Posted by Carmen Garcia

Foreign Tax Credits

Foreign Tax Credits

What are foreign tax credits?

Foreign tax credits are non-refundable income tax credits paid to a foreign government because of income tax. The foreign tax credit is available for those who work abroad or derive investment income from foreign sources. Taxpayers in the United States who pay or accumulate taxes in a foreign country may be entitled to a credit or deduction for those taxes.


Foreign taxes eligible for the foreign tax credit

For a foreign tax to be considered as a foreign tax credit, the following criteria must be met.


The Tax must be imposed on the individual.

A taxpayer can claim a credit only when foreign taxes are imposed by a foreign country or a U.S. possession. United States possessions include Puerto Rico and American Samoa. Foreign countries are considered a foreign state and their political subdivisions.

Taxes on war profits, income, and excess profits paid or accrued in a foreign city or province are eligible for foreign tax credit treatment. Additionally, all qualifying taxes paid on assets in the United States are considered foreign taxes.


The person must have paid or accrued the tax.

Credits can only be claimed if the tax is paid or accrued in a foreign country or possession of the United States. The three main ways that taxes are paid and accrued are (1) joint returns, (2) combined income, (3) as a shareholder in a mutual fund.


The tax must be a legal and actual foreign tax liability.

The qualified foreign tax must be the only real and legal tax debt paid or accrued in one year. The amount of allowable foreign income tax is not necessarily equal to the amount withheld by the foreign government.


The tax must be an income tax (or tax in place of income tax)

Only taxes on profits, income, and excess profits taxes qualify for foreign tax credits. However, foreign taxes on wages, interest, and dividends are also generally eligible for credit. The tax credit may also apply to foreign income taxes, even if an income tax law does not impose them if the tax is in place of war profits, income, or capital gains.

The tax must be an unpaid foreign rate for an economic benefit already received. Moreover, it must be an imposed tax in place of, and not in addition to, an income tax that would normally be imposed.


The difference in tax treatment between a deduction and a credit

A tax deduction reduces the amount of income subject to income tax, but a tax credit reduces the amount of tax owed. For example, if you are eligible for a tax credit of $ 1,000 and have a debt of $2,000, the credit will reduce your tax debt by $1,000. You can benefit from a tax refund; however, not all tax credits are refundable.


How to claim a foreign tax credit

Claim a U.S. foreign tax credit as an individual, property, or trust. When you have paid or accrued certain foreign taxes for a foreign country or United States possession, you must complete Form 1116, foreign tax credit.

If you are claiming on behalf of a business, you must complete Form 1118, Foreign Tax Credit - Corporation. Any corporation that elects the foreign tax credit benefits under Section 901 must complete and attach Form 1118 to the tax return.


Summary

  • Claiming a foreign tax credit in the U.S.A. as an individual, property, or trust, and when you have paid or accrued certain foreign taxes to a foreign country or U.S. possession, you must file Form 1116, foreign tax credit.

  • Foreign tax credits are non-refundable income tax credits paid to a foreign government due to income tax.

  • To be eligible for foreign tax credits, the following criteria must be met: The tax must be levied on you, you must have accrued or paid the tax, the tax must be foreign tax legal and actual tax payable, and the tax must be income tax.


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Carmen Garcia
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