Foreign Tax Credit: US Expat Taxation
The Foreign Tax Credit (FTC) is a way set up by the US government to solve the problem of double taxation. Normally, if you are a US citizen working abroad then you might be paying taxes to a foreign country and also to the US. To avoid this double taxation situation you need to understand the FTC.
In case the income tax rate of the foreign country is more than or equal to the income tax rate levied by the US government then the FTC can waive off all the US taxes on the foreign earned income.
Qualifications for the FTC credit mechanism:
- Only taxable income is allowed for credits: Any other tax like value added tax, capital, assets or property tax which are not taxes on income are not considered for the tax credit.
- Credit can be obtained only equal to the tax that would have due if you had the same income in US. Therefore, in case the income tax rate is way higher in the foreign country compared to the US then you will have to forfeit the difference. The extra credit can be used in future as a carry forward.
- There are certain foreign taxes which cannot be considered for credits. They include tax on foreign earned income exclusion, tax on foreign housing expenses exclusion, tax on foreign oil or mineral income, tax on extraction foreign oil and gas income, tax on internationally boycotted operations etc.
Whenever the foreign country has a higher income tax rate, you will have extra credits which can be carried forward till 10 years before they expire. If the US has higher income tax then you are required to pay the difference to the US.
For earning tax credits you need to fill out Form 1116. In case you are filing for a corporation than Form 1118 needs to be filled. There are situation where applying both foreign earned income exclusion and FTC is beneficial for you. But you should first calculate which combination and in which order will provide you the maximum benefit as sometimes you might end up with a higher than before income tax.