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Foreign Tax Credit

International Tax Gap Series

US taxpayers claimed over $90 billion of foreign tax credits on US individual and corporate tax returns in 2005. Foreign tax credits allow US taxpayers to avoid or reduce double taxation. You may choose to take a deduction for foreign taxes paid instead of choosing a credit. In most cases, it is to your advantage to take foreign income taxes as a tax credit.

Qualifying Foreign Taxes
You can claim a credit only for foreign taxes that are imposed on you by a foreign country or US possession. Generally, only income, war profits and excess profits taxes qualify for the credit.

What Foreign Taxes Qualify For The Foreign Tax Credit?

Generally, the following four tests must be met for any foreign tax to qualify for the credit:

  1. The tax must be imposed on you
  2. You must have paid or accrued the tax
  3. The tax must be the legal and actual foreign tax liability
  4. The tax must be an income tax (or a tax in lieu of an income tax)

How to Claim the Foreign Tax Credit
File Form 1116 Foreign Tax Credit to claim the foreign tax credit if you are an individual, estate or trust, and you paid or accrued certain foreign taxes to a foreign country or U.S. possession. Corporations file Form 1118 to claim a foreign tax credit.

Compliance Issues

The foreign tax credit laws are complex.  Link to Foreign Tax Credit Compliance Tips for help in understanding some of the more complex areas of the law.  Below are some of the compliance issues:  

  • Foreign sourced qualified dividends and/or capital gains (including long-term capital gains, collectible gains, unrecaptured section 1250 gains, and section 1231 gains) that are taxed in the U.S. at a reduced tax rate must be adjusted in determining foreign source income on Form 1116, line 1a.
  • Interest expense must be apportioned between U.S. and foreign source income.
  • Charitable contributions are not apportioned against foreign source income.
  • The amount of foreign tax that qualifies is not necessarily the amount of tax withheld by the foreign country. If you are entitled to a reduced rate of foreign tax based on an income tax treaty between the United States and a foreign country, only that reduced tax qualifies for the credit.
  • If a foreign tax redetermination occurs, a redetermination of your US tax liability is required in most situations. You must file a Form 1040X or Form 1120X. Failure to notify the IRS of a foreign tax redetermination can result in a failure to notify penalty.
  • A foreign tax credit may not be claimed for taxes on excluded income.

Tools and Links
For more information on claiming a foreign tax credit, the following information is available:

International Information on irs.gov

Foreign Tax Credit Compliance Tips

How to Figure the Foreign Tax Credit

Publication 514 Foreign Tax Credit for Individuals

Publication 901 U.S. Tax Treaties

Form 1116 Foreign Tax Credit

Instructions for Form 1116

Form 1118 Foreign Tax Credit - Corporations

Instructions to Form 1118

 

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The International Tax Gap Series

Page Last Reviewed or Updated: 11-Feb-2014