Complete Form 1116 - US Expat Taxes and the Foreign Tax Credit

As a US citizen living abroad, you may be required to pay local taxes in your host country as well as filing a US tax return. If this is the case you may opt to claim a credit for foreign income taxes paid, on your US taxes as part of your expat tax preparation. You can claim this credit using Form 1116 aka the Foreign Tax Credit and attach this to Form 1040. If you have already claimed the Foreign Earned Income Exclusion you cannot take the Foreign Tax Credit on the same income, and it cannot exceed the US tax liability associated to foreign earned income. Your Expatriate tax preparation advisor can explain the details, but here is an overview.

Foreign Tax Credit Background

A move abroad can trigger a lot of things, one of those being a US tax liability on foreign income earned. This can lead to dual taxation in the USA and in the country where you are working, referred to as the host country. Because of this, US taxpayers are permitted by the IRS to exempt $91,500 of their foreign income (via the Foreign Earned Income Exclusion) and take a credit on their US expat taxes for obligatory foreign taxes (via the Foreign Tax Credit), which will reduce your US expat tax liability.

Foreign Tax Credit Limitations

As part of your expatriate tax preparation you need to ensure that your foreign tax credit claim doesn't exceed the US expat taxes paid on your foreign income source. Use the following formula to determine your liability.

(Foreign Source Taxable Income/Total Taxable Income Before Exemptions) x Total US Tax

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Foreign Sourced US Tax

The foreign source taxable income must include all sources of income earned while working in a foreign country, foreign corporation dividends received, foreign bank interest received, and any rental income from foreign property you own. You should remove any deductions directly associated to the income claimed on your expat tax return before determining what your final foreign source taxable income is. If you earn income in the USA and out of the USA it must be allocated based on the days worked in each country.

Taking Your Foreign Tax Credit on your US Expat Taxes

You must meet 4 criteria to qualify for the foreign tax credit:

Tax is required to be assessed on income earned Your tax liability must have either been incurred or already paid Your tax must be on an individual persons tax return not a company return The tax must have legally originated in a foreign country

Complete your Form 1116, annually, and attach this to your Form 1040 as part of your expatriate tax preparation. The credit will reduce your US tax liability dollar for dollar. All foreign taxes you pay must be reported in US dollars. The IRS likes each individual transaction to be converted at the time it is earned using the current foreign exchange rate for that time period. If you have a large number of transactions, or if you do not have access to the current exchange rate, the US government will accept the average exchange rate. If the US expat taxes have not yet been paid use the exchange rate on the last day of your earnings.

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