Understanding the foreign tax credit: A comprehensive guide for US taxpayers abroad

The intricacies of international taxation can be daunting for US citizens abroad. Let’s take the foreign tax credit – a powerful tool you can leverage to shield you from double taxation and potentially save you thousands.
But is foreign tax credit refundable?
What about the foreign tax credit form?

This guide will help you understand the benefits, eligibility, and how to claim.

What is the foreign tax credit?

Imagine earning money abroad, only to be hit with double taxation. Enter the foreign tax credit, a financial lifeline for expat Americans. This clever tax benefit allows US taxpayers to claim a dollar-for-dollar credit against their US tax bill for income taxes paid to foreign governments.

Whether you're an expat working overseas or an investor with international holdings, the foreign tax credit ensures you're not unfairly taxed twice on the same income, potentially saving you thousands.

Who qualifies for the foreign tax credit?

As everyone’s situation is unique, a tax specialist is always the best option for personalized advice. To qualify for the foreign tax credit, you must meet these key criteria:

Eligibility requirements

1. Tax status and income

• You must be a US citizen, resident alien, or in some cases, a nonresident alien.
• You must have foreign-source income that's taxable under US rules.

2. Foreign tax liability

• You must have paid or accrued foreign income taxes to a foreign government.
• The tax must be legally imposed on you in the foreign jurisdiction.
• It must be an income tax or a tax in lieu of an income tax.

Who can claim the credit?

• US citizens and residents working abroad
• US corporations operating internationally
• US partnerships and S corporations
• estates and trusts subject to foreign taxation

✔️ Pro tip: Not all foreign taxes qualify for the credit. Taxes such as VAT, property taxes, or social security taxes typically don't qualify. However, foreign taxes on wages, dividends, interest, and royalties typically qualify.

How does the foreign tax credit work?

When you pay income taxes to a foreign country, the foreign tax credit allows you to reduce your US tax liability accordingly and prevent double taxation by allowing you to claim a credit against your US tax liability.
Here's how it works:

• You pay income tax to a foreign country on your foreign-sourced income.
• When filing your US tax return, you can claim a credit for those foreign taxes paid.
• This credit directly reduces your US tax liability rather than just lowering your taxable income.

For example, if you earned $100,000 in a foreign country and paid $25,000 in foreign income taxes, you could claim up to $25,000 as a credit against your US tax bill. However, the credit is limited to the lesser of the foreign tax paid or the US tax liability on that foreign income.

To claim the FTC, you typically need to file Form 1116 with your US tax return. Some taxpayers may qualify for an exemption from filing Form 1116 if their total foreign tax credits are under $300 ($600 for joint filers) and all foreign income is passive category income.

The FTC can only be applied to income that is taxable under US tax rules. This includes wages, dividends, interest, and royalties earned abroad. The IRS specifies that the foreign tax must be a legal and actual tax liability imposed on you, and it must be similar to a US income tax.

Foreign tax credit carryover and carryback

If your foreign tax credit exceeds your US tax liability for the year, you can carry the excess back one year or forward up to 10 years, making the most of your foreign taxes.

Let’s say you have a $500 carryover amount and were short $600 in credits on foreign income in the previous year – you must carry that $500 back to the previous year. Any remaining unused credits can then be carried forward for 10 years.

How to calculate foreign tax credits?

Calculating foreign tax credits can be simplified into a few key steps:

1. Figure out how much money you earned from foreign sources.
2. Calculate how much US tax you would owe on that foreign income.
3. Compare the foreign taxes you paid to your US tax bill.
4. Apply any limits based on different types of income.

The idea is to avoid double taxation. If you paid taxes to a foreign country, you might be able to reduce your US taxes by that amount. However, there are limits to prevent you from getting more credit than you would have paid in US taxes.

