This IRS tax provision exists to prevent double taxation on the same income.¹ There is some strategy involved in determining whether the Foreign Tax Credit is the right provision for you, though. In the following article, we’ll define the parameters under which to apply this credit and discuss alternatives that may better fit your US tax situation.

First, let’s walk through the basics.

What is the Foreign Tax Credit?

The US Foreign Tax Credit allows Americans who pay foreign income taxes to reduce their overall US tax liability. How? For every dollar paid in foreign taxes, expats are able to claim a ‘credit’ for foreign taxes paid on their US tax bill.

To illustrate, let’s consider a Foreign Tax Credit example. Tony, a US citizen, lives and works in the UK. He’s employed at a British company and earns the equivalent of $70,000 of foreign income. He pays (very roughly) $20,000 a year in UK taxes. Because the UK income tax rates are higher than those in the US, claiming the Foreign Tax Credit will give him more than enough credits to clear Tony of any US tax liability.

Understanding deadlines and extensions

The IRS acknowledges that expats have to maneuver around the deadlines and shifted tax seasons of other countries. Let’s consider Tony again. The UK tax year spans from April 6th to April 5th. The US tax year, on the other hand, spans January 1st to December 31st. Thus, filing each year before the standard April 15th due date isn’t always possible.

For this reason, expats have an automatic US filing extension to June 15th.

Those who need added time can request an extra extension to October 15th.

If additional time is needed, expats may submit a written request to the IRS for one final extension to December 15th.

Digging in further: Should you claim the Foreign Tax Credit? 

To benefit from the IRS’s Foreign Tax Credit (FTC), it’s important to understand when you can claim it. To do so, you must meet certain requirements:

• The foreign tax must be considered income tax.
• Your country of residence must impose the tax on you.
• The foreign tax must be legal and an actual foreign tax liability²

In some cases, a US citizen may reside abroad, but be unable to claim the Foreign Tax Credit. Let’s think through another example. 

Imagine that you’re a digital nomad. As a result of your highly mobile lifestyle, your time may be broken up between different countries such that you lack the requisite time and/or social ties to be considered a foreign tax resident. This effectively makes you ineligible to claim the Foreign Tax Credit, because you have not paid any foreign taxes. In these cases, the Foreign Earned Income Exclusion (FEIE) may be a better option for reducing US taxes. 

A brief look at the FEIE

The Foreign Earned Income Exclusion allows expats to simply exclude the first around $112,000 of their earned income from US taxation (2022 Tax Year). Note: the exact amount increases each year to account for inflation. 

Earned income includes all income that is paid for services provided, such as salaries, wages, self-employment income, tips, and bonuses. It does not include passive income, such as dividends, interest, rental or pension income, social security benefits, capital gains, or alimony.

The Foreign Tax Credit, on the other hand, doesn’t distinguish between earned and unearned income, so long as foreign income taxes have been paid on it.

Related: The Foreign Earned Income Exclusion in 2023: An Expat Guide

Who should claim the Foreign Tax Credit?

While claiming the Foreign Tax Credit isn’t always possible (or even advisable) in every expat circumstance, there are certain situations where this strategy is likely your best option.

Expats living in high-tax countries

In general, expats who live in a single foreign country and pay foreign income tax at a higher rate than the US rate on all of their global income are generally best off claiming the Foreign Tax Credit. 

Expats who either don’t pay foreign taxes or who pay them at a lower rate, whose only income is earned (and doesn’t exceed over $100,000), and who can meet either the Physical Presence Test or the Bona Fide Residence Test are generally better off claiming the FEIE.

Those planning to live & work abroad for several years

If expats who pay more foreign income tax than the US income tax they owe claim the US Foreign Tax Credit, they can claim a greater value of US tax credits than they need to eliminate their US tax liability. 

This results in excess US tax credits that they can carry forward for up to ten tax years. These can be applied to future income or carried back to the previous tax year. So, the FTC is particularly useful for expats who work abroad for several years.

Related: How to Calculate Your Foreign Tax Credits & Carryover (With Examples!)

Expat parents with dependent children

For the 2022 tax year, the US Child Tax Credit allows expat parents to claim up to $2,000 per qualifying dependent child.

What happens if someone’s US tax liability is already at $0 by applying other credits available to them? Great news: The Child Tax Credit is considered partially “refundable.” This means that parents may receive up to a $1,500 payment per child!

Those hoping to contribute to Roth IRAs

Roth IRAs are useful pension saving plans. Contributions are made from (post-tax) reportable earned income, while distributions in retirement are completely tax-free.

Expats who exclude all their income by claiming the Foreign Earned Income Exclusion, however, don’t have any reportable earned income. So, they cannot make contributions to Roth IRA plans. Expats who claim the Foreign Tax Credit can.

How to claim the Foreign Tax Credit using IRS Form 1116

IRS Form 1116³ is a two-page form that requests the information and figures necessary to calculate what value of US tax credits can be claimed based on foreign taxes paid.

It requires expats to provide details about what country their foreign taxes were paid in, the value of foreign taxes paid (in both the foreign currency and USD), the types of income being reported, and any foreign deductions and expenses.

For detailed, step-by-step filing instructions for Form 1116, check out our recent article, Foreign Tax Credit: Form 1116 Instructions (screenshots & examples are included!).

Catching up on US taxes: Can you still claim the IRS Foreign Tax Credit?

It’s quite common for many Americans living abroad to be unaware of their filing requirements. To support US expats, the IRS created a penalty-free path to US tax compliance for qualifying US expats. The amnesty program is called the Streamlined Procedure.

The Streamlined Procedure requires expats to file their last three US tax returns, file their last six FBARs (Foreign Bank Account Reports), and they must self-certify that they weren’t willfully avoiding filing. Many US expats find it helpful to work closely with a US expat specialized in filing for Americans living overseas. Working with a specialist ensures that all of IRS credits, exclusions, and provisions are properly claimed (including the Foreign Tax Credit!).

The Foreign Tax Credit is often just one piece of the bigger US tax picture.

Bright!Tax is here to ensure that your US expat tax strategy is the most tax efficient it can be. With over 10 years of experience serving Americans worldwide, you can be sure your US tax return is in capable hands.

