 48 of the 1040. If the taxpayer paid foreign taxes on both active an passive income, then the taxpayer should complete two forms 1116s, one for active income and one for passive income.
If you have any questions about the Foreign Tax Credit or need help determining whether to use the Foreign Tax Credit or the Foreign Earned Income Exclusion, send us an email at firstname.lastname@example.org.