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Foreign Tax Credit: What Expats Should Know

Foreign Tax Credit: What Expats Should Know

Every US citizen that wants to live in another country should consider learning what the Foreign Tax Credit Entails and how it works. It also applies to all citizens that desire to live abroad and pay taxes. 

This article explores what everyone needs to know about credit, including how to claim it.


Understanding Foreign Tax Credit 

This is a credit that citizens of the US qualify to claim to balance any income taxes they might have paid to another country. This credit aims to prevent double taxation and reduce the burden of the tax. In combination with other deductions and credit offered by Uncle Sam, the amount reduction can significantly reduce the tax burden. 

This credit, however, applies only to income you generated while living and working off US soil. The credit does not apply to any tax type that might be paid to any foreign tax agency. Also, income that comes from domestic sources does not qualify.

Who Qualifies for Such Credit?

You qualify for the credit as a US citizen living offshore and earning. Such funds might be income from your job or foreign investment. For people who did not pay tax to their country of residence, they do not qualify for the credit. 

The focus is on citizens earning from living abroad and retirees as well. Some retirement income might be taxable, depending on the laws of the host country. This also applies to all foreign investment income taxed by foreign countries.


Is Tax Credit Same as Tax Deduction?

There could be some confusion on how much tax credit differs from the tax deduction. Such credit, without a doubt, reduces your entire tax amount. A deduction, on the other hand, reduces the whole income on which you will be taxed.


Qualification for the Tax Credit 

There are qualifications that Uncle Sam established before one can claim the credit. The most important is that one needs to prove that one is indebted to a foreign tax agency. Your proof might be an official notice or any document if your foreign employer withholds the tax. 

You should also have proof that you have already settled any balance you owe to the foreign agent. However, don't forget that the credit amount you might qualify to claim might not be up to what you paid.


Is Filing a Return Important to Claiming Such Credit?

There is no way you can claim the return without filing your tax credit. Many working abroad don't have this issue since they know the importance of filing a return, irrespective of their location. This also applies to people living offshore but have income generated from domestic investment. 

Even though they don't have to file taxes, some retirees might want to, as a means to claim such credit. This applies to retired expats who rely on social security and other income sources that foreign nationals will tax. 

Filing your return to claim much credit can reduce whatever amount you owe Uncle Sam.


Do I Need to Include Any Form?

There are necessary forms you should fill and send alongside the income tax return and other supporting documents. This is the IRS Form 116. 

It is a two=page form with vast fields on where to input your data. Here are other essential information one needs to provide:

  • The country you are living in, where you paid the tax 

  • Nature of income such as taxable withdrawals, income from an employer, investments, etc. 

Whatever foreign expense or deduction reduces what you eventually pay as tax to the foreign agent. 



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