Meet My CPA

Resources

1. Foreign Tax Credit (FTC) – IRS
2. Foreign Taxes that Qualify for the Foreign Tax Credit | The IRS
3. Form 1116 – IRS

The post The Foreign Tax Credit (FTC): A Guide for US Expat Taxes appeared first on Bright!Tax Expat Tax Services.

Tax credits are more valuable than tax deductions. Credits offset the amount of tax you owe dollar for dollar. Deductions, on the other hand, reduce your taxable income. As a US expat, you’re subject to taxes by the US and your country of residence, meaning you may find yourself facing taxes both in your country of residence and in the United States. 

But, thanks to the IRS Foreign Tax Credit and tax treaties, you can offset the taxes you’ve paid or accrued in your country of residence against your US income tax bill.

As noted at the beginning, the Foreign Tax Credit (FTC) is claimed with Form 1116.

In this article, we’ll walk you through the instructions for filling out Form 1116.

Instructions for Form 1116

The Foreign Tax Credit is one of the most common IRS tax provisions for US expats. If you’re still trying to understand how this credit works and whether it’s the best choice for you, read our comprehensive article for full background on the Foreign Tax Credit.

Step 1: Categorize your income

There are seven different income categories for IRS Form 1116.¹

The IRS requires you to use a separate Form 1116 for each income category. So, when preparing Form 1116 you must categorize your income to understand how many Forms 1116 to use. 

For example, if your total income falls into three categories, you’ll need to use three separate Forms 1116.

Categories of income

Once you’ve identified your income category, it’ll be time to move on to the next section.

Step 2: Fill in your taxable income (Part 1 of Form 1116)

Here’s where you’ll record all your income from foreign sources. If you have paid taxes in more than one foreign country, you need to segregate the earnings by country and enter them into separate columns.

Form 1116 provides three columns. But if you paid taxes in more than three countries, you’ll attach a separate sheet laid out in the same manner as Part 1. There’s no need to use an additional Form 1116.

When filling in your income details, there are a few things to remember:

• Include all your foreign income—even if all or some portion is not taxable by a foreign government.
• Income needs to be reported in US Dollars.
• You’ll need to adjust gross income (line 1a) for any foreign income that you’ve excluded with Form 2555 (the Foreign Earned Income Exclusion).

Then aside from your income, you’ll also input the amount of deductions usually used by the IRS to reduce your taxable income. This may be the standard deduction or itemized deductions for those with enough qualifying expenses. 

These deductions include home mortgage interest as well as losses from foreign sources.

Here’s what this section of the form looks like.

Step 3: List your foreign taxes paid (Part 2 of Form 1116)

Here’s where you’ll list the amount of foreign tax you either paid or accrued in the current tax year on your income reported in Part 1.

Here’s what Part 2 of Form 1116 looks like.

Step 4: Calculate your credit amount (Part 3 of Form 1116)

This is where you’ll calculate the amount of FTC to claim. Generally, the amount of your credit is not the tax you paid in your country of residence. Instead, it’s the amount of tax you’d have paid if the income was earned and taxed according to the US tax code. 

Let’s try to simplify this. 

1️⃣ Suppose you work in Italy and earn an annual salary of $100,000 (US dollar equivalent) in 2022. And you paid $25,000 (US dollar equivalent) to the Italian tax authorities.

However, when your salary ($100,000) is subjected to the US tax code, it will be treated like it was earned in the US. You’ll still generally be allowed to claim all the tax deductions you’re used to, whether it’s the standard deduction or itemizing. 

2️⃣ Let’s say your total deductions are $15,000. Therefore, your taxable income will be $85,000 ($100,000 – $15,000).

3️⃣ Finally, assume the tax payable on $85,000 in the US is $13,000. This is the amount that’ll be treated as your Foreign Tax Credit, NOT the $25,000 you paid in Italy.

The good news is that if you paid more tax than allowed in the current year, you can carry forward the difference for up to ten years.

Alternatively, you can carry it back to the prior year in certain situations.

Related: US Expat Taxes in 2024: A 12-Step Guide to Tax Filing Success

Here’s what this section of Form 1116 looks like using our hypothetical example from above.

Step 5: Add up your total credit (Part 4 of Form 1116)

Finally, the last part. Plus, read on for a summary of all the foreign tax credits claimed in case you had other categories of income that we discussed in Step 1.

Here’s what it looks like.

Never struggle with IRS Form 1116 again.

Is it a challenge to differentiate between categories of income and determine your best US filing strategy? Chat with one of our friendly, expert expat CPAs today for immediate relief.

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References

1. 2022 Foreign Tax Credit – IRS Form 1116

The post Form 1116 Instructions for Expats Claiming the Foreign Tax Credit appeared first on Bright!Tax Expat Tax Services.

It might not be fun to go through all the extra paperwork on top of the taxes you must also file in your new home country. However, thanks to tools like the Foreign Tax Credit, the good news is that there are ways to avoid double taxation on your income. 

This article gives you a brief overview of the Foreign Tax Credit (FTC) and carryover with some example calculations illustrating how many tax credits you can claim.  

Quick overview: What’s the Foreign Tax Credit (FTC)? 

The Foreign Tax Credit (FTC) allows US expats to reduce their tax liability based on what they already paid in foreign taxes on a dollar-for-dollar basis. You can claim foreign tax credits by filing IRS Form 1116 (directly available for download here) as part of your annual tax return to the IRS.

For example, let’s say you owe the US government $1500. At the same, you’ve already paid $1000 in Portugal taxes. With the FTC, you can use the $1000 you paid in Portugal taxes to reduce your US tax liability to $500. (Though the calculation in real life isn’t quite as simple).

One of the goals of the FTC is to help US taxpayers who earn foreign source income avoid double taxation. So if you live in a country with a higher tax rate than the US, like Japan or Finland, you may end up owing nothing in US taxes by using the FTC.   

The maximum amount of tax credits you can claim depends on several factors, including how much foreign tax you’ve already paid and how much of your income is considered foreign sourced.   

What are the rules for the Foreign Tax Credit (FTC)? 

You must follow specific rules to benefit from the IRS’ Foreign Tax Credit (FTC). Here are the requirements that you must meet to be able to offset your taxes with the FTC:

The foreign tax must be an income tax.