The IRS provides a formula to help with this calculation:

Foreign Tax Credit = (Foreign Source Taxable Income / Total Taxable Income) × US Tax on Total Taxable Income

Let’s apply it to a foreign tax credit example scenario:
Imagine you have a total taxable income of $100,000, of which $50,000 is from foreign sources. You paid $10,000 in foreign taxes, and your US tax liability on the foreign income is $8,000.

Here’s how the calculation works:

1. Foreign source income: $50,000
2. US tax on foreign income: $8,000
3. Foreign taxes paid: $10,000

Now, we apply the formula:

Foreign Tax Credit = (Foreign Source Income / Total Taxable Income) × US Tax on Foreign Income

The calculated credit is $4,000. However, remember that you can’t claim more in credits than you paid in foreign taxes. In this case, since you paid $10,000 in foreign taxes, you can claim the full $4,000 credit.

This credit will reduce your US tax liability by $4,000, helping to avoid double taxation on your foreign income.

How to claim the foreign tax credit

Once you know what foreign tax credit is, your next question is going to be, how do I claim it? 

To claim the foreign tax credit, you'll typically need to file Form 1116 with your US tax return. This form allows you to calculate and substantiate your credit amount for foreign taxes paid or accrued.

However, some taxpayers may qualify for an exemption from filing Form 1116 if their total foreign tax credits are under $300 ($600 for joint filers) and all foreign income is passive category income like dividends or interest, read up on Form 1099-DIV or 1099-INT respectively.

To complete Form 1116, you'll need to gather documentation of foreign taxes paid, categorize your foreign income, and calculate the credit using the IRS formula. It's important to note that you cannot claim the foreign tax credit on income excluded through the Foreign Earned Income Exclusion.

Are foreign tax credits refundable?

The question, “Is foreign tax credit refundable?” is important for many taxpayers. The answer is no – the foreign tax credit is non-refundable, meaning it can only reduce your US tax liability to zero and cannot result in a tax refund beyond what you’ve paid.

✔️ Pro tip: Unused credits can be carried back one year or forward up to 10 years. This flexibility allows taxpayers to manage their tax obligations over time, potentially benefiting from foreign taxes paid in high-income years during lower-income periods. Accurate records and an experienced professional can help you maximize this benefit in future tax years.

Foreign tax credit limitation

The IRS imposes a clever balancing act on foreign tax credits through category-based limitations.
These categories include:

• passive income (think dividends and interest)
• general income (wages and business profits)
• IRC 951A (GILTI)
• foreign branch income

This categorization ensures that high-tax foreign income doesn't offset US tax on low-tax foreign income.

The credit limit is calculated using the formula mentioned earlier, and this cap prevents you from claiming more in credits than you would have paid in US taxes on that foreign income. It's a financial tightrope walk, designed to prevent double taxation while safeguarding the US tax base.

Foreign tax credit vs. foreign earned income exclusion

The Foreign Tax Credit (FTC) and Foreign Earned Income Exclusion (FEIE) are both powerful tools for US expats, each with unique advantages.

The FTC offers a dollar-for-dollar reduction in US tax liability based on foreign taxes paid, with no upper limit and the ability to carry over unused credits, making it ideal for high-tax countries.

The FEIE, capped at $130,000 for 2025, allows you to exclude foreign-earned income from US taxation, suited for those in low-tax jurisdictions.

✔️ Pro tip: While you can use both, the FEIE must be applied first. Choosing between FTC and FEIE often depends on factors like income level, tax rates in your country of residence, and long-term tax planning strategies.

Bottom line

The foreign tax credit is a crucial tool for US taxpayers with international income, preventing double taxation and ensuring fairness while maintaining compliance with US tax laws.

Although the calculations and limitations can be intricate, mastering this credit can lead to substantial savings. This is just one of many tax-saving strategies a tax professional would employ to optimize your international tax approach.

Given the evolving nature of international taxation, consulting a tax expert is invaluable. Don’t leave money on the table – reach out to discuss how we can help maximize your international tax benefits.