When you hear the phrase “Foreign Tax Credit,” what goes through your head? Are you curious about what it offers your family, anxious over absolutely any phrase that contains the word “tax” or confused over how this tax credit will impact your personal finances and your overall U.S. tax liability?
Actually, you should be feeling none of these emotions. Instead, if you are an American permanently living overseas, you should be excited by the prospect of reducing your overall tax liability to the United States. The Foreign Tax Credit is just one way the Internal Revenue Service (IRS) recognizes that you are required to pay taxes in your new country of residence and it balances your tax responsibilities out by reducing your tax liabilities to Uncle Sam. Let’s explore the issue of the Foreign Tax Credit further:
A: All U.S. citizens, whether they live in the states or on a deserted island overseas, are required to complete annual tax forms to report their worldwide income. The [Foreign Tax Credit] recognizes that you have already had legally required foreign taxes taken from your paycheck (or paid at the end of the year), so it gives you U.S. tax credits for doing so. This, in turn, reduces your tax liability to the United States. In fact, the vast majority of those living outside the country will not owe any taxes thanks to the Foreign Tax Credit, because foreign tax rates are often higher than U.S. rates.
A: Not all taxes qualify under the Foreign Tax Credit. According to the IRS, the tax must meet these four qualifications:
A: To claim the [Foreign Tax Credit], individuals, estates or trusts complete and return Form 1116 on your federal tax return. Remember, in order to claim the [Foreign Tax Credit], you must have paid or accrued specific foreign taxes to a foreign country or U.S. possession. Corporations can also qualify for the [Foreign Tax Credit]. In order to do so, company leaders need to file Form 1118.
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