Below, is a comprehensive list of foreign taxes that the IRS does not qualify as income tax:

• – Foreign taxes on mineral income
• – Social security taxes paid to a country with a totalization agreement with the US
• – Taxes paid to a country that the US deems to finance terrorism
• – Foreign taxes that are refundable
• – Taxes that US expats can only take an itemized deduction from 
• – Taxes related to a foreign tax splitting event

Your country of residence must impose the tax on you.

For a foreign tax to qualify for the FTC, it must be a compulsory tax imposed on your pay. For example, France automatically deducts taxes from the employee’s monthly paycheck, which qualifies the tax as credits.

The foreign tax must be legal and an actual foreign tax liability

You must be required to pay the foreign tax for it to qualify for the FTC. For example, many US expats live as digital nomads with no official “base” where they have to pay foreign taxes. These type of expats won’t be able to take advantage of the foreign tax credit. 

Let’s say that you’re an American digital nomad that has no established residency anywhere, but spent 5 months in Mexico. In this case, while maybe you spent almost half a year in Mexico, you did not spend enough time in the country or build enough social ties to become a Mexican tax resident. As a result, you can’t claim the FTC. 

Instead, the Foreign Earned Income Exclusion may be a better tool to reduce US taxes for digital nomads. You can read these blog posts to learn more:

• – Claiming the Foreign Tax Credit vs. the Foreign Earned Income Exclusion
• – Digital Nomad Taxes: A Complete Guide

What is the Foreign Tax Credit (FTC) carryover? 

Something that expats should know about the FTC is the potential to carry forward and carryback credits. If you don’t use all of your foreign tax credits in one year, you can carry that amount forward to the next year or back to the year before to lower your tax bill related to foreign income. 

The IRS allows you to use unused foreign taxes for up to 10 years. If you’re short on tax credits the year before, you can also carry the excess back just one tax year to cover them, which may require you to amend a previous year’s return.

Categories of Income on the Form 1116

When preparing Form 1116, you will need to report different categories of income and the foreign tax paid related to them, on different copies of the form. This is because you can only apply foreign tax paid to income in the same category. Let’s say you live in Singapore and pay income tax on your wages, but your capital gains are tax-free in Singapore. On the US tax return, you can use the foreign tax related to your wages to offset your (general category) income tax but not your capital gains tax (passive category)

Here are the different types of income you can report on Form 1116:

• – Section 951A category income: Income under Section 951A refers to any intangible low-taxed income (GILTI) included by U.S. shareholders of certain CFCs. 
• – Foreign branch category income: Any income that consists of profits made by a US person in one or more qualified business units (QBUs) in one or more foreign countries (and doesn’t include passive income).  
• – Passive category income: This covers any passive income via sources such as rental properties, wages, and annuities. 
• – General category income: This includes any wages you collect or income you generate from your business. 
• – Section 901(j) countries: You use this category to report any income you earn from a country accused of supporting international terrorism, that doesn’t have a diplomatic relationship with the US or that the US government doesn’t recognize. 
• – Resourced by treaty: You must use this category to complete Form 1116 if the country where you reside has a tax treaty with the US that classifies all the income you earn as income from the treaty country. 
• – Lump-sum distributions: This category refers to any income you earn from a foreign-sourced pension plan. 

Calculating your Foreign Tax Credit (FTC) and carryover

Here’s the formula you should use to calculate the maximum foreign tax credits you can use:

Foreign sourced income / total taxable income * US tax liability = Maximum FTC you are allowed to take

If the foreign tax you paid is less than this then FTC = Foreign tax paid

If the foreign tax you paid is more than this then FTC = Maximum FTC you are allowed to take

To calculate your carryover amount:

Foreign taxes paid – FTC taken = FTC carryover

We have outlined some examples to give you a better idea how this formula actually works: 

Example #1: John, Web Developer in Zurich, Switzerland

John is a US expat from Illinois. He works as a web developer in Zurich, Switzerland. His salary is $150,000 annually, and John paid over $40,000 in taxes to the Swiss government. He also has rental income from property he owns back in Chicago, earning $30,000, bringing him to a total of $180,000 for the year. John’s US tax liability is $25,000. 

Here’s how we calculate his total FTC based on the elements above:

$150,000 (his foreign income) / $180,000 (his total income) * $25,000 (his US tax bill) = $20,833 is the maximum amount of his US tax bill he can offset with foreign taxes

John can claim up to $20,833 in tax credits. But he must have paid at least that much in Swiss taxes to fully take advantage of the credit. 

Let’s say he paid more, and John paid $30,000 in Swiss tax. He can still only take $20,833 of credit, but the leftover tax can be brought forward to future years, and here’s how we calculate his carry-over amount:

$30,000 (total amount of Swiss paid) – $20,833 (FTC credits)  = $9,167

So in total, John has an FTC carryover amount of $9,167. 

Example #2: Sarah, Psychologist in Costa Rica

Sarah is a California native working as a psychologist in Costa Rica. She has a yearly salary of $100,000 and paid $13,000 in taxes to the Costa Rican government. 

She also has income from a trust fund in the US that provides an extra $20,000 per year. With this in mind, her US tax liability is $20,000. 

Here’s how we calculate the maximum tax credit Sarah can claim:

$100,000 / $120,000 * $20,000 = $16,666 

The total amount she could claim is $16,666, but since she only paid $13,000 to Costa Rica, her credit is only $13,000. 

If Sarah has any excess foreign tax credits next year, she’ll be able to go back and amend her tax return and carry back up to an additional $3,666 ($16,666 maximum -$13,000 taken).   

What is the deadline for claiming the Foreign Tax Credits (FTC)? 

You must file Form 1116 on the same day as your US tax return: April 15th. That being said, US expats benefit from an extension until June 15th and can also request an additional extension to October 15th. 

Need assistance with your FTC? Bright!Tax is here to help!

The Foreign Tax Credit can be a difficult matter to navigate for American expats. If you still have questions about the FTC and whether you qualify, our tax team at Bright!Tax is here to help and offer guidance. Contact us today and one of our CPAs will reply right away with answers about your US expat tax situation. 

The post How to Calculate Your Foreign Tax Credits & Carryover (With Examples!) appeared first on Bright!Tax Expat Tax Services.

