What is the Foreign Tax Credit?

The Foreign Tax Credit (FTC) is a dollar-for-dollar reduction of your US tax liability for income taxes you have paid or accrued to a foreign government. It is the primary mechanism the US provides to prevent double taxation of the same income, and it is available to US citizens, resident aliens, and certain nonresident aliens.

The FTC is claimed on Form 1116, Foreign Tax Credit, and is categorized by type of income (general category, passive category, etc.). You must allocate your foreign taxes to the appropriate income category, and the credit is limited to the amount of US tax attributable to your foreign-source income in each category. This means you cannot use foreign tax credits to offset US tax on US-source income.

The FTC limitation formula is: (Foreign-source taxable income / Worldwide taxable income) x US tax liability = Maximum FTC allowed. If your foreign taxes exceed this limit in a given year, the excess can be carried back 1 year or carried forward 10 years.

Qualifying foreign taxes must be income taxes or taxes imposed in lieu of income taxes. Sales taxes, VAT, property taxes, and social security taxes generally do not qualify for the FTC (though some social taxes may qualify if they function as income taxes). The tax must be a legal and actual foreign tax liability — voluntary payments do not qualify.

The FTC is often more beneficial than the FEIE for expats in high-tax countries because it provides a direct credit against US tax rather than merely excluding income. For example, if you live in a country with a 40% tax rate and your US rate would be 25%, the FTC eliminates your US tax on that income and you can carry forward the excess credits.

One significant advantage of the FTC over the FEIE is that it can apply to all types of income, including investment income, rental income, and capital gains — not just earned income. This makes it particularly valuable for expats with diverse income sources.