US Territories Erroneous Refundable Credits and the Foreign Tax Credit: Foreign Tax Credit Compliance

The Foreign Tax Credit is a great way for Americans abroad to reduce their taxes. But the confusing formula used to calculate the credit can get expats into trouble. To avoid IRS scrutiny and penalties, make sure you’re using the Foreign Tax Credit formula correctly.

Why Does Foreign Tax Credit Compliance Matter?

Every once in a great while, the IRS launches new compliance campaigns. These campaigns allocate staffing and financial resources with the goal of finding taxpayers who aren’t currently in compliance with tax regulation and bringing them into compliance. Some of the IRS’s recent compliance campaigns target expats specifically.

One of these campaigns is entitled, “The US Territories Erroneous Refundable Credits and the Foreign Tax Credit,” which essentially means the IRS will be finding those who are claiming the Foreign Tax Credit in error. The IRS will notify those who are in noncompliance through outreach and traditional examinations.

The IRS will also likely identify international taxpayers that use the Child Tax Credit or Additional Child Tax Credit on non-qualifying children or erroneously combined with the Foreign Earned Income Exclusion and a claim for the Additional Child Tax Credit refund. This also includes the earned income credit for those who have been outside of the United States for more than six months. The PATH Act, which has been around since 2015, has strengthened these measures.

In short, this compliance campaign puts pressure on bona fide residents of US territories and expats to file amended returns and comply with current tax regulations.

How Do I Ensure I’m Using the Foreign Tax Credit Formula Appropriately?

Applying correct foreign tax credit formulas are tricky; just ask the IRS! They recently lost a lawsuit and will soon owe many expats in France a large sum of refunds for misidentifying funds that could go toward the Foreign Tax Credit. So, if you find the Foreign Tax Credit formula mystifying, take comfort in knowing that sometimes even trained minds find it confusing as well. Below is the method you should use and that our expat specialist accounts use:

Check out this step-by-step example of how to fill out Form 1116 – the form that allows you to claim this money-saving credit. Keep in mind that you’ll first need to determine whether or not you qualify for the credit. Lastly, you’ll also need to include an explanation statement that shows how you arrived at your numbers, including which exchange rates you used. Remember, in math class, when your teachers would tell you to “show your work”? That’s essentially what this form accomplishes for the IRS.

Taking the time to double-check your use of the Foreign Tax Credit formula and filing an amendment on past taxes if you’ve made an error can save you the time and stress of being audited by the IRS. Make sure you’re taxes are in order before this compliance campaign is fully underway.

Let Greenback Help You Get Caught Up!

Greenback’s accountants are the experts because expat taxes are the only kind of taxes we do. Place your taxes in the hands of our specialists, and rest assured that you’ll not only be compliant, but you’ll also be using every exclusion and credit available that can save you money.

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