Example: When it comes to filing US tax returns as an expat, you may find the rules and process to be overwhelming. Luckily, there are credits and other tax breaks that US expats can take advantage of to ease their tax burden. These tax breaks often even eliminate any taxes owed. Two of the biggest tax savings tools expats should know about are the Foreign Tax Credit (FTC) and the Foreign Earned Income Exclusion (FEIE). 

If you’re a US expat, you’ll want to consider using both when filing your 2021 tax returns.

As expat tax day (June 15th) approaches, here’s everything you need to know about the FTC and FEIE, so you can decide which one is right for your financial situation. 

How can the FTC and FEIE help lower your tax liability?

First, it’s important to understand the difference between tax credits and deductions. Tax credits allow you to reduce your income tax directly, in other words, lowering any taxes you might owe. And, if the credit is refundable, it can actually increase your tax refund. This is the case even if you haven’t paid US tax during the year. Non-refundable credits, on the other hand, can lower your tax bill, but won’t add on to your refund amount.

Deductions, on the other hand, reduce your taxable income. This lowers the amount the US will calculate your tax on, lessening or even eliminating your tax bill altogether.

As a US expat, both the FTC and FEIE can help reduce the amount of money you’ll owe the IRS in taxes. They can also prevent you from getting taxed twice – once by the country where you’re working or living and again by the US. 

What is the Foreign Tax Credit?

The Foreign Tax Credit reduces your tax bill by one dollar for every dollar (or dollar equivalent using the foreign exchange rate) you’ve already paid in foreign taxes. This saves you from double taxation on the same income.

So, for example, let’s say you are a US expat living abroad in Bali and you make $60,000 per year. If you’ve already paid $10,000 in taxes to Indonesia, then you can claim the Foreign Tax Credit for the amount of $10,000 to directly reduce your US tax bill. As long as the US tax bill related to your income is $10,000 or more, your credit will be the full $10,000. In many cases, this credit will eliminate the need to pay US taxes altogether by wiping out your taxes owed – but you’ll still need to file and claim this credit first.

Beyond using foreign tax paid as a credit, you can choose to instead take the foreign tax paid as an itemized deduction. If you claim it as a deduction, it will reduce your US taxable income, which will in turn lower your tax bill. If you opt to take the FTC as a credit instead, it will directly reduce your foreign tax bill. In most cases, if you’re claiming the FTC, it will be more financially beneficial for you to claim it as a credit.

You can only claim the FTC on foreign-sourced income taxed by provincial, local, or national governments. You can’t claim credits for taxes paid for foreign real estate tax, value-added tax (VAT), sales tax, social security, or property tax.

Who can claim the FTC?

You can only claim the FTC if you are a US citizen or taxpayer who earned and paid taxes on foreign income or other profits. Additional requirements include:

• – The foreign country must have imposed taxes on your income
• – You have already paid the tax or it has accrued (ie it’s due in the future based on income already earned)
• – You did not profit from paying the foreign tax
• – The US has not sanctioned the country to which tax was paid

Who should claim the FTC?

If you’re a US expat, a few situations where it’s advisable to claim this credit are if you…

• – Pay higher taxes in the country where you live than you would in the US: In this case, claiming the FTC typically will end up eliminating any US tax you might otherwise owe.
• – Have passive income streams earned outside of the US: You can apply the FTC to active and passive sources of income, including rental income, pensions, and investments from foreign countries.
• – Have dependents that qualify for the Child Tax Credit: As long as you have a child who is a US citizen and legally your dependent, you can qualify for a refundable CTC.
• – Want to contribute to an IRA: If you claim the FTC as a credit, and not a deduction, it won’t lower your earned income, which in turn allows you to contribute more to an IRA.

A Bright!Tax CPA can help you determine if the FTC makes the most sense for your financial situation.

What is the Foreign Earned Income Exclusion?

The other tax exemption you should consider as a US expat is the Foreign Earned Income Exclusion or FEIE. This tax break is more widely known than the FTC and can also help you reduce your US tax bill by reducing your taxable income. Like the FTC, it will prevent double taxes on your income – but may not make sense for all US taxpayers living overseas.

The FEIE works by lowering the amount of US taxes you’re on the hook for paying, by allowing you to exclude all or some of your foreign earned income from your tax return. Your foreign income must be from earned income including salaries, wages, bonuses, or commissions – you cannot exclude passive income.

For 2021 taxes, you can exclude up to $108,700 in earned foreign income through the FEIE; the 2022 threshold for the FEIE is set at $112,000. This then reduces your taxable income, lowering your US tax bill, and in some cases, may actually eliminate it altogether.

So, for example, if you’re a US expat who earned $80,000 in foreign income last year and made no other money – you could end up with a $0 tax bill. That’s because your income is under the threshold, so you’re able to exclude it all from taxation. 

Who can claim the FEIE?

In order to qualify for the FEIE, the IRS requires that you pass either the Bona Fide residence test or the physical presence test:

• – You can prove that you are a bona fide resident of another country: In this instance, if you’ve established residency in a foreign country for an entire tax year, you can claim this deduction. For example, if you traveled to Cape Town at the end of 2020 and became a resident before the beginning of 2021, you could claim the FEIE on your 2021 taxes. This applies if you’re a US citizen or resident alien.
• – You were outside of the US for 330 days or more: This stipulation requires you to be outside of the US for at least 330 during twelve consecutive months. For example, if you traveled throughout Europe and Asia for most of 2021, and were only in the US for 15 days this year, you would fulfill this requirement.

Who should claim the FEIE?

The FEIE is a great way to save money on your taxes, but how do you know if it’s right for you? Here are some instances where it can make sense to claim the Foreign Earned Income Exclusion:

• – You do not pay foreign income tax: In this instance, claiming the FEIE is the best way to ensure you get the biggest tax break possible.
• – Your foreign taxes are lower than the US tax rate: If you pay less taxes abroad than you would in the US, the FEIE is typically the better option.
• – You’re on an IDR for a US student loan: This exclusion can benefit US expats with student loan debt tremendously. Loan servicers base your US income-driven repayment plans for federal student loans on the amount of income reported on your US taxes. If you claim the FEIE, it could reduce your adjusted gross income to as little as $0, which could eliminate your monthly student loan payments. Even if your AGI is higher than $0, your repayment requirements could still drop tremendously.
• – You’re claiming the stimulus payments from 2020 or 2021: If your income exceeded the threshold for obtaining Economic Impact Payments for COVID, you might still receive your full stimulus payment while claiming the FEIE, as it reduces the income used to evaluate whether you qualify.

