Everything you need to know about Foreign Tax Credit

Taxpayers, including individuals and businesses are liable to file tax returns for their incomes and assets every year to the IRS. But what if a tax payer is also liable to pay taxes to a foreign government for the businesses or asset they have in the foreign land? Are the required to pay twice the taxes to the two governments? The answer is no, because of the concept of the Foreign Tax Credit.
What Is Foreign Tax Credit?
The foreign tax credit is a non-refundable tax credit for income taxes paid to a foreign government as a result of foreign income tax withholdings. The foreign tax credit is available to anyone who either works in a foreign country or has investment income from a foreign source.
The foreign tax credit is a tax break provided by the government to reduce the tax liability of certain taxpayers who have assets or work in a foreign country. Generally, only income, war profits, and excess profits taxes qualify for the credit. The credit can be used by individuals, estates, or trusts to reduce their income tax liability.^In addition, taxpayers can carry unused amounts forward to future tax years, up to ten years.
How isForeign Tax Credit calculated?
Your foreign tax credit is your total U.S. tax liability multiplied by a fraction. The numerator of the fraction is your taxable income from sources outside the United States. The denominator is your total taxable income from U.S. and foreign sources. Foreign Tax credit is limited by this fraction.
A tax credit is applied to the amount of tax owed by the taxpayer after all deductions are made from their taxable income, and it reduces the total tax bill of an individual dollar to dollar. If an individual owes $3,000 to the government and is eligible for a $1,100 tax credit, they will only have to pay $1,900 after the credit is applied.
A tax credit can be either refundable or non-refundable. A refundable tax credit usually results in a refund check if the tax credit is more than the individual’s tax bill.
Exemptions from the Foreign Tax Credit Limit
You will not be subject to the foreign tax credit limit and will be able to claim the foreign tax credit without using Form 1116 if all of the following requirements are met.
1.Your only foreign source gross income for the tax year is passive income, as defined in Publication 514 under Separate Limit Income.
2.Your qualified foreign taxes for the tax year are not more than $300 ($600 if filing a joint return).
3.All of your gross foreign income and the foreign taxes are reported to you on a payee statement (such as a Form 1099-DIV or 1099-INT).
4.You elect this procedure for the tax year. If you make this election, you cannot carry back or carry over any unused foreign tax to or from this tax year.
Various other benefits like the Foreign Tax Credit are provided by the IRS for the taxpayers. But these benefits are a subject to the taxpayers’ knowledge. Our tax experts are the National Tax Preparers of America (NTPA) will help you take due advantage of all such benefits you are eligible for, to ensure a profitable tax season.