No matter where you earn your money, the U.S. still has the right to tax your income, even if it was from abroad (think about your investments or businesses overseas). What’s worse, you might be taxed twice – in the country where you earned the money and in the US.
Don’t worry, the IRS can help you to pay less taxes, so you can use your hard earned money elsewhere. US taxpayers can exclude up to $99,200 of foreign sourced income for the 2014 tax year and $100,800 for the 2015 tax year (please check with a tax professional to find out exemptions for the year you are filing for).
You also have an option to take a credit on US expat tax returns on any foreign taxes imposed, but not on the same income. Taking advantage of all of these can help save you up to thousands of dollars.
What Are Some of the Limitations?
First, let’s define what foreign income taxes are. Briefly put, any tax you pay to a foreign country is considered foreign income taxes. You only qualify for the income tax credit if you are taxed on your foreign earned income.
As well, if you have any foreign taxes you paid that was excluded from US income, you cannot qualify for the credit. You can however, apply the foreign tax credit if your foreign earned income was only partially excluded.
Related Article: 10 Tax Changes You Should Be Aware of in 2015
If you have a corporation, you can claim this credit if you have branches outside of the US or you have invested in affiliates that have incorporated abroad. If you own a foreign branch, your company is still subject to US taxes. You can receive a credit once the branch remits its income to a US branch.
Remember, any foreign tax credit claimed on your expat tax return cannot be larger than the amount of US expatriate taxes paid on your foreign income. A general formula you can use is to divide your total taxable income before exemptions from your foreign source taxable income, then multiply it from the total US taxes.
All income earned in a foreign country counts as foreign source taxable income. This includes rental income from foreign properties, interest from foreign banks, and dividends from foreign corporations. If you earned income from the US and abroad, then your income filed should be based on days you worked in the US and in the foreign country you were in.
How Can I Apply for the Credit?
You will need to claim any Foreign Tax credit using Form 1116 on your expat tax return, which you can attach to Form 1040. Keep in mind that you cannot file a credit for any income where the Foreign Earned Income Exclusion has been claimed. And again, it cannot be more than the US tax liability on foreign earned income.
To see if you are qualified to use the Foreign Tax Credit, you need to make sure that:
- They must be individual taxes (corporations are different. Please consult with a tax professional).
- Taxes must be assessed on your income.
- Taxes must have legally originated from a foreign country.
- There must be a tax liability that you either paid or incurred.
Please ensure that you report all foreign taxes paid in US dollars. The IRS prefers that each transaction gets converted at the exchange rate for the date the transaction occurs. Average foreign exchange rates are also accepted. For more accurate information, either consult a professional or the official IRS website.
Is There Anything I Can’t Claim?
In a nutshell, yes. There are certain taxes that you cannot apply the Foreign Tax Credit on your taxes. Countries that the Secretary of State designates as supporting international terrorism cannot be included, such as Cuba, Iran, and North Korea. As well, you can’t claim shipping and aircraft income.
You also cannot exclude foreign trade income from foreign corporations, foreign oil and gas extraction income or dividends.
You, can however, still claim these on a Schedule A as an itemized deduction instead of a Foreign Tax Credit.
If you are filing taxes on foreign income earned, remember that the rules that govern US expat taxes tend to be complex. You will need to consult with a tax professional with experience in foreign taxes to do a proper analysis and help you make a decision based on your individual situation. You will also need to figure out if you need to file a state return, Again, that depends on your situation, and it is best to consult with a US expat tax preparer.