As an American citizen earning income, you are required to file federal income taxes in the U.S., even if you live and work abroad. The Foreign Tax Credit (FTC) allows you to deduct taxes paid to foreign governments from your American tax return, so you aren’t taxed twice for the same income.
Are you eligible to claim the Foreign Tax Credit?
If you’re a U.S. citizen or resident alien and you can answer yes to all the following questions, you may qualify for the Foreign Tax Credit (FTC).
- Were you required to pay foreign tax?
- Did you pay your foreign tax bill?
- Was the tax legal?
- Was it a tax on your income (or the equivalent of income tax)?
How the Foreign Tax Credit works
The Foreign Tax Credit is a tax break designed to help offset the tax you paid to a foreign country on income you earned in that country. Note that it doesn’t apply to income you earned from a U.S. source.
If you qualify for the credit, you have the option to take that amount as an itemized deduction. You can even change how you choose to claim it from one tax year to the next.
Not all taxes that you pay to a foreign country are eligible for the Foreign Tax Credit. In general, the taxes that qualify must be income taxes or the equivalent of an income tax.
If you take the foreign tax credit and you paid more in taxes than your limit for the tax year, you may be able to carry forward your excess liability to the next year.
Is the Foreign Tax Credit refundable?
The Foreign Tax Credit is non-refundable.
As a reminder, a tax credit is a dollar-for-dollar amount that lowers your tax bill once you’ve calculated how much you owe for income tax.
A non-refundable tax credit like the Foreign Tax Credit can help lower your tax bill. But if you don’t owe taxes, any remaining credit won’t get added to your refund.
How to determine your Foreign Tax Credit limit
There’s a limit to the amount of credit you can claim for foreign tax paid. To understand what your limit will be, you’ll multiply your U.S. tax liability by a fraction. That fraction is the amount of income you earned abroad divided by your total income from all sources, foreign and domestic.
For example, if you earned $20,000 in Madrid and that was your total income for the year, then $20,000 / $20,000. If your American tax liability is $600, you would multiply $600 x ($20,000/$20,000) = $600 foreign tax credit limit.
Let’s say you paid $700 to the Spanish government for the year. In that case, your U.S. tax credit will be worth $600 (your limit).
Now, let’s say you only paid $500 in foreign income tax. In that case, you will receive a tax credit for the entire $500.
Your actual limit is easy to calculate using Form 1116. TaxSlayer makes it easy to file a Form 1116 with your return.
Foreign Tax Credit vs. Foreign Earned Income Exclusion
Another tax break available to U.S. citizens or resident aliens living and working abroad is the Foreign Earned Income Exclusion, or FEIE. The FEIE allows qualified taxpayers to exclude up to $126,500 of foreign-earned income for tax year 2024.
To qualify for the FEIE, you must be a US citizen or resident alien who is physically present in a foreign country, or countries, for at least 330 full days during any period of 12 months in a row. And your tax home must be in a foreign country or countries.
If you qualify for the FEIE, you’ll use Form 2555 to calculate the exclusion when you file your return.
One major difference between the Foreign Earned Income Exclusion and the Foreign Tax Credit is that the FEIE only applies to earned income, but the FTC applies to earned and unearned income, such as interest and dividends.
The FEIE allows you to exclude a large portion of your foreign-earned income from U.S. income tax, which can be beneficial if the country you’re living in has a lower income tax rate than the U.S. But if you’re in a country with higher income tax, the FTC might offer the bigger tax benefit.
Another thing you’ll want to consider if you’re deciding whether to take the FEIE or the FTC is that you may not be able to claim certain credits (like the Child Tax Credit) or make contributions to your IRA accounts if you exclude all your earned income with the FEIE.
It’s important to note that if you claim the FEIE, you can’t take the Foreign Tax Credit.
How to claim the Foreign Tax Credit
To claim the FTC as a credit, you may need to file Form 1116, Foreign Tax Credit with your income tax return. TaxSlayer can help you determine if you’re required to include this form with your return.
When you’re completing Form 1116, you’ll need to enter the category of your income (passive, from general sources, foreign branch income, etc.). You’ll also need to list the countries where your income was earned and the gross amounts of income, as well as the foreign taxes paid.
If you’re taking the FTC as a deduction, you’ll report your foreign taxes on Schedule A (Form 1040), Itemized Deductions.
