Foreign Tax Credit - Explained
What is a Foreign Tax Credit?
Written by Jason Gordon
Updated at June 22nd, 2023
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What is a Foreign Tax Credit?
The foreign tax credit refers to a credit that individuals who pay taxes to foreign government receive from the Internal revenue Service. This tax credit is a means of preventing individuals from paying double taxes on income, earnings or investments whose taxes have been collected by a foreign government. The tax credit can be either refundable or non-refundable. A foreign credit tax credit is however non-refundable, this can be enjoyed by individuals who work in foreign countries or have business facilities, assets, and investments in foreign countries.
How Does a Foreign Tax Credit Work?
The foreign tax credit applies to income, earnings, assets, and investments that been subjected to taxation by governments of other countries or taxed in a different jurisdiction. For instance, if an individual paid taxes on a certain income or investment in a foreign country, he is qualified for a tax credit or deduction for the taxes paid. Qualified taxpayers reduce their tax liability through the foreign tax credit system. A tax credit is either refundable or non-refundable, when refundable, there will be a refund if the individuals tax credit exceeds the individuals tax bill. A non-refundable foreign tax credit, on the other hand, features no refund because the taxed owed by a taxpayer is reduced to zero. A foreign tax credit falls unto the category of a non-refindable tax credit. There are certain requirements that individual taxpayers must meet before they enjoy the foreign tax credit. Although all taxpayers who pay their income tax or other taxes to a foreign government are entitled to a foreign tax credit, there are certain credits that are not allowable by the United States government. For instance, if a taxpayer did not pay the actual tax that was imposed by a foreign government or accrue the tax, the foreign tax credit is not applicable. In the United States, qualified taxpayers can claim the foreign tax credit using Form 1116 which they will file to the IRS. Taxpayers that want to claim a tax credit for the full amount of foreign taxes paid can also do so using Form 1040.