While there may be opposing viewpoints with regard to the extent Americans should be taxed, it’s probably fair to say that individual taxpayers prefer to be taxed only once, if at all. That being said, what happens when income is taxed by a country outside of the U.S.? As a U.S. citizen or resident, is that income taxable again on a U.S. income tax return? The short answer is yes. But… don’t forget about the foreign tax credit.
The Internal Revenue Code generally calls for taxation of a taxpayer’s worldwide income, not just income earned or sourced in the U.S. However, the foreign tax credit is available against a taxpayer’s U.S. tax liability for qualifying foreign taxes paid. In lieu of a credit, a taxpayer could opt instead to take a deduction for foreign taxes paid. In certain circumstances this is advisable, but oftentimes this is not advantageous as the credit avails a more favorable dollar for dollar reduction of tax.
The ability to claim a credit on foreign taxes is designed to eliminate double taxation. To the extent a U.S. taxpayer earns income outside of the U.S. that is taxed by another foreign country, the taxpayer should work with their tax advisor to confirm that ability to claim a foreign tax credit. To the extent foreign taxes are paid or accrued but not able to offset the current year tax liability due to limitation, the taxes available for credit may be carried back one year or forward up to 10 years.
The calculation and limitations of the foreign tax credit have evolved since the credit first became available in the Revenue Act of 1918. The calculations can be somewhat complex, especially if a taxpayer has income taxed in the U.S. at reduced rates (such as capital gains). Since the foreign tax credit’s enactment almost 100 years ago, taxpayers have seen other new informational reporting requirements become mandatory with regard to foreign assets. In an ever-changing global tax landscape, the IRS and Department of Treasury have increased compliance requirements, such as for foreign financial assets (Form 8938) and foreign bank account reports (Form FinCEN 114). If you have questions about the foreign tax credit’s implications to you or any other foreign income reporting questions, GBQ is here to help.
Article written by:
Mary McVicar, CPA
Tax Senior Manager