| Congress passed legislation authorizing foreign tax credits to relieve a taxpayer of the double tax burden of paying tax on foreign source income to both the United States and a foreign country. Generally, if the foreign tax rate is higher than the U.S. rate, there will be no U.S. tax due on the foreign income. If the foreign tax rate is lower than the U.S. rate, U.S. tax on the foreign income will be limited to the difference between the rates. The foreign tax credit can only reduce U.S. taxes on foreign source income; it cannot reduce U.S. taxes on U.S. source income.
U.S. citizens, resident aliens, and nonresident aliens who paid foreign income tax and are subject to U.S. tax on foreign source income may be able to take a foreign tax credit.
In order for a foreign tax to qualify for the credit, the tax must be imposed on the taxpayer who either paid or accrued the tax. The tax has to be a legal and actual foreign tax liability, and it must be an income tax or a tax in lieu of an income tax. Not all foreign taxes qualify for a foreign tax credit. Among those taxes that do not qualify are taxes on excluded income, taxes for which the taxpayer can only take an itemized deduction, taxes on foreign oil related income, taxes on foreign mineral income, taxes from international boycott operations, taxes of U.S. persons controlling foreign corporations or partnerships, and taxes on foreign oil and gas extraction income. No credit is allowed for taxes imposed by a country designated by the United States government as engaging in terrorist activities.
If a taxpayer pays foreign taxes to a foreign country on foreign source income and is subject to U.S. tax on the same income, the taxpayer may be entitled to take either a credit or an itemized deduction for those taxes. As a deduction, foreign income taxes reduce the taxpayer's U.S. taxable income. Taken as a credit, foreign income taxes reduce U.S. tax liability. However, in most cases, it is more advantageous to take foreign income taxes as a tax credit because a credit reduces a taxpayer's actual U.S. income tax on a dollar-for-dollar basis, while a deduction reduces only your income subject to tax. A taxpayer may take the foreign tax credit even if he does not itemize deductions. In that situation, the taxpayer is allowed the standard deduction in addition to the credit.
When a taxpayer decides to take the foreign tax credit, and the taxes paid or accrued exceed the credit limit for the tax year, the taxpayer may be able to carry over or carry back the excess to another tax year. Copyright 2010 LexisNexis, a division of Reed Elsevier Inc. |