Can I use a portion of foreign taxes paid as a deduction and the other portion as a credit?

Taxpayers can choose to deduct foreign taxes paid on Schedule A or claim a credit on Form 1116. The taxpayer must choose either the itemized deduction or credit for any given year. While every taxpayer’s situation is different, it is generally preferred to claim a credit for foreign income taxes paid.

I’ve chosen to take a credit for foreign taxes accrued on Form 1116 in the past. Can I instead take a credit for taxes paid in the current year?

If you’re a cash basis taxpayer, you can only take the foreign tax credit in the year you pay the qualified foreign tax unless you elect to claim the foreign tax credit in the year the taxes are accrued. Once you make this election, you can’t switch back to claiming the taxes in the year paid in later years.

Can I take a credit for taxes paid on foreign income excluded under the Foreign Earned Income Exclusion?

You may not take either a credit or a deduction for taxes paid or accrued on income you exclude under the foreign earned income exclusion or the foreign housing exclusion. The excluded income is not subject to double-taxation and not available for a credit as a result.

Can I carryback or carryover any unused Foreign Tax Credit?

If you can’t claim a credit for the full amount of qualified foreign income taxes you paid or accrued in that particular year, you’re allowed a carryback and/or carryover of the unused foreign income tax. You can carry back the unused foreign tax for one year and then carry it forward for 10 years.

What foreign taxes do not qualify for the Foreign Tax Credit?

The following foreign taxes do not qualify:

1.      Taxes eligible for a refund (even if not claimed)

2.      Taxes used to provide a subsidy to you or someone related to you

3.      Taxes not required by law, because you could have avoided paying the taxes to the foreign country

4.      Taxes that are paid or accrued to a country if the income giving rise to the tax is for a period (the sanction period) during which:

  • a.       The Secretary of State has designated the country as one that repeatedly provides support for acts of international terrorism
  • b.      The United States has severed or doesn’t conduct diplomatic relations with the country
  • c.       The United States doesn’t recognize the country’s government, unless that government is eligible to purchase defense articles or services under the Arms Export Control Act

5.      Withheld foreign taxes on dividends for foreign stocks that don’t meet required minimum holding periods

6.      Withheld foreign taxes on gains and income from other foreign properties that don’t meet required minimum holding periods

What is the foreign tax credit, and do I qualify?

The Foreign Tax Credit is a credit for income taxes paid to a foreign country, and it is designed to help minimize the burden of double-taxation.

In order to qualify for the foreign tax credit, taxpayers must meet all four of the following requirements:

  • The tax must be imposed on you by a foreign country.
  • You must have paid or accrued the tax.
  • The tax must be the legal and actual foreign tax liability.
  • The tax must be an income tax.

Keep in mind that the foreign tax credit only applies to taxes imposed on foreign income. You can’t claim a credit for taxes you may have paid on U.S.-sourced income.  You can’t claim the credit for any taxes you paid that could be refunded or forgiven, either.