United States Expatriate Taxes – Form 1116 (Foreign Tax Credit)

Most foreign countries collect taxes from foreign residents just the same as they do with national residents. The Foreign Tax Credit allows United States residents and citizens living abroad to claim any taxes paid to a foreign country on their United States expat taxes. This credit is claimed on Form 1116 and it needs to be submitted along with the usual tax return, Form 1040. The Foreign Tax Credit reduces your taxes owed to the United States at a 1:1 ratio. However, this credit cannot overlap with the Foreign Earned Income Exclusion and it cannot exceed your tax liability to the United States as sourced by foreign earned income.

Foreign Tax Credit

In order to claim the Foreign Tax Credit, you must meet these stipulations:

  1. You have a foreign tax liability that was paid or incurred
  2. The tax is assessed on income
  3. The tax is imposed on you
  4. The tax has come from a country other than the United States

If you qualify for a tax refund, those taxes are not included as foreign taxes paid. The IRS guidelines say that before you complete Form 1116, you must convert each transaction of paid taxes into US dollars. This should be done at the date of each transaction using the foreign exchange rate. A useful resource for this is oanda.com or the IRS website. If the transactions are too large or if you cannot access the exchange rate, you can submit the annual average foreign exchange rate. If you have not yet paid your taxes, you should use the exchange rate for December 31 of the taxable year.

Equation for Foreign Tax Credit

IRS rules stipulate that you cannot claim more for the Foreign Tax Credit than you paid in United States taxes for you foreign sourced income. To determine the maximum amount available for your Foreign Tax Credit, use the following equation:

Foreign Sourced Taxable Income/Total Taxable Income Before Exemptions x Total US Tax = Foreign Sourced US Tax

Earned interest, dividends from foreign businesses, and rental income from foreign properties should all be included under Foreign Sourced Taxable Income (FSTI), along with your wages. You should remove any deductions related to those incomes before you get your final FSTI amount. If you have earned income both at home and abroad, you should divide the income based on days worked in each country.

Limitations

Some taxes from foreign countries are not eligible to be claimed under the Foreign Tax Credit for your United States expatriate taxes. Taxes paid to countries that support terrorism, such as Cuba, Iraq, or North Korea are not eligible. Taxes on financial services income, dividends from foreign-owned companies, shipping or aircraft income, foreign oil extraction income, and several other types of dividends are examples that cannot be claimed under the credit. Keep in mind that these taxes can be claimed in your itemized deductions on Schedule A.

Carryovers for the Foreign Tax Credit

Citizens and residents from the United States who live in foreign countries for a long period of time can utilize carrybacks and carryforwards for tax purposes. If your United States income taxes are lesser than the Foreign Tax Credit, your remaining credit can be carried forward to apply to next year (up to 10 years) or carried back to apply to the previous year. This will either provide a refund or lessen your future tax liability. It is best to save a schedule detailing all of your Foreign Tax Credit carryovers. You can attach this to your United States expatriates.

Example of Form 1116

To explain how to complete Form 1116, we will use the example of Aaron and Sarah Expat. They recently moved from Iowa to France. Their adjusted gross income is $65,000 in the General Income category. Here are the details:

  • Paid taxes to the French government in the amount of $15,000
  • Used a $3,000 credit carryover from the previous year
  • Used a $4,000 credit carryover from two years ago
  • Had $10,500 in mortgage interest
  • Had $17,129 in itemized deductions
  • The couple will only be using the Foreign Tax Credit, not the Foreign Earned Income Exclusion

At the top of Form 1116, Aaron and Sarah will mark their income as General Income. In Part 1, they will detail the income they had from non-US sources. This is the $65,000 earned in France. They will enter in their deductions to calculate the deductions to minimize their income.

For Part 2, Aaron and Sarah will report the taxes they have paid this year. They will need the US and foreign currency amounts. They will attach a statement with the foreign currency conversion rate.

For Part 3, Aaron and Sarah will figure the tax credit. By entering in the correct figures, they see that their expat tax liability is $5,249. Because they have already paid $15,000 in taxes to the French government, they are eligible for a Foreign Tax Credit to eliminate their United States tax liability. However, they are not eligible to get more than $5,249 in credit. They can carry the remaining $9,751 on to future tax years.

For Part 4, Aaron and Sarah simply have to state what they have made in other tax credits, which is nothing because they only made general income.

Summarizing the Foreign Income Tax Credit

The Foreign Income Tax Credit is just one way to reduce your taxes so that you are not subject to double taxation. We have provided a simple explanation and example here, but your expat taxes may be more complicated. To receive help completing Form 1116, please consult a tax professional.