Table of Contents
- Choosing To Take Credit or Deduction
- Why Choose the Credit?
- Who Can Take the Credit?
- What Foreign Taxes Qualify for the Credit?
- Foreign Taxes for Which You Cannot Take a Credit
- Taxes on Excluded Income
- Taxes for Which You Can Only Take an Itemized Deduction
- Taxes on Foreign Oil Related Income
- Taxes on Foreign Mineral Income
- Taxes From International Boycott Operations
- Taxes on Foreign Oil and Gas Extraction Income
- Taxes of U.S. Persons Controlling Foreign Corporations and Partnerships
- How To Figure the Credit
- Carryback and Carryover
- How To Claim the Credit
- Simple Example — Filled-In Form 1116
- Comprehensive Example — Filled-In Form 1116
- Foreign earned income.
- Employee business expenses.
- Forms 1116
- Computation of Taxable Income
- Part I—Taxable Income or Loss From Sources Outside the United States (for Category Checked Above)
- Part II—Foreign Taxes Paid or Accrued
- Part III—Figuring the Credit
- Part IV—Summary of Credits From Separate Parts III
- Unused Foreign Taxes
- How To Get Tax Help
You can choose each tax year to take the amount of any qualified foreign taxes paid or accrued during the year as a foreign tax credit or as an itemized deduction. You can change your choice for each year's taxes.
To choose the foreign tax credit, you generally must complete Form 1116 and attach it to your U.S. tax return. However, you may qualify for the exception that allows you to claim the foreign tax credit without using Form 1116. See How To Figure the Credit, later. To choose to claim the taxes as an itemized deduction, use Schedule A (Form 1040), Itemized Deductions.

As a general rule, you must choose to take either a credit or a deduction for all qualified foreign taxes.
If you choose to take a credit for qualified foreign taxes, you must take the credit for all of them. You cannot deduct any of them. Conversely, if you choose to deduct qualified foreign taxes, you must deduct all of them. You cannot take a credit for any of them.
See What Foreign Taxes Qualify for the Credit, later, for the meaning of qualified foreign taxes.
There are exceptions to this general rule, which are described next.
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You paid the tax to a country for which a credit is not allowed because it provides support for acts of international terrorism, or because the United States does not have diplomatic relations with it or recognize its government,
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You paid withholding tax on dividends from foreign corporations whose stock you did not hold for the required period of time,
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You paid withholding tax on income or gain (other than dividends) from property you did not hold for the required period of time,
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You paid withholding tax on income or gain to the extent you had to make related payments on positions in similar or related property,
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You participated in or cooperated with an international boycott, or
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You paid taxes in connection with the purchase or sale of oil or gas.
You can make or change your choice to claim a deduction or credit at any time during the period within 10 years from the regular due date for filing the return for the tax year for which you make the claim. You make or change your choice on your tax return (or on an amended return) for the year your choice is to be effective.
Example.
You paid foreign taxes for the last 13 years and chose to deduct them on your U.S. income tax returns. You were timely in both filing your returns and paying your U.S. tax liability. In February 2007, you file an amended return for tax year 1996 choosing to take a credit for your 1996 foreign taxes because you now realize that the credit is more advantageous than the deduction for that year. Because the regular due date of your 1996 return was April 15, 1997, this choice is timely (within 10 years).
Because there is a limit on the credit for your 1996 foreign tax, you have unused 1996 foreign taxes. Ordinarily, you first carry back unused foreign taxes arising in 1996 to, and claim them as a credit in, the 2 preceding tax years. If you are unable to claim all of them in those 2 years, you carry them forward to the 5 years following the year in which they arose.
Because you originally chose to deduct your foreign taxes and the 10-year period for changing the choice for 1994 and 1995 has passed, you cannot carry the unused 1996 foreign taxes back to tax years 1994 and 1995.
Because the 10-year periods have not passed for your 1997 through 2001 income tax returns, you can still choose to carry forward any unused 1996 foreign taxes. However, you must reduce the unused 1996 foreign taxes that you carry forward by the amount that would have been allowed as a carryback if you had timely carried back the foreign tax to tax years 1994 and 1995.

