The foreign tax credit intends to reduce the double tax burden that would otherwise arise when foreign source income is taxed by both the United States and the foreign country from which the income is derived.
Qualifying Tests for the Credit
The tax must meet four tests to qualify for the credit:
- The tax must be a legal and actual foreign tax liability
- The tax must be imposed on you
- You must have paid or accrued the tax, and
- The tax must be an income tax (or a tax in lieu of an income tax)
Generally, only income taxes paid or accrued to a foreign country or a U.S. possession (also referred to as a U.S. territory), or taxes paid or accrued to a foreign country or U.S. possession in lieu of an income tax, will qualify for the foreign tax credit.
Foreign Taxes That Don't Qualify:
- Taxes refundable to you.
- Taxes used to provide a subsidy to you or someone related to you.
- Taxes not required by law, because you could have avoided paying the taxes to the foreign country.
- Taxes that are paid or accrued to a country if the income giving rise to the tax is for a period (the sanction period) during which:
- The Secretary of State has designated the country as one that repeatedly provides support for acts of international terrorism,
- The United States has severed or doesn't conduct diplomatic relations with the country, or
- The United States doesn't recognize the country's government, unless that government is eligible to purchase defense articles or services under the Arms Export Control Act.
- Withheld foreign taxes on dividends for foreign stocks that don't meet required minimum holding periods.
- Withheld foreign taxes on gains and income from other foreign properties that don't meet required minimum holding periods.
Note: These taxes may be claimed as an itemized deduction even if you claim foreign tax credits for qualifying taxes.
Choosing a Credit or a Deduction
You can choose to take the amount of any qualified foreign taxes paid during the year as a credit or as a deduction. To choose the deduction, you must itemize deductions on Form 1040, Schedule A (PDF). To choose the foreign tax credit, you generally must complete Form 1116 (PDF) and attach it to your Form 1040 (PDF) (along with Form 1040, Schedule 3, Nonrefundable Credits (PDF)) or Form 1040NR (PDF). You must choose either the foreign tax credit or itemized deduction for all foreign taxes paid or accrued during the year. This is an annual choice.
If you're a cash basis taxpayer, you can only take the foreign tax credit in the year you pay the qualified foreign tax unless you elect to claim the foreign tax credit in the year the taxes are accrued. Once you make this election, you can't switch back to claiming the taxes in the year paid in later years.
Foreign Earned Income and Housing Exclusions
You may not take either a credit or a deduction for taxes paid or accrued on income you exclude under the foreign earned income exclusion or the foreign housing exclusion. There's no double taxation in this situation because that income isn't subject to U.S. income tax.
Computing the Credit When Filing Form 1116
If you use Form 1116 to figure the credit, your foreign tax credit will be the smaller of the amount of foreign tax paid or accrued, or the amount of U.S. tax attributable to your foreign source income. Compute the limit separately for passive income, income resourced under a tax treaty, income derived from sanctioned countries, and all other income.
Carryback and Carryover of Unused Credit
If you can't claim a credit for the full amount of qualified foreign income taxes you paid or accrued in the year, you're allowed a carryback and/or carryover of the unused foreign income tax. You can carry back for one year and then carry forward for 10 years the unused foreign tax. For more information on this topic (including taxes paid or accrued in years before 2007), see Publication 514, Foreign Tax Credit for Individuals.
Claiming Without Filing Form 1116
You can elect to claim the credit for qualified foreign taxes without filing Form 1116 if you meet all of the following requirements:
- All of your foreign source income is passive income, such as interest and dividends,
- All of your foreign source income and the foreign income taxes are reported to you on a qualified payee statement, such as Form 1099-INT (PDF), Form 1099-DIV (PDF), or Schedule K-1 from a partnership, S corporation, estate or trust, and,
- The total of your qualified foreign taxes isn't more than the limit given in the Form 1040 Instructions (PDF) for the filing status you're using, or in the Form 1040NR Instructions (PDF) (if you file Form 1040-NR).
If you claim the credit without filing Form 1116, you can't carry back or carry forward any unused foreign tax to or from this year.
This election isn't available to estates or trusts.
Amending Your Return to Claim the Tax Credit
If you claimed an itemized deduction for a given year for qualified foreign taxes, you can choose instead to claim a foreign tax credit that'll result in a refund for that year by filing an amended return on Form 1040X (PDF) within 10 years from the original due date of your return. The 10-year period also applies to calculation corrections of your previously claimed foreign tax credit.
If the foreign income taxes you claimed as a credit are refunded to you or otherwise reduced, you must file an amended return on Form 1040X reporting the reduced foreign tax credit. There's no time limit on this requirement.
For more complete information on the foreign tax credit (including information on whether a particular tax is eligible for the credit), refer to the Form 1116 Instructions (PDF), Foreign Tax Credit, and Publication 514, Foreign Tax Credit for Individuals. See also U.S. Citizens and Resident Aliens Abroad for more information for international taxpayers.