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 are considered foreign taxes. For this purpose, U.S. possessions include Puerto Rico and American Samoa.
Tax Must Be Paid Or Accrued
You can claim credit only if you paid or accrued the foreign tax to a foreign country or U.S. Possessions
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, or other Regulated Investment Company (RIC), 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
Your qualified foreign tax is only the legal and actual foreign tax liability that you paid or accrued during the year. 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.
Example: You are a shareholder of a French corporation. You receive a $100 refund of the tax paid to France by the corporation on the earnings distributed to you as dividend. The French government imposes a 15% withholding tax ($15) on the refund you received. You receive a check for $85. You include the $100 in your income. The $15 of tax withheld is a qualified foreign tax.
Tax Must Be an Income Tax or Tax In Lieu of 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. Examples of such taxes in lieu of foreign income taxes include:
- Tax paid or accrued to a foreign country if it is imposed in lieu of an income tax.
- A foreign levy if it is not payment for a specific economic benefit and the tax is imposed in place of, and not in addition to, an income tax otherwise generally imposed.
- A foreign country imposes a soak-up tax in lieu of an income tax.
- The foreign tax you paid that is more than the amount you would have paid if you had been subject to the generally imposed income tax.
Foreign Taxes for Which You Cannot Take a Credit
The following are some foreign taxes for which you cannot take a foreign tax credit:
- Taxes on excluded income,
- Taxes for which you can only take an itemized deduction,
- Taxes on foreign mineral income,
- Taxes from international boycott operations,
- A portion of taxes on combined foreign oil and gas income,
- Taxes of U.S. persons controlling foreign corporations and partnerships who fail to file required information returns, and
- Taxes related to a foreign tax splitting event.
- 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 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, Tax Guide for U.S. Citizens and Resident Aliens Abroad, for more information on the foreign earned income and housing exclusions. Also see Publication 514, Foreign Tax Credit for Individuals, for information about the reduction of foreign taxes available for credit.