What’s the best way for expats to claim the Foreign Tax Credit?

Congratulations! If you’re an American, you are a citizen of one of just a couple of countries around the world that expect citizens living abroad to continue filing taxes. That’s right, you can’t escape the long arms of the IRS  just by moving to another country – even if that country is halfway around the world.

However, there is an upside to your tax situation as an expat. The U.S. government doesn’t wish to overtax you or double-tax your family. It simply wants its fair share, if it is entitled to any portion of your income at all.

The Foreign Tax Credit is a provision the federal government offers to reduce your tax burden. It allows you to claim credits for eligible taxes that you’ve already paid to your new home country. Of course, what would a government provision be with small print though? 

You may qualify for Foreign Tax Credit if:

  • The foreign tax you’ve paid in your new country of residence was imposed on you, meaning that you had no choice but to pay it. An example of this are taxes automatically deducted from your paycheck, or other compulsory income taxes.
  • You actually paid the tax to a foreign country or U.S possession
  • The qualified foreign tax is the legal and actual foreign tax liability you paid or accrued during the year. Because of refunds by the foreign country, this may not be the amount of tax actually withheld 
  • Taxes were an income tax or its equivalent

While you may not appreciate the need for foreign income tax credits, keep in mind that they have intentionally been put in place to reduce overall liability. 

How to claim the Foreign Tax Credit

The good news is that claiming the Foreign Tax Credit is much easier than determining if you qualify in the first place. If you’re an individual, and you paid specific foreign taxes, then you have to complete Form 1116.

The form is pretty straightforward, especially if an income tax was the only tax you paid to another country. What Form 1116 does is allow you to claim credits for taxes already paid. You pay these taxes and then file Form 1116 to subtract them from your U.S tax liability. Many expats end up claiming the Foreign Tax Credit, which if they pay a higher rate of foreign income tax means they won’t owe any US tax.

There are a few more Foreign Tax Credit conditions, as outlined by the Internal Revenue Service:

  • Your qualified foreign taxes for the tax year are not less than $300 for an individual or $600 for those filing jointly
  • All of your gross foreign income and the foreign taxes are reported to you on a payee statement (such as a Form 1099-DIV or 1099-INT)
  • You elect this procedure for the tax year by filing Form 1116

To further minimize your tax liability, consult a professional tax preparer who specializes in expat issues.