How the Foreign Tax Credit Impacts Your US Expat Taxes

How the Foreign Tax Credit Impacts Your US Expat Taxes

Many foreign countries require residents to pay taxes regardless of the resident’s nationality. For this reason, many US expats have an opportunity to claim the foreign tax credit on their US expat taxes. The foreign tax credit is claimed on US expat taxes by completing Form 1116 and attaching it to an individual US expat tax return, Form 1040. The credit reduces the liability on US expat taxes dollar for dollar. The credit cannot be taken against income which has already been excluded by the Foreign Earned Income Exclusion, nor can it exceed the liability on US expat taxes sourced to foreign earned income.

For Americans living overseas, the foreign tax credit can help them reduce the income they need to claim on their US expat taxes, which then reduces their overall tax liability. This short video will provide you with a glimpse of how the foreign tax credit works. More detailed information can also be found in our post on the foreign tax credit and Form 1116; click here to read it.

Foreign Tax Credit

Don’t get double-taxed, file Form 1116 and you could not only save on your US taxes now, but for years to come.

Transcript of an interview with David McKeegan, MBA, EA, President of Greenback Expat Tax Services:

The next thing we’d like to talk to you about is the Foreign Tax Credit, Form 1116, which is basically a dollar-for-dollar tax credit against any tax you paid or incurred to a foreign government. Now, there are a couple of rules about what you have to do in order to be able to qualify for this.

  • First one, you have to have earned income.
  • Second, you have to have paid tax or incurred a tax liability that you’ll have to pay going forward in a foreign country.
  • You have to be living there legally, so if you happen to be living in Cuba or North Korea, sorry, but you’re not going to get this one.

This is generally true, you have to be living somewhere legally, you have to have a tax liability in order to get the credit to offset on your US taxes.

So how does this work?

Say you’re living in the UK, and you are earning money there. The top tax rate there is about 40%, the top tax rate in the US is currently about 35%, and so you’re paying HMRC (Her Majesty’s Registry and Custom) 40% of your earnings, let’s say, and then you take a credit for that on your US taxes. That lowers your earnings in the US, and thereby reduces your tax burden in the US.

But the beauty of this one is that you can actually accrue these tax credits. So you can accrue them and either carry them back one year, or carry them forward up to 10 years.

Who’s going to be able to use this?

I was talking to a client the other day, and his situation was that he had a big job and a big salary working in financial services, made a very nice income in one year. He got laid off, made next to nothing the next year. What he’s doing is filing an amended return for the first year, when he made the big salary, because he’s accrued tax credits and can carry it back and get a refund. So he’s looking at a pretty nice refund now, because he has all of these tax credits accrued, and he’s got a new job now, thankfully, and he’ll start building them up again because he’s going to be paying money on his salary now as he goes forward.

So for people who are in more traditional jobs, you know, you’re working for a company overseas and you’re paying tax in the country you’re living in, this is a pretty good advantage of being an expat.

Now for people who are living in tax-free locations, the Middle East, Abu Dhabi, those kinds of places, you’re not really going to be able to take advantage of this. You’re not really paying any tax, therefore no local tax means no tax credit going forward.

Questions About Your US Expat Taxes?

A good place to start is our US Expat Taxes Explained series. If you have any more questions about your US expat taxes, or if you’d like to learn more about our expat tax services, please contact us.