In contrast to tax deductions, which lower the amount of taxable income you have, tax credits are subtracted from your overall tax liability. For example, a common US tax credit is the child tax credit, which permits taxpayers to claim a credit of up to $1,000 for each child. Depending on your financial circumstances, as a US citizen or resident abroad you may also qualify for the foreign tax credit. In this blog post, US Tax Help will explain who is eligible (and ineligible) to claim the foreign tax credit under the rules and requirements mandated by the IRS, or Internal Revenue Service.
IRS Eligibility Requirements to Claim a Foreign Income Tax
The IRS provides the following explanation of how the foreign tax credit works:
If you paid or accrued foreign taxes to a foreign country on foreign source income and are subject to US tax on the same income, you may be able to take either a credit or an itemized deduction for those taxes.
In other words, claiming a foreign tax credit for which you are eligible can help you avoid being subject to double-taxation.
Generally speaking, taxpayers must pass the following four criteria in order to qualify to claim the foreign tax credit:
- You must be subject to the tax.
- You must also have paid or accrued the tax. Accrued tax is tax for which you are liable, but which has not yet been paid. The tax must be paid or accrued to U.S. possessions, such as American Samoa and Puerto Rico, or to a foreign country. Eligible paid or accrued taxes generally include:
- Excess Profits Tax
- War Profits
- The tax must be both lawful and accurate.
- The tax must either be an income tax, or an alternate tax which substitutes income tax. For example, acceptable taxes “in lieu of income tax” typically include:
- Foreign Tax on Income
Foreign levies may also be acceptable, provided that (1) the levy is not a payment for a benefit, and (2) you are subject to the tax instead of income tax — not in addition to income tax. A foreign levy is a fee that helps compensate copyright holders of movies and TV shows.
If you believe you qualify, you may claim the credit by filing the following forms where applicable with help from an experienced CPA:
- Form 1116 — Meant for use by:
- Form 1118 — Meant for use by corporations.
While both forms are titled “Foreign Tax Credit” and carry the same general purpose, the version intended for use by corporations is dramatically more complex. The individual form is two pages long, while the corporate form consists of seven different schedules, many of which are subdivided into multiple sections, over a total of 11 pages.
However, even where individuals are concerned, the regulations governing foreign tax credits are an exceptionally complex area of the tax code. All taxpayers who are interested in claiming such a credit are advised to consult with a knowledgeable CPA who has experience handling international tax matters — particularly those taxpayers whose circumstances involve any of these commonly-cited compliance stumbling blocks:
- Capital Gains
- Foreign Tax Redetermination
Which Types of Taxes Do Not Qualify?
While many different types of taxes have the potential to qualify for the foreign tax credit, there are also certain taxes which are considered ineligible. Taxpayers generally may not claim credits for any of the following:
- Foreign income tax with respect to foreign mineral income.
- Taxes stemming from multinational boycott efforts.
- Certain taxes stemming from foreign gas income and foreign oil income.
- Taxes on excluded income (i.e. foreign earned income exclusion).
- Taxes on US persons who control partnerships or corporations which do not comply with tax filing requirements. If this description applies to you, you should strongly consider working with with an experienced international CPA like Ted Kleinman to reenter tax code compliance before you are targeted for an audit or IRS criminal investigation. In accordance with IRC Section 7203, criminal penalties for deliberately failing to file or pay taxes (or to supply other tax information which must have been documented) can include a fine of up to $25,000 (or $100,000 for a corporation), in addition to one year of incarceration.
- Social Security taxes which are accrued or paid to a foreign nation which has entered a “Totalization Agreement” with the United States. To date, the US has entered into Totalization Agreements with over two dozen nations around the globe, including but not limited to the following:
If you’re interested in claiming the foreign tax credit, don’t try to navigate the IRS’ complicated procedural requirements without professional tax assistance: get trusted financial advice from CPA Ted Kleinman of US Tax Help. Ted has over 20 years of experience, and offers free, confidential consultations for new clients. To start exploring the financial possibilities, call Ted today at (800) 810-9312.