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A US Expat’s Guide to Foreign Tax Credit

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The threat of double taxation – being taxed twice on income earned outside the US – isn’t a new thing. It dates back to 1918 when Congress recognised the problem and introduced the Foreign Tax Credit (FTC). 

But what started out as a relatively simple measure has become progressively more complex as growing numbers of US citizens make the decision to move their lives and business overseas. 

Here at Nomad Capitalist, we talk a lot about the long arm of the United States IRS and how, if you are a US citizen, the government will impose taxes on you regardless of where you live and where you earn your income.

Alongside coverage of that issue, in a bid to offer some hope to US expats abroad, we’ve also covered Foreign Earned Income Exclusion (FEIE) as a means of reducing your tax bill.

While FEIE allows qualifying individuals to exclude a certain amount of their foreign income, another option expats may qualify for to alleviate the pressure of the US’s citizenship-based tax system is the aforementioned, Foreign Tax Credit. 

Basically, this means you get a dollar-for-dollar tax credit on your US taxes for taxes paid or accrued to a foreign government. So, if you pay taxes in a foreign country and qualify for FTC, you get a tax credit. With this tax incentive, you subtract the amount of credit accrued from the total owed to the Internal Revenue Service (IRS). An FTC, then, is a credit granted in recognition of taxes already paid. 

How the Foreign Tax Credit Works 

So, let’s say you’re a US citizen living in London and paying taxes to His Majesty’s Revenue & Customs (HMRC). Every dollar you pay would qualify for our Foreign Tax Credit, lowering the amount owed in the US. However, because you would pay more taxes in the UK than in the US, you can build up tax credits that can be carried forward for up to 10 years.

Using the FTC, US taxpayers can subtract a portion of the foreign taxes paid from their US tax bill. If they don’t use the full amount available, the unused portion can be carried forward or back. FTC can be carried over and applied to the previous year or up to ten years after it was first claimed.

The US has tax treaty agreements with around 70 countries to avoid double taxation. For higher earners, claiming Foreign Tax Credit under a tax treaty, such as between the US and the United Kingdom (UK), is a more efficient way to mitigate double taxation than FEIE.

In our example, the tax treaty means dual residents will not pay taxes in excess of the highest rate between the US and the UK. Where UK top tax rates exceed those in the US, liabilities are frequently reduced to nil in the US.

If you tried to use the FEIE to reduce how much you owe to the US government, you would still owe taxes for anything above the excludable $120,000 in 2023 and $126,500 in 2024, plus whatever you owe to the UK tax man. 

However, under tax treaty and Foreign Tax Credit rules, many countries worldwide allow you to pay nothing to the US – but only because you are paying the equivalent or higher amount where you are a tax resident.

Because it is based on the income you receive, the credit can only be claimed on taxes you officially pay to a government. In general, foreign taxes on wages, dividends, royalties, and interest qualify for the tax credit. The tax must be an income tax so property taxes won’t qualify. 

You cannot claim a tax credit for income excluded under FEIE and, similarly, if you’ve used FEIE, you can’t also use the Foreign Tax Credit on that same income. However, if you’re a high earner and have an excess of income above the FEIE exclusion, you can then use the Foreign Tax Credit on the amount over the FEIE limit that’s already been excluded.

Most people who use this option, live in countries with higher taxes, so Western European countries tend to prefer FTC over the Foreign Earned Income Exclusion.

The FEIE helps people who wouldn’t otherwise have a tax treaty or tax credit because they have chosen to either travel non-stop without a tax residence or live in low- or zero-tax jurisdictions that do not have a tax agreement with the US.

That’s why the FTC works better for those choosing to live in higher-tax countries, like Germany, France, Switzerland and the UK, where tax treaties and credits do much more to help reduce their tax bills than the Foreign Earned Income Exclusion.

Crucially, a US tax return must be filed to claim such treatment. 

Claiming Foreign Tax Credit 

To avoid double taxation, it’s essential to complete Form 1116 to report foreign earned income. US taxpayers use it to calculate and claim the tax credit. 

Form 1116 is used for foreign-sourced income that is subject to both U.S. and foreign income taxes to determine the credit allowed against U.S. federal income tax liability. It also helps calculate the credit of each country’s tax liability for those who have paid foreign taxes to multiple countries.

It’s crucial to follow the instructions provided by the IRS carefully because Form 1116 is complex, and mistakes can be costly, perhaps even triggering an audit. The first task is to establish the name of the foreign country or US possession, such as Puerto Rico, where you reside. Then, you are asked to report your gross income. 

