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Foreign Tax Credit or Deduction

Internal Revenue Code, Sections 164 & 901

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You may claim the Foreign Tax Credit for taxes paid in a foreign country. However, you may not claim a tax credit for taxes paid on any income which has been excluded from US taxation using the foreign earned income exclusion or the foreign housing exclusion. In this Tax Guide, you will find information on:

General Rule

You may claim a tax credit or an itemized deduction for taxes paid to foreign countries. You do not need to live or to work in that foreign country in order to claim this benefit. For example, you can claim the credit or deduction if foreign taxes were paid on your behalf from a mutual fund. There are no time requirements like there are for the income exclusions. You can claim either the deduction or the tax credit, but not both, for all foreign taxes paid.

Foreign Tax Deduction

You may claim an itemized deduction for foreign taxes. This generally provides the least tax benefit. However, if you cannot claim the foreign tax credit, deducting foreign taxes would be the only alternative.

Foreign Tax Credit

A tax credit reduces your US tax liability on a dollar-for-dollar basis, and so is generally more valuable than a deduction which reduces your taxable income.

Maximum Allowable Foreign Tax Credit

Your foreign tax credit cannot exceed your US tax liability multiplied by a percentage. The percentage is your total foreign-source income divided by your total worldwide income. You must figure the allowable amount by various categories of income. Examples of income categories include investment income and wages.

Carryback and Carryover of the Foreign Tax Credit

Any foreign tax credit amount in excess of the maximum limit may be carried back to a previous tax year or carried forward to a future tax year. You can carry-back the foreign tax credit to the immediately preceding tax year, or carry-forward the credit for the next 10 tax years.

If you paid foreign taxes in 2004 or previous year, a different carryover time frame applies. For tax years 2004 and earlier, any excess foreign tax credit may be carried back to the two previous tax years, or carried forward for the next five tax years. The change in the carryover time frame was part of the American Jobs Creation Act of 2004.

Claiming the Tax Credit or Deduction Each Year

You may claim either the foreign tax credit or deduction each year. You can choose to take a credit in one year, and a deduction in the next year. You can even change your choice by amending your tax return within ten years of the original due date of the tax return.

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