The foreign tax credit is intended to relieve you of the double tax burden when your foreign source income is taxed by both the United States and the foreign country. Generally, if the foreign tax rate is higher than the U.S. rate, there will be no U.S. tax on the foreign income. If the foreign tax rate is lower than the U.S. rate, U.S. tax on the foreign income will be limited to the difference between the rates. The foreign tax credit can only reduce U.S. taxes on foreign source income; it cannot reduce U.S. taxes on U.S. source income.
Although no one rule covers all situations, it is generally better to take a credit for qualified foreign taxes than to deduct them as an itemized deduction. This is because:
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A credit reduces your actual U.S. income tax on a dollar-for-dollar basis, while a deduction reduces only your income subject to tax,
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You can choose to take the foreign tax credit even if you do not itemize your deductions. You then are allowed the standard deduction in addition to the credit, and
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If you choose to take the foreign tax credit, and the taxes paid or accrued exceed the credit limit for the tax year, you may be able to carry over or carry back the excess to another tax year. (See Limit on the Credit under How To Figure the Credit, later.)
Example 1.
For 2007, you and your spouse have adjusted gross income of $80,000, including $20,000 of dividend income from foreign sources. None of the dividends are qualified dividends. You file a joint return and can claim two $3,400 exemptions. You had to pay $2,000 in foreign income taxes on the dividend income. If you take the foreign taxes as an itemized deduction, your total itemized deductions are $15,000. Your taxable income then is $58,200 and your tax is $7,951.
If you take the credit instead, your itemized deductions are only $13,000. Your taxable income then is $60,200 and your tax before the credit is $8,251. After the credit, however, your tax is only $6,251. Therefore, your tax is $1,700 lower ($7,951 - $6,251) by taking the credit.
Example 2.
In 2007, you receive investment income of $5,000 from a foreign country, which imposes a tax of $3,500 on that income. You report on your U.S. return this income as well as $56,000 of income from U.S. sources. You are single, entitled to one $3,400 exemption, and have other itemized deductions of $5,400. If you deduct the foreign tax on your U.S. return, your taxable income is $48,700 ($5,000 + $56,000 - $3,400 - $5,400 - $3,500) and your tax is $8,605.
If you take the credit instead, your taxable income is $52,200 ($5,000 + $56,000 - $3,400 - $5,400) and your tax before the credit is $9,480. You can take a credit of only $777 because of limits discussed later. Your tax after the credit is $8,703 ($9,480 - $777), which is $98 ($8,703 - $8,605) more than if you deduct the foreign tax.
If you choose the credit, you will have unused foreign taxes of $2,723 ($3,500 - $777). When deciding whether to take the credit or the deduction this year, you will need to consider whether you can benefit from a carryback or carryover of that unused foreign tax.
You can claim the credit for a qualified foreign tax in the tax year in which you pay it or accrue it, depending on your method of accounting. “Tax year” refers to the tax year for which your U.S. return is filed, not the tax year for which your foreign return is filed.
Example.
Last year you took the credit based on taxes paid. This year you chose to take the credit based on taxes accrued. During the year you paid foreign income taxes owed for last year. You also accrued foreign income taxes for this year that you did not pay by the end of the year. You can base the credit on your return for this year on both last year's taxes that you paid and this year's taxes that you accrued.
U.S. income tax is imposed on income expressed in U.S. dollars, while the foreign tax is imposed on income expressed in foreign currency. Therefore, fluctuations in the value of the foreign currency relative to the U.S. dollar will affect the foreign tax credit.
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You conduct the business primarily in dollars.
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The principal place of business is located in the United States.
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You choose to or are required to use the dollar as your functional currency.
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The business books and records are not kept in the currency of the economic environment in which a significant part of the business activities is conducted.

Internal Revenue Service
International Section
P.O. Box 920
Bensalem, PA 19020-8518.
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The foreign taxes are paid on or after the first day of the tax year to which they relate.
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The foreign taxes are paid not later than 2 years after the close of the tax year to which they relate.
A foreign tax redetermination is any change in your foreign tax liability that may affect your U.S. foreign tax credit claimed.
The time of the credit remains the year to which the foreign taxes paid or accrued relate, even if the change in foreign tax liability occurs in a later year.
If a foreign tax redetermination occurs, a redetermination of your U.S. tax liability is required in the following situations.
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You must pay additional foreign taxes,
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You receive a refund of foreign taxes paid, or
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There is a change in the dollar amount of your foreign tax credit because of differences in the exchange rate at the time the foreign taxes were accrued and the time they were paid.
