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:
- The tax must be imposed on you
- You must have paid or accrued the tax
- The tax must be the legal and actual foreign tax liability
- The tax must be an income tax (or a tax in lieu of an income tax)
Tax Must Be Imposed on You
You can claim a credit only for foreign taxes that are imposed on you by a foreign country or U.S. possession. For example, a tax that is deducted from your wages is considered to be imposed on you.
A foreign country includes any foreign state and its political subdivisions. Income, war profits, and excess profits taxes paid or accrued to a foreign city or province qualify for the foreign tax credit.
For foreign tax credit purposes, all qualified taxes paid to U.S. possessions (such as Puerto Rico, Guam, The Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, and American Samoa) are considered foreign taxes.
If you file a joint return, you can claim the credit based on the total of any foreign income tax paid or accrued by you and your spouse.
Mutual Fund Shareholder
If you are a shareholder of a mutual fund, you may be able to claim the credit based on your share of foreign income taxes paid by the fund if it chooses to pass the credit on to its shareholders. You should receive from the mutual fund a Form 1099-DIV, or similar statement, showing the foreign country or U.S. possession, your share of the foreign income, and your share of the foreign taxes paid. If you do not receive this information, you will need to contact the fund.
Tax Must Be the Legal and Actual Foreign Tax Liability
The amount of foreign tax that qualifies is not necessarily the amount of tax withheld by the foreign country. Only the legal and actual foreign tax liability that you paid or accrued during the year qualifies for the credit. The amount of the deductible foreign tax must be reduced by any refunds of foreign tax made by the government of the foreign country or the U.S. possession.
Foreign Tax Refund
You cannot take a foreign tax credit for income taxes paid to a foreign country if it is reasonably certain the amount would be refunded, credited, rebated, abated, or forgiven if you made a claim.
For example, the United States has tax treaties or conventions with many countries allowing U.S. citizens and residents reductions in the rates of tax of those foreign countries. However, some treaty countries require U.S. citizens and residents to pay the tax figured without regard to the lower treaty rates and then claim a refund for the amount by which the tax actually paid is more than the amount of tax figured using the lower treaty rate. The qualified foreign tax is the amount figured using the lower treaty rate and not the amount actually paid, since the excess tax is refundable.
Tax Must Be an Income Tax
Generally, only income, war profits, and excess profits taxes (income taxes) qualify for the foreign tax credit. Foreign taxes on wages, dividends, interest, and royalties generally qualify for the credit. Furthermore, foreign taxes on income can qualify even though they are not imposed under an income tax law if the tax is in lieu of an income, war profits, or excess profits tax. See Publication 514 for Taxes in Lieu of Income Taxes.
Simply because the levy is called an income tax by the foreign taxing authority does not make it an income tax for this purpose. A foreign levy is an income tax only if it meets both of the following tests:
- It is a tax; that is, you have to pay it and you get no specific economic benefit (discussed below) from paying it
- The predominant character of the tax is that of an income tax in the U.S. sense
A foreign levy may meet these requirements even if the foreign tax law differs from U.S. tax law. The foreign law may include in income items that U.S. law does not include, or it may allow certain exclusions or deductions that U.S. law does not allow.
Pension, Unemployment, and Disability Fund Payments
A foreign tax imposed on an individual to pay for retirement, old-age, death, survivor, unemployment, illness, or disability benefits, or for similar purposes, is not payment for a specific economic benefit if the amount of the tax does not depend on the age, life expectancy, or similar characteristics of that individual.
No deduction or credit is allowed, however, for social security taxes paid or accrued to a foreign country with which the United States has a social security agreement. For more information about these agreements, refer to Totalization Agreements.
Reduction in Total Foreign Taxes Available for Credit
You must reduce your total foreign taxes that are available for the credit under the following circumstances. You must reduce your foreign taxes available for the credit by the amount of those taxes paid or accrued on income that is excluded from U.S. income under the foreign earned income exclusion or the foreign housing exclusion. See Publication 54 for more information on the foreign earned income and housing exclusions. Also see Publication 514 for information about the reduction of foreign taxes available for credit.