If you’re not sure if you qualify for the FEIE, you can use the IRS’s interactive tax assistant tool or chat with a tax professional at Bright!Tax.

Which is best for you, the Foreign Tax Credit and the Foreign Earned Income Exclusion?

While both the FTC and FEIE can help lower your US tax bill, choosing the best tax exemption for your financial situation is important – choosing the wrong one could lead to you paying more taxes than you owe.

In general, at Bright!Tax, we recommend checking to see if you can apply for the Foreign Tax Credit first, for a few reasons. First, you can apply this credit to active and passive income streams, which can help reduce your tax burden comprehensively. Secondly, the stipulations for the FTC are less stringent than the FEIE – you don’t have to limit your US travel unless you’re earning income there. On top of this, you can carry any unused tax credit from the FTC forward and apply it to your next 10 years of tax returns or carry it back to your previous year’s taxes.

Perhaps most importantly, the FTC offers more flexibility for the majority of US expats. Once you claim the FEIE, you’ll need to claim it each year. If you decide to instead claim the FTC, you’ll need to revoke the FEIE. You’re then locked out of claiming it for the next five years.

For example, if you claim the FEIE for your 2020 taxes and decide to discontinue using the FEIE in 2021, you’re then prevented from claiming the FEIE for your next five tax returns.

Of course, everyone’s situation is different and depending on your financial situation, you may only be eligible for one of these two credits. For example, if you don’t pay foreign taxes, you can’t claim the FTC, so you should claim the FEIE in this case. Likewise, if you earn income sourced in the US, even if you pay foreign taxes on it, you cannot claim the FTC.

Here’s a quick comparison of when we recommend using each tax exemption:

The good news is, you don’t have to figure this out on your own. Bright!Tax can help you figure out which foreign tax break will save you the most money.

Can you claim both the Foreign Tax Credit and Foreign Earned Income Exclusion?

Yes, it’s possible to claim both tax exemptions, but not on the same income. It’s actually quite common – especially when people earn more than the FEIE threshold.

For example, if you’re a US expat whose foreign tax rate is lower than the US rate, you might opt to claim the FEIE for the income you earn abroad. You could then claim the FTC for any passive income you earn, such as from rental properties or other investments. This strategy may maximize the amount you’ll save on your US tax bill.

How do you claim the FTC or FEIE?

You can claim both the FTC or FEIE when filling out your tax returns.

The Foreign Tax Credit is filed with IRS Form 116 and the Foreign Earned Income Exclusion with IRS Form 2555. You can submit these forms electronically or by mail with your Form 1040.

 If you need help filing a return, understanding the difference between the FTC and FEIE, or have other tax questions, reach out to an expert CPA at Bright!Tax.

When do I have to file my taxes?

If you reside abroad as of tax day 2022, as a US expat, you receive an automatic two-month extension to file your tax return. While US residents had to submit their 2021 tax returns on April 18th of this year, your tax return is due on June 15. If you still need more time to file, you can request an extension, which will extend your due date to October 15, 2022.

You can give yourself a little extra time to decide which tax exemption is best for you, by filing an extension with IRS Form 4868. You can mail this form directly to the IRS or work with your tax preparer or software service to submit it electronically. 

And, if you realize you need even more time to get your tax documentation in order, you can send a written request to the IRS asking for an additional extension, moving your tax due date to December 15, 2022.

Can I claim the FTC or FEIE if I did not file my taxes last year?

Are you a little behind on your US taxes? Don’t panic. Thanks to the IRS Streamlined Procedure, catching up on past tax returns is simpler and less stressful than in the past. You can file three past-due tax returns via this process if you’re a US expat who has been out of the US for at least 330 days during one of these delinquent tax years. To take advantage of this process, you’ll also need to certify not filing was a result of non-willful conduct (for instance, you didn’t know you owed the US a tax return). The IRS also must not have contacted you about these returns first.

If you qualify for the Streamlined Procedure, you can also claim the Foreign Earned Income Exclusion and Foreign Tax Credit for the tax years submitted. 

Bright!Tax can help you find the best tax breaks

While both the FTC and FEIE are great options for reducing your tax bill as a US expat, they’re just the start of the tax credits and exemptions you can apply to your 2021 tax return. Bright!Tax CPAs are experts in US expat tax and can help you minimize your tax liabilities, so you don’t end up paying more than you should..

Talk to a Bright!Tax CPA today to claim the Foreign Tax Credit or Foreign Earned Income Exclusion and make filing your tax return quick and painless.

The post Claiming the Foreign Tax Credit vs Foreign Earned Income Exclusion: Which one is right for you? appeared first on Bright!Tax Expat Tax Services.

Don’t forget that the US has a citizenship-based taxation system. That means that all US expats, regardless of where they live, have to declare their worldwide income. Yep, you heard that right. Not only do they have to pay taxes within their new home country but also to good ol’ Uncle Sam. 

In this blog post, you’ll learn everything you need to know about Form 1116 to claim your foreign tax credits and reduce your tax liability. 

What Is the Foreign Tax Credit (FTC)? 

The IRS has a program called the Foreign Tax Credit (FTC), which helps US expats eliminate double taxation and save money on US taxes. It’s an especially helpful program for American expats that live in countries with a higher income tax rate than the US.

With the FTC, American citizens who pay foreign income taxes within their new country can claim US tax credits on a dollar-for-dollar basis, not to exceed the US tax rate (meaning the foreign tax credit won’t ever result in a refund). The FTC assigns the credits to the same value of taxes they’ve already paid overseas. As a result, US expats can avoid double taxation and reduce their US tax liability.  

Who’s Eligible for the Foreign Tax Credit (FTC)? 

US expats must meet certain criteria before they can claim the benefits of the Foreign Tax Credit (FTC). American expats must be able to prove that they’re paying taxes on their foreign earned income in their new country of residence.