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$10,000, or
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2% of the total dollar amount of the foreign tax initially accrued for that foreign country.
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The accrued taxes when paid differ from the amounts claimed as a credit.
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The accrued taxes you claimed as a credit in one tax year are not paid within 2 years after the end of that tax year.
If this applies to you, you must reduce the credit previously claimed by the amount of the unpaid taxes. You will not be allowed a credit for the unpaid taxes until you pay them. When you pay the accrued taxes, you must translate them into U.S. dollars using the exchange rate as of the date they were paid. The foreign tax credit is allowed for the year to which the foreign tax relates. See Rate of exchange for foreign taxes paid, earlier, under Foreign Currency and Exchange Rates.
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The foreign taxes you paid are refunded in whole or in part.
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For taxes taken into account when accrued but translated into dollars on the date of payment, the dollar value of the accrued tax differs from the dollar value of the tax paid because of fluctuations in the exchange rate between the date of accrual and the date of payment.
However, no redetermination is required if the change in foreign tax liability for each foreign country is less than the smaller of:
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$10,000, or
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2% of the total dollar amount of the foreign tax initially accrued for that foreign country for the U.S. tax year.
In this case, you must adjust your U.S. tax in the tax year in which the accrued foreign taxes are paid.
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The notification requirements discussed here apply to foreign tax redeterminations occurring in:
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2008 and later tax years.
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2005, 2006, and 2007 if:
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The redetermination reduced the amount of foreign taxes you paid or accrued for any tax year, and
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As of November 7, 2007, you had not notified the IRS of the redetermination.
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If you are required to notify the IRS about a redetermination of your U.S. tax liability for each tax year affected by the redetermination, you generally must file Form 1040X, Amended U.S. Individual Income Tax Return, with a revised Form 1116 and a statement that contains information sufficient for the IRS to redetermine your U.S. tax liability for the year or years affected. See Contents of statement later.
You are not required to attach Form 1116 for a tax year affected by a redetermination if:
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The amount of your creditable taxes paid or accrued during the tax year is not more than $300 ($600 if married filing a joint return) as a result of the foreign tax redetermination, and
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You meet the requirements listed under Exemption from foreign tax credit limit under How To Figure the Credit, later.
There are other exceptions to this requirement. They are discussed later under Due date of notification to IRS.
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Your name, address, and taxpayer identification number.
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The tax year or years that are affected by the foreign tax redetermination.
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The date or dates the foreign taxes were accrued, if applicable.
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The date or dates the foreign taxes were paid.
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The amount of foreign taxes paid or accrued on each date (in foreign currency) and the exchange rate used to translate each amount.
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Information sufficient to determine any interest due from or owing to you, including the amount of any interest paid to you by the foreign government and the dates received.
You have 10 years to file a claim for refund of U.S. tax if you find that you paid or accrued a larger foreign tax than you claimed a credit for. The 10-year period begins the day after the regular due date for filing the return for the year in which the taxes were actually paid or accrued.
You have 10 years to file your claim regardless of whether you claim the credit for taxes paid or taxes accrued. The 10-year period applies to claims for refund or credit based on:
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Fixing math errors in figuring qualified foreign taxes,
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Reporting qualified foreign taxes not originally reported on the return, or
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Any other change in the size of the credit (including one caused by correcting the foreign tax credit limit).
The special 10-year period also applies to making or changing your choice of whether to claim a deduction or credit for foreign taxes. See Making or Changing Your Choice discussed earlier under Choosing To Take Credit or Deduction.
U.S. citizens, resident aliens, and nonresident aliens who paid foreign income tax and are subject to U.S. tax on foreign source income may be able to take a foreign tax credit.
If you are a U.S. citizen, you are taxed by the United States on your worldwide income wherever you live. You are normally entitled to take a credit for foreign taxes you pay or accrue.
If you are a resident alien of the United States, you can take a credit for foreign taxes subject to the same general rules as U.S. citizens. If you are a bona fide resident of Puerto Rico for the entire tax year, you also come under the same rules.
Usually, you can take a credit only for those foreign taxes imposed on income you actually or constructively received while you had resident alien status.
For information on alien status, see Publication 519.
