What is the foreign tax credit?

The foreign tax credit reduces US tax on income that was also taxed by a foreign country or a US possession. An individual, estate, or trust claims it on Form 1116 for certain foreign taxes paid or accrued during the year. Unused credit can carry between years, and a later change in the foreign tax has to be reported.

Key points

The foreign tax credit relieves double taxation by reducing US tax on income that a foreign country or US possession also taxed.
An individual, estate, or trust claims the foreign tax credit on Form 1116 for certain foreign taxes paid or accrued during the year, although a filer whose only foreign income is passive income reported on a payee statement, and whose qualified foreign taxes stay under a small annual limit, can elect to claim the credit without filing Form 1116.
Foreign tax that cannot be used in the current year can carry to other years, and Schedule B of Form 1116 reconciles a prior-year carryover with the current-year carryover.
A foreign tax redetermination, meaning a later change to the foreign tax claimed, is identified on Schedule C of Form 1116, and in most situations it also requires redetermining the US tax liability on an amended return, Form 1040-X; failing to notify the IRS of a redetermination can carry a penalty.
Publication 514 is the IRS guide to the foreign tax credit for individuals and sets out which foreign taxes qualify.

What is the foreign tax credit and who claims it?

Because the United States taxes its citizens and residents on worldwide income, income earned abroad can be taxed twice — once where it was earned and once at home. The foreign tax credit under section 901 is the relief for that overlap. It is a credit, so it reduces the US tax itself rather than the income the tax is computed on.

Form 1116 is the claim form for an individual, estate, or trust that paid or accrued certain foreign taxes to a foreign country or a US possession. Not every payment described as a tax in another country qualifies, and the Form 1116 instructions together with Publication 514 set out the tests. The credit is computed by category of income and is limited by reference to how much US tax relates to the foreign income, which is why it does not usually offset the US liability exactly.

What happens to credit you cannot use this year?

Foreign tax that exceeds the limitation in one year is not necessarily lost. Carryovers move between years, and Schedule B of Form 1116 exists to reconcile a prior-year foreign tax carryover with the current-year carryover, which is the mechanism that keeps the balance alive and documented.

The practical failure here is administrative rather than technical. A carryover that is not tracked from return to return tends to disappear when a preparer changes or a year is filed in a hurry. Keeping the Schedule B reconciliation current, and holding the foreign tax documents that support it, is what turns an unused credit into a real one later.

What if the foreign tax changes after you file?

Foreign tax figures move. A refund arrives, an assessment is revised, or the foreign authority adjusts the year. That is a foreign tax redetermination, and it does not simply sit on the foreign side of the ledger. Schedule C of Form 1116 is used to identify current-year foreign tax redeterminations, the years to which they relate, and the other information that satisfies the obligation to notify the IRS.

The point for an owner is that the credit is not finished when the return is filed. If a foreign assessment changes after the fact, that change needs to reach whoever prepares the US return, and it needs to reach them with the year it relates to attached.

How does the credit fit with the exclusion for income earned abroad?

Excluding foreign earned income and claiming a credit for foreign tax are two separate reliefs, and they do not apply to the same dollars. A foreign tax credit may not be claimed for taxes on income excluded under the foreign earned income exclusion, and taking the credit on excluded income may be treated as revoking the exclusion election. Foreign tax on income that stays in US gross income — earnings above the cap, or income the exclusion does not reach — can still be credited. Which relief leaves a household better off depends on the countries involved, the type of income, and the rest of the return. It is a calculation to run for the specific facts, not a default to apply.

Where a tax treaty is doing the work, a treaty-based return position is disclosed separately on Form 8833. And the credit generally reaches only income, war profits, and excess profits taxes, together with foreign levies imposed in lieu of an income tax; indirect taxes and fees do not qualify, and social security taxes paid to a country with which the United States has a totalization agreement are specifically non-creditable. Publication 514 is the detailed guide for individuals and the right reference before assuming a foreign payment qualifies.