The IRS will assess these three tests to determine if your income overseas qualifies for the Foreign Tax Credit:

• – Your new home country imposed the tax on you. You can’t qualify for the FTC if your new home country doesn’t require residents to pay income tax. For example, if you live in France and your employer automatically deducts taxes from your paycheck, that counts as imposed taxes. 
• – The tax must be legal within your new home country. You can only benefit from the FTC if you paid legal taxes. For example, if you spent six months in Portugal (a popular spot for digital nomads) but paid no imposed tax while you were there, you don’t qualify for the FTC. 
• – The tax you paid needs to be income tax. The IRS only accepts income taxes paid in a foreign country to qualify expats for the FTC. Below, you’ll find a list of foreign taxes that the IRS doesn’t accept.

Once your taxes paid fit the three requirements above, then you can claim the FTC. However, taxes that aren’t eligible for the FTC include:

• – Sales tax
• – Social security taxes
• – Real estate taxes paid on a foreign property
• – Taxes on mineral, gas, or oil income
• – Taxes to a country sanctioned by the US government

To learn more about if the income in your new country qualifies for Foreign Tax Credit, contact a trusted tax advisor to offer guidance on your situation. 

What Is Form 1116? 

To claim your foreign tax credit on your tax return as a U.S citizen, you’ll need to use Form 1116. According to the IRS official website, you can use Form 1116 to “claim the foreign tax credit if you are an individual, estate, or trust, and you paid or accrued certain foreign taxes to a foreign country or U.S. possession.”

On Form 1116, you must convert all of your foreign earned income into US dollars. You’ll have to go through the IRS’ yearly exchange rates for the foreign currency that pays you to calculate this. 

Form 1116 consists of four different sections:

• – Part 1: In this section, taxpayers will have to declare all of their sources of income outside the US. 
• – Part 2: The taxpayer will have to report all of the foreign taxes they paid throughout the year. 
• – Part 3: You must calculate your FTC credit eligibility based on your income category. 
• – Part 4: This section is where US taxpayers will have to summarize all FTC credits from each category. 

How Are Foreign Tax Credits on Form 1116 Calculated? 

To calculate the limit on your foreign tax credits, you’ll have to take your foreign taxable income and divide it by your total taxable income. Once you do this calculation, you then multiply it by your total US tax obligation. The final number is the limit on how much you can claim in foreign tax credits. 

Let’s dive into a basic example. You live in the Netherlands and earn $70,000. You already paid $25,000 in foreign taxes to the Dutch government. On top of that, you make an extra $15,000 from rental U.S income each tax year. 

The IRS tells you that you owe $16,000 in US income taxes.  

$70,000 (foreign taxable income) / $85,000 (total taxable income) =  .82

Next, we use that number and multiply it by our US tax obligation. This calculates the number of foreign tax credits we can claim:

.82 X $16,000 = $13,120

In total, you can claim up to $13,120 worth of foreign tax credits. What’s also great is that if you don’t use the total amount of your foreign tax credits, you can “carry over” that unused amount to the next tax year. 

How Much Foreign Tax Credit Can I Claim with Form 1116? 

There’s a limit to the number of foreign tax credits you can claim. You cannot claim more foreign tax credits than the amount you’re already paying in foreign earned income. 

If you don’t want to bother doing all the math to determine how much you can claim in foreign tax credits, you can always let a tax advisor handle the calculation. 

Can You Claim Foreign Tax Credit without Form 1116? 

Depending on your situation as an American expat, you may not have to file Form 1116 to claim the Foreign Tax Credit. 

For example, let’s say that all your foreign-earned income is passive income. In this case, filing Form 1116 won’t be necessary due to ineligibility. 

If you’re an expat in a US territory such as the Virgin Islands, you’ll also have different instructions when it comes to filing Form 1116. With earnings less than $300 per person (or $600 per couple) in foreign taxes, you won’t have to file Form 1116 to claim your foreign tax credit either or file the US tax return altogether. 

Are There Penalties if I Don’t File Form 1116? 

No, there are no penalties if you don’t file Form 1116. That said, if you don’t file Form 1116, you’ll lose dollar-for-dollar credits that you could use to reduce your US tax liability. So why not take advantage of the extra savings on taxes? 

Form 1116 vs. Form 2555: What’s the Best Option? 

Some US expats wonder whether it’s better to file Form 2555, the form to claim the Foreign Earned Income Exclusion (FEIE), to reduce their tax liability. The FEIE allows US expats to exclude a portion of their foreign income from their US tax liability. While both forms help eliminate double taxation for US expats, they are not the same. 

What makes the FEIE different from the FTC is the types of income it can be applied to are different. Unlike the FTC, FEIE only applies to income from wages. That means that the FEIE doesn’t cover other forms of income, such as passive income from dividends.  

If you’re still unsure which program better fits your need, contact a US tax advisor to guide you through the process. 

Let Bright!Tax Help You File Form 1116

There are a lot of complex calculations that go into filing Form 1116. You have to determine first if you’re eligible for the Foreign Tax Credit, calculate how many credits you can claim based on how much you earn…it can seem like you have to go through various loops and holes before you can finally benefit from the credit. 

This is why Bright!Tax saves US expats stress from filing their tax returns –  by handling all required paperwork. Our tax professionals have helped Americans across 200 countries comply with their IRS obligations with total peace of mind. 

You can get started today! Simply share with us some brief information about your current expat tax situation. Shortly after, one of our CPAs will then be in touch to guide you through the next steps. 

The post How to Claim the Foreign Tax Credit (FTC) with Form 1116 appeared first on Bright!Tax Expat Tax Services.

To avoid double taxation, American expats in this situation can claim US tax credits on their foreign income when they file their US taxes, and tax credits in their country of residence in lieu of US taxes paid on their US sourced income (e.g. passive income such as rents arising in the US, or income for work they did while they were physically in the US).

Expats who pay income taxes abroad claim US tax credits to reduce their US personal income tax bill by filing IRS Form 1116 when they file Form 1040.

Americans living abroad also have to report their foreign registered corporations to the IRS and pay US corporation tax, and this often puts them at risk of double corporate taxation.