If you are a nonresident alien, you generally cannot take the credit. However, you may be able to take the credit if:
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You were a bona fide resident of Puerto Rico during your entire tax year, or
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You pay or accrue tax to a foreign country or U.S. possession on income from foreign sources that is effectively connected with a trade or business in the United States. But if you must pay tax to a foreign country or U.S. possession on income from U.S. sources only because you are a citizen or a resident of that country or U.S. possession, do not use that tax in figuring the amount of your credit.
For information on alien status and effectively connected income, see Publication 519.
Generally, the following four tests must be met for any foreign tax to qualify for the credit.
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The tax must be imposed on you.
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You must have paid or accrued the tax.
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The tax must be the legal and actual foreign tax liability.
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The tax must be an income tax (or a tax in lieu of an income tax).

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. You cannot shift the right to claim the credit by contract or other means.
Generally, you can claim the credit only if you paid or accrued the foreign tax to a foreign country or U.S. possession. However, the paragraphs that follow describe some instances in which you can claim the credit even if you did not directly pay or accrue the tax yourself.
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.
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 a dividend. The French government imposes a 15% withholding tax ($15) on the refund you received. You receive a check for $85. You include $100 in your income. The $15 of tax withheld is a qualified foreign 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 Taxes in Lieu of Income Taxes, later.
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.
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It is a tax; that is, you have to pay it and you get no specific economic benefit (discussed below) from paying it.
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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.
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If there is a generally imposed income tax, the economic benefit is not available on substantially the same terms to all persons subject to the income tax, or
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If there is no generally imposed income tax, the economic benefit is not available on substantially the same terms to the population of the foreign country in general.
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Goods.
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Services.
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Fees or other payments.
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Rights to use, acquire, or extract resources, patents, or other property the foreign country owns or controls.
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Discharges of contractual obligations.

Internal Revenue Service
International Section
P.O. Box 920
Bensalem, PA 19020-8518.
A tax paid or accrued to a foreign country qualifies for the credit if it is imposed in lieu of an income tax otherwise generally imposed. A foreign levy is a tax in lieu of an income tax only if:
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It is not payment for a specific economic benefit as discussed earlier, and
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The tax is imposed in place of, and not in addition to, an income tax otherwise generally imposed.
A tax in lieu of an income tax does not have to be based on realized net income. A foreign tax imposed on gross income, gross receipts or sales, or the number of units produced or exported can qualify for the credit.
A soak-up tax (discussed earlier) generally does not qualify as a tax in lieu of an income tax. However, if the foreign country imposes a soak-up tax in lieu of an income tax, the amount that does not qualify for foreign tax credit is the lesser of the following amounts.
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The soak-up tax.
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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.
This part discusses the foreign taxes for which you cannot take a credit. These are:
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Taxes on excluded income,
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Taxes for which you can only take an itemized deduction,
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Taxes on foreign oil related income,
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Taxes on foreign mineral income,
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Taxes from international boycott operations,
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Taxes on foreign oil and gas extraction income, and
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Taxes of U.S. persons controlling foreign corporations and partnerships.
You cannot take a credit for foreign taxes paid or accrued on income excluded from U.S. gross income.
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.
Example.
You are a U.S. citizen and a cash basis taxpayer, employed by Company X and living in Country A. Your records show the following:
| Foreign earned income received | $120,000 |
| Unreimbursed business travel expenses | 20,000 |
| Income tax paid to Country A | 30,000 |
|
Exclusion of foreign earned
income and housing allowance |
87,225 |
Because you can exclude part of your wages, you cannot claim a credit for part of the foreign taxes. To find that part, do the following.
First, find the amount of business expenses allocable to excluded wages and therefore not deductible. To do this, multiply the otherwise deductible expenses by a fraction. That fraction is the excluded wages over your foreign earned income.
| $20,000 | × | $87,225 $120,000 |
= | $14,538 | |
Next, find the numerator of the fraction by which you will multiply the foreign taxes paid. To do this, subtract business expenses allocable to excluded wages ($14,538) from excluded wages ($87,225). The result is $72,687.
Then, find the denominator of the fraction by subtracting all your deductible expenses from all your foreign earned income ($120,000 - $20,000 = $100,000).
Finally, multiply the foreign tax you paid by the resulting fraction.
| $30,000 | × | $72,687 $100,000 |
= | $21,806 |
The amount of Country A tax you cannot take a credit for is $21,806.







