Much of the concern to the U.S. tax payer living and working overseas is the problem that is posed by the fact that he or she pays tax to the U.S. Government, the country in which they work and in some cases reside. To respond to it, the U.S. tax regime proposes the Foreign Tax Credit (FTC). This credit derives to enable the U.S. taxpayers to pay a lesser amount of tax as equal to the tax amount that they have already paid to a foreign government. This is basically aimed at curbing the taxation of the same income twice.
Working abroad or having an income that is being received abroad then you should be knowledgeable of Foreign Tax Credit (FTC). It will help you save quite a good amount of your tax return in the U.S. In this article, we are going to give a detailed explanation on what a Foreign tax credit (FTC) is, who qualifies (applies) and how to claim it. Either as an expatriate or a person receiving international income, this information will assist you in making sure that you are not paying tax more than you should.
Foreign Tax Credit (FTC) is open to U.S. citizen, residents, and other U.S. incorporated entities that find themselves under the local foreign income tax. To however; qualify to the FTC, there are certain requirements attached to it. One should know the specific rules and restrictions of the credit and how it applies to your specific circumstances. This will be your guide through all these considerations so that you will be armed to make the best out of the Foreign Tax Credit (FTC).
What is Foreign Tax Credit (FTC)?
Foreign Tax Credit (FTC) is a tax credit privilege that enables the U.S. taxpayers to claim the quantity of tax paid to a foreign nation. The primary objective of the FTC is to minimize the tax burden of taxes that are imposed twice on the U.S. citizens and residents involved in the event of earning income in the other country, when they are taxed by the government of the country as well as the U.S. government.
As an example, you may pay taxes to the UK government when you are working in the UK, in that case, you would be able to claim the taxes as a credit against the U.S. taxes owed to the government. In this way you will pay less U.S. tax. The FTC is applicable to any foreign income whether in the form of wages, interest and dividends or capital gains.
Conditions of allowances of Foreign Tax Credit (FTC)
The taxpayers paying foreign taxes are not necessarily eligible to the Foreign Tax Credit (FTC). In order to obtain the credit, you need to achieve some eligibility criteria and adhere to application procedure. These are the main requirements in a nutshell:
1. U.S. Citizenship / Resident Status
The U.S., together with its citizens, resident aliens, and other foreign corporations are eligible to make use of the Foreign Tax Credit (FTC). The credit is usually inaccessible to Non-resident aliens who reside in U.S. on a tax basis.
2. Liability of Foreign Income Tax
In order to claim the FTC, you should have paid, or accrued foreign taxes on foreign income. This is because the taxes have to be legal taxes paid to the government of a foreign country or the tax that has been accrued under the laws of taxation of the foreign country. The taxes that the person pays to foreign government on other grounds are not subject to the credit, which includes property taxes or taxes on sales.
3. Foreign Income
The FTC is only applicable to the income that is taxed abroad. It is not imposed on the amount of income earned inside the United States or which will not be subject to the U.S. tax because of the peculiar needs, and one of those was the Foreign Earned Income Exclusion (FEIE).
To claim the credit, the income should in most cases be subjected to foreign income tax. In case you are employed in a country overseas yet are remunerated within the U.S., the income remains to have a foreign source, however, to qualify as a FTC, must be taxed by overseas authority.
4. No Getting Something For Nothing
Among the most significant regulations worth keeping in mind when claiming the Foreign Tax Credit (FTC) is that you cannot engage in what is termed as a double dipping. This implies that you will not have the capacity to assert the FTC on foreign taxes paid in case you already have a deduction of the taxes. Overall, in certain situations, the deduction will be available to you, in lieu of the credit, however, you will not be able to claim both.
5. Filing Requirements
In order to take the credit, the Foreign Tax Credit (FTC), then you need to file IRS Form 1116 that should be used to reporting foreign paid taxes and determine how much credit you should receive. In some cases, especially the case with simple situations, you might be able to take the FTC directly on your normal tax return (Form 1040), though Form 1116 is usually required in more complicated situations.
