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What Income Does and Doesn't Qualify for US Foreign Tax Credit?

How to claim Foreign Tax Credit on Form 1116 for US expatsAccording to US law, Americans living abroad are required to file a US federal tax return reporting their worldwide income every year. This is because the US taxes all of its citizens, rather than just residents, like most other countries.

A US expat living in the UK for example will also have to file UK taxes as a UK resident too though. So that they don’t pay income tax twice (i.e. to both countries) on the same income, when they file their US taxes they can claim the Foreign Tax Credit by filing IRS Form 1116.

The Foreign Tax Credit allows Americans who pay foreign taxes abroad to claim a $1 US tax credit for every dollar equivalent of foreign income tax that they’ve paid on their income abroad.

Expats should also note that the tax treaties the US has with other countries don’t intrinsically prevent US expats from filing US taxes. Most often, they simply allow for claiming foreign tax credits.

Exactly which income can US expats claim the US Foreign Tax Credit for though?

As a rule of thumb, expats can claim the Foreign Tax Credit for any income that is sourced outside the US.

This includes earned income that is paid anywhere in the world (including in the US) while the expat is living and working abroad. It also includes passive (so not actively earned) income that is sourced abroad, such as property rental income, dividends and interest.

US expats can’t claim the Foreign Tax Credit for passive income that is sourced in the US though, and neither for earned income that was earned by services or work performed while the expat was physically in the US, even if only visiting.

To avoid double taxation on income that is either earned while the expat is in the US, or passive income such as rent, dividends or interest sourced in the US, instead the expat has to claim foreign tax credits in the foreign country where they live.

This can mean expats claiming both US foreign tax credits for part of their income, as well as tax credits in another country. This would mean filing both tax returns simultaneously.

Expats who are behind with their US tax filing because they weren’t aware of the requirement to file US taxes from overseas can catch up by utilizing an IRS amnesty program called the Streamlined Procedure.

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