Americans in this situation can file IRS Form 1118 to claim US corporation tax credits based on the value of foreign corporation tax they’ve paid.

Form 1118 should be filed along with the other IRS corporation reporting forms due, normally either Form 5471 or Form 8858.

How to file Form 1118

Form 1118 is a complicated form to file. The IRS estimates that it takes 25 hours to complete. Expats with a foreign business who need to claim corporate foreign tax credits should always seek assistance from an expat tax specialist.

Form 1118 consists of seven pages containing schedules A-K, requesting details about the company and its income (types and amounts), foreign taxes paid (converted into US dollars) and foreign tax credit computations.

Other US filing requirements for American expat business owners

FATCA rules meanwhile state that Americans with foreign financial assets, including the value of a business, must report their foreign assets on IRS Form 8938. Minimum total foreign assets reporting thresholds start at $200,000 for Americans living abroad.

What if you’re behind with filing US taxes from abroad?

There is an IRS amnesty program called the Streamlined Procedure that lets Americans abroad who are behind with their US tax filing because they weren’t aware of the requirement to file to catch up without facing penalties.

The post When Should US Expats File IRS Form 1118? appeared first on Bright!Tax Expat Tax Services.

But the Foreign Tax Credit can only go so far in reducing your US tax bill – there are limits to the ways it can be used.

Read on to learn what expats need to know about the Foreign Tax Credit Limitation.

What is the Foreign Tax Credit?

In short, the Foreign Tax Credit (FTC)¹ allows you to offset the tax paid to a foreign country against what you owe the IRS. 

Becoming law in 1919, the Foreign Tax Credit was intended to eliminate the misfortune of double taxation. 

More than a century after its enactment, the system remains largely unchanged. Today, if you owe the Canadian government $3,500 in taxes, for instance, and the IRS requires you to pay $4,000 on the same income, you can generally offset the $3,500 against the $4,000, only paying the IRS $500. 

Read more: The Foreign Tax Credit (FTC): A Guide for US Expat Taxes

What is the Foreign Tax Credit Limitation?

While the FTC is a favorable tax tool, courtesy of the IRS, there are limitations to claiming it. This cap or ceiling is known as the Foreign Tax Credit Limitation. 

Let’s look at a simple example.

Suppose you owe Hong Kong’s Inland Revenue Department $3,000 in income tax on your salary. And you owe the IRS $2,000. You can’t claim the whole $3,000—thanks to Foreign Tax Credit Limitation.

How much is the Foreign Tax Credit Limitation?

According to the IRS, your Foreign Tax Credit Limitation is your total US tax liability multiplied by the fraction of your foreign income over your total worldwide income. In its essence, the limitation allows the foreign tax credit only to be applied to foreign income.

Let’s look at another example with George, a US citizen and expat. Assume the following facts about George’s income.

• Income earned in Hong Kong = $150,000
• Income earned in the US = $50,000
• Income tax paid in Hong Kong = $30,000
• Income tax owed in the US = $20,000

George’s worldwide income is $200,000 ($150,000 + $50,000).

His foreign income is 75% of his total income ($150,000 / $200,000).

So, George can offset 75% of his US tax liability with the tax he paid in Hong Kong. 

He’ll have a Foreign Tax Credit of $15,000 ($20,000 x 75%). 

At this point, you may wonder: what if the amount of your foreign tax is more than the limit you can claim from the IRS? Does this mean you’ll get a refund of this excess amount?

What happens if your foreign taxes exceed your Foreign Tax Credit limit?

When the amount of taxes you pay to foreign countries is larger than your Foreign Tax Credit limit, you’ll be able to carry the excess amount backward or forward into past or future years. 

Carrybacks can only be applied to the immediately preceding year. 

But, if you carry forward the unused portion, you have up to 10 years to use it.

Let’s see how this works with an example.

In our example above, George has $1,500 ($3,000 – $1,500) of unused Foreign Tax Credit. Let’s assume he chooses to carry that forward, not back.

Assume, the following year, George’s income situation is as follows:

• Income earned in Hong Kong = $10,000
• Income earned in the US = $200,000
• Income tax paid in Hong Kong = $500
• Income tax owed to US = $5,000

George’s worldwide income is $210,000 ($10,000 + $200,000).

His foreign income is approximately 4.8% of his total income ($10,000 / $210,000).

So, George can offset 4.8% of his US tax liability with the tax he paid in Hong Kong. 

He’ll have a Foreign Tax Credit of $240 ($5,000 x 4.8%) and owes the IRS $4,760.

Remember, George has a $1,500 Foreign Tax Credit as a prior year carry forward. 

Therefore, he’ll owe the IRS $3,260 ($4,760 – $1,500). And he’ll still have a $260 ($500 – $240) FTC to carry forward to next year.

Elect exemption from Foreign Tax Credit Limitation   

You can claim the full amount of your foreign tax credit—without any limitation—and without even using Form 1116, provided that:

• Your only foreign source of gross income for the tax year is passive income such as dividends and interest.
• Your qualified foreign taxes for the tax year are not more than $300 or $600 if filing a joint return. 
• All of your gross foreign income and foreign taxes are reported to you on a payee statement (e.g., 1099-DIV, 1099-INT). 
• You elect this procedure for the tax year by attaching a written statement to your return.           

But there’s a catch.

If you elect to take the exemption, you’ll be limited on your carryforwards and carrybacks. This can be pretty costly. So think this through with a professional before deciding.

Our experts in US expat tax are ready to get started when you are!

If you’re seeking to minimize your US tax liability (potentially to $0!), void double taxation, and submit your tax return with confidence, contact us today for an initial discussion about your tax situation.

Get Started

References

1. Foreign Tax Credit | Internal Revenue Service (irs.gov)

The post Foreign Tax Credit Limitation – What Expats Need to Know appeared first on Bright!Tax Expat Tax Services.

This means that many Americans living abroad face the prospect of double taxation, paying income taxes both in the country where they live as well as to the US.

Unfortunately, the tax treaties that the US has signed with other countries don’t often help mitigate this risk, as they often contain what’s called a Saving Clause, which allows the US to tax its citizens abroad as if the rest of the treaty didn’t exist.

Instead, to prevent double taxation, the IRS has made available a foreign income tax offset called the Foreign Tax Credit.