The next steps involve:

  • Defining income categories such as general and passive
  • Calculating FTC for each income category separately by determining the tax paid or accrued
  • Calculate the Foreign Tax Credit carryover
  • Combining FTC amounts to arrive at the total credit for the tax year.

Form 1116 must be completed accurately and contain all relevant information before being attached to your Form 1040 federal income tax return.

Foreign Tax Credit for Companies

FTC also applies to taxes on foreign corporations controlled by US persons. Controlled Foreign Corporations (CFCs) are entities directly or indirectly controlled by a US-based parent company but organised under foreign law.

A company is considered to have control of a subsidiary where it directly or indirectly controls more than 50% of the foreign corporation’s share capital, voting rights, or distributed dividends. 

US corporations that satisfy these control and ownership requirements can take an indirect Foreign Tax Credit for taxes paid on profits paid as dividends. If you’re a US expat with a foreign business holding, you’re required to file information returns to the IRS. Those that fail to do so do not qualify for the tax credit.

Corporations must file Form 1118 to claim a Foreign Tax Credit. However, the picture for companies has become more complex with the introduction of Global Intangible Low-Taxed Income (GILTI). 

GILTI and Foreign Tax Credit

The creation of GILTI by the 2017 Tax Cuts and Jobs Act (TCJA) effectively imposes a minimum tax on the worldwide earnings of corporations. It expanded the remit under which US income tax may be imposed on controlled foreign corporations. Read our article: What is GILTI Tax and How Can You Reduce It? – to learn more. 

Before its introduction, it was possible for a US company to defer the tax on the active business earnings of a foreign corporation if those earnings were not repatriated to the US. Only certain foreign earnings, royalties, dividends, and interest income of US companies would be taxed annually. 

In other words, as a US citizen living overseas and running an offshore company, you can keep active business earnings out of the US tax net. 

Under the GILTI rules, aimed at inducing companies to return to the US, the government exempted active business earnings even when repatriated. Still, it introduced a 10.5% minimum tax on all global income from intangible assets not already taxed in the source country. 

Since intellectual property (IP) is one of the easiest assets to shift offshore, the proposal was aimed at dissuading US companies from moving IP transfer pricing to entities in zero- and low-tax jurisdictions.  

These entities must now pay annual taxes on any income the CFC earns on intangible assets. Intangible assets, including patents, trademarks and copyrights held by US persons are now more expensive to move offshore.

Today, the GILTI tax rate ranges between 10.5% and 13.125% and is scheduled to increase in 2026 to a higher limit of around 16.5%.

Individuals who qualify for the GILTI tax rate and deemed to control foreign corporations must pay the tax if they own at least 10% of the foreign corporation’s vote or value. Any foreign corporation with over 50% ownership by a US shareholder is also liable for GILTI tax.

It’s important to draw a distinction between GILTI Foreign Tax Credit and Foreign Tax Credit on other foreign-source income. In certain circumstances, a Foreign Tax Credit of 80% of the GILTI income is allowed but is not allowed to be carried over.

In most cases, even after Foreign Tax Credit is applied, a foreign company deemed controlled by a US person will incur a GILTI tax. For more information about taxes abroad for both US citizens, consult IRS Publication 54

Planning to Save on Your Taxes?

If the above is beginning to tax your ability to focus on and retain crucial information, you’re not alone. This is complicated, dificult-to-negotiate tax law territory – even for the most nimble of financial minds.

It takes planning to ensure you have the ideal mix of location, lifestyle, tax planning and asset protection strategies working in combination to achieve your personal and business goals. After all, your personal and business tax situations are inherently linked and must be viewed holistically rather than in splendid isolation of each other.

You will need to incorporate the best solutions among all available options. It’s what we call ‘going where you are treated best’ and it looks different for each of the 1500+ high-net-worth people we’ve helped. Whether it’s renouncing your US citizenship or developing a bespoke tax-efficient overseas plan, we are here to help. 

Our global team of over 60 professionals and country-specific advisors leaves no stone unturned in helping you win personal and financial freedom. We help seven- and eight-figure entrepreneurs and investors create a bespoke strategy using our uniquely successful methods. We’ll help you keep more money, create new wealth faster, and be protected from whatever happens in just three steps. So, if you’re a US citizen reviewing your options, take the first step here

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