The Procedure of Applying the FTC (Foreign Tax Credit)
Assuming that you qualify, you will then follow it up by filing the necessary forms together with your tax. Approach to FTC application here goes:
In Step 1: Gather Documentation the documentation must be compiled.
Prior to an application to the FTC, the documentation that includes evidence of foreign taxes paid is to be gathered. This may be in the form of foreign income tax statements, payroll records and other statements it may be the foreign employer or the foreign tax authority who may give them.
Step 2: Fill in the IRS form 1116
You shall be required to report on your foreign income and any foreign taxes that you paid and information on how you satisfy the requirement set on your eligibility.
In case your source of foreign income has more than one source, you cannot report that income collectively but you must report the difference. The form will assist you in calculating the amount of total credit which you are entitled to get.
Step 3: The Form should be attached to your Tax Return
When you are done filling the 1116 form, you will have to attach it to your form 1040. The IRS will consider the documents in order to determine the amount of credit that you are entitled to and will offset your tax liability with the same. One should file within the deadline to avoid a late filing fee and penalty.
The Key To Maximising Your Foreign Tax Credit (FTC)
Although the Foreign Tax Credit (FTC) is considered to be a great tax advantage, there are some ideas to make the most out of it. The following are few tips that can help you make the best of what you have with credit:
1. Follow Your Overseas Taxes
Write down in detail all the taxes you are paying to the foreign governments such as income taxes and social security taxes. This will simplify the calculation process of the FTC and help you not to underclaim on the taxes.
2. It is possible to think about Tax Treaties
A number of countries entered into tax treaty with the U.S. which can modify the extent of the foreign tax you pay and of FTC that you can claim. Such treaties can enable you to pay less taxes that you would otherwise pay in the foreign country, or it could have other advantages which could add to your FTC.
3. Isolate Your Expatriate Statement of Income
When you have more than one source of foreign income like wages, interest, and dividends, etc. it is usually helpful to compute the FTC by type of income. This enables you to make maximum credit and not include calculation mistakes.
4. According to the Authorities 101,
the following are the limitations of the paper: With the exception of being unremarkable, there are no limitations to the paper.
The extent of the amount that can be used to credit foreign tax has a cap. In the event that, the foreign tax rate exceeds the tax rate of the U.S., then you might not be in a position to claim all your foreign taxes. Being familiar with such limits can assist in your planning.
FAQ Section:
Q1: What is foreign Tax Credit (FTC)?
A1: The (FTC) enables the U.S. persons to lessen the U.S. tax that they pay by the sum of the foreign tax which has been taxed on the foreign-sourced revenue.
Q2: Who qualifies to the Foreign Tax Credit (FTC)?
A2: To claim the FTC, you should be a U.S citizen or a resident with paid or accrued foreign taxes about the foreign income. The foreign taxes should be legitimate tax imposed by the foreign government and also the income should be taxable under foreign jurisdiction.
Q3: What is the process of applying as a Foreign Tax Credit (FTC)?
A3: You have to file the IRS Form 1116 with your regular tax so that they apply the FTC. This form assists you in computing the credit depending on the foreign taxes you have been paying and how much foreign income you have received.
Q4: Am I allowed to take both the Foreign Tax Credit (FTC) and Foreign Earned income Exclusion (FEIE)?
A4: There is no yes, you can not take both FTC and the Foreign Earned Income Exclusion (FEIE) on the same income. In the event of you excluding your foreign earned income under FEIE, you will be barred the ability to use the same income to file the FTC.
Q5: is there a cap to the amount of Credit on Foreign Tax (FTC) I can take?
A5: Yes, the FTC is usually confined to the U.S. tax which would have been payable on the foreign income. In case the foreign tax rate is in excess of the rate of the U.S, there is a possibility of you failing to take advantage of the entire amount of the foreign taxes paid.
To get in-depth ideas and practical steps concerning tax laws, go to Tax Laws in USA.