The US Foreign Tax Credit – the foreign income tax offset for expats

The US Foreign Tax Credit allows Americans with foreign source income to offset their foreign income tax by claiming US tax credits to the same value as the foreign taxes that they’ve already paid on the income.

As many foreign countries have higher income tax rates than the US, this often means that expats who claim the Foreign Tax Credit can reduce their US tax bill to nothing, and have excess US tax credits left over, which they can carry forward to use in future years (or apply to the previous year, if beneficial).

Expats who do owe any US tax still have to pay it by April 15^th to avoid interest however.

The Foreign Tax Credit can be applied to any type of income, whether earned (such as wages, or self employment income) or passive (such as investment income or rental income), so long as the income is foreign source.

Expats can also choose to take their foreign income tax paid as a deduction rather than as a credit, if they want to, although it’s normally more beneficial to take it as a credit.

What about US source income?

Many expats have US source income as well as (or instead of) foreign source income, perhaps from services performed on US soil, or from US-based investments or pensions, or US rental income. As the IRS will not allow expats to apply the Foreign Tax Credit to US source income, expats who are taxed on their worldwide income in their country of residence may be subject to double taxation.

There are two ways possible ways that expats can prevent double taxation on their US source income for expats.

The most common way of preventing double taxation in these cases is to seek a foreign tax credit on the tax return in the country of residence

US Foreign Tax Credits can be applied to corporate taxation too though, this time by filing IRS Form 1118 rather than Form 1116.

Expats should note that there is a new Form 1118 in 2019, following changes made to corporate taxation in the 2017 tax reform.

Expats who need to file US back taxes

In summary, expats should never have to pay more income tax than the higher of the two tax rates they are subject to (the US rate and the rate in the country where they live).

Expats who are behind with their US tax filing because they were unaware that they had to file from abroad need to file back taxes, and they can do so without facing any penalties under an IRS amnesty program called the Streamlined Procedure, so long as they do before the IRS contacts them.

The post Is There a Foreign Income Tax Offset for US Expats? appeared first on Bright!Tax Expat Tax Services.

The tax treaties that the US has signed with around 100 other countries don’t prevent American expats from having to file US taxes.

Instead, to prevent expats paying US taxes on income that they’ve earned abroad, the IRS has made available several exemptions that expats can claim when they file. One of the main exemptions is called the Foreign Tax Credit

The Foreign Tax Credit

The Foreign Tax Credit allows expats who are already paying foreign taxes on their income in the country where they live to claim US tax credits to the same value as the foreign taxes that they’ve paid.

To claim the Foreign Tax Credit, expats must file IRS form 1116 when they file their federal tax return, providing proof of the foreign taxes they’ve paid.

The IRS doesn’t specify a currency conversion source for expats to use when they convert the value of the foreign taxes that they’ve paid into US dollars, just that they use a reputable source and are consistent in the source that they choose to use.

The Foreign Earned Income Exclusion can only be applied to earned income though, not passive income from pensions, rents and dividends for example. However it doesn’t matter where the income is earned, so expats who receive a salary or other compensation for services rendered from the US can exempt it from US taxation (up to the threshold).

The Foreign Tax Credit on the other hand can only be applied to income that was sourced abroad, regardless of whether the income was earned or unearned, so long as foreign income taxes have been paid on it.

Expats can in fact claim both, if they apply them to the different income.

One advantage of the Foreign Tax Credit though is that if expats pay a higher amount of income tax on their foreign sourced income abroad than they owe the US, they can claim more US tax credits than they need, and they can carry the excess tax credits forward for use in future years. This is sometimes known as the Foreign Tax Credit Carryover.

Expats who claim the Foreign Tax Credit Carryover and who have children with US social security numbers can also claim the new Child Tax Credit, which will give them a refundable payment even if they don’t owe any US taxes.

Expats that need to file back taxes

Expats who are behind with their US tax filing because they weren’t aware of the rules can catch up under an IRS amnesty program that also lets them claim the Foreign Earned Income Exclusion or the Foreign Tax Credit (including the carryover), so long as they do so voluntarily before the IRS writes to them (and the IRS is receiving both foreign tax information from foreign governments, and contact and balance information from foreign banks).

The amnesty program is called the Streamlined Procedure, and it requires that expats file their last three tax returns and their last six FBARs (required for some expats with foreign bank and investment accounts), and that they self certify that their previous non-compliance wasn’t willful evasion.

The post The IRS Foreign Tax Credit Carryover – What US Expats Need to Know appeared first on Bright!Tax Expat Tax Services.

Millions of U.S. expats must also pay income tax in the country where they live, so the question arises of how to avoid paying taxes on the same income twice, in their country of residence as well as to Uncle Sam.

Some assume that a tax treaty between the two countries will prevent this, but in fact all of the around 100 tax treaties that the U.S. has with foreign countries protect foreigners living in the States, rather than American expats, with very few exceptions.

There are however other ways for expats to avoid paying taxes on the same income twice.

Is there a foreign income tax credit available for U.S. expats?

While expats who earn over $10,000, or just $400 of self-employment income, always have to file a federal tax return, when they file they can claim a foreign income tax credit against taxes that they’ve already paid abroad.

The Foreign Tax Credit works by offering expats a $1 U.S. tax credit for every dollar of foreign tax that they’ve already paid abroad.

Is the Foreign Tax Credit the only and best way for expats to avoid double taxation?

The Foreign Tax Credit is a good solution to potential double taxation for many expats, including those:

– who pay at least as much foreign income tax as the U.S. income tax they would owe. If they pay less foreign tax on the other hand, they won’t be able to claim enough U.S. tax credits to nullify their U.S. tax liability, so it may not be the best solution. (If they pay more in foreign income tax though, they can claim excess U.S. tax credits which they can defer for future use).

The Foreign Earned Income Exclusion can be claimed by filing form 2555.

Expats who aren’t sure which exemption to claim should consult with a U.S. expat taxes specialist.

How can expats who are behind with their U.S. tax filing catch up?

Expats who are behind with their U.S. federal tax return (or foreign account FBAR reporting) can catch up while claiming the best exemption for them and without facing any late penalties under an IRS amnesty program called the Streamlined Procedure.

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