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FOREIGN TAX CREDIT ON
FORM-1116

FTC - US EXPAT GUIDE ON FORM 1116

TABLE OF CONTENTS:

Introduction:

   

A US Tax Person who is a Tax resident, Green card holder in the United states, could also be a Tax resident for the year in another Foreign country. They may end up paying taxes on the same income twice, also known as (Double taxation). In order to avoid Double taxation, US Tax Individuals can claim Foreign Tax Credit Form-1116 on their Tax return with countries, the United States has Foreign Tax Treaty. Claiming Foreign Tax Credit is another benefit given to the Taxpayer apart from the Foreign earned income Exclusion (FEIE). The Taxpayer can use both Foreign Earned Income exclusion (FEIE) and Foreign Tax credit (FTC) in the same year on the Tax return, subject to limitations.

In order to figure out the maximum benefit, an optimization will be needed in the 1st Year of departure. In this blog, let us explore in more detail, Foreign tax credit on Form 1116.

What is Foreign Tax Credit Form 1116
If you are in a High Tax Country, Foreign Tax Credit is very beneficial

What are the two methods of claiming FOREIGN TAX CREDIT ON form -1116

Foreign Tax Credit on Form 1116 can be claimed on a cash and accrual basis to report credit on your US Tax Return.

Cash Basis: Income is recognized when it’s received and deductions are claimed when expenses are usually paid. It’s like a real-time transaction. 

Accrued Basis: Income is recognized when it is earned and deductions are claimed to the period it relates to. 

Claiming Foreign Taxes credit on Form-1116.

Foreign Taxes can be claimed as a credit for the foreign taxes paid on employment income in the foreign country. No credit can be claimed for Foreign real estate taxes, value-added taxes, wealth taxes, service taxes, goods & services taxes, etc. Also, the accrued method for FTC, if once taken, is applicable for all the future tax years. It’s an irrevocable choice, hence you need to be very careful before considering that option. Usually, for countries with a high tax rate, which don’t follow the calendar tax year like the United States, the accrued method may not be more useful for matching income and expenses. Similarly, taxes can be claimed as credit for the taxes withheld on Foreign Income like interest and dividends on Form 1116 under the passive income basket. Foreign rental property under the new rule will be classified as the “foreign branch”.  The unused foreign tax credit can be carried forward for 10 years and carried back for 1 year.

Denial of double dipping

According to the IRS, you cannot claim the double benefit of claiming FTC on the income that is exempt from taxation in the US.  In a Tax year, if you do claim FEIE and FTC, the foreign taxes would be subjected to “scale-down” which reduces your foreign taxes. Optimization is necessary for the year of departure assuming the taxpayer is relocating to a high tax country.  Assuming your income in the UK is $150,000 and UK taxes are $40,000, you take FEIE of 108,700/150,000*40,000  = $28,987. This amount cannot be claimed as the FTC. The remainder of it, (40,000-28,987) $11,013 can be claimed as the FTC on the Tax return, subject to the US tax Liability on the Foreign Income.

Foreign Tax Credit limitation on Form 1116

The Foreign Tax Credit on Form 1116  is a non-refundable tax credit. Once your US Tax Liability goes to “ zero” it won’t result in a US tax refund. The FTC is limited to the US taxes applicable to the foreign income. Considering from the above example, if $20,000 of net foreign income is left after exclusion on which $5,000 US tax is due, then the lower of $5,000 and $11,013 ($40,000-$28,987) is considered on your Tax return. The excess of ($11,013-$5,000) $6,013 is carried over to the next year.

Conclusion

Being a credit, claiming FTC does reduce your tax liability dollar-to-dollar. If you are currently on assignment to a high tax country, claiming FTC only would be more beneficial than claiming both FEIE & FTC or FEIE only.  It is very crucial in the year of departure from the US, to carry out an optimization of the maximum benefits one can get using these exclusions or foreign tax credit. Also, equally important is the method of taking credit. If you have any more questions, regarding claiming foreign tax credit on Form 1116 on your Tax Return, feel free to get in touch with us.

DISCLAIMER: The above info should only be considered for the knowledge of US Tax. Every Taxpayer’s situation is unique, strongly advise you to consult a tax professional.